<PAGE>
 
     AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 29, 1998
 
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                      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
 
  [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT OF
      1934
 
                 FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1997
 
                                      OR
 
  [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      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                         THE NETHERLANDS
     (TRANSLATION OF REGISTRANT'S          (JURISDICTION OF INCORPORATION
          NAME INTO ENGLISH)                      OR ORGANIZATION)
 
                     TECHNOPARC DU PAYS DE GEX - B.P. 112
                            165, RUE EDOUARD BRANLY
                           01637 SAINT GENIS POUILLY
                                    FRANCE
                   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
  Securities registered or to be registered pursuant to Section 12(b) of the
Act:
 
<TABLE>
<CAPTION>
                                                    NAME OF EACH EXCHANGE
               TITLE OF EACH CLASS:                 ON WHICH REGISTERED:
               --------------------                -----------------------
 <S>                                               <C>
 COMMON SHARES, NOMINAL VALUE NLG 13.75 PER SHARE  NEW YORK STOCK EXCHANGE
 LIQUID YIELD OPTION(TM) NOTES DUE JUNE 10, 2008   NEW YORK STOCK EXCHANGE
</TABLE>
 
                               ----------------
 
  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 issuer's classes of
capital or common stock as of the close of the period covered by the annual
report:
 
     COMMON SHARES, NOMINAL VALUE NLG 13.75 PER COMMON SHARE: 139,132,397
 
  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 [X]   No [_]
 
  Indicate by check mark which financial statement item the registrant has
elected to follow:
 
                           Item 17 [_]   Item 18 [X]
 
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<PAGE>
 
                               TABLE OF CONTENTS
 
                                     PART I
 
<TABLE>
 <C>      <S>                                                          <C>  
 Cautionary Statement Regarding Forward-Looking Statements...........     2
 Item 1.  Description of Business...................................      3
 Item 2.  Description of Property...................................     31
 Item 3.  Legal Proceedings.........................................     35
 Item 4.  Control of Registrant.....................................     35
 Item 5.  Nature of Trading Market..................................     39
          Exchange Controls and Other Limitations Affecting Security
 Item 6.  Holders...................................................     41
 Item 7.  Taxation..................................................     41
 Item 8.  Selected Consolidated Financial Data......................     45
                   Management's Discussion and Analysis of Financial
 Item 9.  Condition and Results of Operations.......................     47
               Quantitative and Qualitative Disclosures About Market
 Item 9A. Risk......................................................     58
 Item 10. Directors and Officers of Registrant......................     61
 Item 11. Compensation of Directors and Officers....................     68
                   Options to Purchase Securities from Registrant or
 Item 12. Subsidiaries..............................................     68
 Item 13. Interest of Management in Certain Transactions............     69
 
                                    PART II
 
 Item 14. Description of Securities to be Registered *..............     71
 
                                    PART III
 
 Item 15. Defaults Upon Senior Securities *.........................     71
                   Changes in Securities and Changes in Security for
 Item 16. Registered Securities *...................................     71
 
                                    PART IV
 
 Item 17. Financial Statements*.....................................     71
 Item 18. Financial Statements......................................     71
 Item 19. Financial Statements and Exhibits.........................     71
 Certain Terms.......................................................  II-2
</TABLE>
 
--------
*  Omitted because item is not applicable.
<PAGE>
 
           CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
 
  Certain of the statements contained in this annual report that are not
historical facts, including without limitation, certain statements made in the
sections hereof entitled "Item 1: Description of Business" and "Item 9:
Management's Discussion and Analysis of Financial Condition and Results of
Operations," are statements of future expectations and other forward-looking
statements (within the meaning of Section 27A of the Securities Act of 1933,
as amended) that are 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 due to, among other factors, (i) the semiconductor industry
downturn, (ii) competition, (iii) increased industry capacity, (iv)
variability of operating results, (v) capital requirements, (vi) new product
developments and technological change, (vii) manufacturing risks, (viii) the
loss of key personnel, (ix) economic downturn in Asia, (x) possible
acquisitions, (xi) control of the Company and potential conflicts of interest,
(xii) key customers and strategic relationships, (xiii) intellectual property
issues, (xiv) certain legal proceedings, (xv) the uncertainties of state
support for research and development and other funding, (xvi) international
operations, (xvii) currency fluctuations, (xviii) dependence on certain
sources of supply, (xix) environmental regulation and (xx) year 2000
compliance. See "Risk Factors" included in the Company's Prospectuses dated
June 5, 1998.
 
                                       2
<PAGE>
 
                                    PART I
 
                        ITEM 1: DESCRIPTION OF BUSINESS
 
THE COMPANY
 
   STMicroelectronics N.V. (the "Company") is a global independent limited
liability semiconductor company that designs, develops, manufactures and
markets a broad range of semiconductor integrated circuits and discrete
devices used in a wide variety of microelectronic applications, including
computer systems, telecommunications systems, consumer products, industrial
automation and control systems and automotive products. According to published
industry data, in 1997 STMicroelectronics maintained its position as one of
the top 10 worldwide suppliers of semiconductor devices. On the basis of 1997
revenues, STMicroelectronics was the world's leading supplier of MPEG 2
decoder ICs, smartcard ICs, special automotive ICs and EPROM memories and the
second leading supplier of analog monolithic and mixed-signal ICs, disk drive
ICs and EEPROM memories. The Company currently offers more than 3,000 main
types of products to approximately 700 direct customers. Major customers
include Alcatel, Bosch, Bull, Chrysler, Ericsson, Ford, Gemplus, Hewlett-
Packard, IBM, Matsushita, Motorola, Nokia, Nortel, Philips, Samsung,
Schlumberger, Seagate Technology, Siemens, Sony, Thomson Multimedia and
Western Digital. The Company also sells its products through distributors.
 
   The Company offers a diversified product portfolio and develops products
for a wide range of market applications to reduce its dependence on any single
product, industry or application market. The Company has focused on developing
products that exploit its technological strengths in creating customized,
system-level solutions with substantial analog and mixed signal content.
Products include differentiated ICs (which the Company defines as being its
dedicated products, semicustom devices and microcontrollers) and analog ICs
(including mixed-signal ICs), the majority of which are also differentiated
ICs. As a leading provider of differentiated ICs, the Company has developed
close relationships with customers, resulting in early knowledge of customers'
evolving requirements. These relationships have enabled the Company to
identify opportunities to increase the functionality of products and to create
solutions that meet customers' needs. The customized nature of differentiated
ICs makes them less vulnerable to competitive pressures than standard
commodity products. Differentiated ICs accounted for approximately 57% of the
Company's net revenues in 1997, compared to approximately 59% in 1996. Analog
ICs accounted for approximately 49% of net revenues in 1997, compared to
approximately 46% in 1996, while discrete devices accounted for approximately
14% of the Company's net revenues in both 1997 and 1996. In recent years,
these families of products, in particular analog ICs, have experienced less
volatility in sales growth rates and average selling prices than the overall
semiconductor industry.
 
   STMicroelectronics' products are manufactured and designed using a broad
range of manufacturing processes and proprietary design methods.
STMicroelectronics uses all of the prevalent function-oriented process
technologies, including CMOS, bipolar and nonvolatile memory technologies. In
addition, by combining basic processes, the Company has developed advanced
systems-oriented technologies that enable it to produce differentiated and
application-specific products, including BiCMOS technologies (bipolar and
CMOS) for mixed-signal applications, BCD technologies (bipolar, CMOS and DMOS)
for intelligent power applications and embedded memory technologies. This
broad technology portfolio, a cornerstone of the Company's strategy for many
years, enables the Company to meet the increasing demand for "system-on-a-
chip" solutions. To complement this depth and diversity of process and design
technology, the Company also possesses a broad intellectual property portfolio
that it has used to enter into cross-licensing agreements with many major
semiconductor manufacturers.
 
   In September 1997, STMicroelectronics was awarded the 1997 European Quality
Award for Business Excellence in the category of large businesses by the
European Foundation for Quality Management (the "EFQM"). In presenting
STMicroelectronics with the award, the EFQM committee cited the Company's
commitment to the principles of Total Quality Management ("TQM") in its
business practices. TQM defines a
 
                                       3
<PAGE>
 
common set of objectives and performance measurements for employees in all
geographic regions, at every stage of product design development and
production for all product lines. See "Item 2: Description of Property--
Manufacturing."
 
   In 1997, the Company introduced several new products and plans to further
develop and produce superintegrated, system-level silicon solutions for a set
of targeted applications such as computer peripherals (including hard disk
drives, inkjet printers and monitors), digital consumer devices (including
set-top boxes, DVDs and digital television), wireless telecommunications
products (digital cellular handsets, digital cordless and pagers), digital
networks (ADSL, with xDSL and ATM currently under development) and automotive
electronics (including injection control, safety, and car multimedia
navigation).
 
   In November 1997, the Company and Daewoo Electronics announced an agreement
to establish a joint design center company in Seoul, Korea. The center will be
used to develop ICs for existing consumer electronics applications and future
products for digital and high definition television, digital VCR and DVD,
telecommunications, computing and other products jointly selected by the two
companies. The Company also confirmed that it entered into a partnership with
British Sky Broadcasting ("B Sky B") to develop a complete hardware and
software reference platform for digital set-top boxes to support B Sky B's
launch of digital satellite television service in the spring of 1998. As a
result of this agreement, STMicroelectronics will be supplying the set-top box
manufacturers selected by B Sky B with chips for all the major functions of
the box as well as memory components.
 
   In addition to the many dedicated and semicustom ICs developed using power
analog, digital and mixed signal technologies, the Company has focused its
research and manufacturing efforts on developing an advanced range of the key
technological building blocks required by the targeted applications. These
building blocks include (i) MPEG 2 ICs, (ii) a family of 16 bit (ST10) and 32
bit (ST20) microcontrollers, (iii) a family of DSP cores for embedded
applications based on the current D950 solution and the D960 (currently under
development), (iv) microprocessor architecture (x86 equivalent) aimed at
integrated applications and (v) the ability to integrate nonvolatile memory
(particularly EEPROM and flash) functionality.
 
   Applying its broad range of technologies and its expertise in diverse
application domains, the Company is currently embedding dedicated and
semicustom circuits and applying these advanced building blocks on the same
chip. Superintegrated products developed to date include the STi5500 Omega
chip (a platform for digital consumer applications such as set-top boxes and
DVDs), the ST PC Consumer (a one-chip computer for motherboards of low-end
personal computers and network computers), the V187 (a superintegrated chip-
set for hard disk drives) and the M39432 (a one-chip nonvolatile memory
integrating both an EEPROM and a flash memory). The Company is also developing
superintegrated chips for wireless telecommunications and automotive
applications.
 
   The Company's products are organized into four principal product groups:
Dedicated Products, Discrete and Standard ICs, Memory Products and
Programmable Products. As part of its activities outside the four principal
product groups, the Company also has a New Ventures Group and produces
subsystems for industrial and other applications.
 
      The DEDICATED PRODUCTS GROUP produces application-specific
   semiconductor products using advanced bipolar, CMOS, BiCMOS, mixed-signal
   and power technologies. The Group's dedicated products are used in all
   major end-user applications, including such new applications as mobile
   communications networks, asynchronous transfer mode communications
   systems, global positioning systems, flat panel displays, hard disk
   drives and digital video systems. The breadth of the Group's customer and
   application base provides it with a source of stability in the cyclical
   semiconductor market, while its position as a strategic supplier of
   application-specific products provides it with opportunities to supply
   its customers' requirements for other products, including discrete
   devices, programmable products and memories.
 
      The DISCRETE AND STANDARD ICS GROUP produces discrete power devices,
   power transistors, standard linear and logic ICs and radio frequency
   ("RF") products. The Group's discrete and standard
 
                                       4
<PAGE>
 
   products are manufactured using mature technological processes that are
   less capital intensive than the Company's other principal products. The
   Group has a diverse customer base and broad product portfolio.
 
      The MEMORY PRODUCTS GROUP produces a broad range of memory products,
   including EPROMs, chips for smartcards, EEPROMs, flash memories and
   specialty nonvolatile SRAMs. According to published industry data, the
   Company was the leading supplier of EPROMs in 1997, accounting for
   approximately 32% of worldwide EPROM sales, as well as the leading
   supplier of smartcard chips and the second leading supplier of EEPROMs.
   The Company has developed proprietary know-how for flash memory devices
   and has started mass production for this market. The Group does not
   produce DRAMs, a commodity memory product.
 
     The Company's sales of smartcard chips in 1997 totaled approximately
   $222 million (approximately a 30% increase on 1996 smartcard sales) of
   the approximately $515 million worldwide market (according to Company
   estimates), reinforcing the Company's leading market position with
   approximately a 43% market share.
 
      In February 1998, the Company and Mitsubishi announced that they will
   jointly develop a new generation of flash memory products, starting with
   multi-level 64Mbit, which will provide the advantages of both DINOR and
   NOR architectures as well as associated processes from 0.20 through 0.18
   micron.
 
      The PROGRAMMABLE PRODUCTS GROUP produces microcomponents (including
   microcontrollers and digital signal processors), digital semicustom
   devices, graphic controllers and MPEG decoder ICs and image processing
   semicustom devices for many diverse products targeted at high growth
   digital applications, including information technology, automotive and
   multimedia.
 
      In December 1997, STMicroelectronics and Hitachi, Ltd ("Hitachi")
   announced an agreement to collaborate on the development of next-
   generation SuperH microprocessors for consumer electronics and multimedia
   applications. Under the agreement, the two companies will develop the new
   64-bit SH-5/ST50 series based on Hitachi's original SuperH architecture
   and STMicroelectronics' know-how in 64-bit microprocessors, for
   interactive set-top boxes, digital video products, car multimedia systems
   and other consumer-orientated products.
 
      The NEW VENTURES GROUP identifies and develops new business
   opportunities to complement the Company's existing businesses and exploit
   its technological know-how, manufacturing capabilities and global
   marketing team. Initial activities have focused on manufacturing and
   marketing x86 microprocessors and products based on x86 embedded cores.
   New activities include design and manufacturing of "system on silicon"
   solutions based on the 486 CPU core.
 
      In 1997, STMicroelectronics introduced the ST PC Consumer chip, a low
   cost, high performance multimedia PC on a single chip with a view to
   developing new generations of ST PC products. The new device integrates a
   high performance processor that is fully compatible with standard fifth
   generation x86 devices, comprehensive support logic, a graphics subsystem
   and a video pipeline. In 1997, STMicroelectronics also acquired a
   majority interest in Metaflow Technologies Incorporated ("Metaflow"), a
   specialist developer of microprocessor architecture, which is working
   with the Company in the development of x86 products and cores. The
   Company also has licensed the high speed Rambus interface for its
   Multimedia IC product family.
 
   STMicroelectronics has substantially increased its front-end manufacturing
capacity in recent years through the addition of new 8-inch submicron
fabrication plants designed to meet the growing demand for its products. The
Company has added an 8-inch, 0.5/0.25 micron facility in Crolles, France that
is already operating at close to full capacity, and is ramping up production
at new 8-inch, 0.5/0.35 micron facilities in Phoenix, Arizona and Catania,
Italy. New 8-inch submicron fabrication plants are currently under
construction at existing plant sites in Rousset (France), Agrate (Italy) and
Singapore. An additional 8-inch submicron fabrication plant in Italy is
planned to become operational by the year 2001. The Company has decided to
build a new 300 millimeter, 12-inch wafer research fabrication and pilot line
at Crolles (France) using 0.18 micron and below process technology. The pilot
line will be operated in partnership with Leti and CNET, which are already
 
                                       5
<PAGE>
 
working with the Company in Crolles. The Company has also announced plans for
a new center for advanced research and development and industrialization in
the field of nonvolatile memories in Agrate (Italy) to target 0.13 micron CMOS
technology generation by 2003.
 
   STMicroelectronics is international in scope. The Company operates front-
end and/or back-end manufacturing facilities in Europe, the United States, the
Mediterranean and Asia Pacific regions, and conducts research and development
primarily in France and Italy and design, marketing and sales activities in
each of the electronics industry's major economic regions: Europe, the United
States, the Asia Pacific region and Japan. In 1997, approximately 43.6% of the
Company's net revenues originated in Europe (compared to 43.4% in 1996),
approximately 22.4% in the Americas (compared to 21.9% in 1996), approximately
26.5% in the Asia Pacific region (compared to 27.3% in 1996), approximately
5.3% in Japan (compared to 5.5% in 1996) and approximately 2.2% in Region Five
(compared to 1.9% in 1996). See "--Sales, Marketing and Distribution." In
1997, more than one-third of the 6-inch equivalent wafers manufactured by the
Company were manufactured outside Europe and approximately 57% of the
Company's employees were located outside Europe.
 
   STMicroelectronics believes that strategic alliances are critical to
success in the semiconductor industry, and has entered into strategic
alliances with customers, other semiconductor manufacturers and major
suppliers of design software. The Company has entered into several strategic
customer alliances, including alliances with Alcatel, Seagate Technology,
Thomson Multimedia and Western Digital, among others. Customer alliances
provide the Company with valuable systems and application know-how and access
to markets for key products, while allowing the Company's customers to share
some of the risks of product development with the Company and gain access to
the Company's process technologies and manufacturing infrastructure. Alliances
with other semiconductor manufacturers, such as the recently announced
agreement with Hitachi on SuperH microprocessors, permit costly research and
development and manufacturing resources to be shared to mutual advantage for
joint technology development. The Company has also entered into technology
development alliances with customers and other manufacturers. In 1997, the
Company extended the technology cooperation agreements with CNET (the research
laboratory of France Telecom), and with Philips Semiconductors aimed at the
joint development in Crolles, France of advanced submicron CMOS logic
manufacturing processes. Other agreements include the ongoing cooperation with
also for the development of CMOS logic, the cooperation with Nortel for the
development of 0.5/0.35 micron BiCMOS technology, and the new agreement with
Mitsubishi for CMOS flash memory processes using 0.20 through 0.18 micron. The
Company has established joint development programs with leading suppliers such
as Air Liquide, Applied Materials, ASM Lithography, Canon, Hewlett-Packard,
KLA-Tencor, LAM, MEMC, Schlumberger, Teradyne and Wacker and with CAD tool
producers including Cadence and Synopsys. It is a participant in Sematech I
300I for the development of 300 millimeter wafer manufacturing processes.
STMicroelectronics is active in joint European research efforts such as the
new MEDEA program (which succeeded JESSI in 1997), and also cooperates with
major research institutions and universities.
 
   In March 1998, STMicroelectronics with its partners Philips Semiconductors
and CNET completed the first phase of the development of HCMOS-8, the next
generation CMOS process, at Crolles, France. This process is targeted at high-
performance and low-power applications and will have a 0.15 micron effective
gate length (equivalent to 0.18 micron drawn). Prototyping in this process
will begin in the second half of 1998. At the same time, STMicroelectronics
has started production of its 0.20 micron effective gate length (0.25 micron
drawn) CMOS technology, known as HCMOS-7. This process will be used to produce
"system-on-chip" products incorporating tens of millions of transistors
combined with embedded memory for telecom, digital consumer and PC
applications.
 
RECENT DEVELOPMENTS
 
   More specific recent developments include the following:
 
      Within the DEDICATED PRODUCTS GROUP, in 1997 STMicroelectronics signed
   an agreement with Alcatel to access the technology for implementing ATM
   over Asymmetrical Digital Subscriber Line
 
                                       6
<PAGE>
 
   (ADSL) with rate adaptive capability, which increases data transmission
   over existing telephone subscriber loop networks. The Company intends to
   develop a family of highly integrated xDSL ICs as a result of this
   partnership. STMicroelectronics also has entered into a product
   development agreement with Philips Semiconductors to develop jointly and
   promote a front-end chip-set for Digital Video Broadcast-Terrestrial
   (DVB-T*), the European standard for terrestrial broadcasting of digital
   television signals. Applying third-generation bipolar-CMOS-DMOS (BCD3)
   technology, STMicroelectronics also introduced a super smart power
   doorlock (L9942) IC that combines on one chip all of the functions needed
   to control and drive a doorlock actuator motor. In the computer
   peripherals area, the Company is currently developing superintegrated
   solutions using its broad range of technologies (CMOS, BiCMOS, BCD) and
   its distinctive know-how in microcontrollers/DSP cores, dedicated IC
   megacells and embedded memory capability for hard disk drive application.
   The same methodology is applied to other computer peripherals such as
   monitors and inkjet printers.
 
      In October 1997, ST Microelectronics introduced the first of its
   Starman chip-set to equip the receivers for the first direct-to-listener
   satellite systems now being developed by WorldSpace to be launched in
   1998. WorldSpace will operate three geostationary satellites in Asia,
   Africa and Latin America. The Company will supply the Starman chip-set to
   consumer electronics equipment manufacturers selected by WorldSpace.
 
      The Company has joined forces with Logitech to market a kit for
   implementing video camera functions in desktop computer monitors. The kit
   comprises a chip-set manufactured by the Company and software driver
   designed by Logitech and will be marketed to manufacturers of computer
   monitors.
 
      Within the DISCRETE AND STANDARD ICS GROUP, in 1997 STMicroelectronics
   announced that it will support the VCX standard for logic devices with a
   new family of products, designed for high-end applications, that combine
   high speed and low power dissipation in applications operating in the 1.8
   to 3.6V range. The Company also introduced monolithic TRANSIL diode
   arrays designed to provide low cost, reliable protection against
   electrostatic overloads for computer I/O parts, modems and similar
   systems employing data outputs. Another new family of products, low
   voltage power MOSFETs known as the NE series, are being produced with a
   new technology that provides substantial advantages over conventional
   cellular power MOSFET processes. In 1997, the Company also introduced the
   VIPer 100, STMicroelectronics' new device in a family of intelligent
   power ICs for switch mode power supply applications.
 
      In the first quarter of 1998, the Company extended its offering of
   VIPower technology by introducing a Smart H Bridge Driver that can
   sustain high peak current streams for short time periods. The Company
   also introduced innovative front-end and packaging technologies that
   significantly increase MOSFET power density and a new range of products
   based on its Application Specific Discrete (ASD) technology that
   integrate two key telephone set functions into a single surface mounting
   package.
 
      Within the MEMORY PRODUCTS GROUP, in 1997 the Company acquired a
   minority interest in WaferScale Integration, a specialist in nonvolatile
   memory architectures. The Company also introduced an 8 Mbit single
   voltage flash memory that can operate down to 1.8 volts, offering
   significant advantages in portable applications. In 1997, the Company
   introduced a series of flash memory ICs combining 4 Mbit flash memory and
   a 256 Kbit parallel EEPROM memory for use in cellular phones and other
   portable equipment. In the smartcard area, STMicroelectronics introduced
   a new device (ST1GRF42) for use in high volume contactless and contact-
   based applications, and also licensed the Java Card implementation
   (called Solo(TM)) from Schlumberger for advanced security MCU smartcard
   chips.
 
      In February 1998, the Company and Mitsubishi announced that they will
   join their efforts and resources to develop a new generation of flash
   memory products, starting with multi-level 64Mbit, which will provide the
   advantages of both DINOR and NOR architectures as well as associated
   processes from 0.20 through 0.18 micron.
 
                                       7
<PAGE>
 
      Within the PROGRAMMABLE PRODUCTS GROUP, in 1997 STMicroelectronics
   introduced the STi5500 Omega chip, the first in a family of highly
   integrated devices that combine an MPEG 2 audio/video decoder with a 32-
   bit microprocessor and other functions to create a complete DVD or set-
   top box back-end on a single chip. The STi5500, designed to replace three
   existing ICs, will enter volume production in 1998.
 
      In December 1997, STMicroelectronics and Hitachi announced an
   agreement to collaborate on the development of next-generation SuperH
   microprocessors for consumer electronics and multimedia applications.
   Under the agreement, the two companies will develop the new 64-bit SH-
   5/ST50 series based on Hitachi's original SuperH architecture and
   STMicroelectronics' know-how in 64-bit microprocessors, for interactive
   set-top boxes, digital video products, car multimedia systems and other
   consumer-orientated products.
 
      In March 1998, STMicroelectronics introduced a chip-set that enables
   customers, for the first time, to make a complete Global Positioning by
   Satellite ("GPS") navigation system with only two ICs, for use in
   automotive applications.
 
      In April 1998, STMicroelectronics introduced the STi7000 chip, the
   first integrated solution for High-Definition Television (HDTV) combining
   an MPEG-2 decoder with an advanced display and format converter into one
   single chip.
 
      Certain major international PC OEMs and add-in card manufacturers have
   selected the Company's RIVA 128(TM) 3D, PCI/AGP multimedia accelerator to
   deliver visual computing on PC platforms. The RIVA 128, which was
   developed in conjunction with nVidia, combines advanced interactive 3D
   graphics acceleration and industry-leading 2D graphics acceleration with
   superior video and imaging capabilities into a single-chip mainstream
   multimedia accelerator.
 
      Within the NEW VENTURES GROUP, in 1997 STMicroelectronics introduced
   the ST PC Consumer chip, a low cost, high performance multimedia PC on a
   single chip with a view to developing new generations of ST PC products.
   The new device integrates a high performance processor that is fully
   compatible with standard fifth generation x86 devices, comprehensive
   support logic, a graphics subsystem and a video pipeline. In 1997,
   STMicroelectronics also acquired a majority interest in Metaflow, a
   specialist developer of microprocessor architecture, that is working with
   the Company in the development of x86 products and cores. The Company
   also has licensed the high speed Rambus interface for its Multimedia IC
   product family.
 
   In order to remain competitive in emerging technologies, STMicroelectronics
has entered into several strategic agreements. The Company has also entered
into technology development alliances with customers and other manufacturers.
The Company has recently extended the technology cooperation agreement with
Philips Semiconductors aimed at the joint development in Crolles, France of
advanced submicron CMOS logic manufacturing processes. Other agreements
include the ongoing cooperation with CNET (the research laboratory of France
Telecom), also for the development of CMOS logic, and the cooperation with
Nortel for the development of 0.5/0.35 micron BiCMOS technology, and the new
agreement with Mitsubishi for CMOS flash memory processes using 0.20 through
0.18 micron.
 
   In March 1998, STMicroelectronics and its partners completed the first
phase of the development of HCMOS-8, the next generation CMOS process, at
Crolles, France. This process is targeted at high-performance and low-power
applications and will have a 0.15 micron effective gate length (equivalent to
0.18 micron drawn). Prototyping in this process is scheduled to begin in the
second half of 1998. At the same time, STMicroelectronics has started
production of its 0.20 micron effective gate length (0.25 micron drawn) CMOS
technology, known as HCMOS-7. This process will be used to produce "system-on-
chip" products incorporating tens of millions of transistors combined with
embedded memory for telecom, digital consumer and PC applications.
 
 
                                       8
<PAGE>
 
INDUSTRY BACKGROUND
 
   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, automotive products, consumer
goods 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 TAM as a percentage of worldwide revenues from production of electronic
equipment according to published industry data, semiconductor pervasiveness
has increased from approximately 9% in 1991 to approximately 15% in 1997. The
demand for electronic systems has also expanded geographically with the
emergence of new markets, particularly in the Asia Pacific region.
 
   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 $17.8 billion in 1983 to $132
billion in 1996 (growing at a compound annual rate of approximately 17%,
according to trade association data), while the SAM increased from
approximately $15.0 billion in 1983 to $103 billion in 1996 (growing at a
compound annual rate of approximately 16%). In 1996, the TAM decreased by
8.6%, while in 1997 the TAM increased by 4.0%. Based on preliminary trade
association data for the first quarter of 1998, the TAM decreased in the first
quarter of 1998 by approximately 4.9% compared to the first quarter of 1997.
The SAM increased 3.5% in 1996 compared to 1995 and 9.9% in 1997 compared to
1996; however, based on preliminary trade association data for the first
quarter of 1998, the SAM decreased by approximately 2.5% in the first quarter
of 1998 compared to the first quarter of 1997. In 1997, approximately 33.4% of
all semiconductors were shipped to the Americas, 23.4% to Japan, 21.2% to
Europe, and 22% to the Asia Pacific region.
 
   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 (complementary metal-oxide-
silicon). Bipolar devices typically operate at higher speeds than CMOS
devices, but CMOS devices consume less power and permit more transistors to be
integrated on a single IC. While bipolar semiconductors were once used
extensively in large computer systems, CMOS has become the prevalent
technology, particularly for devices used in personal computer systems. In
connection with the development of new semiconductor applications and the
demands of system designers for more integrated semiconductors, advanced
technologies have been developed during the last decade that are particularly
suited to more systems-oriented semiconductor applications. For mixed-signal
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
 
                                       9
<PAGE>
 
technologies. For intelligent power applications, 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. The use of systems-
oriented technologies requires knowledge of system design and performance
characteristics (in particular, analog and mixed-signal systems and power
systems) as well as expertise and experience with several semiconductor
process technologies.
 
   Semiconductors are often classified as either discrete devices (such as
individual diodes, thyristors, transistors as well as opto-electronic
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 or
application-specific ICs ("ASICs"). Standard components are used by a large
group of systems designers for a broad range of applications, while ASICs are
designed to perform specific functions in specific applications. Generally,
there are three types of ASICs: full-custom devices, semicustom devices and
application-specific standard products ("ASSPs"). Full custom devices are
typically designed to meet the particular requirements of one specific
customer. Semicustom devices are more standardized ICs that can be customized
with efficient CAD tools within a short design cycle time to perform specific
functions. ASSPs are standardized ASICs that are designed to perform specific
functions in a specific application, but are not proprietary to a single
customer.
 
   The two basic functional technologies for semiconductor products are analog
and digital. Analog (or linear) devices monitor, condition, amplify or
transform analog signals, which are signals that vary continuously over a wide
range of values. Analog circuits are critical as an interface between
electronic systems and a variety of real world phenomena such as sound, light,
temperature, pressure, weight or speed. Electronics systems continuously
translate analog signals into digital data, and vice versa.
 
   The analog semiconductor market consists of a large and growing group of
specific markets that serve numerous and widely differing applications,
including applications for automotive systems, instrumentation, computer
peripheral equipment, industrial controls, communications devices, video
products and medical systems. Because of the varied applications for analog
circuits, manufacturers typically offer a greater variety of devices to a more
diverse group of customers. Compared to the market for commodity digital
devices such as standard memory and logic devices, the analog market is
characterized by longer product life cycles, products that are less vulnerable
to technological obsolescence, and lower capital requirements due to the use
of mature manufacturing technologies. Such characteristics have resulted in
growth rates that have been less volatile than growth rates for the overall
semiconductor industry.
 
   Digital devices perform binary arithmetic functions on data represented by
a series of on/off states. Historically, the digital IC market has been
primarily focused on the fast growing markets for computing and information
technology systems. Increasing demands for high-throughput computing and
networking and the proliferation of more powerful personal computers and
workstations in recent years have led to dramatic increases in digital device
density and integration. As a result, significant advances in electronic
system integration have occurred in the design and manufacture of digital
devices.
 
   There are two major types of digital ICs: memory products and logic
devices. Memory products, which are used in electronic systems to store data
and program instructions, are generally 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). Volatile memories are used to store data in virtually
all computer systems, from large and mid-range computers to personal computers
and workstations. Memory products are typically standard, general purpose ICs
that can be manufactured in high volumes using basic CMOS processes, and they
are generally differentiated by cost and physical and performance
characteristics, including data capacity, die size, power consumption and
access speed.
 
                                      10
<PAGE>
 
   The primary volatile memory devices are DRAMs, which accounted for 67.5% of
semiconductor memory sales in 1997, and SRAMs (static RAMs). DRAMs are
volatile memories that lose their data content when power supplies are
switched off, whereas SRAMs are volatile memories that allow the storage of
data in the memory array but without the need for clock or refresh logic
circuitry. SRAMs are roughly four times as complex as DRAMs (four transistors
per bit of memory compared to one transistor) and are significantly more
expensive than DRAMs per unit of storage. DRAMs are used in a computer's main
memory to temporarily store data retrieved from low cost external mass memory
devices such as hard disk drives. SRAMs are principally used as caches and
buffers between a computer's microprocessor and its DRAM-based main memory.
 
   Nonvolatile memories are typically used to store program instructions that
control the operation of microprocessors and electronic systems. 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 and reprogrammed several times, but to do so EPROMs
must be physically removed from electronic systems, exposed to ultraviolet
light, reprogrammed using an external power supply and then returned to the
systems. Electrically erasable PROMs (EEPROMs) can be erased byte by byte and
reprogrammed "in-system" without the need for removal. Using EEPROMs, a system
designer or user can program or reprogram systems at any time. "Flash"
memories are products that represent an intermediate solution for system
designers between EPROMs and EEPROMs based on their cost and functionality.
 
   Flash memories are typically less expensive than EEPROMs, but can also be
erased and rewritten. The entire contents of a flash memory or large blocks of
data (not individual bytes) can be erased with a "flash" of current. Because
flash memories can be erased and reprogrammed electrically and in-system, they
are more flexible than EPROMs and, therefore, may replace EPROMs in many of
their current applications. Flash memories may also be used for solid state
mass storage of data, a potentially high volume application, and in other
applications including, in particular, mobile telephone systems. Flash
memories are smaller and use less power than the hard disk drives now commonly
used for mass data storage, and, therefore, are considered candidates to
replace disk drives, particularly in portable computers.
 
   Logic devices process digital data to control the operation of electronic
systems. The largest segment of the logic market, standard logic devices,
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. They contain
microprocessor cores as well as logic circuitry and memory capacity.
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
products (alarm systems, household appliance controls and video products),
automotive systems (engine control and dashboard instrumentation), computer
peripheral equipment (disk drives, facsimile machines, printers and optical
scanners), industrial applications (motor drives and process controllers), and
telecommunications systems (telephones, answering machines and digital
cellular phones). Digital signal processors ("DSPs") are parallel processors
used for high complexity, high speed real-time computations in a wide variety
of applications, including answering machines, modems, digital cellular
telephone systems, audio processors and data compression systems. Standard
devices are intended to be utilized by a large group of systems designers for
a broad range of applications. Consequently, standard devices usually contain
more functions than are actually required and, therefore, may not be cost-
effective for certain specific applications. In addition to standard logic
devices, a broad range of full-custom, semicustom and ASSP logic devices has
been developed for a wide variety of applications. These devices are typically
designed to meet particular customer requirements. Compared to memory markets,
logic device markets are much more differentiated and dependent upon
intellectual property and advanced product design skills.
 
   Analog/digital (or "mixed-signal") ICs combine analog and digital devices
on a single chip to process both analog signals and digital data.
Historically, analog and digital devices have been developed separately as
they are fundamentally different and it has been technically difficult to
combine analog and digital devices on a
 
                                      11
<PAGE>
 
single IC. System manufacturers have generally addressed mixed-signal
requirements using printed circuit boards containing many separate analog and
digital circuits acquired from multiple suppliers. However, 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.
 
   Mixed-signal ICs are typically characterized as analog ICs due to their
similar market characteristics, including longer product life cycles, diverse
applications and customers and more stable growth through economic cycles as
compared to digital devices. However, certain parts of the mixed-signal market
are becoming higher volume markets as the increasing use of mixed-signal
devices has enhanced the options of system designers and contributed to the
development of new applications, including multimedia, video conferencing,
automotive, mass storage and personal communications.
 
THE SEMICONDUCTOR MARKET
 
   The following table sets forth information with respect to worldwide
semiconductor sales by type of semiconductor and geographic region:
 
<TABLE>
<CAPTION>
                         WORLDWIDE SEMICONDUCTOR SALES(1)    COMPOUND ANNUAL GROWTH RATES(2)
                         -------------------------------- ---------------------------------------
                         1983 1988 1993 1995  1996  1997  83-88 88-93 93-95  95-96   96-97  93-97
                         ---- ---- ---- ----- ----- ----- ----- ----- ------ ------  -----  -----
                                 (IN BILLIONS $)               (EXPRESSED AS PERCENTAGES)
<S>                      <C>  <C>  <C>  <C>   <C>   <C>   <C>   <C>   <C>    <C>     <C>    <C>
Integrated Circuits..... 13.3 35.9 66.0 126.1 114.9 119.5 22.0  13.0   38.2    (8.9)   4.0  16.0
 Analog (linear and
  mixed-signal).........  2.8  7.2 10.7  16.6  17.0  19.7 20.8   8.2   24.6     2.4   15.9  16.5
 Digital Logic..........  6.7 17.8 34.1  56.0  61.9  70.4 21.6  13.9   28.1    10.5   13.6  19.8
  Memory:
   DRAM.................  1.7  6.3 13.1  40.8  25.1  19.7 30.0  15.8   76.5   (38.5) (21.5) 10.7
   Others...............  2.0  4.6  8.1  12.6  10.9   9.6 18.1  12.0   24.7   (13.5) (11.9)  4.3
                         ---- ---- ---- ----- ----- ----- ----  ----   ----  ------  -----  ----
  Total Memory..........  3.7 10.9 21.2  53.4  36.0  29.3 24.1  14.2   58.7   (32.6) (18.6)  8.4
                         ---- ---- ---- ----- ----- ----- ----  ----   ----  ------  -----  ----
Total digital........... 10.4 28.7 55.3 109.4  97.9  99.6 22.5  14.0   40.7   (10.5)   1.7  15.8
Discrete................  3.7  7.0  8.6  14.0  12.9  13.1 13.6   4.2   27.6    (7.9)   1.6  11.1
Opto-electronics........  0.7  2.1  2.6   4.3   4.1   4.5 24.6   4.4   28.6    (4.7)   9.8  14.7
                         ---- ---- ---- ----- ----- ----- ----  ----   ----  ------  -----  ----
  TAM................... 17.8 45.0 77.3 144.4 132.0 137.2 20.4  11.4   36.7    (8.6)   4.0  15.4
                         ==== ==== ==== ===== ===== ===== ====  ====   ====  ======  =====  ====
Europe..................  3.3  8.1 14.6  28.2  27.6  29.1 19.7  12.5   39.0    (2.1)   5.4  18.8
Americas................  7.8 13.4 24.7  47.0  42.7  45.9 11.4  13.0   37.9   (9.1)    7.5  16.8
Asia Pacific............  1.2  5.4 14.2  29.5  27.5  30.1 35.1  21.3   44.1   (6.8)    9.5  20.7
Japan...................  5.5 18.1 23.8  39.7  34.2  32.1 26.9   5.6   29.2  (13.9)   (6.1)  7.8
                         ---- ---- ---- ----- ----- ----- ----  ----   ----  ------  -----  ----
  TAM................... 17.8 45.0 77.3 144.4 132.0 137.2 20.4  11.4   36.7   (8.6)    4.0  15.4
                         ==== ==== ==== ===== ===== ===== ====  ====   ====  ======  =====  ====
</TABLE>
--------
(1) Source: WSTS.
(2) Calculated using end points of the periods specified.
 
   During the 1960s and 1970s, the development of semiconductor process
technologies was critical to the success of participants in the industry. As
process technologies matured, manufacturing sciences became important; in the
1980s, the emphasis shifted to increasing production volumes and yields and
lowering production costs. The large capital expenditures and other resources
required during this period to develop advanced manufacturing capabilities
resulted in a stratification of the industry between broad range suppliers
operating multiple front-end and back-end manufacturing facilities and
specialty niche players operating small wafer fabs or subcontracting wafer
production.
 
   With the continuing development of new semiconductor applications and
increasing demands of system designers for more integrated systems-oriented
products, semiconductor manufacturers must continually improve
 
                                      12
<PAGE>
 
their core technology and manufacturing competencies. In addition, the
increasing diversity and complexity of semiconductor products, the demands of
technological change, and the costs associated with keeping pace with industry
developments have contributed to the growth of cooperative product design and
development and manufacturing alliances with customers as well as among
semiconductor suppliers. Alliances with customers provide the manufacturer
with valuable systems and application know-how and access to markets for key
products, while allowing the manufacturer's customers to share some of the
risks and benefits of product development. Customers also gain access to the
manufacturer's process technologies and manufacturing infrastructure.
Alliances with other semiconductor manufacturers permit costly research and
development and manufacturing resources to be shared to mutual advantage for
joint technology development.
 
   The Company believes that major new growth segments in the semiconductor
market are developing, in particular for digital multimedia, networking and
wireless communications applications. New applications have emerged, such as
set-top boxes, digital television, digital video discs, digital mobile
computing and communication smartcards, automotive multimedia, digital still
imaging and mass storage, that are requiring new and rapidly evolving
semiconductor technologies. The Company believes many of these new products
will require a high level of semiconductor integration, combining various
technologies such as bipolar, analog, CMOS, power and nonvolatile memory, on a
single chip.
 
   To compete as a broad line semiconductor manufacturer, management believes
that it is important to have: (i) a broad and diverse customer base; (ii) a
diversified product portfolio (including analog, digital mixed-signal and
power products) and experience in several application markets; (iii) a broad
range of process technologies (including basic function-oriented and advanced
systems-oriented technologies); (iv) design extension and CAD tools in both
analog and digital technologies; (v) an efficient, quality, global
manufacturing infrastructure; (vi) global marketing and technical support; and
(vii) a worldwide network of strategic alliances with customers and other
semiconductor manufacturers. The Company also believes that its independence
from any single system group manufacturer is an advantage for
STMicroelectronics in working closely with customers in different market
segments.
 
STRATEGY
 
   In 1996 the Company achieved its Vision 2000 objective, originally adopted
in 1993, to become one of the world's top ten semiconductor suppliers and to
achieve operating results better than the average of the top ten semiconductor
suppliers. The Company maintained its position as one of the world's top ten
semiconductor suppliers in 1997. Management's objective is to consolidate and
improve its ranking within the top ten semiconductor suppliers while
sustaining or improving its operating results relative to its peer group. The
key elements of the Company's strategy are set forth below.
 
   Broad Range Supplier. The Company offers a diversified product portfolio
and develops products for a wide range of market applications to reduce its
dependence on any single product, industry or application market. As a broad
range supplier, the Company provides its customers with a single source of
supply for multiple product needs. Within its diversified product portfolio,
the Company has focused on developing products that exploit its technological
strengths, including differentiated ICs (which the Company defines as being
its dedicated products, semicustom devices and microcontrollers).
Differentiated ICs foster close relationships with customers, resulting in
early knowledge of their evolving requirements and opportunities to access
their markets for other products, and are less vulnerable to competitive
pressures than standard commodity products. Differentiated ICs accounted for
approximately 57% of the Company's net revenues in 1997 compared to
approximately 59% in 1996. The Company also targets applications that require
substantial analog and mixed-signal content and can exploit the Company's
system level expertise. Analog ICs (including mixed-signal ICs), the majority
of which are also differentiated ICs, accounted for approximately 49% of the
Company's 1997 net revenues compared to approximately 46% in 1996, while
discrete devices accounted for approximately 14% of the Company's 1997 and
1996 net revenues. In recent years, analog ICs and discrete devices have
experienced less volatility in sales growth rates and average selling prices
than the overall semiconductor industry.
 
                                      13
<PAGE>
 
   However, as a broad range supplier, the Company can also benefit from
selling standard products. Consistent with this view, the Company has
established the Gold Standard program to promote the sale of certain standard
products meeting specified quality, cost and lead-time criteria. The related
initiatives include worldwide advertising, promotional task forces in all
regions, special distribution initiatives and worldwide training of sales and
marketing personnel.
 
   Total standard products (including all nonvolatile memories, discrete
devices, and all standard logical and linear ICs) represented over 40% of the
Company's sales in 1997, and in management's view increased sales of these
products represent an opportunity to improve cash flow because they require
little capital investment.
 
   Leader in a Broad Range of Process and Design Technologies. The Company
intends to continue to exploit its expertise and experience with a wide range
of process and design technologies to develop its capabilities. The Company is
committed to continuing to increase research and development expenditures in
the future as well as continuing to develop alliances with other semiconductor
manufacturers and suppliers and suppliers of software development tools.
Technological advances in the areas of transistor performance and
interconnection technologies are being developed through the Company's logic
products and semicustom devices. In 1996, the Company developed a 0.25 micron,
six-metal layers process that can be used to create either circuits which
operate at high speed (clock frequency of 400 MHZ at 2.5V) or circuits with
low power consumption (1.0V supply) and capable of densities of up to 30,000
gates per millimeter square. In 1997 the Company started to develop the
advanced process steps necessary for its 0.18 micron seven metal layer process
that can operate at high clock speeds (frequency of 500 MHZ at 1.8V) and
capable of densities of up to 50,000 gates per square millimeter. The first
phase of development of this process was completed at the beginning of 1998.
The Company continually works with key suppliers to develop advanced and
standardized design methodologies for its CMOS processes as well as libraries
of macrofunctions and megafunctions for many of its products, and is focusing
on improving its concurrent engineering practices to better coordinate design
activities and reduce overall time-to-market. It is also working closely with
many of its key suppliers to develop easy-to-use design tools for specific
applications. Alliances with other semiconductor manufacturers are generally
designed both to permit costly research and development and manufacturing
resources to be shared to mutual advantage for joint technology development
and to reduce time to market. Technology development alliances have been
formed with customers and other manufacturers, including Philips
Semiconductors, aimed at the joint development of advanced CMOS 0.25/0.18
micron semiconductor manufacturing processes, and the new agreement with
Mitsubishi for CMOS flash memory processes using 0.20 through 0.18 micron. The
Company has also established joint development programs with leading suppliers
such as Applied Materials, ASM Lithography, LAM Research and Air Liquide, and
with CAD Tools producers including Cadence and Synopsys. It is a participant
in Sematech I 300I for the development of 300 millimeter (12-inch) wafer
manufacturing processes. STMicroelectronics is active in joint European
research efforts such as the new MEDEA program (which succeeded JESSI as of
1997), and also cooperates with major research institutions and universities.
 
   Diversified Customer Base with Focus on Strategic Alliances. The Company
works with its key customers to identify evolving needs and new applications
and to develop innovative products and product features. The Company also
seeks to use its access to key customers as a supplier of application-specific
products to establish itself as a supplier across a broad range of products.
Alliances with customers allow the Company and its customers to share some of
the risks of product development and the customers to gain access to the
Company's process technologies and manufacturing infrastructure. The Company
has targeted alliances with customers in each of its key application markets
of telecommunications, automotive, consumer and computer. It has established
alliances with, among others, Alcatel, Bosch, Daewoo Electronics, Hewlett-
Packard, Marelli, Nokia, Nortel, Seagate, Thomson Multimedia and Western
Digital. In establishing these alliances, the Company has also aimed to cover
its key geographical markets.
 
   Integrated Presence in Key Regional Markets. The Company has consistently
sought to develop a competitive advantage by building an integrated presence
in each of the world's three major economic zones: Europe, Asia and North
America. An integrated presence means having manufacturing, design, sales and
marketing capabilities in each region, in order to ensure that the Company is
well positioned to anticipate and
 
                                      14
<PAGE>
 
meet its customers' business requirements in local markets. Therefore, the
Company has established front-end manufacturing facilities in the United
States (in Phoenix, Carrolton and Rancho Bernardo), in Europe (Agrate,
Casteletto, Catania, Crolles, Rennes, Rousset and Tours) and in Asia
(Singapore); the more labor-intensive back-end facilities have been located in
Malaysia, Malta, Morocco, Singapore and China, enabling the Company to take
advantage of favorable production costs (particularly labor costs). With major
design centers and local sales and marketing groups within close proximity of
key customers in each region, the Company believes it can maintain strong
relationships with its customers. STMicroelectronics intends to continue to
build its integrated local presence in each region where it competes in its
efforts to better serve its customers and to develop an early presence in
potential high growth markets such as China, where the Company has both a
back-end facility and a design center, and India, where the Company has a
design center.
 
   Balanced Sales by Application and Region in High Growth Market Segments.
The Company has developed a strong product portfolio across major application
markets including computer peripherals, wireless communications, digital
consumer electronics, smartcards, automotive and power management. While the
Company is consolidating its position in its established high volume
businesses, including switching, engine management, car safety, TV, VCR,
computer peripherals, power and industrial and consumer appliances, it has
also been investing research and development and design resources to develop
the next generation of high growth applications, such as smartcards, portable
computing, digital consumer (DVD, new generations of set-top boxes, digital
TV), wireless communications (digital cellular phones), high speed modems
(xDSL), new automotive products (car multimedia) and new generations of hard
disk drive. The Company also maintains a geographically diverse customer base
across a broad range of market applications.
 
   To date, the Company's growth has been attributable primarily to internal
growth. However, the Company may, from time to time, consider making selected
acquisitions that the Company believes would complement or expand its existing
business. Announcements concerning potential acquisitions could be made at any
time. Acquisitions involve a number of risks that could adversely affect the
Company's operating results, including: (i) the diversion of management's
attention; (ii) the assimilation of the operations and personnel of the
acquired companies; (iii) 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; (iv) the risk
that the financial and accounting systems utilized by the business acquired
will not meet the Company's standards; (v) the risk that the businesses
acquired will not maintain the quality of products and services that the
Company has historically provided; (vi) the inability to attract and retain
qualified management for the acquired business; and (vii) the inability of the
Company to retain customers of the acquired entity. There can be no assurance
that (a) the Company 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 the Company, if at all, or (c) any
operations acquired will be successfully integrated or that such operations
will ultimately have a positive impact on the Company. See "Item 9:
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." Announcements concerning
potential acquisitions could be made at any time.
 
CUSTOMERS AND APPLICATIONS
 
   STMicroelectronics designs, develops, manufactures and markets over 3,000
main types of products that it sells to more than approximately 700 direct
customers. The Company also sells its products through distributors. To many
of its key customers the Company provides a wide range of products, including
dedicated products, discrete devices, memory products and programmable
products. The Company's position as a strategic supplier of application-
specific products to certain customers fosters close relationships that
provide it with opportunities to supply such customers' requirements for other
products, including discrete devices, programmable products and memory
products.
 
                                      15
<PAGE>
 
   The following table sets forth certain of the Company's significant
customers and certain applications for its products:
<TABLE>
---------------------------------------------------------------------------------------------
<S>            <C>               <C>               <C>                <C>                 
TELECOMMUNICATIONS
 Customers:    Alcatel           Fujitsu           Nokia              Samsung
               AT&T              Goldstar          Nortel             Siemens
               Daewoo            Italtel           Philips
               Ericsson          Motorola          Sagem
            ---------------------------------------------------------------------------------
 Applications: Answering machines                  Modems
               Central office switching systems    PBX systems
               Digital cellular telephones         Telephone sets (corded and cordless)
               ISDN controllers
---------------------------------------------------------------------------------------------
COMPUTER SYSTEMS
 Customers:    ACER              Compaq            Hewlett-Packard    Seagate Technology
               Adaptec           Creative          IBM                Tatung
                                 Technology
               ATI Technologies  Cyrix             Matsushita         Western Digital
               Bull              DEC               Olivetti           Xerox
               Canon             Epson             Quantum
            ---------------------------------------------------------------------------------
 Applications: Disk drives                         Optical scanners
               Monitors                            Photocopiers
               Network controllers                 Printers
---------------------------------------------------------------------------------------------
AUTOMOTIVE
 Customers:    BMW               Daimler-Benz      Ford               Marelli
               Bosch             Delco             Hyundai            Valeo
               Chrysler          Fiat              Peugeot S.A.       Renault
            ---------------------------------------------------------------------------------
 Applications: Alternator regulators               Ignition circuits
               Airbags                             Injection circuits
               Antiskid braking systems            Instrument
               Automotive entertainment systems    Electric motor controllers
               Body and chassis electronics        Multiplex wiring kits
               Central locking systems             Transmission control systems
               Engine management systems           Global positioning systems
---------------------------------------------------------------------------------------------
CONSUMER PRODUCTS
 Customers:    Canal Plus        Goldstar          Nokia              Sharp
               Canon             Grundig           Pace               Sony
               Creative          Kenwood           Philips            Thomson Multimedia
               Technology
               Daewoo            Matsushita        Pioneer
               General           NEC               Samsung
               Instrument
            ---------------------------------------------------------------------------------
 Applications: Audio power amplifiers              Pay television decoders
               Audio processors                    Satellite receiver decoding circuits
               Cable television systems            Set up boxes
               Compact disk players                TV sets and monitors
               Digital video encoders and decoders Video cassette recorders
               Graphic equalizers
---------------------------------------------------------------------------------------------
INDUSTRIAL AND OTHER
 APPLICATIONS
 Customers:    Astec                 Emerson       Mannesman          Schlumberger
               Asea Brown Boveri     Gemplus       Orga               Siemens
               Bull                  IBM           Philips            Schneider
            ---------------------------------------------------------------------------------
 Applications: Battery chargers                    Motor controllers
               Chips for smartcards                Power supplies
               Industrial automation and control   Smartcard readers
               systems
               Intelligent power switches          Switch mode power supplies
               Lighting systems (lamp ballasts)
---------------------------------------------------------------------------------------------
</TABLE>
 
                                      16
<PAGE>
 
   In 1997, one customer accounted for more than 5% of the Company's net
revenues (two customers accounted for more than 5% of net revenues in 1996),
and sales to the Company's top ten customers accounted for approximately 39%
of the Company's net sales in 1997 (38% in 1996). The Company has several
large customers, certain of whom have entered into strategic alliances with
the Company. Many of the Company's 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 22% of the
Company's net revenues in 1997 were made through distributors, compared to
approximately 21% in 1996. There can be no assurance that such customers or
distributors, or any other customers, will continue to place orders with the
Company in the future at the same levels as in prior periods. The loss of one
or more of the Company's customers or distributors, reduced bookings or
product returns by its key customers or distributors, could adversely affect
the Company's operating results. In addition, in a declining market the
Company has been in the past and may in the future be driven to lower prices
in response to competitive pressures. Despite price reductions, however, in an
industry downturn order cancellations may be expected, particularly by
distributors and for commodity products.
 
PRODUCTS AND TECHNOLOGY
 
   STMicroelectronics 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. The
Company's products include standard commodity components, full custom devices,
semicustom devices and ASSPs for analog, digital and mixed-signal
applications. Historically, the Company has not produced DRAMs or, until
recently, x86 microprocessors.
 
   The Company's products are organized into four principal product groups:
Dedicated Products, Discrete and Standard ICs, Memory Products and
Programmable Products. As part of its activities outside the four principal
product groups, the Company also has a New Ventures Group and produces
subsystems for industrial and other applications.
 
   DEDICATED PRODUCTS GROUP
 
   The Dedicated Products Group designs, develops and manufactures
application-specific products using advanced bipolar, CMOS, BiCMOS mixed-
signal and power technologies as well as mixed analog/digital semicustom
devices. The Group offers complete system solutions to customers in several
application markets. As the largest of STMicroelectronics' product groups, the
Dedicated Products Group generated revenues of $1,696.3 million in 1997 (a
decrease of 5% over 1996 revenues), representing approximately 42.2% of
STMicroelectronics' 1997 revenues. Approximately 36% of the Group's net
revenues in 1997 were generated in Europe, while approximately 22%, 36%, and
6% were generated in the Americas, the Asia Pacific region, and Japan,
respectively. Many of the dedicated products sold to the Asia Pacific region
are sold to U.S.-based original equipment manufacturers located in the region.
All of the Group's products are ASSPs or full custom devices.
 
   The Dedicated Products Group works closely with customers to develop
application-specific products using STMicroelectronics' technologies and
manufacturing capabilities. The breadth of the Group's customer and
application base provides it with a source of stability in the cyclical
semiconductor market. In addition, the Company's position as a strategic
supplier of application-specific products fosters close relationships that
provide it with opportunities to supply such customers' requirements for other
products, including discrete devices, programmable products and memory
products.
 
   The Group particularly emphasizes dedicated ICs for telecommunications,
audio, automotive, power and computer applications.
 
   The Group is organized into the following six product divisions: (i)
wireline telecommunications; (ii) wireless telecommunications; (iii) computer
and industrial; (iv) audio and automotive; (v) video; and (vi) mixed analog
and digital semicustom devices.
 
                                      17
<PAGE>
 
   Wireline Telecommunications Products. The Company's telecommunications
products are used primarily in telephone sets, modems and subscriber line
interface cards (SLICs) for digital central office switching equipment. The
Group is targeting applications in high speed communications networks and
telephone sets and asynchronous transfer mode ("ATM") communication systems.
In 1997, STMicroelectronics signed an agreement with Alcatel to obtain the
technology for implementing ATM over Asymetrical Digital Subscriber Line
(ADSL) with rate adaptive capability, which increases data transmission over
existing telephone subscriber loop networks. The Company intends to develop a
family of highly integrated, xDSL ICs as a result of this partnership and its
own development efforts.
 
   Wireless Telecommunications Products. In wireless telecommunications, the
Company focuses its product offerings on cellular phones, pagers and wireless
local loop applications, serving the major OEMs in each of these areas with
customer-specific ICs. In cellular phones, the Company is supplying products
for both the analog and digital market segments (including GSM and CDMA). The
Company has gained experience and know-how with the major silicon components
of cellular phone applications, and is developing system and software
capabilities to provide full solutions for specifically targeted applications.
 
   Computer and Industrial Products. STMicroelectronics' computer and
industrial products include components for computer peripheral equipment,
facsimile machines, photocopiers, industrial automation systems and lighting
applications. Its 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, particularly mobile telephone sets. The Company is
currently developing superintegrated solutions using its broad range of
technologies (CMOS, BiCMOS, BCD) and its expertise in microcontrollers/DSP
cores, dedicated IC megacells and embedded memory capability for hard disk
drive applications. The same methodology is being applied to develop ICs for
other computer peripherals such as monitors and inkjet printers.
 
   Audio and Automotive Products. STMicroelectronics' audio products include
audio power amplifiers, audio processors and graphic equalizer ICs. The
Company has sold more than 1.2 billion audio power amplifier ICs since 1972.
The Company's automotive products include alternator regulators, airbag
controls, antiskid braking systems, ignition circuits, injection circuits,
multiplex wiring kits and products for body and chassis electronics, engine
management and instrumentation systems. The Company is currently targeting the
emerging application of global positioning systems. Applying third-generation
bipolar-CMOS-DMOS (BCD3) technology, in 1997 STMicroelectronics introduced a
super smart power doorlock (L9942) IC that combines on one chip all of the
functions needed to control and drive a doorlock actuator motor. In October
1997, ST Microelectronics introduced the first of its Starman chip-set to
equip the receivers for the first direct-to-listener satellite systems now
being developed by WorldSpace to be launched in 1998. WorldSpace will operate
three geostationary satellites in Asia, Africa and Latin America. The Company
will supply the Starman chip-set to consumer electronic equipment
manufacturers selected by WorldSpace.
 
   Video Products. STMicroelectronics produces ICs for TV sets, monitors,
videocassette recorders, satellite receivers, pay-tv decoders and digital
video disks. The Company is focusing on developing products for applications
in the growing satellite and digital cable television markets. Leveraging its
BCD Technology know-how, the Group is now targeting the emerging market of
flat panel displays. In 1997, the Company entered into a product development
agreement with Philips Semiconductors to develop jointly and promote a front-
end chip-set for Digital Video Broadcast-Terrestrial (DVB-T*), the European
standard for terrestrial broadcasting of digital television signals. The
Company also joined forces with Logitech to market a kit for implementing
video camera functions in desktop computer monitors. The kit comprises a chip-
set manufactured by the Company and software driver designed by Logitech and
will be marketed to manufacturers of computer monitors.
 
   Mixed-Signal Semicustom Devices. STMicroelectronics and its predecessor
companies have also manufactured mixed-signal BiCMOS semicustom gate arrays,
standard cells and embedded arrays since 1985. Mixed-signal devices combine
standard cells of digital gates and analog devices on the same semicustom IC.
 
                                      18
<PAGE>
 
Such devices can be used in a wide variety of analog/digital applications,
including computer peripherals, telecommunications products and industrial
systems. STMicroelectronics manufactures a wide range of mixed-signal
semicustom devices, including a 0.5 micron BiCMOS library of cells.
 
   DISCRETE AND STANDARD ICS GROUP
 
   The Discrete and Standard ICs Group designs, develops and manufactures
discrete power devices, power transistors, standard linear and logic ICs, and
RF products. Including revenues from RF products, the Group generated revenues
of $846.8 million in 1997 (an increase of 8.0% over 1996 revenues),
representing approximately 21.1% of STMicroelectronics' net revenues.
Approximately 46% of the Group's 1997 revenues were generated in Europe, while
approximately 23%, 30%, and 1% were generated in the Americas, the Asia
Pacific region, and Japan, respectively. According to preliminary published
industry data, based on 1997 revenues, STMicroelectronics is among the leading
suppliers of power transistors (1997 total market of $5 billion) and among the
top two suppliers of thyristors (1997 total market of $906 million).
 
   The Group's discrete and standard products are manufactured using mature
technological processes. Although such products are less capital intensive
than the Company's other principal products, the Company is continuously
improving product performance and developing new product features. The Group
has a diverse customer base, and a large percentage of the Group's products
are sold through distributors.
 
   Discrete Power Devices. STMicroelectronics manufactures and sells a variety
of discrete power devices, including rectifiers, protection devices and
thyristors (SCRs and triacs). The Company's devices are used in various
applications, including in particular telecommunications systems (telephone
sets, modems and line cards), household appliances and industrial systems
(motor control and power control devices). More specifically, rectifiers are
used in voltage converters and voltage regulators, protection devices are used
to protect electronic equipment from power supply spikes or surges, and
thyristors are used to vary current flows through a variety of electrical
devices, including lamps and household appliances. In 1997, the Company
introduced monolithic TRANSIL diode arrays designed to provide low cost,
reliable protection against electrostatic overloads for computer I/O parts,
modems and similar systems employing data outputs.
 
   Power Transistors. STMicroelectronics designs, manufactures and sells power
transistors, which (like the Company's discrete power devices) operate at high
current and voltage levels in a variety of switching and pulse mode systems.
The Company has three power transistor divisions: bipolar transistors, power
MOSFETs (metal-oxide-silicon field effect transistors) and new power
transistors such as IGBTs.
 
   The Company's bipolar power transistors are used in a variety of high-
speed, high-voltage applications, including SMPS (switch mode power supply)
systems, television/monitor deflection circuits and lighting systems.
According to published industry data, on the basis of 1997 revenues,
STMicroelectronics is among the leading suppliers of bipolar transistors,
including RF power transistors (1997 total market of $2.2 billion). The
Company introduced power MOSFETs in 1991 to extend the use of power
transistors to new high-frequency, high-voltage applications, including
automotive components, crowbar protection devices, resonant converters and
power factor correction devices. According to industry data, the Company has
been ranked number five worldwide in the fast growing segment of the power
MOSFETs. A new family of products, low voltage power MOSFETs known as the NE
series, are being produced with a new technology that provides substantial
advantages over conventional cellular power MOSFET processes.
 
   The Company also offers a family of VIPower (vertical integration power)
products, as well as omnifets and application-specific devices. VIPower
products exhibit the operating characteristics of power transistors while
incorporating full thermal, short circuit and overcurrent protection and
allowing logic level input. VIPower products are used in consumer goods (lamp
ballasts) and automotive products (ignition circuits, central locking systems
and transmission circuits). In 1997, the Company introduced the VIPer 100,
STMicroelectronics' new device in a family of intelligent power ICs for switch
mode power supply applications. Omnifets are power MOSFETs with fully-
integrated protection devices that are used in a variety of sophisticated
automotive and
 
                                      19
<PAGE>
 
industrial applications. Application-specific devices are semicustom ICs that
integrate diodes, rectifiers and thyristors on the same chip, thereby
providing cost-effective and space-saving components with a short design time.
 
   In the first quarter of 1998, the Company extended its offer of VIPower
technology by introducing a Smart H Bridge Driver that can sustain high peak
current streams for short time periods. The Company also introduced innovative
front-end and packaging technologies that significantly increase MOSFET power
density and a new range of products based on its Application Specific Discrete
(ASD) technology that integrate two key telephone set functions into a single
surface mounting package.
 
   Standard Logic and Linear ICs. The Company produces a variety of bipolar
and HCMOS logic devices, including clocks, registers, gates and latches. Such
devices are used in a wide variety of applications, including increasingly in
portable computers, computer networks and telecommunications systems. The
Company also offers standard linear ICs covering a variety of applications,
including amplifiers, comparators, decoders, detectors, filters, modulators,
multipliers and voltage regulators. In 1997, STMicroelectronics announced that
it will support the VCX standard for logic devices with a new family of
products, designed for high-end applications, that combine high speed and low
power dissipation in applications operating in the 1.8 to 3.6V range.
 
   Radio Frequency Products. The Company supplies components for RF
transmission systems used in television broadcasting equipment, radar systems,
telecommunications systems and avionic equipment. At present, most of the
Company's RF products are sold in the United States. The Company is targeting
new applications for its RF products, including two-way wireless
communications systems (in particular, cellular telephone systems) and
commercial radio communication networks for business and government
applications.
 
   MEMORY PRODUCTS GROUP
 
   The Memory Products Group designs, develops and manufactures a broad range
of semiconductor memory products. The Memory Products Group generated revenues
of $708.6 million in 1997 (a decrease of 3.8% over 1996 revenues),
representing approximately 17.6% of STMicroelectronics' 1997 revenues.
Approximately 57% of the Group's 1997 revenues were generated in Europe, while
approximately 17%, 15% and 11% were generated in the Americas, the Asia
Pacific region, and Japan, respectively. According to published industry data,
on the basis of 1997 revenues, STMicroelectronics was the leading producer of
EPROMs (1997 total market of $740 million, declining in 1998) and the second
leading supplier of EEPROMs (1997 total market of $1.2 billion, increasing in
1998).
 
   According to published industry data, the total market for memory devices
in 1997 was approximately $29.3 billion, with DRAMs, SRAMs, ROMs, EPROMs,
flash and EEPROMs accounting for approximately 67.5%, 13.1%, 3.5%, 2.5%, 9.2%
and 4.2% of the total, respectively.
 
   The Company's Memory Products Group is organized into the following
divisions: (i) EPROMs; (ii) smartcard products; (iii) flash memories; (iv)
EEPROMs and application-specific memories; and (v) SRAMs.
 
   EPROMs. STMicroelectronics produces a broad range of EPROMs, from 16 Kbit
to 16 Mbit. According to published industry data, STMicroelectronics
consolidated its world's leading market position for EPROMS in 1997, with
revenues of $251 million (compared to $337 million in 1996) or approximately
32% of worldwide EPROM sales. The Company currently produces EPROMs using 0.5
micron CMOS technologies. The Company has entered into an agreement with
WaferScale Integrated, a specialist in nonvolatile memory architecture in
which the Company acquired a minority interest in 1997, for the development of
advanced architecture designed to reduce die size by over 20% in high level
memory products.
 
   The EPROM market is relatively mature, and worldwide sales declined in 1996
and 1997 according to published industry data due to declining prices. The
Company has succeeded in maintaining its market leadership
 
                                      20
<PAGE>
 
because of its EPROM technology, which has allowed the Company to build one of
the broadest product portfolios currently offered in the market. At the same
time, this technology has permitted continuous improvement of manufacturing
yields and reduction of die size, giving the Company an advantageous cost
position. Efficient manufacturing in the Singapore and Malaysia assembly
plants together with STMicroelectronics' sales and distribution channels have
contributed to the exploitation of the Company's technological advantage.
 
   Smartcard Products. Smartcards are credit card-like 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 (primarily in France and Germany),
cellular telephone systems (primarily in Europe), bank cards (primarily in
France) and pay television systems (primarily in the United Kingdom and
France). Other potential applications include medical record applications,
card-access security systems and toll-access applications. The Company's sales
of smartcard chips in 1997 totaled approximately $222 million (approximately a
30% increase on 1996 smartcard sales) of the approximately $515 million
worldwide market (according to Company estimates), reinforcing the Company's
leading market position with approximately a 43% market share.
STMicroelectronics' cumulative shipments of integrated circuits for smartcards
passed the one billion mark in 1996.
 
   Smartcards incorporate a variety of products manufactured by the Company,
including microcontrollers, EPROMs, EEPROMs and flash memory components. In
1997, STMicroelectronics introduced a new device (ST1GRF42) for use in high
volume contactless and contact-based applications, and also licensed the Java
Card implementation (called Solo) from Schlumberger for advanced security MCU
smartcard chips. In 1996, SGS-THOMSON was the first company to obtain security
certification for banking and Pay-TV applications according to the ITSEC
European norms.
 
   Flash Memories. The Company is using its EPROM and EEPROM know-how to
develop advanced flash memory products. The Company currently supplies single
voltage (1.8 volt) NOR cell structure flash memory products up to 8 Mbit, and
is developing a family of 16 Mbit and 64 Mbit flash memories. In 1997, the
Company also introduced a series of flash memory ICs combining 4 Mbit flash
memory and a 256 Kbit parallel EEPROM memory for use in cellular phones and
other portable equipment. The Company intends to develop a broad portfolio of
flash memory devices to cover all EPROM-like market needs, including dual
voltage and single voltage devices up to 16 Mbit. The Company also intends to
develop specific processes based on current technology to produce 64 Mbit 0.35
micron devices for the mass storage market. The Company is using its flash
memories and fast SRAMs as the focal point of its process development efforts
due to their standardized design features, manufacturability and potential
high volumes.
 
   In February 1998, the Company and Mitsubishi announced that they will
jointly develop a new generation of flash memory products, starting with
multi-level 64 Mbit, which will provide the advantages of both DINOR and NOR
architecture, as well as associated processes from 0.20 through 0.18 micron.
 
   EEPROMs and Application-Specific Memories. The Company offers 1.2 micron
serial EEPROMs up to 16 Kbit and parallel EEPROMs up to 64 Kbit. Serial
EEPROMs are the most popular type of EEPROMs and are generally used in
computer, automotive and consumer applications. Parallel EEPROMs account for a
smaller portion of the EEPROM market, being used mainly in telecommunications
equipment. STMicroelectronics entered the parallel EEPROM market in late 1993.
The Company intends to work closely with its key customers and strategic
allies to identify and develop new application-specific memory devices using
mixed technologies.
 
   SRAMS. The Company focuses on producing nonvolatile SRAMs (battery back-up)
used in computers and telecommunications equipment.
 
   PROGRAMMABLE PRODUCTS GROUP
 
   The Programmable Products Group designs, develops and manufactures
microcomponents (including microcontrollers and digital signal processors),
digital semicustom devices, graphic controllers and MPEG
 
                                      21
<PAGE>
 
decoder ICs and image processing semicustom devices for many diverse products
targeted at high growth digital applications, including information
technology, automotive and multimedia. The Group generated revenues of $642.1
million in 1997 (a decrease of 6.9% over 1996), representing approximately
16.0% of STMicroelectronics' 1997 revenues. Approximately 44% of the Group's
1997 revenues were generated in Europe, while approximately 35%, 16% and 5%
were generated in the Americas, the Asia Pacific region and Japan,
respectively.
 
   Microcomponents. The Company's microcomponents division manufactures and
sells microcontrollers, microprocessors and digital signal processors.
 
   Based on its experience with a variety of second-sourced microcontrollers,
the Company has developed its complete "ST" family of proprietary
microcontroller products, ranging from the 8-bit ST6, ST7 and ST9
microcontrollers to the 16-bit ST10 and 32-bit ST20 devices. The ST10 and ST20
families are designed to address the full spectrum of embedded processor
applications, from computer peripherals such as hard disk drives and printers
to high volume consumer appliances such as digital telephone handsets and
digital satellite receivers. STMicroelectronics' microcontrollers draw on the
Company's large product and technology portfolios to combine logic devices,
EPROMs, EEPROMs, flash memories and various macrofunctions around a range of
second-sourced and proprietary cores. The Company has also developed a line of
starter kits and code generators and compilers that permit system designers to
quickly and easily implement the Company's microcontrollers into their
electronic systems. The Company is targeting emerging applications for
microcontrollers, including televisions, monitors, set-top boxes for cable and
satellite receivers, cellular telephones, global positioning systems and
automobile navigation systems.
 
   Digital signal processors ("DSPs") are processors used for high complexity,
high speed real-time computations. DSPs are used in a wide variety of multi-
media applications. While STMicroelectronics does not sell DSPs as stand-alone
products, the Company and its predecessors have been producing embedded DSPs
for more than ten years. The Company is producing the D950 core, a fixed point
DSP core based upon the Company's 0.5 micron/3.3V triple-level-metal HCMOS5
technology for a wide range of applications in the computer,
telecommunications and consumer markets. The Company is prototyping a 0.35
micron/2.7V five-metal layer HCMOS6 technology version of the D950 core and is
developing a new DSP core (D960) with high performance at very low power
dissipation. Examples of applications include mobile phones, telephone
answering machines, fax machines, modems, disk drives, video conferencing
systems and speech, sound, music and other multimedia functions.
 
   In December 1997, STMicroelectronics and Hitachi announced an agreement to
collaborate on the development of next-generation SuperH microprocessors for
consumer electronics and multimedia applications. Under the agreement, the two
companies will develop the new 64-bit SH-5/ST50 series based on Hitachi's
original SuperH architecture and STMicroelectronics' know-how in 64-bit
microprocessors, for interactive set-top boxes, digital video products, car
multimedia systems and other consumer-orientated products.
 
   In March 1998, STMicroelectronics introduced a chip-set that enables
customers, for the first time, to make a complete Global Positioning by
Satellite ("GPS") navigation system with only two ICs, for use in automotive
applications.
 
   Digital Semicustom Devices. Semicustom devices are ICs containing
standardized lines or arrays of transistors that can be configured or
interconnected to perform specific functions after a short design cycle time.
STMicroelectronics manufactures a wide range of digital semicustom devices,
including high-speed low-voltage 0.35 micron CMOS five-metal layer standard
cells. A 0.25 micron CMOS process is available for designs in a semicustom
environment.
 
   STMicroelectronics' semicustom devices are supported by libraries of cells,
macro functions and design tools. STMicroelectronics supports popular CAD
tools and platforms, and has strategic alliances with Cadence Design Systems,
Inc., Mentor, Inc. and Synopsys, Inc. to develop semicustom CAD tools.
STMicroelectronics is
 
                                      22
<PAGE>
 
developing proprietary libraries for semicustom devices for
telecommunications, computer and consumer applications.
 
   Image Processing. STMicroelectronics has created a business unit to design
and manufacture products for the emerging digital video processing industry.
Emerging digital video technologies offer a number of advantages over
traditional analog video, including the ability to compress video data for
transmission and storage, to transmit and reproduce video data without
perceptible image degradation and to randomly access and edit video data.
 
   Despite the advantages of digital video, its widespread adoption has been
constrained by the lack of high-performance, cost-effective compression
devices and by the absence of digital video compression standards. Video
compression, which uses complicated mathematical algorithms operating at high
speeds to encode the large amounts of data that result from digitizing video
signals, is both highly complex and technically challenging. Digital video
compression technology is expected to contribute to the development of a
number of new or enhanced applications in the consumer electronics, computer
and communications markets, including video CD players, interactive game
consoles and video conferencing systems.
 
   The Company's image processing business unit delivers large volumes of
Motion Picture Experts Group ("MPEG") decoder ICs suitable for video CD
products, personal computers, set-top boxes (including both cable and
satellite) and digital TV applications. These products implement the MPEG 2
standard. According to industry data and the Company's estimation, in 1997
STMicroelectronics was the leading supplier of MPEG 2 decoder ICs with an
approximately 50% share of the MPEG 2 decoders market. In 1997,
STMicroelectronics introduced the STi5500 Omega chip, the first in a family of
highly integrated devices that combine an MPEG 2 audio/video decoder with a
32-bit microprocessor and other functions to create a complete DVD or set-top
box back-end on a single chip. The STi5500, designed to replace three existing
ICs, is scheduled to enter volume production in 1998. In April 1998,
STMicroelectronics introduced the STi7000 chip, the first integrated solution
for High-Definition Television (HDTV) combining an MPEG-2 decoder with an
advanced display and format converter into one single chip. The Company
expects production of the STi7000 to start in the fourth quarter of 1998.
 
   The Company has developed and is currently supplying a single chip solution
(called Omega) integrating a 32-bit microcontroller core, an MPEG 2 decoder IC
and a transport function IC, as well as an MPEG 2 HDTV full decoder for
implementation of ATV in the United States. Certain major international PC
OEMs and add-in card manufacturers have selected the Company's RIVA 128(TM)
3D, PCI/AGP multimedia accelerator to deliver visual computing on PC
platforms. The RIVA 128, which was developed in conjunction with nVidia,
combines advanced 3D graphics acceleration, industry leading 2D graphics
acceleration with superior video and imaging capabilities into a single-chip
mainstream multimedia accelerator. The Company has licensed the high speed
Rambus interface for its Mulitmedia IC product family.
 
   NEW VENTURES GROUP
 
   STMicroelectronics established the New Ventures Group in May 1994 to bring
together various major product initiatives that would otherwise have been
coordinated within and across individual product groups. The Group identifies
and develops new business opportunities to complement the Company's existing
businesses and exploit its technological know-how, manufacturing capabilities
and global marketing team. Initial activities have focused on manufacturing
and marketing x86 and products based on x86 embedded cores. New activities
include design and manufacturing of "system on silicon" solutions based on the
486 CPU core.
 
   The Company expects to be able to use microprocessor technology, its broad
range of other products and technologies and its strengths in developing and
marketing application-specific products to produce powerful x86 core-based
embedded applications and derivative products.
 
   In 1997, STMicroelectronics introduced the ST PC Consumer chip, a low cost,
high performance multimedia PC on a single chip with a view to developing new
generations of ST PC products. The new device integrates a high performance
processor that is fully compatible with standard fifth generation x86 devices,
 
                                      23
<PAGE>
 
comprehensive support logic, a graphics subsystem and a video pipeline. In
1997, STMicroelectronics also acquired a majority interest in Metaflow, a
specialist developer of microprocessor architecture, that is working with the
Company in the development of x86 products and cores. The Company also has
licensed the high speed Rambus interface for its Multimedia IC product family.
 
SALES, MARKETING AND DISTRIBUTION
 
   In 1997, the Company derived approximately 78% of its revenues from sales
directly to customers through its regional sales organizations (compared to
approximately 79% in 1996) and 22% of its net revenues from sales through
distributors (compared to approximately 21% in 1996). The Company operates
regional sales organizations in Europe, North America, the Asia Pacific
region, Japan and, since January 1, 1998, in "Region Five" which includes
emerging markets such as South America, Africa, Eastern Europe, the Middle
East and India. In 1997, approximately 43.6% of the Company's revenues
originated in Europe (compared to approximately 43.4% in 1996), while 22.4%
originated in the Americas (compared to approximately 21.9% in 1996), 26.5%
originated in the Asia Pacific region (compared to approximately 27.3% in
1996), 5.3% originated in Japan (compared to approximately 5.5% in 1996) and
2.2% originated in Region Five (compared to approximately 1.9% in 1996). In
1996 the Company's sales in the Asia Pacific region passed the $1 billion
level. One customer accounted for more than 5% of the Company's net revenues
in 1997.
 
   The European region is divided into ten sales and marketing units: five
major accounts groups organized by market segments (telecom, industrial and
smartcards, consumer, automotive and computer), four geographically-configured
units to cover mid-sized OEM customers (France and the Benelux, Central
Europe, Northern Europe and Southern Europe) and a distribution unit.
 
   In North America, the sales and marketing team is organized into five
business units that are located near major centers of activity for either a
particular application or geographic region: automotive (Detroit, Michigan),
industrial and consumer (Chicago, Illinois), computer and peripheral equipment
(San Jose, California), communications (Dallas, Texas) and distribution
(Boston, Massachusetts). Each 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 STMicroelectronics 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 its current product
portfolio. A central product marketing operation in Boston provides product
support and training for standard products for the North America region, while
a logistics center in Phoenix supports just-in-time delivery throughout North
America. In addition, a comprehensive distribution business unit provides
product and sales support for the nationwide distribution network.
 
   In the Asia Pacific region, sales and marketing is organized by country and
is managed from the Company's regional sales headquarters in Singapore. The
Company has sales offices in Taiwan, Korea, China, Hong Kong, Malaysia,
Thailand and Australia. The Singapore sales organization provides central
marketing, customer service, technical support, shipping, laboratory and
design services for the entire region. In addition, there are design centers
in Taiwan, Korea and Hong Kong.
 
   In Japan, the large majority of the Company's sales are made through
distributors, as is typical for foreign suppliers to the Japanese market.
However, the Company's sales and marketing engineers in Japan work directly
with the customers as well as with the distributors to meet customers' needs.
The Company provides marketing and technical support services to customers
through sales offices in Tokyo and Osaka. In addition, the Company has
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 STMicroelectronics' products in
specific applications.
 
   Region Five was created as of January 1, 1998 and includes emerging markets
such as South America, Africa, Eastern Europe, the Middle East and India.
Prior to that time, these markets had been covered, where
 
                                      24
<PAGE>
 
appropriate, by the other existing sales and marketing organizations. Region
Five also includes the design center in India, which employs 300 people in a
wide range of activities. The Company intends to increase its focus on the new
sales and marketing region to enhance its presence in these new markets.
 
   The Company's central marketing efforts are organized into a central
strategic marketing organization and a key account management organization.
The strategic marketing organization is organized by application market. The
focus is on system research and development and the timely generation of the
advanced system know-how and intellectual property that is critical to the
successful introduction of future generations of differentiated products.
 
   In 1996, the Company undertook the Gold Standard program, a long-term
commitment to excellence in standard products. The program consists of
manufacturing and offering standard products at the same price level as the
market but with a superior level of quality, service and lead time. The
related initiatives included worldwide advertising, promotional task forces in
all regions, special distribution initiatives and worldwide training of
salespeople and marketing personnel.
 
   In addition to the central strategic marketing team, the Company has
established key account management teams to serve key multinational customers.
The key account management teams work with the Company's regional and
divisional managers to provide a broad range of products to its major accounts
and to develop complete systems solutions for customers. The teams build
strategic relationships with the Company's major accounts that can lead to the
development of new products, increased access to evolving technologies and
enhanced knowledge of customer requirements.
 
   Each of the five regional sales organizations operate dedicated
distribution organizations. To support the distribution network,
STMicroelectronics operates logistic centers in Saint Genis, France, Phoenix,
Arizona and Singapore, and has made considerable investments in warehouse
computerization and logistics support.
 
   The Company also uses distributors and representatives to distribute its
products around the world. Typically, distributors handle a wide variety of
products, including products that compete with STMicroelectronics' products,
and fill orders for many customers. Most of the Company's sales to
distributors are made under agreements allowing for price protection and/or
the right of return on unsold merchandise. The Company recognizes revenues
when it ships products to distributors. Sales representatives generally do not
offer products that compete directly with the Company's 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 STMicroelectronics and are referred to distributors for
smaller orders.
 
RESEARCH AND DEVELOPMENT
 
   Management believes that research and development is critical to the
Company's success and is committed to increasing research and development
expenditures in the future. Despite significant cost reductions following the
Company's formation in 1987, and particularly in 1990 and 1991 when the
Company experienced losses, management did not reduce research and development
spending. The table below sets forth information with respect to the Company's
research and development spending since 1993 (not including design center,
process engineering, pre-production or industrialization costs):
 
<TABLE>
<CAPTION>
                                    YEAR ENDED DECEMBER 31,
                               --------------------------------------
                                1993    1994    1995    1996    1997
                               ------  ------  ------  ------  ------
                                   (IN MILLIONS, EXCEPT PERCENTAGES)
<S>                            <C>     <C>     <C>     <C>     <C>     
Expenditures.................. $270.9  $338.3  $440.3  $532.3  $610.9
as a percentage of net
 revenues.....................   13.3%   12.8%   12.4%   12.9%   15.2%
</TABLE>
 
   As a result of the history of the Company, approximately 83% of the
Company's research and development expenses in 1997 were incurred in Europe,
primarily in France and Italy. See "--State Support for the Semiconductor
Industry." As of December 31, 1997, approximately 4,100 employees were
employed in research and development activities.
 
                                      25
<PAGE>
 
   Central research and development units conduct research on the basic VLSI
technologies, packaging technologies and design tools that are used by all
product groups and the front-end manufacturing organization.
STMicroelectronics' central research and development activities are conducted
in Crolles, France; Agrate, Italy; Carrollton, Texas; Phoenix, Arizona;
Berkeley, California; and Noida, India. The central research and development
units participate in several strategic partnerships. The Company's
manufacturing facility at Crolles, France houses a research and development
center that is operated pursuant to a partnership agreement between the
Company and CNET, the research laboratory of France Telecom, an indirect
shareholder of the Company. This center has developed submicron process
technologies and is currently working on the development of 0.18 micron and
future generation technologies. The Company has also entered into an agreement
with Philips Semiconductors to jointly develop such sub-micron CMOS logic
processes in Crolles, France which has recently been extended through the year
2000. A technical center in Noida, India, develops design software and CAD
libraries and tools.
 
   The Company has signed an agreement providing for a research and
development cooperation with GRESSI, the research and development Groupement
d'Interet Economique ("GIE") formed by the CNET, a research laboratory wholly
owned by France Telecom, and the Laboratoire d'Electronique de Technologie
d'Instrumentation ("LETI"), a research laboratory of CEA, the parent company
of one of the indirect shareholders of the Company. The objectives of the
cooperation are to develop know-how on innovative aspects of VLSI technology
evolution which can be transferred to industrial applications, and to address
the development of innovative process steps and process modules to be used in
future generations of VLSI products. The cooperation agreement is based upon a
pluriannual plan through 1998, and the Company is expected to bear half of the
program's total cost. See "Item 13: Interest of Management in Certain
Transactions." The Company has developed a wide network of cooperation with
several universities in the United Kingdom (Bristol and Newcastle), Italy
(Bologna, Catania, Milan, Pavia and Turin), France (Grenoble, Marseille,
Toulouse and Tours), in the United States (Carnegie Mellon, Stanford, Berkeley
and UCLA) and Singapore for basic research projects on design and process
development.
 
   In addition to central research and development, each operating division
also conducts independent research and development activities on specific
processes and products.
 
STATE SUPPORT FOR THE SEMICONDUCTOR INDUSTRY
 
   Due to the importance of the semiconductor industry, various government
authorities in the world, including the European Commission and individual
countries in Europe, have established programs for the funding of research and
development, innovation, industrialization and training in the industry. In
addition, many countries grant various forms of tax relief, direct grants and
other incentives to semiconductor companies as well as other industries to
encourage investment. The Company has structured its operations to benefit
from such programs and incentives and expects to continue to do so in the
future. Unlike certain of its competitors, however, the Company does not
receive significant direct or indirect financing from defense development
programs.
 
   The main European programs in which the Company is involved include: (i)
the Micro-Electronics Development for European Application ("MEDEA")
cooperative research and development program, (ii) European Union research and
development projects such as ESPRIT (European Strategic Programme for
Information Technology) and RACE (Research and Development in Advanced
Communications Technologies for Europe), (iii) national programs for research
and development and industrialization in the electronics industries, and (iv)
investment incentive programs for the economic development of certain regions.
The pan-European programs are generally open to eligible companies operating
and investing in Europe and cover a period of several years. In Italy, both
electronics and economic development programs are open to eligible companies
regardless of their ownership or country of incorporation.
 
   The MEDEA cooperative research and development program was launched in June
1996 by the Eureka Conference and is designed to bring together many of
Europe's top researchers in a 12,000 man-year program that will cover the
period 1997-2000. The MEDEA program replaced the joint European research
program called JESSI, which was a European cooperative project in
microelectronics among several countries that covered the period 1988 through
1996 and involved more than 80 companies. ESPRIT started in 1983 and is being
extended
 
                                      26
<PAGE>
 
through 1998 within the fourth framework program of the European Commission on
Information and Communication Technologies ("ICT"). In Italy, the Programma
Nazionale per la Microelettronica has 18 participants, and various programs
for intervention in the Mezzogiorno (southern Italy) are open to eligible
companies, including non-European companies, operating in the region and
regulated by specific laws. Italian programs often cover several years, but
funding is typically subject to annual budget appropriation. 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.
 
   As a result of the history of the Company, its research and development
facilities and activities are mainly concentrated in France and Italy, and the
substantial majority of the Company's state funding has been derived from
programs in such countries. The Company has entered into funding agreements
with France and Italy which set forth the parameters of state support under
certain national programs and require, among other things, compliance with
European Commission ("EC") regulations and approval by EC authorities and
annual and project-by-project reviews and approvals.
 
   The EC adopted guidelines in 1995 seeking to limit state aid for research
and development activities routinely performed in the normal course of the
business. There can be no assurance that the Company will be able to continue
to benefit from state aid previously committed, that such aid will not be
revoked or discontinued at any time or that aid granted by a material
government for research and development will not be reviewed or challenged by
the EC.
 
   Funding of programs in France and Italy is subject to annual appropriation,
and if such governments were unable to provide anticipated funding on a timely
basis or if existing government-funded programs were curtailed or
discontinued, such an occurrence could have a material adverse effect on the
Company's business, operating results and financial condition. From time to
time the Company has experienced delays in the receipt of funding under these
programs. As the availability and timing of such funding are substantially
outside the Company's control, there can be no assurance that the Company will
continue to benefit from such government support, that funding will not be
delayed from time to time, that sufficient alternative funding would be
available if necessary or that any such alternative funding would be provided
on terms favorable to the Company as those previously provided.
 
   Public authority funding for research and development is reported in "Other
Income and Expenses" in the Company's consolidated statements of income. See
Note 19 to the consolidated audited financial statements for each of the years
in the three-year period ended December 31, 1997, including the Notes thereto
(collectively, the "Consolidated Financial Statements") included elsewhere in
this annual report on Form 20-F. Such funding has totalled $89.6 million,
$63.8 million and $55.3 million in the years 1995, 1996 and 1997,
respectively. Public funding for industrialization costs (which include
certain costs incurred to bring prototype products to the production stage) is
offset against expenses in computing cost of sales, and has the effect of
increasing the Company's gross profit. Such funding of industrialization costs
has totalled $11.8 million, $4.6 million and $6.2 million in 1995, 1996 and
1997, respectively. See Note 19 to the Consolidated Financial Statements.
Government support for capital expenditures funding has totalled
$64.5 million, $93.3 million, and $30.2 million in the years 1995, 1996 and
1997, respectively. Such funding has been used to support the Company's
capital investment; while receipt of these funds is not directly reflected in
the Company's results of operations, the resulting lower amounts recorded in
property, plant and equipment reduce the level of depreciation recognized by
the Company.
 
   Low interest financing has been made available (principally in Italy) under
programs such as the Italian Republic's Fund for Applied Research, established
in 1968 for the purpose of supporting Italian research projects meeting
specified program criteria. At year-end 1995, 1996 and 1997, the Company had
$115.4 million, $95.2 million and $63.7 million, respectively, of indebtedness
outstanding under state-assisted financing programs at an average interest
cost of 2.6%, 2.3% and 2.1%, respectively.
 
INTELLECTUAL PROPERTY
 
   Intellectual property rights which apply to various Company products
include patents, copyrights, trade secrets, trademarks and maskwork rights.
STMicroelectronics owns more than 15,000 original invention patents or pending
patent applications, most of which have been registered in several countries
around the world. In 1997, the Company filed 561 original patent applications
around the world. Management believes that its intellectual property
 
                                      27
<PAGE>
 
represents valuable property and intends to protect the Company's investment
in technology by enforcing all of its intellectual property rights.
 
   The Company has entered into several patent cross-licenses with several
major semiconductor companies, consisting primarily of most of the major
Japanese and Korean semiconductor companies.
 
   Pursuant to a 1977 license agreement (the "Intel License Agreement"),
STMicroelectronics' U.S. subsidiary ("ST Microelectronics U.S.") is licensed
to make, have made, use and sell (in addition to other rights) products that
practice all Intel patents filed prior to March 1999 for the life of such
patents. The Intel License Agreement was originally entered into by Mostek
Corporation ("Mostek") and Intel. ST Microelectronics U.S. succeeded to the
interest of Mostek under the Intel License Agreement upon the Company's
formation in 1987. ST Microelectronics U.S.'s succession rights under the
Intel License Agreement were upheld in a court judgment rendered in July 1992
which is now final as well as in a court judgment dated December 30, 1994
which has been confirmed on appeal.
 
   The Company has also acquired a majority ownership interest in Metaflow and
is working with Metaflow and others to develop and manufacture x86
microprocessors and related products.
 
   The Company's success depends in part on its ability to obtain patents,
licenses and other intellectual property rights covering its products and
their design and manufacturing processes. To that end, the Company has
acquired certain patents and patent licenses and intends to continue to seek
patents on its inventions and manufacturing processes. 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 the Company. 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 the Company or available to the Company
subject to adverse terms and conditions. Litigation, which could demand
financial and management resources, may be necessary to enforce patents or
other intellectual property rights of the Company.
 
   Also, there can be no assurance that litigation will not be commenced in
the future against the Company regarding patents, maskworks, copyrights,
trademarks or trade secrets, or that any licenses or other rights to necessary
intellectual property could be obtained on acceptable terms. The failure to
obtain licenses or other intellectual property rights, as well as the expense
or outcome of litigation, could adversely affect the Company's results of
operations or financial condition. The Company has from time to time received,
and it may in the future receive, communications alleging possible
infringement of certain patents and other intellectual property rights of
others. Regardless of the validity or the successful assertion of such claims,
the Company could incur significant costs with respect to the defense thereof
which could have a material adverse effect on the Company's results of
operations or financial condition. See "Item 3: Legal Proceedings."
 
BACKLOG
 
   The Company's 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 to reflect changes in customer needs
or industry conditions.
 
   The Company's backlog decreased during 1997 in difficult semiconductor
market conditions. In the first quarter of 1998, backlog increased marginally
compared to year-end 1997. During periods of industry overcapacity and
declining selling prices customer orders are not generally made as far in
advance of the scheduled shipment date as during periods of capacity
constraint. The resulting lower levels of backlog have reduced management's
ability to forecast production levels and revenues.
 
   STMicroelectronics also sells certain products to key customers pursuant to
frame contracts. Frame contracts are annual fixed-price contracts with
customers setting forth the terms of purchase and sale of specific products
that may be ordered in the future. These contracts allow the Company to
schedule production capacity in advance and allow customers to manage their
inventory levels consistent with just-in-time principles while
 
                                      28
<PAGE>
 
shortening the cycle times required to produce ordered products. Orders under
frame contracts are also subject to risks of price reduction and order
cancellation.
 
COMPETITION
 
   Markets for the Company's products are intensely competitive. While only a
few companies compete with STMicroelectronics in all of the Company's product
lines, the Company faces significant competition in each of its product lines.
STMicroelectronics competes with major international semiconductor companies,
some of which have substantially greater financial and other resources than
the Company 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 the Company's competitors are also its customers.
 
   The Company does not manufacture DRAMs, which are commodity memory products
sold in high volumes that have experienced severe price cutting in 1996, 1997
and to date in 1998. The Company's absence from the DRAM market contributed to
the Company's outperformance of the semiconductor industry in 1996, when the
Company's net revenues increased by approximately 15.8%. According to trade
association data, the TAM increased by 4% in 1997 compared to 1996, while the
SAM increased 10%. The Company gained market share in 1995 and 1996 against
both the TAM and the SAM, lost market share against both the TAM and the SAM
in 1997 and, based on preliminary data for the first quarter of 1998, gained
market share against both the TAM and the SAM in the first quarter of 1998
compared to the first quarter of 1997. The Company attributes its lower market
share in 1997 in part to its marginal presence in the x86 microprocessor
market and the market for datacom products, two market segments that
experienced sustained growth in 1997, and in part to fierce competition for
hard disk drives and a market slowdown in sales of set-top boxes, two market
segments in which the Company has strong market positions. The Company
believes that recent difficult market conditions have led certain of its
competitors to redirect their marketing focus and manufacturing capacity
toward products that compete with the Company's products. The Company believes
increased competition in its core product markets is generating greater
pricing pressure, increased competition for market share in the SAM, and a
generally more challenging market environment for the Company.
 
   According to trade association data, the SAM increased approximately 9.9%
in 1997 over 1996. The Company's net revenues for 1997 decreased 2.5% compared
to net revenues for 1996, due in part to declining prices resulting from
production overcapacity in the industry and strong competition from foundry
and other manufacturers in certain product families, as well as the impact of
the appreciation of the U.S. dollar on net revenue registered in European and
Japanese currencies and a less favorable product mix. The Company's gross
profit margin declined from 41.4% in 1996 to 38.9% in 1997. There can be no
assurance that the Company will experience revenue growth at or above the
growth rate for the TAM or the SAM, or that increased competition in the
Company's core product markets will not lead to further price erosion, lower
revenue growth rates and lower margins for the Company.
 
   According to published industry data and other industry sources, investment
in worldwide semiconductor fabrication capacity totalled approximately $39
billion in 1995, $44 billion in 1996 and $40 billion in 1997, or approximately
27%, 33% and 29.2%, respectively, of the TAM for such years. In addition to
international semiconductor companies, companies specializing in operating
semiconductor foundries such as UMC, TSMC and Charter Semiconductors, have
added significant capacity, particularly in Asia. These additions to capacity
have contributed to an increase of supply over demand and to declines in
average selling prices and the downturn in the industry. These has also been a
shift in existing industry capacity to production of products that compete
with the Company's products. The Company believes that fluctuations in the
rate of industry capacity additions relative to the growth rate in demand for
semiconductor products could continue to contribute to fluctuations in average
selling prices and affect the Company's results of operations.
 
                                      29
<PAGE>
 
   The Company's primary competitors include Advanced Micro Devices, Inc.,
Hitachi, Intel Corporation, Lucent Technologies, Inc., Mitsubishi Electric
Corporation, Motorola, Inc., National Semiconductor Corporation, Nippon
Electric Company, Ltd., Philips Semiconductors, Samsung, Siemens, Texas
Instruments Incorporated and Toshiba. The market for the Company's new x86
microprocessors is currently dominated by Intel Corporation. Companies
primarily operating foundries include UMC, TSMC and Charter Semiconductors.
 
   The Company competes 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. The Company's ability to compete successfully
depends on elements both within and outside of its 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.
 
EMPLOYEES
 
   At December 31, 1997, the Company employed approximately 28,728 people, of
whom approximately 5,650 were employed in France, 5,979 were employed in
Italy, 610 were employed in the rest of Europe, 2,741 were employed in the
United States, 5,297 were employed in Malta and Morocco and 8,451 were
employed in Singapore, Malaysia and Japan. As of December 31, 1997
approximately 4,100 employees were engaged in research and development, 1,700
in marketing and sales, 20,200 in manufacturing, 1,400 in administration and
general services and 1,300 in divisional functions.
 
   The Company's future success will depend, in part, on its ability to
continue to attract, retain and motivate highly qualified technical,
marketing, engineering and management personnel. Unions are present in France,
Italy, Malta, Morocco and Singapore. The Company has not experienced any
significant strikes or work stoppages in recent years, other than in
connection with national strikes in Italy, and management believes that the
Company's employee relations are good.
 
   As part of its commitment to the principles of TQM, the Company decided in
July 1994 to develop an internal education organization called "ST
University", responsible for organizing training courses to executives,
engineers, technicians and sales personnel within the Company and coordinating
all training for STMicroelectronics' employees. In 1997, ST University
organized over 64,000 hours of training for 2,200 employees.
 
   In order to optimize the training given by ST University and the
requirements of the Company's personnel, as well as to optimize costs, ST
University has endeavored to qualify internal trainers chosen from among the
Company's personnel, and 85 such trainers have been qualified to date.
 
ENVIRONMENTAL MATTERS
 
   The Company's manufacturing operations use many chemicals and gases and the
Company is subject to a variety of governmental regulations related to the
use, storage, discharge and disposal of such chemicals and gases and other
emissions and wastes. Consistent with the Company's TQM principles, the
Company has established proactive environmental policies with respect to the
handling of such chemicals and gases and emissions and waste disposals from
its manufacturing operations. The Company has engaged outside consultants to
audit its environmental activities and has created environmental management
teams, information systems, education and training programs, and environmental
assessment procedures for new processes and suppliers. All of the Company's
plants are certified for the Eco-Management and Audit Scheme ("EMAS") and
seven sites have also obtained ISO 14001 certification. The Company expects
that all of its sites will obtain ISO 14001 certification during 1998.
 
 
                                      30
<PAGE>
 
   Although the Company has not suffered material environmental claims in the
past and believes that its activities conform to presently applicable
environmental regulations, in all material respects, environmental claims or
the failure to comply with present or future regulations could result in the
assessment of damages or imposition of fines against the Company, suspension
of production or a cessation of operations.
 
                        ITEM 2: DESCRIPTION OF PROPERTY
 
MANUFACTURING
 
   STMicroelectronics currently operates 17 main manufacturing facilities
around the world. The table below sets forth certain information with respect
to STMicroelectronics' current manufacturing facilities, products and
technologies. Front-end manufacturing facilities are wafer fabrication plants
and back-end facilities are assembly, packaging and final testing plants.
 
<TABLE>
<CAPTION>
      LOCATION                      PRODUCTS                         TECHNOLOGIES
      --------                      --------                         ------------
<S>                    <C>                                <C>
FRONT-END FACILITIES:
Crolles, France        Semicustom devices, x86,           Fab -  8-inch 0.5/0.25 micron CMOS
                       microcontrollers and dedicated            and 0.7/0.5 micron BiCMOS;
                       products                                  R&D on VLSi submicron
                                                                 technologies in conjunction
                                                                 with CNET and Philips
                                                                 Semiconductors
Phoenix, Arizona       Dedicated products                 Fab -  8-inch 0.7/0.35 micron CMOS
Agrate, Italy          Nonvolatile memories,              Fab 1- 6-inch 0.8/0.5 micron CMOS
                       microcontrollers and
                       dedicated products                 Fab 2- 6-inch 2.0/1.0 micron
                                                                 BiCMOS and BCD
                                                          Fab 3- 6-inch 0.5/0.25 micron
                                                                 CMOS pilot line being
                                                                 converted to 8-inch
Rousset, France        Microcontrollers, nonvolatile      Fab - 6-inch 0.6 micron CMOS
                       memories and smartcard ICs
Catania, Italy         Power transistors, smart power     Fab 1-5-inch 3 micron bipolar
                       ICs and flash memories                    power
                                                          Fab 2-6-inch 4/1 micron MOS power
                                                          Fab 3-6-inch 4/1 micron pilot
                                                                 line
                                                          Fab 4-8-inch 0.7/0.35 CMOS
Rennes, France         Dedicated and power products       Fab -  5-inch 2 micron BiCMOS,
                                                                 BCD and bipolar
Castelletto, Italy     Smart power BCD                    Fab - 6-inch 4.0/1.0 micron
                                                                 bipolar and mixed BCD pilot
                                                                 line
Tours, France          Protection thyristors, diodes and  Fab 1-4/5-inch discrete
                       application-specific discretes     Fab 2-4/5-inch discrete
Ang Mo Kio, Singapore  Dedicated products,                Fab 1- 5-inch 1.5 micron CMOS and
                       microcontrollers, power                   power MOS
                       transistors and commodity
                       products
                                                          Fab 2- 5-inch 6/3 micron bipolar
                                                                 transistor
                                                          Fab 3-5-inch 2 micron bipolar ICs
                                                          Fab 4-5-inch 5 micron standard
                                                          linear
Carrollton, Texas      Memories, microcontrollers,        Fab 1- 6-inch 1.2 micron CMOS and
                       dedicated products and semicustom         BiCMOS
                       devices
                                                          Fab 2- 6-inch 0.8/0.6 micron CMOS
Rancho Bernardo,       Dedicated products                 Fab -6-inch 1 micron BCD
 California
BACK-END FACILITIES:
Muar, Malaysia         Standard products
Kirkop, Malta          Dedicated, microcontrollers,
                       semicustom devices
Toa Payoh, Singapore   Nonvolatile memories and power
                       ICs
Ain Sebaa, Morocco     Discrete products
Shenzhen, China        Discrete and Standard products
Bouskoura, Morocco     Subsystems, RF
</TABLE>
 
 
                                      31
<PAGE>
 
   STMicroelectronics has expanded its diversified manufacturing
infrastructure while improving the cost, quality and flexibility of its
operations. STMicroelectronics has applied recent investments in its
manufacturing facilities to bring to close to full capacity the 8-inch front-
end manufacturing facility in Crolles, France, to continue the ramp up of the
new 8-inch front-end manufacturing facility in Phoenix, Arizona, to complete
the building of and to begin equipping the third 8-inch front-end
manufacturing facility in Catania, Italy, and to continue to build and equip a
new back-end facility in Shenzhen, China. During 1997, the Company completed
conversion from 4-inch to 5-inch of the two front-end wafer fabrication plants
in Tours, France, from 5-inch to 6-inch of the front-end wafer fabrication
facility in Rousset, France, and has installed a new 6-inch module in the
Rancho Bernardo, California front-end wafer fabrication facility. In addition,
the Company has continued the construction of a new 8-inch front-end wafer
fabrication facility in Rousset, France, and the 6-inch to 8-inch conversion
and expansion of one of its front-end wafer fabrication plants in Agrate,
Italy, and has started the construction of a new 8-inch front-end wafer
fabrication facility in Singapore. The Company has also identified one more 8-
inch front-end wafer fabrication plant to be built in Italy that is planned to
be operational by the year 2001. The Company has decided to build a new 300
millimeter, 12-inch wafer research fabrication and pilot line at Crolles
(France) using 0.18 micron and below process technology. The pilot line will
be operated in partnership with Leti and CNET, which are already working with
the Company in Crolles. The Company has also announced plans for a new center
for advanced research and development and industrialization in the field of
nonvolatile memories in Agrate (Italy) to target 0.13 micron CMOS technology
generation by 2003. In 1997 the Company closed its last major 4-inch
fabrication plant, and almost all of the Company's production is now
manufactured on 5-, 6- and 8-inch wafers.
 
   In April 1998, STMicroelectronics signed an agreement with Burr-Brown
Corporation bringing together Burr-Brown's circuit design expertise in high
performance analog and mixed signal circuits and the Company's advanced mixed
signal process technology and know-how. Under the agreement, Burr-Brown will
design integrated circuits using the Company's bipolar-CMOS-DMOS (BCD) mixed
signal process technology. The Company will also provide Burr-Brown with
front-end manufacturing and packaging services.
 
   In 1994, the Company created a joint venture with a subsidiary of the
Shenzhen Electronics Group ("SEG") that built and equipped a back-end
manufacturing facility mentioned above in the Futian free-trade zone of
Shenzhen in southern China. STMicroelectronics owns a 60% interest in the
joint venture, with a subsidiary of SEG owning the remaining 40%. Construction
of the plant and equipment installation was completed in 1996 as scheduled and
production started at the end of 1996. The joint venture will have invested
approximately $120 million in the project by the end of 1998. SEG is a
diversified export-oriented electronics company controlled by the Shenzhen
Municipal Government that manufactures communications equipment, computers and
electronic products and components and engages in import-export trading,
financial investment management and real estate.
 
   Although each fabrication plant is dedicated to specific processes, the
Company's strategy is to develop local presences, better serve customers and
mitigate manufacturing risks by having key processes operated in different
manufacturing plants. The Company is also seeking to take advantage of current
industry overcapacity by qualifying subcontractors on a limited basis both for
wafer foundry and back-end services and thereby minimizing its capital
expenditure needs.
 
   The Company's 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 have become even more demanding.
Although the Company's increased manufacturing efficiency has been an
important factor in its improved results of operations, the Company has 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 the Company will be able to increase
manufacturing efficiency in the future to the same extent as in the past
 
                                      32
<PAGE>
 
or that the Company will not experience production difficulties in the future.
In addition, during past periods of high revenue growth for the Company, the
Company's manufacturing facilities, particularly back-end assembly, packaging
and testing facilities, have operated at high capacity.
 
   STMicroelectronics is fostering a corporate-wide TQM culture that defines a
common set of objectives and performance measurements for employees in all
geographic regions, at every stage of product design, development, production
and consignment for all product lines. TQM in STMicroelectronics is based on
five key principles: management commitment, employee empowerment, continuous
improvement, management by fact and customer focus. TQM has become an integral
part of the STMicroelectronics' culture and it is designed to develop a self-
directed work force with a common set of values, objectives and problem-
solving processes. Since 1987, the Company has improved average AIQ
(electrical) status levels from 5,000 ppm to 14 ppm in the third quarter of
1997. The Company uses through-the-wall mounted equipment for clean rooms to
reduce the risk of wafer contamination from equipment. The Company also uses
robot confinement systems to reduce the risk of wafer contamination. The
Company's CIM systems provide management with real time data on all aspects of
the performance of its manufacturing systems. Most of the Company's
manufacturing facilities have been certified to conform to ISO international
quality standards. Several major customers, including in 1997, Hewlett-
Packard, Nokia, Sharp, Chrysler and Sanyo, have recognized STMicroelectronics'
commitment to quality and have honored the Company with quality awards. In
September 1997, the Company was awarded the 1997 European Quality Award For
Business Excellence in the category of large business by the EFQM.
 
   STMicroelectronics' manufacturing processes use many raw materials,
including silicon wafers, lead frame, mold compound, ceramic packages and
chemicals and gases. The Company obtains its raw materials and supplies from
diverse sources on a just-in-time basis. Although supplies for the raw
materials used by the Company are currently adequate, shortages could occur in
various essential materials due to interruption of supply or increased demand
in the industry.
 
   The Company has principal executive offices located in the vicinity of
Geneva Airport at Route de Pre-Bois 20, ICC Bloc A, 1215 Geneva 15,
Switzerland and at Technoparc du Pays de Gex- BP112, 165 rue Edouard Branly,
01637 St. Genis Pouilly, France. The latter office is maintained by the
Company's French subsidiary. The Company also maintains executive offices in
Agrate Brianza, Italy, and Paris, France. The Company's corporate seat is in
Amsterdam, The Netherlands. The Company also operates nine research and
development centers and 31 design centers. The Company maintains regional
sales headquarters in Geneva, Switzerland, Boston, Massachusetts, Singapore
and Tokyo, Japan, and has 57 sales offices in 23 countries throughout Europe,
North America and the Asia Pacific region. In general, the Company owns its
manufacturing facilities and leases most of its sales offices.
 
   As is common in the semiconductor industry, the Company has from time to
time experienced difficulty in ramping up production at new facilities or
effecting transitions to new manufacturing processes and, consequently, has
suffered delays in product deliveries or reduced yields. There can be no
assurance that the Company 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, construction delays, ramping up production at new facilities,
upgrading or expanding existing facilities, changing its 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 include 8-inch or larger capabilities
and require 0.5 micron or smaller technology 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, the Company 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 impact on
the Company's relationship with its customers could be significant. The
Company's operating results could also be adversely affected by the increase
in fixed costs and operating expenses related to increases in production
capacity if revenues do not increase commensurately.
 
 
                                      33
<PAGE>
 
                           ITEM 3: LEGAL PROCEEDINGS
 
   As is the case with many companies in the semiconductor industry, the
Company has from time to time received communications alleging possible
infringement of certain intellectual property rights of others. Irrespective
of the validity or the successful assertion of such claims, the Company could
incur significant costs with respect to the defense thereof which could have a
material adverse effect on the Company's results of operations or financial
condition.
 
   The Company is currently involved in certain legal proceedings; however,
the Company does not believe that the ultimate resolution of pending legal
proceedings will have a material adverse effect on its financial condition.
 
   Criminal proceedings are currently ongoing against certain current and
former Company employees in connection with alleged unauthorized use of public
funds for research and development in the management of the research and
development consortium Corimme, in which the Company's Italian subsidiary
("STMicroelectronics Italy") has a two-thirds voting interest (the remaining
one-third interest is held by the University of Catania). The proceedings
started in 1994 when, following some fiscal audits made by the tax authorities
of Catania at the premises of Corimme, the tax authorities in Catania informed
the public prosecutor of alleged criminal violations relating to taxes
(unauthorized VAT deductions and irregular invoicing for services between
Corimme and STMicroelectronics Italy) and the use of public financing
(unauthorized use of public funds intended solely for research and development
activities) from 1988 to 1994. As part of the tax proceedings, the VAT office
of Catania issued verification notices against Corimme alleging unauthorized
VAT deductions and irregular invoicing and against STMicroelectronics Italy
alleging improper invoicing for alleged production services performed by
Corimme for the account of STMicroelectronics Italy. To date, several tax
commissions and courts of competent jurisdiction have upheld the positions of
STMicroelectronics Italy and Corimme. However, appeals are still pending and
no final decision has been reached yet.
 
   The public prosecutor in Catania also commenced a criminal investigation
into alleged unauthorized use of public funds for research and development.
Based on a report from a panel of experts appointed by the public prosecutor,
the prosecutor issued a request for indictment in June 1997 against the 11
members of the Board of Directors of Corimme, comprising eight employees or
ex-employees of STMicroelectronics Italy and three professors of the
University of Catania.
 
   Following such request for indictment, the 11 members of Corimme's Board of
Directors filed an incidente probatorio in December 1997, requesting the
appointment of a panel of independent experts to verify the assertions made by
the public prosecutor's experts. During a hearing on March 25, 1998, the judge
for the preliminary hearing accepted the incidente probatorio and named a
panel of independent experts, who will make a report to her to decide on the
request for indictment. The panel of independent experts commenced its review
on May 7, 1998 and has 120 days to complete its review, subject to extensions
permitted by law.
 
   The Company's management believes that Corimme's contractual and other
requirements have been honored in all material respects in accordance with the
requirements and with applicable financial procedures provided by the Italian
government and has no grounds to suspect malfeasance. The Company has offered
to cooperate in full with the authorities in the conduct of the inquiry.
Although it is impossible to determine the ultimate scope or outcome of the
investigation, management believes the investigation will not have a material
effect on the financial condition or results of operations of the Company.
 
                                      34
<PAGE>
 
                         ITEM 4: CONTROL OF REGISTRANT
 
PRINCIPAL SHAREHOLDERS
 
   The following table sets forth certain information with respect to the
ownership of the Company's Common Shares as of June 10, 1998.
 
<TABLE>
<CAPTION>
                                                                 COMMON SHARES
SHAREHOLDERS                                                        OWNED (1)
------------                                                     ---------------
                                                                   NUMBER    %
                                                                 ---------- ----
<S>                                                              <C>        <C>
STMicroelectronics Holding II B.V. ("ST Holding II")............ 79,863,880 56.2
</TABLE>
--------
(1) Prior to the offer and sale of Common Shares by the Company and ST Holding
    II, completed on June 10, 1998 (the "Share Offering"), ST Holding II held
    68.9% of the outstanding Common Shares of the Company. In connection with
    the Share Offering, the Company and ST Holding II granted the underwriters
    of such offering an overallotment option exercisable within thirty days of
    June 5, 1998 for 450,000 and 2,400,000 Common Shares, respectively.
    Assuming such over-allotment option is exercised in full, ST Holding II
    will own 77,463,880 Common Shares, or 54.3% of the outstanding Common
    Shares. Simultaneously with the Share Offering, the Company offered and
    sold $513,852,000 principal amount at maturity Liquid Yield Option(TM)
    Notes (the "Notes") convertible, subject to certain conditions, into
    Common Shares at a conversion rate of 8.952 Common Shares per $1,000
    principal amount at maturity. Assuming all Notes are converted, ST Holding
    II will own 54.4% of the outstanding Common Shares (52.6% if the Share
    over-allotment option is also exercised in full). These calculations do
    not give effect to Common Shares that may be issued under the Employee
    Stock Plan or pursuant to options granted to members and professionals of
    the Supervisory Board.
 
   The officers and directors of the Company as a group do not own a material
number of Common Shares.
 
   On September 26, 1997, the Board of Directors of Thomson-CSF approved the
sale of its entire minority interest in FT2CI, the French holding company that
owned a 50% indirect interest in the Company through ST Holding and ST Holding
II to FT1CI, a holding company whose shareholders are CEA-Industrie and France
Telecom. The purchase price for such transaction was $1,226,500,000, and the
transfer of shares was completed on October 6, 1997. As a result of the
transaction, CEA-Industrie and France Telecom have doubled their joint
indirect interest in the Company. The Company has been informed by CEA-
Industrie and France Telecom that FT1CI and FT2CI were merged at the end of
1997, with FT1CI as the surviving company in the merger. These transactions do
not modify the equality in ownership interests between the French shareholders
and the Italian shareholders.
 
                                      35
<PAGE>
 
   The chart below illustrates the current shareholding structure:
  
   This information was represented by an organizational chart in the original
document.

   Description of Shareholding Structure: STMicroelectronics N.V. is owned
56.2% by STMicroelectronics Holding II B.V. and 43.8% by the public.
STMicroelectronics Holding II B.V. is a wholly-owned subsidiary of
STMicroelectronics Holding N.V. which is 50% owned by a group of French
shareholders and 50% owned by a group of Italian shareholders. The French
shareholder, FT1CI, is owned 51% by CEA-Industrie and 49% by France Telecom, 
respectively. The Italian shareholder, MEI, is owned 50.1% and 49.9% by I.R.I.
and Comitato SIR, respectively.

SHAREHOLDER AGREEMENTS
 
   In connection with the formation of the Company, Thomson-CSF and STET, as
shareholders of the Company, entered into a shareholders agreement on April
30, 1987. In connection with the formation of ST Holding in 1989, which
coincided with the acquisition by Thorn EMI of its interest in the Company,
the shareholders agreement (as amended, the "Holding Shareholders Agreement")
was amended to apply to the parties' ownership in ST Holding. The rights and
obligations of Thomson-CSF and STET under the Holding Shareholders Agreement
were subsequently transferred to or assumed by, as the case may be, FT2CI for
Thomson-CSF, and Finmeccanica and MEI for STET. In connection with the
transfer by Finmeccanica of its interest in ST Holding to MEI, the rights and
obligations of Finmeccanica under the Holding Shareholders Agreement were
subsequently transferred to or assumed by, as the case may be, MEI.
 
   The Holding Shareholders Agreement contemplates that the parties shall
agree upon common proposals and jointly exercise their powers of decision and
their full control of the strategies and actions of ST Holding and the
Company. Under the Holding Shareholders Agreement, the Supervisory Board of ST
Holding, which is composed of three representatives of the French Owner and
three representatives of the Italian Owner, must give its prior approval
before ST Holding, the Company, or any subsidiary of the Company may: (i)
modify its articles of incorporation; (ii) change its authorized share
capital, issue, acquire or dispose of its own shares, change any shareholder
rights or issue any instruments granting an interest in its capital or
profits; (iii) be liquidated or dispose of all or a substantial and material
part of its assets or any shares it holds in any of its subsidiaries; (iv)
enter into any merger, acquisition or joint venture agreement (and, if
substantial and material, any agreement relating to intellectual property) or
form a new company; (v) approve such company's draft consolidated balance
sheets and financial statements or any profit distribution by such company; or
(vi) enter into any agreement with any of the direct or indirect French or
Italian Owners outside the normal course of business. The Holding Shareholders
Agreement also provides that long-term business plans and annual budgets of
the Company and its subsidiaries, as well as any significant modifications
thereto, shall be approved in advance by the Supervisory Board of ST Holding.
In addition, the Supervisory Board of ST Holding shall also decide upon
operations of exceptional importance contained in the annual budget even after
financing thereof shall have been approved.
 
 
                                      36
<PAGE>
 
   Such agreement also provides that similar and adequate levels of research,
development and technological innovation shall be achieved by the Company and
its subsidiaries in France and Italy and that there shall be no substantial
discrepancy in the percentage of state financing compared to research,
development and technological innovation expenditures by the Company and its
subsidiaries in each such country. See "Item 1: Description of Business--State
Support for the Semiconductor Industry." Pursuant to the terms of the Holding
Shareholders Agreement, ST Holding is not permitted, as a matter of principle,
to operate outside the field of semiconductor products. The parties to the
Holding Shareholders Agreement also undertake to refrain directly or
indirectly from competing with the Company in the area of semiconductor
products, subject to certain exceptions, and to offer the Company
opportunities to commercialize or invest in any semiconductor product
developments by them. Any financing or capital provided by the parties to ST
Holding or the Company is intended to be provided pro rata based on the
parties' respective shareholdings in ST Holding. In the Holding Shareholders
Agreement, the parties state that it is of the utmost importance that the
French and Italian governments grant sufficient and continuous financial
support for research and development, and undertake to take suitable actions
with a view to obtaining such funding. See "Item 1: Description of Business--
State Support for the Semiconductor Industry."
 
   In the event of a disagreement that cannot be resolved between the parties
as to the conduct of the business and actions contemplated by the Holding
Shareholders Agreement, each party has the right to offer its interest in ST
Holding to the other, which then has the right to acquire, or to have a third
party acquire, such interest. If neither party agrees to acquire or have
acquired the other party's interest, then together the parties are obligated
to try to find a third party to acquire their collective interests, or such
part thereof as is suitable to change the decision to terminate the agreement.
The Holding Shareholders Agreement otherwise terminates in the event that one
of the parties thereto ceases to hold shares in ST Holding.
 
   Pursuant to the terms of the Holding Shareholders Agreement and for the
duration of such agreement, FT2CI (the "French Owner"), on the one hand, and
MEI (the "Italian Owner"), on the other hand, have agreed to maintain equal
interests in the share capital of ST Holding and maintain, together, ownership
of the majority of ST Holding's issued voting shares. As a result of the
merger of FT1CI and FT2CI, the rights and obligations of FT2CI under the
Holdings Shareholders Agreement have been transferred to FT1CI. The admission
of a third party to the share capital of ST Holding, whether through the sale
of ST Holding's outstanding shares or through the issue by ST Holding of new
shares, or by any other means, must be unanimously agreed upon. In the event
of a new shareholder, the parties undertake to ensure that the balance between
the French and Italian shareholdings is maintained until at least December 31,
1998. The Company has been informed that, pursuant to a Memorandum of
Understanding, the arrangements set forth in the Holding Shareholders
Agreement are being extended until at least December 31, 1998. The Company has
also been informed that the Shareholders Agreement between FT1CI and Thomson-
CSF relating to the management of their respective holdings in ST Holding and
the Company has terminated due to the sale of Thomson-CSF's holdings in FT2CI.
 
   The Company has been informed that the shareholders of FT1CI have also
entered into a separate shareholder agreement that requires the consent of the
Board of Directors of each such company to certain actions taken by ST
Holding, the Company and its subsidiaries. These agreements provide for the
management of the interests of CEA-Industrie and France Telecom in ST Holding
and the Company, with the object of defining between them the positions,
strategies and decisions to be taken by the French Owner in ST Holding
affecting the management of ST Holding, and the Company and its subsidiaries.
The Company is not a party to such agreement.
 
   The agreement between the shareholders of FT1CI (CEA-Industrie and France
Telecom) provides that the following acts with respect to ST Holding or the
Company must be approved by three-quarters of the Board of Directors of FT1CI
(which consists of five directors, three of whom are chosen by CEA-Industrie
and two of whom are chosen by France Telecom): (i) any modification of the
articles of association of ST Holding or the Company, (ii) any change in the
capital of ST Holding or the Company, or issuance, purchase or sale by ST
Holding or the Company of their shares or rights attached thereto, or the
issuance of any securities giving rights to a share in the capital or profits
of ST Holding or the Company, (iii) the liquidation or dissolution of ST
Holding or the Company or the sale of all or an important and material part of
the business or assets of ST
 
                                      37
<PAGE>
 
Holding or the Company representing at least $10,000,000 of the consolidated
shareholders' equity of the Company, (iv) any merger, acquisition, partnership
in interest or the execution of any material agreement relating to
intellectual property rights, in each case in which ST Holding or the Company
participates or in which a proposal is made to participate, or the
establishment by ST Holding or the Company of new companies or groups, (v)
approval of the balance sheets and consolidated accounts of ST Holding, the
Company and its subsidiaries as well as the policies of distributions of
profits among the group, (vi) any agreement between ST Holding and/or the
Company and the shareholders of FT1CI which is out of the ordinary course of
business, (vii) the approval of, or material modifications to, shareholders
agreements with the Italian Owner with respect to ST Holding or the Company
and (viii) approval of strategic multi-year plans and annual consolidated
budgets of ST Holding and the Company. Transfers of shares in FT1CI to third
parties are subject to the approval of at least four members of the Board of
Directors, and are subject to a right of first refusal of the other
shareholders, as well as other provisions. In the event CEA-Industrie proposes
to sell its interest in FT1CI, in whole or in part, France Telecom has the
right to require the acquiror to purchase its interest as well. The FT1CI
shareholders agreement terminates upon the termination of FT1CI.
 
   As is the case with other companies controlled by the French Government,
the French Government has appointed a Commissaire du Gouvernement and a
Controleur d'Etat for FT1CI. Pursuant to Decree No. 94-214, dated March 10,
1994, these Government representatives have the right (i) to attend any board
meeting of FT1CI, and (ii) to veto any board resolution or any decision of the
president of FT1CI within 10 days of such board meeting (or, if they have not
attended the meeting, within 10 days of the receipt of the board minutes or
the notification of such president's decision); such veto lapses if not
confirmed within one month by the Ministry of the Economy or the Ministry of
Industry. FT1CI is subject to certain points of the arrete of August 9, 1953
pursuant to which the Ministry of the Economy and any other relevant
ministries (a) have the authority to approve decisions of FT1CI relating to
budgets or forecasts of revenues, operating expenses and capital expenditures,
and (b) may set accounting principles and rules of evaluation of fixed assets
and amortization.
 
   In connection with the Initial Public Offering, ST Holding II and the
Company entered into a registration rights agreement pursuant to which the
Company agreed that, upon request from ST Holding II, the Company will file a
registration statement under the Securities Act of 1933, as amended, to
register Common Shares held by ST Holding II, subject to a maximum number of
five requests in total as well as a maximum of one request in any twelve-month
period. Subject to certain conditions, the Company will grant ST Holding II
the right to include its Common Shares in any registration statements covering
offerings of Common Shares by the Company. ST Holding II will pay a portion of
the costs of any requested or incidental registered offering based upon its
proportion of the total number of Common Shares being registered, except that
ST Holding II will pay any underwriting commissions relating to Common Shares
that it sells in such offerings and any fees and expenses of its separate
advisors, if any. Such registration rights agreement will terminate upon the
earlier of December 15, 2004 and such time as ST Holding II and its affiliates
own less than 10% of the Company's outstanding Common Shares.
 
   The Company has been informed by ST Holding II that it does not currently
have any plans to reduce its ownership interest to less than a controlling
interest in the Company for the foreseeable future. The timing and size of any
future primary or secondary offerings will depend upon a variety of factors,
including in particular market conditions.
 
   The French and Italian shareholders of ST Holding have agreed that they
will continue to manage their interest in the Company through ST Holding until
at least December 31, 1998, and accordingly, for so long as they hold their
interests in ST Holding, they have undertaken (i) to jointly hold 100% of ST
Holding's capital and voting rights, (ii) to maintain equality between the
shareholdings of the French and Italian shareholders, (iii) to ensure that ST
Holding maintains more than 50% of the Company's share capital and voting
rights, and (iv) to jointly exercise their decision-making powers and monitor
strategies and actions as part of ST Holding's management bodies.
 
                                      38
<PAGE>
 
                       ITEM 5: NATURE OF TRADING MARKET
 
COMMON SHARES
 
   Since 1994, the Common Shares have been traded on the New York Stock
Exchange under the symbol "STM" and on the Bourse de Paris and were quoted on
SEAQ International. On June 5, 1998, the Common Shares were also listed for
the first time on the Italian Stock Exchange, where they have been traded
since that date.
 
   The Common Shares have been included in the CAC 40, the principal index
published by the SBF-Bourse de Paris, since November 12, 1997. The CAC 40 is
derived daily by comparing the total market capitalization of 40 stocks
included in the monthly settlement market of the Bourse de Paris to a baseline
established on December 31, 1987. Adjustments are made to allow for expansion
of the sample due to new issues. The CAC 40 indicates the trends in the French
stock market as a whole and is one of the most widely followed stock price
indices in France.
 
   The table below indicates the range of the high and low prices in U.S.
dollars for the Common Shares on the New York Stock Exchange and the high and
low prices in French francs for the Common Shares on the Bourse de Paris
during each quarter since the Company's Initial Public Offering. In December
1994, the Company completed the Initial Public Offering of 21,000,000 Common
Shares at an initial price to the public of $22.25 per share.
 
<TABLE>
<CAPTION>
                         NEW YORK STOCK EXCHANGE               BOURSE DE PARIS
                          PRICE PER COMMON SHARE           PRICE PER COMMON SHARE
                         ----------------------------      -----------------------
CALENDAR PERIOD              HIGH             LOW             HIGH         LOW
---------------          ------------     -----------      ----------- -----------
<S>                      <C>              <C>              <C>         <C>
1994
  Fourth quarter
   (beginning December
   8, 1994).............   $       22 3/4  $       21 5/8    FRF 126.0   FRF 116.1
1995
  First quarter.........   $       32 1/2  $       22 1/2    FRF 160.0   FRF 119.0
  Second quarter........   $       41 7/8  $       29 1/4    FRF 205.5   FRF 142.0
  Third quarter.........   $       57 1/2  $       40 3/8    FRF 288.0   FRF 197.0
  Fourth quarter........   $       49      $       40 3/8    FRF 244.0   FRF 201.0
1996
  First quarter.........   $       41 3/8  $       29 1/2    FRF 211.9   FRF 141.0
  Second quarter........   $       47 1/2  $       34 5/8    FRF 246.5   FRF 175.5
  Third quarter.........   $       49 7/8  $       29 3/4    FRF 258.0   FRF 150.0
  Fourth quarter........   $       70 5/8  $       44 3/8    FRF 397.0   FRF 228.0
1997
  First quarter.........   $       80 5/8  $       64 5/8    FRF 438.0   FRF 353.0
  Second quarter........   $       86      $       65 1/8    FRF 494.0   FRF 431.2
  Third quarter.........   $       98 1/2  $       81 1/4    FRF 605.0   FRF 481.5
  Fourth quarter........   $       94      $       51 1/2    FRF 565.0   FRF 313.1
1998
  First quarter.........   $       78 3/4  $       51 1/4    FRF 488.5   FRF 310.0
  Second quarter
   (through June 25)....   $       90      $       66        FRF 553.0   FRF 401.0
</TABLE>
 
   At December 31, 1997, there were 139,132,397 Common Shares issued and
outstanding, of which 11,437,482 or 8.22% were registered in the Common Share
registry maintained on the Company's behalf in New York.
 
LIQUID YIELD OPTION(TM) NOTES
 
   The Liquid Yield Option(TM) Notes ("LYONs") of the Company are traded on
the New York Stock Exchange and the Bourse de Paris. Since the date of initial
listing (June 5, 1998) through June 25, 1998, the high and low price per LYON
on the New York Stock Exchange was 86.88% and 83.38% of principal amount at
maturity, respectively, and the high and low price per LYON on the Bourse de
Paris was 99.00% and 84.00% of principal amount at maturity, respectively.
 
                                      39
<PAGE>
 
BOURSE DE PARIS
 
   The securities of most large public companies are listed on the Premier
Marche with the Second Marche available for small and medium-sized companies.
Both the Premier Marche and the Second Marche are operated by the SBF-Bourse
de Paris (the "SBF"). Securities are also traded on the Hors-Cote, or over-
the-counter market also operated by the SBF, however, since this market will
be phased out in July 1998, no new admission can be granted for listing on
this market. A new over-the-counter market, organized by the SBF, the Marche
Libre-OTC was created in September, 1996.
 
   The Common Shares are listed on the Premier Marche. Shares listed on the
Bourse de Paris are placed in one of four categories depending on the volume
of transactions. The Common Shares are listed in the category known as Continu
A, which includes the most actively traded shares (with a minimum daily
trading volume of FF250,000 or twenty trades).
 
   Official trading of listed securities on the Bourse de Paris is transacted
through providers of investment services (investment companies and other
financial institutions) and takes place continuously on each business day from
10:00 a.m. to 5:00 p.m., with a pre-opening session from 8:30 a.m. to 10:00
a.m. Any trade effected after the close of a stock exchange session will be
recorded, on the next Bourse de Paris trading day, at the closing price for
the relevant security at the end of the previous day's session. The SBF
publishes a daily Official Price List that includes price information on each
listed security. The Bourse de Paris has introduced continuous trading by
computer for most listed securities.
 
   Trading in the listed securities of an issuer may be suspended by the SBF
if quoted prices exceed certain price limits defined by the regulations of the
SBF. In particular, if the quoted price of a Continu A security varies by more
than 10 percent from the previous day's closing price, trading may be
suspended for up to 15 minutes. Further suspensions for up to 15 minutes are
also possible if the price again varies by more than five percent. The SBF may
also suspend trading of a listed security in certain other limited
circumstances, including, for example, the occurrence of unusual trading
activity in such security.
 
   Trades of securities listed on the Premier Marche of the Bourse de Paris
are settled in either of two ways: in the cash settlement market or the
monthly settlement market. The Common Shares are settled in the marche a
reglement mensuel (monthly settlement market). In the monthly settlement
market, the purchaser may elect to settle on the third trading day following
the trade (reglement immediat or immediate settlement) or decide on the
determination date (date de liquidation, which is the fifth trading day prior
to the end of the month) either (i) to settle the trade no later than on the
last trading day of such month or (ii) upon payment of an additional fee, to
extend to the determination date of the following month the option either to
settle no later than the last trading day of such month or to postpone further
the selection of a settlement date until the next determination date (a
procedure known as report). Such purchaser may decide to renew its option on
each subsequent determination date upon payment of an additional fee. The
majority of transactions in equity securities on the Bourse de Paris are
settled on the monthly settlement market. In accordance with French securities
regulation, any sale of shares executed on the monthly settlement market
during the month of a dividend payment date is deemed to occur after payment
of the dividend, and the purchaser's account will be credited with an amount
equal to the dividend paid and the seller's account will be debited in the
same amount.
 
                                      40
<PAGE>
 
  ITEM 6: EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
 
   None.
 
                               ITEM 7: TAXATION
 
   The following is a summary of certain tax consequences of the acquisition,
ownership and disposition of the Common Shares based on tax laws of The
Netherlands and the United States as in effect on the date of this annual
report on Form 20-F, and is subject to changes in Netherlands or U.S. law,
including changes that could have retroactive effect. The following summary
does not take into account or discuss the tax laws of any country other than
The Netherlands or the United States, nor does it take into account the
individual circumstances of an investor. Prospective investors in the Common
Shares in all jurisdictions are advised to consult their own tax advisers as
to Netherlands, U.S. or other tax consequences of the purchase, ownership and
disposition of the Common Shares.
 
NETHERLANDS TAXATION
 
   The following summary of Netherlands tax considerations is based on present
Netherlands tax laws as interpreted under officially published case law. The
description is limited to the tax implications for an owner of Common Shares
who is not, or is not deemed to be, a resident of The Netherlands for purposes
of the relevant tax codes (a "non-resident Shareholder" or "Shareholder").
 
   Withholding Tax
 
   Dividends distributed by the Company are subject to a withholding tax
imposed by The Netherlands at a rate of, generally, 25%. The expression
"dividends distributed by the Company" as used herein includes, but is not
limited to:
 
   (i)   distributions in cash or in kind, deemed and constructive
         distributions and repayments of paid-in capital not recognized for
         Netherlands dividend withholding tax purposes;
 
   (ii)  liquidation proceeds, proceeds of redemption of Common Shares or, as
         a rule, consideration for the repurchase of Common Shares by the
         Company in excess of the average paid-in capital recognized for
         Netherlands dividend withholding tax purposes;
 
   (iii) the par value of Common Shares issued to a Holder of Common Shares
         or an increase of the par value of Common Shares, as the case may
         be, to the extent that it does not appear that a contribution,
         recognized for Netherlands dividend withholding tax purposes, has
         been made or will be made; and
 
   (iv)  partial repayment of paid-in capital, recognized for Netherlands   
         dividend withholding tax purposes, if and to the extent that there 
         are net profits ("zuivere winst"), unless the general meeting of   
         shareholders of the Company has resolved in advance to make such   
         repayment and provided that the par value of the Common Shares     
         concerned has been reduced by an equal amount by way of an amendment
         of the Articles of Association.                                     
 
   If a Holder of Common Shares is resident in a country other than The
Netherlands and if a double taxation convention is in effect between The
Netherlands and such country, such Holder may, depending on the terms of such
double taxation convention, be eligible for a full or partial exemption from,
or refund of, Netherlands dividend withholding tax.
 
   U.S. Shareholders. Under the Tax Convention of December 18, 1992, concluded
between the United States and The Netherlands (the "Convention"), the
withholding tax on dividends paid by the Company to a resident of the United
States (as defined in the Convention) who is entitled to the benefits of the
Convention under Article 26 may be reduced to 15% pursuant to Article 10 of
the Convention. Dividends paid by the
 
                                      41
<PAGE>
 
Company to U.S. pension funds and U.S. exempt organizations may be eligible
for an exemption from dividend withholding tax.
 
   Relief/refund Procedure. If the 15% rate, or an exemption in case of a
qualifying U.S. pension fund, is applicable pursuant to the Convention, the
Company is allowed to pay out a dividend under deduction of 15%, or
respectively without any deduction, if, at the payment date, the relevant
shareholders have submitted the duly signed form IB 92 USA, which form
includes a banker's affidavit. Holders of Shares through DTC will initially
receive dividends subject to a withholding rate of 25%. An additional 10% of
the dividend will be paid to holders upon receipt by the dividend disbursing
agent of notification from the Participants in DTC that such holders are
eligible for the reduced rate under the Convention. Only where the applicant
has not been able to claim full or partial relief at source, will he be
entitled to a refund of the excess tax withheld. In that case he should
mention in the Form IB 92 USA the circumstances that prevented him from
claiming relief at source.
 
   Qualifying U.S. exempt organizations can only ask for a full refund of the
tax withheld by using the Form IB 95 USA, which form also includes a banker's
affidavit.
 
   Income Tax and Corporate Income Tax
 
   A non-resident individual or corporate Shareholder will not be subject to
Netherlands income tax (as opposed to the dividends withholding tax discussed
above) with respect to dividends distributed by the Company on the Common
Shares or with respect to capital gains derived from the sale or disposition
of Common Shares in the Company, provided that:
 
     (a) the non-resident Shareholder does not have an enterprise or an
  interest in an enterprise that is, in whole or in part, carried on through
  a permanent establishment or a permanent representative in The Netherlands
  and to which enterprise or part of an enterprise, as the case may be, the
  Common Shares are attributable; and
 
     (b) the non-resident Shareholder does not have a substantial interest or
  a deemed substantial interest in the Company or, in the event the
  Shareholder does have such an interest, it forms part of the assets of an
  enterprise.
 
   Generally, a Shareholder will not have a substantial interest if he, his
spouse, certain other relatives (including foster children) or certain persons
sharing his household, do not hold, alone or together, whether directly or
indirectly, the ownership of, or certain other rights over, shares
representing five per cent or more of the total issued and outstanding capital
(or the issued and outstanding capital of any class of shares) of the Company
or rights to acquire shares, whether or not currently issued, that represent
at any time (and from time to time) five percent or more of the total issued
and outstanding capital (or the issued and outstanding capital of any class of
shares) of the Company or the ownership of certain profit participating
certificates that relate to five percent or more of the annual profit of the
Company and/or to five percent or more of the liquidation proceeds of the
Company. A deemed substantial interest is present if (part of) a substantial
interest has been disposed of, or is deemed to have been disposed of, on a
non-recognition basis.
 
   Net Wealth Tax
 
   A non-resident individual Shareholder is not subject to Netherlands net
wealth tax with respect to the Shares, provided that the non-resident
Shareholder does not have an enterprise or an interest in an enterprise that
is, in whole or in part, carried on through a permanent establishment or a
permanent representative in The Netherlands and to which enterprise or part of
an enterprise, as the case may be, the Common Shares are attributable.
 
   Corporations are not subject to Netherlands net wealth tax.
 
                                      42
<PAGE>
 
   Gift and Inheritance Tax
 
   A gift or inheritance of Common Shares from a non-resident Shareholder will
not be subject to a Netherlands gift and inheritance tax, unless:
 
     (a) the non-resident Shareholder at the time of the gift has or at the
  time of his death had an enterprise or an interest in an enterprise that is
  or was, in whole or in part, carried on through a permanent establishment
  or a permanent representative in The Netherlands and to which enterprise or
  part of an enterprise, as the case may be, the Common Shares are
  attributable; or
 
     (b) in the case of a gift of Common Shares by an individual Shareholder
  who at the time of the gift was neither resident nor deemed to be resident
  in The Netherlands, the death of such individual occurs within 180 days
  after the date of the gift, while such individual is resident or deemed to
  be resident in The Netherlands.
 
UNITED STATES TAXATION
 
   The following discussion is a summary of certain U.S. federal income tax
consequences of the ownership of Common Shares by U.S. Holders, as defined
below. This summary applies only to a beneficial owner of Common Shares (a)
who owns, directly or indirectly, less than 10% of the voting stock of the
Company, (b) who is (i) a citizen or resident of the United States for U.S.
federal income tax purposes, (ii) a U.S. domestic corporation or (iii)
otherwise subject to U.S. federal income taxation on a net income basis in
respect of the Common Shares, (c) who holds the Shares as capital assets, (d)
whose functional currency is the U.S. dollar, (e) who is a resident of the
United States and not also a resident of The Netherlands for purposes of the
Convention, (f) who is entitled under the "limitation on benefits" provisions
contained in the Convention to the benefits of the Convention and (g) who does
not have a permanent establishment or fixed base in The Netherlands (a "U.S.
Holder"). Certain holders (including, but not limited to, United States
expatriates, tax-exempt organizations, persons subject to the alternative
minimum tax, securities broker-dealers and certain other financial
institutions, persons holding the Shares in a hedging transaction or as part
of a straddle or conversion transaction or holders whose functional currency
is not the U.S. dollar) may be subject to special rules not discussed below.
Because this is a general summary, prospective purchasers are advised to
consult their own tax advisors with respect to the U.S. federal, state, local
and applicable foreign tax consequences of the purchase, ownership and
disposition of Common Shares.
 
   This summary is based on the Internal Revenue Code of 1986, as amended (the
"Code"), the Convention, judicial decisions, administrative pronouncements and
existing and proposed Treasury regulations as of the date hereof, all of which
are subject to change, possibly with retroactive effect.
 
   DIVIDENDS
 
   For U.S. federal income tax purposes, the gross amount of distributions
made by the Company with respect to the Common Shares (including the amount of
any Netherlands taxes withheld therefrom) will generally be includable in the
gross income of a U.S. Holder in the year received as foreign source dividend
income to the extent that such distributions are paid out of the Company's
current or accumulated earnings and profits as determined under U.S. federal
income tax principles. To the extent, if any, that the amount of any such
distribution exceeds the Company's current or accumulated earnings and
profits, it will be treated first as a tax-free return of the U.S. Holder's
tax basis in the Common Shares (thereby increasing the amount of any gain or
decreasing the amount of any loss realized on the subsequent sale or
disposition of such Common Shares) and thereafter as capital gain. No
dividends received deduction will be allowed with respect to dividends paid by
the Company. The amount of any distribution paid in Dutch guilders will be
equal to the U.S. dollar value of such Dutch guilders on the date of
distribution, regardless of whether the payment is in fact converted into U.S.
dollars at that time. Gain or loss, if any, realized on the sale or other
disposition of such Dutch guilders will be U.S. source ordinary income or
loss. The amount of any distribution of property other than cash will be the
fair market value of such property on the date of distribution.
 
 
                                      43
<PAGE>
 
   Subject to certain limitations, Netherlands taxes withheld from a
distribution at the rate provided in the Convention will be eligible for
credit against a U.S. Holder's U.S. federal income tax liability. Under
current Dutch law, the Company under certain circumstances may be permitted to
deduct and retain from such withholding a portion of the amount that would
otherwise be required to be remitted to the taxing authorities in The
Netherlands. This amount generally may not exceed 3% of the total dividend
distributed by the Company. To the extent that the Company has withheld an
amount from dividends paid to shareholders which it then is not required to
remit to any taxing authority in The Netherlands, such amount in all
likelihood would not qualify as a creditable tax for U.S. tax purposes. The
Company will endeavor to provide to U.S. Holders information concerning the
extent to which it has applied the reduction described above to dividends paid
to U.S. Holders. The limitation on foreign taxes eligible for credit is
calculated separately with respect to specific classes of income. For this
purpose, dividends distributed by the Company with respect to the Common
Shares will generally constitute "passive income" or, in the case of certain
U.S. Holders, "financial services income." The rules relating to the
determination of the U.S. foreign tax credit are complex and holders should
consult their tax advisors to determine whether and to what extent a credit
would be available. U.S. Holders that do not elect to claim a foreign tax
credit may instead claim a deduction for all foreign taxes paid in the taxable
year.
 
   SALE OR OTHER DISPOSITION OF COMMON SHARES
 
   Upon a sale or other disposition of Common Shares, a U.S. Holder will
recognize gain or loss for U.S. federal income tax purposes in an amount equal
to the difference between the amount realized and the U.S. Holder's tax basis
in such Common Shares. Such gain or loss will be capital gain or loss. Any
such gain, if any, will generally be U.S. source gain. U.S. Holders should
consult their tax advisors regarding the source of loss recognized on the sale
or other disposition of Shares. In the case of a U.S. Holder who is an
individual, any capital gain generally will be subject to U.S. federal income
tax at preferential rates if specified minimum holding periods are met.
 
   U.S. INFORMATION REPORTING AND BACKUP WITHHOLDING
 
   Dividend payments with respect to Common Shares and proceeds from the sale,
exchange or redemption of Common Shares may be subject to information
reporting to the Internal Revenue Service ("IRS") and possible U.S. backup
withholding at a 31% rate. Backup withholding will not apply, however, to a
holder who furnishes a correct taxpayer identification number or certificate
of foreign status and makes any other required certification or who is
otherwise exempt from backup withholding. Persons required to establish their
exempt status generally must provide such certification on IRS Form W-9
(Request for Taxpayer Identification Number and Certification) in the case of
U.S. persons and on IRS Form W-8 (Certificate of Foreign Status) in the case
of non-U.S. persons. Finalized Treasury regulations have generally expanded
the circumstances under which information reporting and backup withholding may
apply for payments made after December 31, 1999. Holders of Shares should
consult their tax advisors regarding the application of the information
reporting and backup withholding rules, including the finalized Treasury
regulations.
 
   Amounts withheld as backup withholding may be credited against a holder's
U.S. federal income tax liability, and a holder may obtain a refund of any
excess amounts withheld under the backup withholding rules by filing the
appropriate claim for refund with the IRS and furnishing any required
information.
 
                                      44
<PAGE>
 
                 ITEM 8: SELECTED CONSOLIDATED FINANCIAL DATA
 
   The table below sets forth selected consolidated financial data for the
Company for each of the years in the five-year period ended December 31, 1997.
Such data have been derived from the consolidated financial statements of the
Company. Consolidated audited financial statements for each of the years in
the three-year period ended December 31, 1997, including the Notes thereto
(collectively, the "Consolidated Financial Statements"), are included
elsewhere in this annual report on Form 20-F.
 
   The following information should be read in conjunction with "Item 9:
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and the related notes
thereto included elsewhere in this annual report on Form 20-F.
 
<TABLE>
<CAPTION>
                                       YEAR ENDED DECEMBER 31,
                            -------------------------------------------------
                            1993(1)   1994(1)   1995(1)     1996      1997
                            --------  --------  --------  --------  ---------
                            (IN MILLIONS EXCEPT PER SHARE AND RATIO DATA)
<S>                         <C>       <C>       <C>       <C>       <C>
CONSOLIDATED STATEMENT OF
 INCOME DATA:
Net sales.................. $2,007.7  $2,602.2  $3,520.7  $4,078.3  $ 3,969.8
Other revenues.............     29.8      42.7      33.7      44.1       49.4
                            --------  --------  --------  --------  ---------
Net revenues...............  2,037.5   2,644.9   3,554.4   4,122.4    4,019.2
Cost of sales(2)........... (1,248.4) (1,528.7) (2,096.0) (2,414.7)  (2,457.4)
                            --------  --------  --------  --------  ---------
  Gross profit(2)..........    789.1   1,116.2   1,458.4   1,707.7    1,561.8
Operating expenses:
  Selling, general &
   administrative..........   (302.5)   (339.9)   (413.2)   (421.1)    (454.3)
  Research and
   development(3)..........   (270.9)   (338.3)   (440.3)   (532.3)    (610.9)
  Restructuring costs......    (49.9)    (37.0)    (13.0)      --         --
  Other income and
   expenses(3).............     49.7      32.0      59.1      45.1       23.2
                            --------  --------  --------  --------  ---------
    Total operating
     expenses..............   (573.6)   (683.2)   (807.4)   (908.3)  (1,042.0)
                            --------  --------  --------  --------  ---------
Operating income...........    215.5     433.0     651.0     799.4      519.8
Net interest expenses......    (37.8)    (21.0)    (16.8)    (11.2)      (2.6)
Gain on disposal of
 investment................      --        --        --        7.3        --
                            --------  --------  --------  --------  ---------
Income before income taxes
 and minority interests....    177.7     412.0     634.2     795.5      517.2
Income tax expense.........    (17.6)    (49.5)   (108.3)   (171.6)    (113.0)
                            --------  --------  --------  --------  ---------
Income before minority
 interests.................    160.1     362.5     525.9     623.9      404.2
Minority interests(4)......      --        --        0.6       1.6        2.4
                            --------  --------  --------  --------  ---------
Net income................. $  160.1  $  362.5  $  526.5  $  625.5  $   406.6
                            ========  ========  ========  ========  =========
Earnings per share
 (basic)(5)................ $   1.92  $   3.04  $   4.03  $   4.50  $    2.92
                            ========  ========  ========  ========  =========
Earnings per share
 (diluted)(5).............. $   1.92  $   3.03  $   4.01  $   4.49  $    2.91
                            ========  ========  ========  ========  =========
Number of shares used in
 calculating earnings per
 share (basic).............     83.5     119.4     130.6     138.7      139.1
                            --------  --------  --------  --------  ---------
Number of shares used in
 calculating earnings per
 share (diluted)...........     83.5     119.7     131.3     139.2      139.9
                            --------  --------  --------  --------  ---------
Ratio of earnings to fixed
 charges(6)................      4.6      10.9      13.2      18.6       13.4
</TABLE>
 
 
                                      45
<PAGE>
 
<TABLE>
<CAPTION>
                                             YEAR ENDED DECEMBER 31,
                                    ------------------------------------------
                                    1993(1) 1994(1) 1995(1)    1996     1997
                                    ------- ------- -------- -------- --------
                                       (IN MILLIONS EXCEPT PER SHARE DATA)
<S>                                 <C>     <C>     <C>      <C>      <C>
CONSOLIDATED BALANCE SHEET DATA
 (END OF PERIOD):
Cash, cash equivalents and
 marketable securities............. $ 327.4 $ 461.5 $  758.4 $  556.4 $  702.2
Working capital(7).................   390.0   291.1    417.4    611.8    443.5
Total assets....................... 2,240.9 3,224.7  4,486.0  5,005.5  5,445.7
Short-term debt (including current
 portion of long-term debt)........   231.1   322.5    492.8    428.2    424.6
Long-term debt (excluding current
 portion)(1).......................   374.8   277.2    200.7    194.9    356.4
Shareholders' equity(1)............ 1,004.0 1,680.0  2,661.7  3,260.0  3,307.4
CONSOLIDATED OPERATING DATA:
Capital expenditures(8)............ $ 445.9 $ 779.7 $1,001.9 $1,125.2 $1,035.4
Net cash provided by operating
 activities........................   460.9   728.1    825.1    980.7    983.8
Depreciation and amortization(8)...   229.4   288.0    392.4    535.9    608.1
</TABLE>
--------
(1) In October 1995, the Company completed a second public offering, with net
    proceeds to the Company of approximately $371.6 million. In December 1994,
    the Company completed the Initial Public Offering, with net proceeds to
    the Company of approximately $198.7 million. In 1993, the Company received
    a $500 million capital contribution that was effected in two steps, $250
    million in May and $250 million in September. The Company also received a
    $100 million capital contribution in each of 1988, 1989 and 1991.
(2) Cost of sales is net of certain funds received through government
    subsidies for industrialization costs (which include certain costs
    incurred to bring prototype products to the production stage) included
    therein. See Note 19 to the Consolidated Financial Statements. For a
    discussion of certain significant charges reflected in cost of sales in
    1995, 1996 and 1997, see "Item 9: Management's Discussion and Analysis of
    Financial Condition and Results of Operations--Results of Operations."
(3) Other income and expenses include, among other things, funds received
    through government subsidies for research and development expenses, and
    the cost of new plant start-ups, as well as foreign currency gains and
    losses, and the costs of certain activities relating to intellectual
    property. The Company's reported research and development expenses do not
    include design center, process engineering, pre-production or
    industrialization costs.
(4) In 1994, the Company created a joint venture with a subsidiary of the
    Shenzhen Electronics Group ("SEG"). The Company owns a 60% interest in the
    joint venture, with a subsidiary of SEG owning the remaining 40%. Minority
    interests also include other minor investments made by the Company.
(5) Earnings per share amounts have been restated for 1993 to reflect a 40:1
    stock split effected in connection with the Initial Public Offering.
    Earnings per share have been restated to reflect the adoption in 1997 of
    Statement of Financial Accounting Standards No. 128 "Earnings Per Share."
    See Note 2.15 and Note 12 to the Consolidated Financial Statements.
(6) 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.
(7) Working capital is calculated as current assets (excluding cash, cash
    equivalents and marketable securities) less current liabilities (excluding
    bank overdrafts, short-term debt and current portion of long-term debt).
(8) Capital expenditures are net of certain funds received through government
    subsidies, the effect of which is to decrease depreciation.
 
                                      46
<PAGE>
 
ITEM 9: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS
                                 OF OPERATIONS
 
   The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included elsewhere in this
annual report on Form 20-F. The following discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended. The Company's actual results may differ significantly from those
projected in the forward-looking statements. Factors that might cause future
actual results to differ materially from the Company's recent results or those
projected in the forward-looking statements include, but are not limited to,
those discussed in "Cautionary Statement Regarding Forward-Looking
Statements", under the caption "Risk Factors" in the Company's Prospectuses
dated June 5, 1998 and below. The Company assumes no obligation to update the
forward-looking statements or such factors.
 
OVERVIEW
 
   The semiconductor industry slowdown experienced in 1996, as compared to
previous years, continued in 1997 and the Company experienced increased
competition and pricing pressure in its core product markets. According to
trade association data, worldwide sales of semiconductor products (the total
available market or "TAM") increased 4.0% in 1997 over 1996, only a modest
improvement over 1996 when the TAM decreased 8.6% compared to 1995. According
to trade association data, the estimated market for products produced by the
Company (the serviceable available market or "SAM") (which prior to 1995
consisted of the TAM without DRAMs, microprocessors and opto-electronic
products and commencing in 1995 and for all subsequent periods presented
includes microprocessors as a result of the Company's production of x86
products) increased approximately 9.9% in 1997 over 1996, compared to an
increase of 3.5% in 1996 over 1995.
 
   The Company's net revenues for 1997 decreased 2.5% compared to net revenues
for 1996, due in part to declining prices resulting from production
overcapacity in the industry and strong competition in certain product
families, as well as to the impact of the appreciation of the U.S. dollar on
net revenues registered in European and Japanese currencies and a less
favorable product mix.
 
   Despite difficult market conditions and a 2.5% net revenue decline in 1997,
from 1993 to 1997 the Company's net revenues increased from $2,037.5 million
to $4,019.2 million. Such revenue gains were achieved despite the Company's
absence during that period from the market for DRAMs (a commodity memory
product) and, until the second half of 1994, from the market for personal
computer microprocessors (such as the x86 family of products). According to
trade association data, the TAM increased from $77.3 billion in 1993 to $137.2
billion in 1997, while the SAM increased from $61.5 billion in 1993 to $112.9
billion in 1997. The Company's share of the TAM increased from 2.6% to 2.9%
during this period, while the Company's share of the SAM increased from 3.3%
to 3.6%. Revenue growth within the Company from 1993 through 1997 was
particularly significant for dedicated products, EPROMs and semicustom
devices.
 
   The Company's absence from the DRAM market contributed to the Company's
outperformance of the semiconductor industry in 1996, when the Company's net
revenues increased by approximately 16%. The Company gained market share in
1995 and 1996 against both the TAM and the SAM, lost market share against both
the TAM and the SAM in 1997 and, based on preliminary trade association data
for the first quarter of 1998, gained market share against both the TAM and
the SAM in the first quarter of 1998 compared with the first quarter of 1997.
The Company attributes its lower market share in part to its marginal presence
in the x86 microprocessor market and in the market for datacom products, two
market segments that experienced sustained growth in 1997, and in part to
fierce competition and a market slowdown in sales of hard disk drives and set-
top boxes, two market segments in which the Company has strong market
positions. The Company believes that recent difficult market conditions have
led certain of its competitors to redirect their marketing focus and
manufacturing capacity toward products that compete with the Company's
products. The Company believes increased competition in its core product
markets is generating greater pricing pressure, increased competition for
market share in the SAM, and a generally more challenging market environment
for the Company.
 
                                      47
<PAGE>
 
   The Company continues to focus on differentiated ICs and analog ICs.
Differentiated ICs (which the Company defines as being its dedicated products,
semicustom devices and microcontrollers) accounted for approximately 57% of
the Company's net revenues in 1997, compared to approximately 59% in 1996.
Such products foster close relationships with customers, resulting in early
knowledge of their evolving requirements and opportunities to access their
markets for other products, and are less vulnerable to competitive pressures
than standard commodity products. Analog ICs (including mixed signal ICs), the
majority of which are also differentiated ICs, accounted for approximately 49%
of the Company's net revenues in 1997, compared to approximately 46% in 1996
while discrete devices accounted for approximately 14% of the Company's net
revenues in both 1997 and 1996. In recent years, these families of products,
in particular analog ICs, have experienced less volatility in sales growth
rates and average selling prices than the overall semiconductor industry.
However, the difficult competitive situation in the semiconductor market in
1997 has led to price pressures also in these families.
 
   The Company's gross profit margin increased from 38.7% in 1993 to 41.0% in
1995. Benefiting from a favorable industry environment in 1993, 1994 and 1995,
such increases in gross profit margins combined with significant reductions in
selling, general and administrative expenses as a percentage of net revenues
and lower interest expenses led to significantly increased profitability. In
1996, the gross profit margin improved to 41.4%, due primarily to a more
favorable product mix and improved manufacturing productivity despite an
unfavorable industry environment which increased pricing pressures. However,
the Company's gross profit margin declined to 38.9% in 1997 primarily as a
result of declining prices, strong competition and other factors previously
discussed.
 
   There can be no assurance that the Company will experience revenue growth
at or above the growth rate for the TAM or the SAM, or that increased
competition in the Company's core product markets will not lead to further
price erosion, lower revenue growth rates and lower margins for the Company.
 
RECENT OFFERINGS
 
   On June 10, 1998, the Company completed a global offering of 3,000,000
shares of capital stock and concurrently therewith ST Holding II completed a
global offering of 16,000,000 shares, both at $72.1875 per share (the "Share
Offering"). The net proceeds to the Company in connection with the Share
Offering were approximately $208 million. On June 10, 1998, the Company also
completed a public offering of $432 million aggregate initial principal amount
of zero-coupon convertible Liquid Yield Option(TM) Notes due 2008 (the
"LYONs") with yield to maturity of 1.75%. The net proceeds to the Company in
connection with the LYONs offering was approximately $423 million.
 
                                      48
<PAGE>
 
RESULTS OF OPERATIONS
 
   The tables below set forth information on the Company's net revenues by
product group and by geographic region:
 
<TABLE>
<CAPTION>
                               TWELVE MONTHS ENDED DECEMBER 31,
                         ------------------------------------------------
                           1993      1994      1995      1996      1997
                         --------  --------  --------  --------  --------
                                  (IN MILLIONS, EXCEPT PERCENTAGES)
<S>                      <C>       <C>       <C>       <C>       <C>       
NET REVENUES BY PRODUCT
 GROUP:
  Dedicated
   Products(1)(2)....... $  755.6  $  997.1  $1,344.4  $1,788.7  $1,696.3
  Discrete and Standard
   ICs(3)...............    514.6     636.3     838.0     784.1     846.8
  Memory Products(2)....    440.0     560.7     653.3     736.8     708.6
  Programmable
   Products(1)..........    288.9     372.0     550.6     689.5     642.1
  New Ventures Group and
   Others(4)............     38.4      78.8     168.1     123.3     125.4
                         --------  --------  --------  --------  --------
    Total............... $2,037.5  $2,644.9  $3,554.4  $4,122.4  $4,019.2
                         ========  ========  ========  ========  ========
NET REVENUES BY
 GEOGRAPHIC REGION:(5)
  Europe................ $  949.7  $1,187.5  $1,593.8  $1,788.5  $1,753.3
  Americas(6)...........    463.4     643.9     812.5     903.0     899.1
  Asia Pacific..........    463.2     617.6     916.7   1,125.7   1,065.8
  Japan.................    102.8     134.7     155.4     228.2     214.5
  Region Five(5)........     58.4      61.2      76.0      77.0      86.5
                         --------  --------  --------  --------  --------
    Total............... $2,037.5  $2,644.9  $3,554.4  $4,122.4  $4,019.2
                         ========  ========  ========  ========  ========
NET REVENUES BY PRODUCT
 GROUP:                            AS A PERCENTAGE OF NET REVENUES
  Dedicated
   Products(1)(2).......     37.0%     37.7%     37.8%     43.4%     42.2%
  Discrete and Standard
   ICs(3)...............     25.3      24.1      23.6      19.0      21.1
  Memory Products(2)....     21.6      21.2      18.4      17.9      17.6
  Programmable
   Products(1)..........     14.2      14.0      15.5      16.7      16.0
  New Ventures Group and
   Others(4)............      1.9       3.0       4.7       3.0       3.1
                         --------  --------  --------  --------  --------
    Total...............    100.0%    100.0%    100.0%    100.0%    100.0%
                         ========  ========  ========  ========  ========
NET REVENUES BY
 GEOGRAPHIC REGION:(5)
  Europe................     46.6%     44.9%     44.8%     43.4%     43.6%
  Americas(6)...........     22.8      24.3      22.9      21.9      22.4
  Asia Pacific..........     22.7      23.4      25.8      27.3      26.5
  Japan.................      5.0       5.1       4.4       5.5       5.3
  Region Five(5)........      2.9       2.3       2.1       1.9       2.2
                         --------  --------  --------  --------  --------
    Total...............    100.0%    100.0%    100.0%    100.0%    100.0%
                         ========  ========  ========  ========  ========
</TABLE>
--------
(1) In January 1997, analog array products were moved from the Programmable
    Products Group to the Dedicated Products Group and image processing
    products from the Dedicated Products Group to the Programmable Products
    Group. Revenues for the Dedicated Products Group and the Programmable
    Products Group have been restated in this "Item 9: Management's Discussion
    and Analysis of Financial Condition and Results of Operations" for prior
    periods to reflect this change.
(2) 1996 revenues for the Dedicated Products Group include $5.6 million of
    revenues from certain foundry activities which were moved from the Memory
    Products Group in January 1996. Revenues for the Dedicated Products Group
    and the Memory Products Group have been restated for prior periods to
    reflect this change.
(3) Includes revenues from sales of RF products, which were moved to the
    Discrete and Standard ICs product group in May 1994. Revenues for the
    Discrete and Standard ICs group have been restated for prior years to
    include RF product revenues.
 
                                      49
<PAGE>
 
(4) Includes revenues from sales of subsystems and other products and from the
    New Ventures Group, which was created in May 1994 to act as a focal point
    for the Company's new business opportunities.
(5) Revenues are classified by location of customer invoiced. For example,
    products ordered by U.S.-based companies to be invoiced to Asia Pacific
    affiliates are classified as Asia Pacific revenues. Net revenues by
    geographic region have been reclassified to reflect the creation of Region
    Five in January 1998 which includes emerging markets such as South
    America, Africa, Eastern Europe, the Middle East and India. Prior years
    have been restated to reflect this reclassification.
(6) Substantially all of the revenues derived from the Americas are derived
    from the United States.
 
   The following table sets forth certain financial data from the Company's
consolidated statements of income since 1993, expressed in each case as a
percentage of net revenues:
 
<TABLE>
<CAPTION>
                                        TWELVE MONTHS ENDED DECEMBER 31,
                                       --------------------------------------
                                        1993    1994    1995    1996    1997
                                       ------  ------  ------  ------  ------
<S>                                    <C>     <C>     <C>     <C>     <C>
Net sales.............................   98.5%   98.4%   99.1%   98.9%   98.8%
Other revenues........................    1.5     1.6     0.9     1.1     1.2
                                       ------  ------  ------  ------  ------
Net revenues..........................  100.0   100.0   100.0   100.0   100.0
Cost of sales.........................  (61.3)  (57.8)  (59.0)  (58.6)  (61.1)
                                       ------  ------  ------  ------  ------
  Gross profit........................   38.7    42.2    41.0    41.4    38.9
Operating expenses:
  Selling, general and
   administrative.....................  (14.8)  (12.9)  (11.6)  (10.2)  (11.3)
  Research and development............  (13.3)  (12.8)  (12.4)  (12.9)  (15.2)
  Restructuring costs.................   (2.4)   (1.4)   (0.4)    --      --
  Other income and expenses...........    2.4     1.3     1.7     1.1     0.5
                                       ------  ------  ------  ------  ------
    Total operating expenses..........  (28.1)  (25.8)  (22.7)  (22.0)  (26.0)
                                       ------  ------  ------  ------  ------
Operating income......................   10.6    16.4    18.3    19.4    12.9
Net interest expenses.................   (1.9)   (0.8)   (0.5)   (0.3)    --
Gain on disposal of investment........    --      --      --      0.2     --
                                       ------  ------  ------  ------  ------
Income before income taxes & minority
 interests............................    8.7    15.6    17.8    19.3    12.9
Income tax expense....................   (0.8)   (1.9)   (3.0)   (4.2)   (2.9)
                                       ------  ------  ------  ------  ------
Income before minority interests......    7.9    13.7    14.8    15.1    10.0
Minority interests....................    --      --      --      0.1     0.1
                                       ------  ------  ------  ------  ------
Net income............................    7.9%   13.7%   14.8%   15.2%   10.1%
                                       ======  ======  ======  ======  ======
</TABLE>
 
1997 VS. 1996
 
   The difficult market environment during 1997 resulted in a decrease in the
Company's net revenues, gross profit, operating income and net income in 1997
compared to 1996. While unit volumes increased substantially in the 1997
period, average selling prices in 1997 declined compared to 1996.
 
   Net revenues. Net sales decreased 2.7%, from $4,078.3 million in 1996 to
$3,969.8 million in 1997. This decrease originated from difficult market
conditions for certain product families for which supply exceeded demand and
produced strong negative pressures on the Company's selling prices, while in
other product families demand itself declined because of high inventories
accumulated by the Company's customers in previous periods. In general, as is
normal in a situation of excess capacity, memory and commodity products
experienced price declines. In particular, hard disk drives were affected by
decreasing prices due to increased competition both at the system and
semiconductor levels and set-top boxes experienced a slowdown in sales due to
inventory corrections and lower demand. The Company's unit volumes increased
substantially in 1997 compared to 1996, with commodity products (which are
typically more price sensitive than other products in the Company's product
portfolio) constituting a higher proportion of the overall product mix. The
impact of these market conditions was
 
                                      50
<PAGE>
 
particularly apparent in the Asia Pacific region and Japan. In addition, since
a significant part of the Company's net revenues was billed in European and
Japanese currencies, the strong appreciation of the U.S. dollar during 1997
resulted in a negative impact on total net revenues when translated from local
currencies into U.S. dollars. Other revenues increased from $44.1 million in
1996 to $49.4 million in 1997 due primarily to an increase in licensing
revenues. Net revenues decreased 2.5%, from $4,122.4 million in 1996 to
$4,019.2 million in 1997.
 
   The Dedicated Products Group's net revenues fell 5.2% primarily as a result
of price pressure and a less favorable product mix in certain major products
including telecommunication, video and automotive products. Price and volume
declines in computer (hard disk drives) products also contributed to the
revenues decline. In January 1997, analog array products were moved from the
Programmable Products Group to the Dedicated Products Group and image
processing products from the Dedicated Products Group to the Programmable
Products Group. Revenues for the Dedicated Products Group and the Programmable
Products Group have been restated in this "Item 9: Management's Discussion and
Analysis of Financial Condition and Results of Operations" for prior periods
to reflect this change. The Discrete and Standard ICs Group's net revenues
increased by 8.0%, as significant volume increases were partly offset by price
declines in substantially all major products including standard commodities
and discrete and power devices. Net revenues of the Memory Products Group
declined by 3.8%, as the sales increases in smartcard ICs (used primarily in
European telephone and bank cards) were more than offset by price declines in
the major memory product families (such as EPROMs, flash memories and EEPROMs)
and volume declines in EPROMs. The Programmable Products Group's net revenues
decreased 6.9% as an improved product mix in digital semicustom devices and
higher volumes in microcontroller products were more than offset by declines
in sales of image processing products and price declines in certain major
products.
 
   Gross profit. The Company's gross profit decreased 8.5%, from $1,707.7
million in 1996 to $1,561.8 million in 1997. As a percentage of net revenues,
gross profit decreased from 41.4% in 1996 to 38.9% in 1997, primarily as a
result of the reduction in average selling prices and a less favorable product
mix.
 
   Cost of sales increased slightly from $2,414.7 million in 1996 to $2,457.4
million in 1997, primarily due to an increase in production volume related to
higher sales volume and higher depreciation charges linked to the higher level
of capital investment.
 
   The exchange rate impact on gross profit in 1997 compared to 1996 was
marginal, as the negative impact of the appreciation of the U.S. dollar on net
revenues was only slightly higher than the positive impact on cost of sales.
See "--Impact of Changes in Exchange Rates." Cost of sales in 1997 and 1996
was net of $6.2 million and $4.6 million, respectively, of funds received
through government subsidies to offset industrialization costs (which include
certain costs incurred to bring prototype products to the production stage)
included in cost of sales.
 
   Selling, general and administrative expenses. Selling, general and
administrative expenses increased 7.9%, from $421.1 million in 1996 to $454.3
million in 1997, reflecting higher expenditure in the marketing organization
and for information technology. As a percentage of net revenues, selling,
general and administrative expenses increased from 10.2% in 1996 to 11.3% in
1997, due primarily to the increase in selling, general and administrative
expenses and the decrease in net revenues.
 
   Research and development expenses. Research and development expenses
increased 14.8%, from $532.3 million in 1996 to $610.9 million in 1997. The
Company continued to invest heavily in research and development and plans to
continue increasing its research and development staff. The Company is
allocating significant financial resources to expand its market leadership in
key applications, reflecting the commitment to service and continuous
innovation. As a percentage of net revenues, research and development expenses
increased from 12.9% in 1996 to 15.2% in 1997. The Company's reported research
and development expenses do not include design center, process engineering,
pre-production or industrialization costs.
 
   Other income and expenses. Other income and expenses decreased from income
of $45.1 million in 1996 to income of $23.2 million in 1997. Other income and
expenses include primarily funds received from
 
                                      51
<PAGE>
 
government agencies in connection with the Company's research and development
programs, the cost of new plant start-ups, as well as foreign currency gains
and losses, the costs of certain activities relating to intellectual property
and miscellaneous revenues and expenses. The decrease in other income and
expenses resulted primarily from higher start-up costs of new production
facilities and from a decrease in funds received from government agencies in
connection with the Company's research and development programs.
 
   Operating income. The Company's operating income decreased 35.0%, from
$799.4 million in 1996 to $519.8 million in 1997, primarily as a result of the
decrease in net revenues and the increase in research and development
expenses, which more than offset the favorable exchange rate impact.
 
   Net interest expenses. Net interest expenses decreased from $11.2 million
in 1996 to $2.6 million in 1997 reflecting primarily improved cash flow during
1997 and a slight reduction in interest rates.
 
   Income tax expense. Provision for income tax was $113.0 million in 1997
compared to $171.6 million in 1996, primarily as a result of the substantial
decrease in income before income taxes and minority interests. The accrued
effective tax rate increased slightly from 21.6% in 1996 to 21.8% in 1997. The
still favorable 1997 rate was mainly due to the application of favorable tax
regimes in certain countries. As certain of these benefits may not be
available after 1997, the Company could experience an increase in the
effective tax rate in the coming years.
 
1996 VS. 1995
 
   Following the growth that the worldwide semiconductor market experienced in
1994 and 1995, total industry sales declined in 1996 compared to 1995. See "--
Overview." However, the Company enjoyed significant growth in net revenues in
1996 despite lower average selling prices compared to 1995. Coupled with
improvements in manufacturing productivity, this revenue growth led to strong
increases in operating income and net income in 1996.
 
   Net revenues. Net sales increased 15.8%, from $3,520.7 million in 1995 to
$4,078.3 million in 1996. The increase in net sales of $557.6 million was
primarily a result of an improved product mix, including sales of new
products, in each of the Company's principal product groups. The exchange rate
impact on net sales in 1996 was not significant. See "--Impact of Changes in
Exchange Rates." Other revenues (consisting primarily of co-development
contract fees, certain contract indemnity payments and patent royalty income)
increased from $33.7 million in 1995 to $44.1 million in 1996, primarily due
to an increase in licensing fees and co-development fees, partly offset by a
decrease in patent and royalty income. As a result, net revenues increased
16.0%, from $3,554.4 million in 1995 to $4,122.4 million in 1996.
 
   The Dedicated Products Group's net revenues increased 33.0% primarily as a
result of an improved mix in computer, video/image processing and
telecommunications products. In 1996, revenues for the Dedicated Products
Group included $5.6 million of revenues from certain foundry activities which
were moved from the Memory Products Group in January 1996 and in January 1997,
analog array products were moved from the Programmable Products Group to the
Dedicated Products Group and image processing products from the Dedicated
Products Group to the Programmable Products Group. Revenues for the Dedicated
Products Group, Memory Products Group and the Programable Products Group have
been restated for prior periods in this "Item 9: Management's Discussion and
Analysis of Financial Condition and Results of Operations" to reflect this
change. Higher volumes in computer, audio, automotive and telecommunications
products also contributed to the increase in net revenues. The Discrete and
Standard ICs Group's net revenues declined 6.4% as volume increases in
transistors and an improved mix in discrete devices were not sufficient to
offset declining volumes in discrete devices, standard commodities and
standard logic devices. Net revenues of the Memory Products Group increased
12.8% due to higher volumes in smartcard ICs (primarily used in European
telephone and bank cards) and an improved mix in EPROMs. Increased volume and
an improved product mix in flash memories and EEPROMs also contributed to the
increase in net revenues. The Programmable Products Group's net revenues
increased 25.2% principally due to higher volumes and an improved product mix
in analog arrays and microcontroller products.
 
                                      52
<PAGE>
 
   Gross Profit. The Company's gross profit increased 17.1%, from $1,458.4
million in 1995 to $1,707.7 million in 1996, primarily as a result of an
improved product mix, higher other revenues and improvements in manufacturing
performances. As a percentage of net revenues gross profit was 41.0% in 1995
and 41.4% in 1996.
 
   Cost of sales increased from $2,096.0 million in 1995 to $2,414.7 million
in 1996, due primarily to higher depreciation resulting from increased capital
spending in recent periods and to higher variable costs associated with
increased volume. Increased cost of sales was also attributable to the new
plant in Phoenix, Arizona whose costs were not included in cost of sales until
the third quarter of 1995, and to upgrades of manufacturing facilities in
1996.
 
   The exchange rate impact on gross profit in 1996 was not significant. See
"--Impact of Changes in Exchange Rates." Cost of sales in 1996 and 1995 was
net of $4.6 million and $11.8 million, respectively, of funds received to
offset industrialization costs (which include certain costs incurred to bring
prototype products to the production stage) included in cost of sales.
 
   Selling, general and administrative expenses. Selling, general and
administrative expenses increased 1.9%, from $413.2 million in 1995 to $421.1
million in 1996. This increase was due primarily to increases in general and
administrative activities and to a strengthening in the Company's marketing
efforts. The 1995 period included a $10 million provision related to specific
charges to cover the estimated financial impact related to legal proceedings
in one of the Company's subsidiaries. As a percentage of net revenues,
selling, general and administrative expenses decreased from 11.6% in 1995 to
10.2% in 1996, due primarily to higher net revenues.
 
   Research and development expenses. Research and development expenses
continued to represent a substantial amount of the Company's net revenues,
increasing 20.9%, from $440.3 million in 1995 to $532.3 million in 1996.
Despite the growth in net revenues in 1996, research and development expenses
as a percentage of net revenues increased from 12.4% in 1995 to 12.9% in 1996.
The Company continued to invest heavily in both its research and development
staff and research and development activities. The Company's reported research
and development expenses do not include design center, process engineering,
pre-production or industrialization costs.
 
   Restructuring costs. There were no restructuring costs in 1996. The $13.0
million in restructuring costs in 1995 included costs associated with certain
personnel lay-offs.
 
   Other income and expenses. Other income and expenses decreased from income
of $59.1 million in 1995 to income of $45.1 million in 1996. The decrease in
other income and expenses resulted primarily from a decrease in funds received
from government agencies in connection with the Company's research and
development programs and higher start-up costs, partly offset by foreign
currency gains.
 
   Operating income. The Company's operating income increased 22.8%, from
$651.0 million in 1995 to $799.4 million in 1996, primarily as a result of
increased net revenues and improved efficiency in manufacturing. The exchange
rate impact on operating income was marginal.
 
   Net interest expenses. Net interest expenses decreased from $16.8 million
in 1995 to $11.2 million in 1996, primarily as a result of a capital increase
undertaken by the Company in October 1995, which allowed the Company to repay
a substantial majority of its outstanding debt.
 
   Income tax expense. Provision for income tax was $171.6 million in 1996
compared to $108.3 million in 1995, primarily as a result of the substantial
increase in income before income taxes and minority interests. The accrued
effective tax rate increased from approximately 17% in 1995 to approximately
22% in 1996, since certain favorable tax benefits on capital investments were
no longer available in certain countries in 1996 compared to 1995. As such
benefits may not be available in future periods, the Company could experience
an increase in the effective tax rate in the coming years.
 
                                      53
<PAGE>
 
QUARTERLY RESULTS OF OPERATIONS
 
   The following table sets forth certain financial information for the years
1996 and 1997. Such information is derived from unaudited consolidated
financial statements, prepared on a basis consistent with the audited
consolidated financial statements, that include, in the opinion of management,
only normal recurring adjustments necessary for a fair presentation of the
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 experienced by the Company in recent years, the
increasingly competitive nature of the markets in which the Company operates,
the changes in product mix and the currency effects of changes in the
composition of sales and production among different geographic regions, the
Company believes that period-to-period comparisons of its operating results
should not be relied upon as an indication of future performance.
 
<TABLE>
<CAPTION>
                                                 QUARTER ENDED (UNAUDITED)
                         --------------------------------------------------------------------------------
                         MAR. 30,  JUN. 29,   SEP. 28,  DEC. 31,   MAR. 29,  JUN. 28,  SEP. 27,  DEC. 31,
                           1996      1996       1996      1996       1997      1997      1997      1997
                         --------  ---------  --------  ---------  --------  --------  --------  --------
                                             (IN MILLIONS, EXCEPT PERCENTAGES AND PER SHARE DATA)
 <S>                     <C>       <C>        <C>       <C>        <C>       <C>       <C>       <C>       
 CONSOLIDATED
  STATEMENT OF INCOME
  DATA
 Net revenues.........   $1,027.7  $ 1,047.4  $ 988.4   $ 1,058.9  $ 944.9   $ 969.7   $1,000.1  $1,104.4
 Cost of sales........     (586.4)    (582.1)  (589.2)     (657.0)  (583.8)   (595.9)    (608.2)   (669.5)
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Gross profit.........      441.3      465.3    399.2       401.9    361.1     373.8      391.9     434.9
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Operating expenses:
 Selling, general &
  administrative......     (107.9)    (102.8)  (103.7)     (106.7)  (103.0)   (113.3)    (111.2)   (126.7)
 Research and
  development.........     (121.4)    (136.0)  (134.5)     (140.4)  (142.2)   (151.5)    (151.5)   (165.7)
 Other income and
  expenses............        8.7       (2.2)     6.4        32.1     (2.4)      6.9       (5.5)     24.3
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Total operating
  expenses............     (220.6)    (241.0)  (231.8)     (215.0)  (247.6)   (257.9)    (268.2)   (268.1)
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Operating income.....      220.7      224.3    167.4       186.9    113.5     115.9      123.7     166.8
 Net interest
  expenses............       (0.5)      (1.6)    (3.2)       (5.9)    (0.7)     (0.7)      (0.5)     (0.8)
 Gain on disposal of
  investment..........        7.3        --       --          --       --        --         --        --
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Income before income
  taxes & minority
  interests...........      227.5      222.7    164.2       181.0    112.8     115.2      123.2     166.0
 Income tax expense...      (52.7)     (46.9)   (32.1)      (39.8)   (23.5)    (23.4)     (26.5)    (39.7)
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Income before
  minority interests..      174.8      175.8    132.1       141.2     89.3      91.8       96.7     126.3
 Minority interests...        0.2        0.3      0.3         0.8      1.2       0.3        0.9       --
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Net income...........   $  175.0  $   176.1  $ 132.4   $   142.0  $  90.5   $  92.1   $   97.6  $  126.3
                         ========  =========  =======   =========  =======   =======   ========  ========
 Earnings per share
  (basic).............   $   1.26  $    1.27  $  0.95   $    1.02  $  0.65   $  0.66   $   0.70  $   0.91
                         ========  =========  =======   =========  =======   =======   ========  ========
 Earnings per share
  (diluted)...........   $   1.26  $    1.27  $  0.95   $    1.02  $  0.65   $  0.66   $   0.70  $   0.90
                         ========  =========  =======   =========  =======   =======   ========  ========
 Number of shares used
  in calculating
  earnings per share
  (basic).............      138.4      138.7    138.8       138.9    139.0     139.1      139.1     139.1
 Number of shares used
  in calculating
  earnings per share
  (diluted)...........      138.8      139.2    139.2       139.6    139.8     139.8      140.0     139.8
<CAPTION>
                                                    AS A PERCENTAGE OF NET REVENUES
                         ----------------------------------------------------------------------------------
 <S>                     <C>       <C>        <C>       <C>        <C>       <C>       <C>       <C>       
 Net revenues.........      100.0%     100.0%   100.0%      100.0%   100.0%    100.0%     100.0%    100.0%
 Cost of sales........      (57.1)     (55.6)   (59.6)      (62.0)   (61.8)    (61.5)     (60.8)    (60.6)
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Gross profit.........       42.9       44.4     40.4        38.0     38.2      38.5       39.2      39.4
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Operating expenses:
 Selling, general &
  administrative......      (10.5)      (9.8)   (10.5)      (10.1)   (10.9)    (11.7)     (11.1)    (11.5)
 Research and
  development.........      (11.8)     (13.0)   (13.6)      (13.3)   (15.0)    (15.6)     (15.1)    (15.0)
 Other income and
  expenses............        0.9       (0.2)     0.6         3.1     (0.3)      0.8       (0.6)      2.2
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Total operating
  expenses............      (21.4)     (23.0)   (23.5)      (20.3)   (26.2)    (26.5)     (26.8)    (24.3)
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Operating income.....       21.5       21.4     16.9        17.7     12.0      12.0       12.4      15.1
 Net interest
  expenses............        --        (0.1)    (0.3)       (0.6)    (0.1)     (0.1)      (0.1)     (0.1)
 Gain on disposal of
  investment..........        0.6        --       --          --       --        --         --        --
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Income before income
  taxes & minority
  interests...........       22.1       21.3     16.6        17.1     11.9      11.9       12.3      15.0
 Income tax expense...       (5.1)      (4.5)    (3.2)       (3.8)    (2.4)     (2.4)      (2.6)     (3.6)
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Income before
  minority interests..       17.0       16.8     13.4        13.3      9.5       9.5        9.7      11.4
 Minority interests...        --         --       --          0.1      0.1       --         0.1       --
                         --------  ---------  -------   ---------  -------   -------   --------  --------
 Net income...........       17.0%      16.8%    13.4%       13.4%     9.6%      9.5%       9.8%     11.4%
                         ========  =========  =======   =========  =======   =======   ========  ========
</TABLE>
 
   In 1997, approximately 44% of the Company's net revenues originated in
Europe, compared to approximately 43% in 1996. The Company's third quarter
revenues in Europe have averaged slightly less than average revenues during
other quarters due to production slowdowns by its European customers in July
and August. During the third quarter of 1997, the negative impact of third
quarter seasonality in Europe was offset by increased sales in other regions.
Quarterly results have also been and may be expected to continue to be
 
                                      54
<PAGE>
 
substantially affected by the cyclical nature of the semiconductor and
electronic systems industries, the timing and success of new product
introductions and the levels of provisions and other unusual charges incurred.
 
   The Company's 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, and the loss of key personnel. As only a
portion of the Company's expenses varies with its revenues, there can be no
assurance that the Company 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 the Company's operating
results.
 
   First quarter 1997 net revenues declined 10.8% compared to the fourth
quarter of 1996, and were 8.1% below first quarter 1996 net revenues, due to
difficult market conditions, lower demand for certain product families and an
adverse currency effect. Second quarter 1997 net revenues increased 2.6%
compared to the first quarter, but remained 7.4% below second quarter 1996 net
revenues. Third quarter 1997 revenues showed a 3.1% sequential improvement
over the second quarter of 1997 despite seasonal factors that generally reduce
sales during the summer months and were 1.2% above 1996 third quarter net
revenues. Fourth quarter 1997 net revenues registered a 10.4% sequential
improvement over the third quarter of 1997 and a 4.3% increase over the fourth
quarter of 1996. Fourth quarter 1997 performance was characterized by gains in
substantially all major product families. Sales of differentiated products
were up significantly in the fourth quarter of 1997 over the third quarter of
1997 as the weakness in the market for hard disk drives and set top boxes was
more than offset by increased sales of products such as graphics destined for
the PC market and specialized devices for automotive and telecom applications.
 
   Gross profit as a percentage of net revenues in the fourth quarter of 1997
increased to 39.4% from 39.2% in the third quarter, 38.5% in the second
quarter and 38.2% in the first quarter of 1997. Excluding other revenues,
gross profit as a percentage of net revenues for the fourth quarter of 1997
and third quarter of 1997 would have been 38.3% and 38.0%, respectively,
comparable to the second quarter and reflecting a continued difficult pricing
environment. Fourth quarter 1997 gross profit included costs associated with
the ramping up of the 8-inch fab in Catania, Italy, whose costs were
previously considered as start-up costs and therefore included in other income
and expenses.
 
   The Company anticipates that industry-wide excess capacity will extend
through the remainder of 1998. The economic situation in Asia has made
visibility on market requirements more difficult, and its full impact on the
semiconductor industry is not yet clear. However, the Company believes that
Asian market developments are creating additional pressures on semiconductor
prices in general and, to a lesser extent, on unit demand. In addition, to the
extent the Company's customers experience reduced demand for their products
that incorporate the Company's products due to the economic difficulties in
Asia, the Company's results of operations could be adversely affected. Towards
the end of 1998, the Company should begin to benefit from improved
manufacturing efficiency and new product sales.
 
IMPACT OF INFLATION
 
   The Company believes that inflation has not had a material effect on the
results of its operations during the periods presented.
 
IMPACT OF CHANGES IN EXCHANGE RATES
 
   The Company's results of operations and financial condition can be
significantly affected by changes in exchange rates between the U.S. dollar
and other currencies, particularly the Italian lira, the French franc, the
German mark, the Japanese yen and other Asian currencies.
 
                                      55
<PAGE>
 
   Revenues for certain 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 quoted in U.S. dollars and 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.
 
   Certain significant costs incurred by the Company, such as manufacturing
labor costs and depreciation charges, selling, general and administrative
expenses, and research and development expenses, are incurred in the
currencies of jurisdictions where the Company's operations are located.
Fluctuations in the value of these currencies, particularly the Italian lira
and the French franc, compared to the U.S. dollar can affect the Company's
costs and therefore its profitability.
 
   The appreciation in the U.S. dollar in 1997 compared to 1996 against the
principal European and Asian currencies that have a material impact on the
Company resulted in a favorable impact on results of operations for the period
because the negative impact on net revenues was more than offset by the
positive impact on cost of sales and operating expenses resulting in a net
favorable impact on operating income. Net revenues in 1997 were materially
adversely affected by the depreciation of European currencies and the Japanese
yen against the U.S. dollar due to the significance of the Company's sales in
these currencies and the impact of translating such local currency revenues
into U.S. dollars. In 1996, the U.S. dollar on average appreciated slightly
against the principal European (except Italian) and Asian currencies which
have a material impact on the Company. The exchange rate impact on results of
operations in 1996 was not significant. The strong depreciation of the U.S.
dollar against such currencies in the first six months of 1995 resulted in a
negative impact on results of operations in 1995.
 
   The Company's principal strategies to reduce the risks associated with
exchange rate fluctuations have been (i) to increase the proportion of sales
to customers denominated in U.S. dollars, (ii) to purchase raw materials and
services in transactions denominated in U.S. dollars (thereby reducing the
exchange rate risk for costs relative to revenues, which are principally
denominated or determined by reference to the U.S. dollar), and (iii) to
manage certain other costs, such as financial costs, to maintain an
appropriate balance between U.S. dollars and other currencies based upon the
currency environment at the time. From time to time, the Company purchases or
sells currencies forward to cover currency risk in obligations or receivables.
The Company has not experienced significant gains or losses as a result of
exchange coverage activities. Its management strategies to reduce exchange
rate risks have served to mitigate, but not eliminate, the positive or
negative impact of exchange rate fluctuations. See "Item 9A: Quantitative and
Qualitative Disclosures About Market Risk."
 
   Assets and liabilities of subsidiaries are, for consolidation purposes,
translated into U.S. dollars at the period-end exchange rate. See Note 2.4 to
the Consolidated Financial Statements. Income and expenses are translated at
the average exchange rate for the period. Adjustments resulting from the
translation are recorded directly in shareholders' equity, and are shown as
"translation adjustment" in the consolidated statements of changes in
shareholders' equity. The balance sheet impact of such translation adjustments
has been, and may be expected to be, significant from period to period.
 
   The Company's outstanding indebtedness is denominated principally in
Italian lire, U.S. dollars, French francs, Maltese lire and Singapore dollars.
See Note 15 to the Consolidated Financial Statements.
 
LIQUIDITY AND CAPITAL RESOURCES
 
   The Company's net cash generated from operations totaled $983.8 million in
1997 compared to $980.7 million in 1996 and $825.1 million in 1995.
Significant amounts of net cash generated from operations in 1995, 1996 and
1997 coupled with capital increases undertaken by the Company in October 1995,
which resulted in net proceeds to the Company of $371.6 million, enabled the
Company to substantially reduce its indebtedness, finance capital expenditures
and improve its balance sheet over the last five years. The Company had a
negative net financial position (cash, cash equivalents and marketable
securities net of total debt) of $78.8 million at
 
                                      56
<PAGE>
 
December 31, 1997 compared to a negative net financial position of $66.7
million at December 31, 1996. At December 31, 1997, cash and cash equivalents
was $702.2 million, compared to $551.9 million at December 31, 1996 and $754.0
million at December 31, 1995. At December 31, 1997, the aggregate amount of
the Company's long-term credit facilities was approximately $415 million, all
of which was outstanding, and the aggregate amount of the Company's short-term
facilities was approximately $873 million, under which approximately $366
million of indebtedness was outstanding. At December 31, 1997, the Company had
approximately $58.6 million of long-term indebtedness that will become due
within one year and expects to fund such debt repayments from available cash.
See also "--Recent Events."
 
   In 1997, the Company's capital expenditure payments totaled $1,035.4
million, compared to $1,125.2 million in 1996 and $1,001.9 million in 1995.
Capital expenditures for 1997 were devoted principally (i) to equip and
upgrade both the new 8-inch and existing 6-inch front-end facilities at the
Catania, Italy plant, (ii) to the expansion of the 8-inch front-end wafer
fabrication plant in Crolles, France, (iii) to the extension and conversion of
an existing facility in Agrate, Italy, (iv) to the upgrading of the front-end
facility and the construction of a new 8-inch wafer fabrication plant in
Rousset, France, (v) to the ramp-up of production at the Phoenix, Arizona 8-
inch front-end manufacturing facility, (vi) to the expansion of the back-end
facility in Muar, Malaysia, (vii) to the expansion of the 6-inch facility in
Carrollton, Texas, (viii) to the expansion of the back-end facilities in
Singapore, Shenzhen (China), Malta and Morocco and (ix) to the upgrade of the
wafer fabrication facility in Rancho Bernardo. Capital expenditures for 1996
were devoted principally (i) to equip and upgrade both the new 8-inch and
existing 6-inch front-end facilities at the Catania, Italy plant, (ii) to the
expansion of the 8-inch front-end wafer fabrication plant in Crolles, France,
(iii) to the extension and conversion of an existing facility in Agrate,
Italy, (iv) to the upgrading of the front-end facility and the construction of
a new 8-inch wafer fabrication plant in Rousset, France, (v) to the ramp-up of
production at the Phoenix, Arizona 8-inch front-end manufacturing facility,
(vi) to the upgrade of the wafer fabrication facility in Rancho Bernardo,
(vii) to the completion of the first phase of the back-end facility of
Shenzhen, China and (viii) to expand the back-end facilities in Malaysia,
Malta and Morocco.
 
   The Company currently expects that capital spending for 1998 will continue
to be at levels at least as high as in 1996 and 1997, and possibly higher.
Although the Company has not yet finalized its budget planning for 1999, which
is subject to market conditions and approval by the Supervisory Board, capital
expenditures for 1999 could be significantly higher. The most significant of
the Company's 1998 capital expenditure projects are expected to be the
conversion of its facilities in Crolles, France to 0.25 micron and 0.18 micron
processes, the increase of capacity of the 8-inch facilities in Catania,
Italy, and Phoenix, Arizona, the completion of construction of its new 8-inch
front-end wafer fabrication facility in Rousset, France, the conversion from
6-inch to 8-inch and expansion at one of its front-end wafer fabrication
plants in Agrate, Italy, and the construction of a new 8-inch facility in
Singapore. The Company has also identified an additional 8-inch wafer
fabrication facility to be built in Italy that is planned to be operational by
the year 2001. The Company has decided to build a new 300 millimeter, 12-inch
wafer research fabrication and pilot line at Crolles (France) using 0.18
micron and below process technology. The pilot line will be operated in
partnership with Leti and CNET, which are already working with the Company in
Crolles. The Company has also announced plans for a new center for advanced
research and development and industrialization in the field of nonvolatile
memories in Agrate (Italy) to target 0.13 micron CMOS technology generation by
2003. The Company will continue to monitor its level of capital spending,
however, taking into consideration factors such as trends in the semiconductor
market, capacity utilization and announced additions.
 
   In 1997, the Company's receivables from government agencies totaled $154.9
million compared to $217.3 million in 1996 and $184.7 million in 1995. The
decrease in 1997 was due primarily to cash received from certain government
contracts that was recognized in previous periods. See Note 7 to the
Consolidated Financial Statements. In 1997, the Company's advances from
government agencies totaled $10.1 million compared to $10.7 million in 1996
and $11.2 million in 1995. See Note 16 to the Consolidated Financial
Statements. The timing of receipt of funds under government contracts has been
delayed from time to time in the past, and while generally the Company has
received the amounts recorded in such receivables, there have been instances
in which such funds ultimately have not been paid.
 
                                      57
<PAGE>
 
   The Company expects to have significant capital requirements in the coming
years and intends to continue to devote a substantial portion of its net
revenues to research and development. The Company plans to fund its capital
requirements from cash from operations, available funds, available support
from third parties (including state support, principally from the French and
Italian governments) and may make recourse to borrowings under available
credit lines and, to the extent necessary or attractive based on market
conditions prevailing at the time, the sale of debt or additional equity
securities. There can be no assurance that additional financing will be
available as necessary to fund the Company's working capital requirements,
research and development, industrialization costs or expansion plans, or that
any such financing, if available, will be on terms acceptable to the Company.
 
   The Company believes that its available funds, available support from third
parties, and additional borrowings will be sufficient to meet its anticipated
needs for liquidity through at least 1998.
 
YEAR 2000 COMPLIANCE
 
   The Company is aware of the issues associated with the limitations of the
programming code in many existing computer systems, whereby the computer
systems may not properly recognize date sensitive information as the
millennium (year 2000) approaches. Computer systems include, but are not
limited to, computer systems embedded in production equipment, products
containing computer systems, business data processing systems, production
management and planning systems and personal computers. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Company is currently engaged in the ongoing process of
evaluating its information technology infrastructure for year 2000 compliance
and is working with suppliers and key customers to ensure that their systems
are year 2000 compliant. A Company-wide taskforce has been assembled to
identify, correct or replace, and test the Company's systems to ensure that
they do not malfunction as a result of the year 2000. While the total
estimated cost of these efforts is difficult to predict with accuracy, based
on a preliminary evaluation, the Company believes that there should not be a
material adverse impact on its operating results or financial condition.
However, year 2000 issues could have a significant impact on the Company's
operations and its financial results if modifications cannot be completed on a
timely basis, unforeseen needs or problems arise, or if there are unforeseen
compliance problems with the systems operated by its customers, suppliers,
vendors or subcontractors. In addition, while the Company has initiated
programs to determine whether its current products are year 2000 compliant,
the Company cannot be certain that all its products are year 2000 compliant.
Moreover, the change to the year 2000 may negatively impact the Company's
customers or the semiconductor industry as a whole, causing reduced demand and
market disruption in anticipation of, or following, the year 2000.
 
      ITEM 9A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
   The Company is subject in its operations to interest rate risk and foreign
exchange risk. The Company's exposure to market risk for changes in interest
rates relates primarily to the Company's investment portfolio and long-term
debt obligations. The Company places its cash and cash equivalents with high
credit quality financial institutions. The Company controls the credit risks
associated with financial instruments through credit approvals, investment
limits and centralized monitoring procedures but does not normally require
collateral or other security from the parties to the financial instruments
with off-balance sheet risk. The Company is averse to principal loss and
ensures the safety and preservation of its invested funds by limiting default
risk, market risk and reinvestment risk. The Company primarily enters into
debt obligations to support general corporate and local purposes including
capital expenditures and working capital needs.
 
   The Company enters into forward contracts and foreign currency options to
protect against potentially adverse changes in foreign currency exchange rates
and to cover a portion of both its probable anticipated, but not firmly
committed, transactions and transactions with firm foreign currency
commitments. The risk of loss associated with purchased options is limited to
premium amounts paid for the option contracts. The risk of loss associated
with forward contracts is equal to the exchange rate differential from the
time the contract is made until the time it is settled.
 
                                      58
<PAGE>
 
   Forward contracts outstanding as of December 31, 1997 mature mainly during
first quarter 1998, and amount to $149.5 million forward sale of U.S. dollars,
$17.3 million forward purchase of U.S. dollars, $64.0 million forward sale of
other foreign currencies, and $74.4 million forward purchase of other foreign
currencies. There were no foreign currency options outstanding as of December
31, 1997. All forward contracts outstanding as of December 31, 1997 mature
during 1998. The principal currencies covered are the German mark, the British
pound, the Japanese yen, the French franc, the Swiss franc and the Italian
lira.
 
   The Company does not anticipate any material adverse effect on its
financial position, result of operations or cash flow resulting from the use
of these instruments in the future. There can be no assurance that these
strategies will be effective or that transaction losses can be minimized or
forecasted accurately. The Company does not use financial instruments for
speculative or trading purposes.
 
 
   The table below presents principal amounts and related weighted-average
interest rates by year of maturity for the Company's investment portfolio and
debt obligations:
 
<TABLE>
<CAPTION>
                                                                                         FAIR VALUE AT
                                                                                         DECEMBER 31,
                           1998     1999     2000    2001    2002   THEREAFTER  TOTAL        1997
                         --------  ------- -------- ------- ------- ---------- --------  -------------
                                     (IN THOUSANDS OF U.S. DOLLARS, EXCEPT PERCENTAGES)
<S>                      <C>       <C>     <C>      <C>     <C>     <C>        <C>       <C>
ASSETS:
Cash equivalents:
 Fixed rate............. $702,157       --       --      --      --       --   $702,157    $702,157
 Average interest rate..     5.64%      --       --      --      --       --       5.64%
LONG-TERM DEBT:
 Fixed rate.............  $58,614  $50,430 $107,553 $98,093 $72,609  $27,722   $415,021    $405,445
 Average interest rate..    5.36%    4.77%    4.90%   5.43%   5.43%    5.30%      5.19%
</TABLE>
 
   Long-term debt by currency:
<TABLE>
<CAPTION>
                                                        AMOUNT IN
                                                        THOUSANDS
                                                           OF      AMOUNT IN
                                                        ORIGINAL  THOUSANDS OF
                                                        CURRENCY  U.S. DOLLARS
                                                        --------- ------------
      <S>                                               <C>       <C>
      Italian lira (in million lire)...................  427,050    $242,754
      French franc.....................................  565,952      94,403
      Maltese pound....................................   17,680      45,105
      U.S. dollar......................................   20,000      20,000
      Other currencies.................................      --       12,759
                                                                    --------
      Total in U.S. dollars............................             $415,021
                                                                    ========
</TABLE>
 
 
   The following table provides information about the Company's foreign
exchange forward contracts at December 31, 1997 (in thousands of U.S.
dollars):
<TABLE>
<CAPTION>
                                                                  ESTIMATED
                                   NOTIONAL   AVERAGE CONTRACT   FAIR VALUE
                                   AMOUNT(1)   EXCHANGE RATE   IN U.S. DOLLARS
                                   ---------  ---------------- ---------------
<S>                                <C>        <C>              <C>
FOREIGN CURRENCY FORWARD EXCHANGE
 CONTRACTS TO BUY (SELL)
 U.S. DOLLARS FOR FOREIGN
 CURRENCIES:
Deutsche mark.....................  (20,000)        1.753         $   (431)
Spanish peseta....................   (1,000)      148.850              (19)
Malaysian ringgit.................    2,302         3.861               19
Franch franc......................  (25,000)        5.811             (767)
Chinese yuan......................   15,000         8.323              (39)
Korean wong.......................  (10,000)        1.352           (1,898)
Singapore dollar..................  (93,500)        1.485          (10,705)
                                   --------                       --------
Total net in U.S. dollars......... (132,198)                      $(13,840)
                                   ========                       ========
</TABLE>
 
 
                                      59
<PAGE>
 
<TABLE>
<CAPTION>
                                                                   ESTIMATED
                                    NOTIONAL   AVERAGE CONTRACT   FAIR VALUE
                                   AMOUNT(1)    EXCHANGE RATE   IN U.S. DOLLARS
                                   ----------  ---------------- ---------------
<S>                                <C>         <C>              <C>
FOREIGN CURRENCY FORWARD EXCHANGE
 CONTRACTS TO BUY (SELL)
 GERMAN MARKS FOR FOREIGN
 CURRENCIES:
U.S. dollar......................     (50,000)       1.781           $ 184
Malaysian ringgit................         173        1.910              12
Franch franc.....................       5,000        3.347              (2)
Singapore dollar.................        (840)       0.910             (13)
                                   ----------                        -----
Total net in German marks........     (45,667)
Total net in U.S. dollars........     (25,484)                       $ 181
                                                                     =====
FOREIGN CURRENCY FORWARD EXCHANGE
 CONTRACTS TO BUY (SELL)
 JAPANESE YEN FOR FOREIGN
 CURRENCIES:
U.S. dollar......................    (450,000)     125.590           $ 110
Italian lira.....................     400,000       13.216              (9)
French franc.....................     400,000        0.048            (144)
Singapore dollar.................  (2,100,000)       0.013            (199)
                                   ----------                        -----
Total net in Japanese yen........  (1,750,000)
Total net in U.S. dollars........     (13,505)                       $(242)
                                                                     =====
FOREIGN CURRENCY FORWARD EXCHANGE
 CONTRACTS TO BUY (SELL)
 SWISS FRANCS FOR FOREIGN
 CURRENCIES:
U.S. dollar......................      49,000        1.417           $(917)
Malaysian ringgit................       2,435        2.590              55
French franc.....................         500        4.145              (2)
Singapore dollar.................       1,322        1.132              16
                                   ----------                        -----
Total Swiss francs...............      53,257
Total net in U.S. dollars........      36,628                        $(848)
                                                                     =====
</TABLE>
--------
(1) Amounts in thousands of original currency (Italian lira expressed in
    millions).
 
   The Company also entered into additional forward sale contracts, for a
countervalue of $15.9 million, and forward purchase contracts, for a
countervalue of $28.8 million, denominated in various currencies including
pounds sterling, French francs, Italian lire, Singapore dollars, Spanish
pesetas and Dutch guilders, which approximated the fair value of such
contracts.
 
                                      60
<PAGE>
 
                 ITEM 10: DIRECTORS AND OFFICERS OF REGISTRANT
 
SUPERVISORY BOARD
 
   The management of the Company is entrusted to the Management Board under
the supervision of the Supervisory Board. The Supervisory Board advises the
Management Board and is responsible for supervising the policies pursued by
the Management Board and the general course of affairs of the Company and its
business. In fulfilling their duties under Dutch law, the members of the
Supervisory Board must serve the interests of the Company and its business.
 
   The Supervisory Board consists of such number of members as is resolved by
the general meeting of shareholders upon proposal of the Supervisory Board,
with a minimum of six members. The members of the Supervisory Board are
appointed upon proposal of the Supervisory Board by the general shareholders'
meeting by a majority of the votes cast at a meeting where at least one-half
of the outstanding share capital is present or represented.
 
   Pursuant to various shareholders agreements, the membership of the
Supervisory Board of the Company must include three members designated by the
French shareholders from the Board of Directors of FT1CI (following the merger
of FT2CI and FT1CI, a corporation owned by CEA-Industrie and France Telecom),
and three members designated by the Italian shareholders (of whom I.R.I. has
the right to appoint two members and Comitato SIR has the right to appoint one
member). See "Item 4: Control of Registrant--Shareholder Agreements." The
Supervisory Board of the Company currently includes two members who are not
affiliated with ST Holding and its direct and indirect shareholders.
 
   The members of the Supervisory Board appoint a chairman and vice chairman
of the Supervisory Board from among the members of the Supervisory Board (with
approval of at least three-quarters of the members of the Supervisory Board)
and may appoint one or more members as a delegate supervisory director to
communicate on a regular basis with the Management Board. Resolutions of the
Supervisory Board require the approval of at least three-quarters of its
members. The Supervisory Board must meet upon request by two or more of its
members or by the Management Board. The Supervisory Board has adopted internal
regulations to clarify the manner by which it carries out the supervisory
duties imposed upon it by law, the Company's Articles of Association and
resolutions of the shareholders and the Supervisory Board itself. By such
resolution the Supervisory Board has authorized (i) the establishment of a
secretariat (headed by an individual approved by it and appointed for a one-
year renewable term) whose functions are to: (a) assist the Chairman and Vice
Chairman of the Supervisory Board in the operations of the Board, (b)
implement and oversee the execution within the Company of decisions adopted by
the Supervisory Board, and (c) cooperate in and contribute to the execution of
the functions of the designated Secretary and Assistant Secretary of the
Supervisory Board; (ii) (a) the possibility of the appointment by the members
of the Supervisory Board of assistants and (b) the appointment by such board
of two controllers to exercise operational and financial control over the
operations of the Company who, with assistants, will also review operation
reports and the implementation of Supervisory Board decisions; and (iii) the
establishment by the Supervisory Board of advisory committees. In addition,
the Supervisory Board has established procedures for the preparation of
Supervisory Board resolutions and the setting of the Board's calendar.
 
   Members of the Supervisory Board must retire no later than at the ordinary
general meeting of shareholders held after a period of three years following
their appointment, but may be re-elected. A member of the Supervisory Board
must retire at the ordinary general meeting of shareholders held in the year
in which he reaches the age prescribed by Dutch law for retirement of a
supervisory director (currently at age 72). Members of the Supervisory Board
may be suspended or dismissed by the general meeting of shareholders. The
Supervisory Board may make a proposal to the general meeting of shareholders
for the suspension or dismissal of one or more of its members. The members of
the Supervisory Board may receive compensation if authorized by the general
meeting of shareholders.
 
                                      61
<PAGE>
 
   The shareholders agreement between the group of French shareholders and the
group of Italian shareholders, as shareholders of ST Holding, also includes
certain provisions requiring the approval of the Supervisory Board of ST
Holding for certain actions by ST Holding, the Company and its subsidiaries.
In addition, pursuant to the shareholders agreement among the group of French
shareholders and a decree issued by certain Ministries of The Republic of
France, the approval by members of the Supervisory Board appointed by the
French shareholders of certain actions to be taken by the Company or its
subsidiaries requires the approval of the Board of Directors of FT1CI and is
subject to a veto by certain Ministries of The Republic of France. These
requirements for the prior approval of various actions to be taken by the
Company and its subsidiaries may give rise to a conflict of interest between
the interests of the Company and the individual shareholders approving such
actions, and may result in a delay in the ability of the Management Board to
respond as quickly as may be necessary in the rapidly changing environment of
the semiconductor industry. Such approval process is subject to the provisions
of Dutch law requiring members of the Supervisory Board to act independently
in the supervision of the management of the Company.
 
   The members of the Supervisory Board are:
 
<TABLE>
<CAPTION>
   NAME                          POSITION                  YEAR APPOINTED               AGE
   ----                          --------                  --------------               ---
   <S>                         <C>                         <C>                          <C>
   Bruno Steve                 Chairman                         1989                     56
   Jean-Pierre Noblanc         Vice Chairman                    1994                     59
   Tom de Waard                Member                           1998                     51
   Remy Dullieux               Member                           1993                     47
   Riccardo Gallo              Member                           1997                     54
   Francis Gavois              Member                           1998                     62
   Alessandro Ovi              Member                           1994                     54
   Robert M. White             Member                           1996                     59
</TABLE>
 
   Bruno Steve has been Chairman of the Supervisory Board since June 1996, and
has been a member of the Company's Supervisory Board since 1989. He served as
Vice Chairman of the Supervisory Board from 1989 to July 1990. From July 1990
to March 1993, Mr. Steve served as Chairman of the Supervisory Board. He has
been with I.R.I., Finmeccanica's parent company, Finmeccanica and other
affiliates of I.R.I. in various senior positions for over 17 years. Mr. Steve
is currently Chairman of MEI and a member of the board of statutory auditors
of Alitalia S.p.a. He served as the Chief Operating Officer of Finmeccanica
from 1988 to July 1997 and Chief Executive Officer from May 1995 to July 1997.
He was Senior Vice President of Planning, Finance and Control of I.R.I. from
1984 to 1988. Prior to 1984, Mr. Steve served in several key executive
positions at Telecom Italia, I.R.I.'s holding company for the
telecommunications sector.
 
   Jean-Pierre Noblanc has been a member of the Supervisory Board since 1994
and its Chairman until June 1996. Mr. Noblanc is presently General Manager of
the Components Sector of CEA Industrie. Prior to joining CEA Industrie, Mr.
Noblanc served at CNET, the Research Center of France Telecom, as Director of
the Applied Research Center of Bagneux and of the Microelectronics Center of
Grenoble. Mr. Noblanc holds a degree in engineering from the Ecole Superieure
d'Electricite and a doctoral degree in physical sciences from the University
of Paris. Mr. Noblanc is an Associate Member of the Committee on Applications
of the French Academy of Sciences and a director of Thomson S.A. Mr. Noblanc
also serves on the board of Pixtech Inc. and Picogiga S.A.
 
   Tom de Waard was appointed to the Supervisory Board in 1998. Mr. de Waard
is a partner of Stibbe Simont Monahan Duhot, a leading Dutch law firm, where
he has held several positions since 1979 and has gained extensive experience
working with major international companies, particularly with respect to
corporate finance. He is a member of the Amsterdam bar and received his law
degree from Leiden University in 1979.
 
   Remy Dullieux has been a member of the Supervisory Board since 1993. He is
a graduate of the Ecole Polytechnique. Since June 1996, Mr. Dullieux has
served as a France Telecom Executive Manager for the Northern and Eastern
areas of France. From 1991 to June 1996, Mr. Dullieux served as Group
Executive Vice
 
                                      62
<PAGE>
 
President for Strategic Procurement and Development of France Telecom. From
1985 to 1988, Mr. Dullieux served as Regional Manager of Creteil.
 
   Riccardo Gallo was appointed to the Supervisory Board in 1997. He is
Associate Professor of Industrial Economics at the Engineering Faculty of "La
Sapienza" University in Rome. He is also a member of the board of directors of
Comitato Sir. From 1982 to 1991, he served as Director General at the Italian
Ministry of the National Budget. In the early 1990s, he served as Vice
Chairman of I.R.I. In 1994, he was appointed by the Italian Minister of
Industry as Extraordinary Commissioner of Fidia, a research-oriented
pharmaceutical company.
 
   Francis Gavois was appointed to the Supervisory Board in 1998. Mr. Gavois
is the Chairman of the Supervisory Board of ODDO et Cie. He is also a member
of the Board of Directors of Plastic Omnium and the Supervisory Board of the
Consortium de Realisation (CDR). From 1984 to 1997, Mr. Gavois held several
positions, including Chairman of the Board of Directors and President of
Banque Francaise du Commerce Exterieur (BFCE). Prior to that time Mr. Gavois
held positions in the French government. He is a graduate of the Institut
d'Etudes Politiques de Paris and the Ecole Nationale d'Administration.
 
   Alessandro Ovi has been a member of the Supervisory Board since 1994. He
received a doctoral degree in Nuclear Engineering from the Politecnico in
Milan and a masters degree in operations research from Massachusetts Institute
of Technology. He is currently the Chief Executive Officer of Tecnitel S.p.A.,
a subsidiary of Telecom Italia Group. Prior to joining Tecnitel S.p.A., Mr.
Ovi was the Senior Vice President of International Affairs and Communications
at I.R.I. He currently serves on the boards of Alitalia, Telecom Italia,
Italtel (a Telecom Italia and Siemens Company), MEI, Sirti, Zambon, Carnegie
Mellon University and Corporation Development Committee of the Massachusetts
Institute of Technology.
 
   Robert M. White was appointed to the Supervisory Board in June 1996. Mr.
White is a University Professor and Department Head at Carnegie Mellon
University and serves as a member of several corporate boards, including those
of Ontrack Data Systems, Inc., and Zilog, Inc. He is a member of the U.S.
National Academy of Engineering. From 1990 to 1993, Mr. White served as Under
Secretary of Commerce for Technology in the United States Government. Prior to
1990, Mr. White served in several key executive positions at Xerox
Corporation, Control Data Corporation and MCC. He received a doctoral degree
in physics from Stanford University and graduated with a degree in science
from Massachusetts Institute of Technology.
 
   The Supervisory Board has established an Audit Committee comprised of
Messrs. Dullieux, Ovi and an independent director, Mr. White, and a
Compensation Committee comprised of the Chairman (Mr. Steve), the Vice
Chairman (Mr. Noblanc) and an independent director (Mr. White).
 
MANAGEMENT BOARD
 
   The management of the Company is entrusted to the Management Board under
the supervision of the Supervisory Board. Under the Articles of Association,
the Management Board must obtain prior approval from the Supervisory Board for
(i) all proposals to be submitted to a vote at the general meeting of
shareholders; (ii) the formation of all companies, acquisition or sale of any
participation, and conclusion of any cooperation and participation agreement;
(iii) all multi-year plans of the Company and the budget for the coming year,
covering investment policy, policy regarding research and development, as well
as commercial policy and objectives, general financial policy, and policy
regarding personnel; and (iv) all acts, decisions or operations covered by the
foregoing and constituting a significant change with respect to decisions
already taken by the Supervisory Board. The Management Board must seek
approval from the general meeting of shareholders for decisions relating to
(i) the sale of all or of an important part of the Company's assets or
concerns; and (ii) all mergers, acquisitions or joint ventures which the
Company wishes to enter into and which the Supervisory Board considers to be
of material significance. In addition, under the Articles of Association, the
Supervisory Board may specify by resolution certain actions by the Management
Board that require its prior approval. Following the adoption of such a
resolution, the actions by the Management Board requiring such prior approval
include the following:
 
                                      63
<PAGE>
 
(i) modification of its Articles of Association; (ii) change in its authorized
share capital, issue, acquisition or disposal of its own shares, change in any
shareholder rights or issue of any instruments granting an interest in its
capital or profits; (iii) liquidation or disposal of all or a substantial and
material part of its assets or any shares it holds in any of its subsidiaries;
(iv) entering into any merger, acquisition or joint venture agreement (and, if
substantial and material, any agreement relating to intellectual property) or
formation of a new company; (v) approval of such company's draft consolidated
balance sheets and financial statements or any profit distribution by such
company; (vi) entering into any agreement with any of the direct or indirect
French or Italian shareholders outside the normal course of business; (vii)
submission of documents reporting on (a) approved policy, expected progress
and results and (b) strategic long-term business plans and consolidated annual
budgets or any modifications to such; (viii) preparation of long-term business
plans and annual budgets; (ix) adoption and implementation of such long-term
business plans and annual budgets; (x) approval of all operations outside the
normal course of business, including operations already provided for in the
annual budget; and (xi) approval of the quarterly, semi-annual and annual
consolidated financial statements prepared in accordance with internationally
accepted accounting principles. Such resolution also requires that the
Management Board obtain prior approval from the Supervisory Board for (i) the
appointment of the members of the statutory management, administration and
control bodies of the Company's French and Italian subsidiaries; and (ii) the
nomination of the statutory management, administration and control bodies of
the Company and each of the Company's other direct and indirect subsidiaries
followed by confirmation to the Supervisory Board of such nominees'
appointments. The general meeting of shareholders may also specify certain
actions of the Management Board that require shareholder approval. The
Company's Articles of Association provide that the Management Board must
obtain shareholder approval prior to (i) the sale of all or an important part
of the Company's assets and concerns; and (ii) all mergers, acquisitions or
joint ventures which the Company wishes to enter into and which the
Supervisory Board considers to be of material significance. See "Item 1:
Description of Business" and "Item 13: Interest of Management in Certain
Transactions."
 
   The Management Board shall consist of such number of members as resolved by
the general meeting of shareholders upon the proposal of the Supervisory
Board. The members of the Management Board are appointed for three year terms
upon proposal by the Supervisory Board at the general shareholders' meeting by
a majority of the votes cast at a meeting where at least one-half of the
outstanding share capital is present or represented. The Supervisory Board
appoints one of the members of the Management Board to be chairman of the
Management Board (upon approval of at least three-quarters of the members of
the Supervisory Board). Resolutions of the Management Board require the
approval of a majority of its members. Mr. Pasquale Pistorio, the Company's
President and Chief Executive Officer, is currently the sole member of the
Management Board.
 
   The general meeting of shareholders may suspend or dismiss one or more
members of the Management Board at a meeting at which at least one-half of the
outstanding share capital is present or represented. No quorum is required if
a suspension or dismissal is proposed by the Supervisory Board. The
Supervisory Board may suspend members of the Management Board, but a general
meeting of shareholders must be convened within three months after such
suspension to confirm or reject the suspension. The Supervisory Board shall
appoint one or more persons who shall, at any time, in the event of absence or
inability to act of all the members of the Management Board, be temporarily
responsible for the management of the Company. The Supervisory Board
determines the compensation and other terms and conditions of employment of
the members of the Management Board.
 
                                      64
<PAGE>
 
EXECUTIVE OFFICERS
 
   The executive officers of the Company support the Management Board in its
management of the Company, without prejudice to the Management Board's
ultimate responsibility.The Company is organized in a matrix structure with
geographical regions interacting with product divisions, bringing all levels
of management closer to the customer and facilitating communication among
research and development, production, marketing and sales organizations.
 
   The executive officers of the Company are:
 
<TABLE>
<CAPTION>
                                                                    YEARS IN
                                                     YEARS WITH   SEMICONDUCTOR
          NAME                  POSITION           THE COMPANY(1)   INDUSTRY    AGE
          ----                  --------           -------------- ------------- ---
 <C>                    <S>                        <C>            <C>           <C>
 Pasquale Pistorio      President and Chief              18             34       62
                         Executive Officer
 Laurent Bosson         Corporate Vice                   15             15       55
                         President, Central
                         Front-end Manufacturing
 Carlo Bozotti          Corporate Vice                   21             21       45
                         President, European and
                         Headquarters Region
 Salvatore Castorina    Corporate Vice                   16             32       61
                         President, Discrete and
                         Standard ICs Group
 Murray Duffin          Corporate Vice                   11             38       61
                         President, Total
                         Quality and
                         Environmental
                         Management
 Alain Dutheil          Corporate Vice                   15             28       53
                         President, Strategic
                         Planning and Human
                         Resources
 Ennio Filauro          Corporate Vice                   29             38       65
                         President, Memory
                         Products Group
 Philippe Geyres        Corporate Vice                   14             22       46
                         President, Programmable
                         Products Group
 Maurizio Ghirga        Corporate Vice                   15             15       60
                         President, Chief
                         Financial Officer
 Jean-Claude Marquet    Corporate Vice                   12             31       56
                         President, Asia Pacific
                         Region
 Pier Angelo Martinotti Corporate Vice                   17             30       57
                         President, New Ventures
                         Group
 Joel Monnier           Corporate Vice                   15             24       52
                         President, Central
                         Research and
                         Development
 Piero Mosconi          Corporate Vice                   34             34       58
                         President, Treasurer
 Richard Pieranunzi     Corporate Vice                   17             32       59
                         President, Americas
                         Region
 Aldo Romano            Corporate Vice                   32             32       57
                         President, Dedicated
                         Products Group
 Giordano Seragnoli     Corporate Vice                   33             35       61
                         President, Back-end
                         Manufacturing and
                         Subsystems
 Keizo Shibata          Corporate Vice                    6             33       61
                         President, Japan Region
 Enrico Villa           Corporate Vice                   30             30       57
                         President, Region Five
</TABLE>
--------
(1) Including years with Thomson Semiconducteurs or SGS Microelettronica.
 
   Pasquale Pistorio has more than 34 years of experience in the semiconductor
industry. After graduating in Electrical Engineering from the Polytechnical
University of Turin in 1963, he started his career selling Motorola products.
Mr. Pistorio joined Motorola in 1967, becoming Director of World Marketing in
1977 and General Manager of the International Semiconductor Division in 1978.
Mr. Pistorio joined SGS Microelettronica as President and Chief Executive
Officer in 1980 and became President and Chief Executive Officer of the
Company upon its formation in 1987.
 
 
                                      65
<PAGE>
 
   Laurent Bosson has served as Corporate Vice President, Central Front-end
Manufacturing and VLSI Fabs since 1989 and from 1992 to 1996 he was given
additional responsibility as President and Chief Executive Officer of the
Company's operations in the Americas. Mr. Bosson received a Masters degree in
Chemistry from the University of Dijon in 1969. He joined Thomson-CSF in 1964
and has held several positions in engineering and manufacturing. In 1982, Mr.
Bosson was appointed General Manager of the Tours and Alencon facilities of
Thomson Semiconducteurs. In 1985, he joined the French subsidiary of SGS
Microelettronica as General Manager of the Rennes, France manufacturing
facility.
 
   Carlo Bozotti has served as Corporate Vice President, Europe and
Headquarters Region since 1994. Mr. Bozotti joined SGS Microelettronica in
1977 after graduating in Electronic Engineering from the University of Pavia.
Mr. Bozotti served as Product Manager for the Industrial, Computer Peripheral
and Telecom divisions and as Product Manager for the Monolithic Microsystems'
Telecom business unit from 1986 to 1987. He was appointed Director of
Corporate Strategic Marketing and Key Accounts for the Headquarters Region in
1988 and became Vice President, Marketing and Sales, Americas Division in
1991.
 
   Salvatore Castorina has served as Corporate Vice President, Discrete and
Standard ICs Group since 1989. Mr. Castorina received his engineering degree
in Electronics from the Polytechnical University of Turin and began his career
as a teacher of electrical and electronic technologies prior to joining
Thomson-CSF in Milan in 1965. In 1967, he joined Motorola Semiconductors and
held various positions in sales and marketing. In 1981, Mr. Castorina joined
the Company as General Manager of Transistors in Catania and became the
General Manager of the Company's Discrete Division in 1989.
 
   Murray Duffin has served as Corporate Vice President, Total Quality and
Environmental Management since 1992. Mr. Duffin graduated from the University
of Manitoba in Electrical Engineering and later studied Semiconductor Physics
and Computer Logic at the University of California Los Angeles and received an
MBA from Arizona State University. Mr. Duffin started his career in 1959 as an
RF Applications Engineer and thereafter held numerous managerial positions
within most of the departments at TRW and Motorola Semiconductors prior to
joining the Company in 1986. From 1986 to 1992, Mr. Duffin was in charge of
the quality and service organization.
 
   Alain Dutheil has served as Corporate Vice President, Strategic Planning
and Human Resources since 1994 and 1992, respectively. Mr. Dutheil is also
President of the Company's French subsidiary. After graduating in Electrical
Engineering from the Ecole Superieure d'Ingenieurs de Marseilles (ESIM), Mr.
Dutheil joined Texas Instruments in 1969 as a Production Engineer, becoming
Director for Discrete Products in France and Human Resources Director for
Texas Instruments, France in 1980 and Director of Operations for Texas
Instruments, Portugal in 1982. He joined Thomson Semiconducteurs in 1983 as
General Manager of a plant in Aix-en-Provence, France and then became General
Manager of the Company's Discrete Products Division. From 1989 to 1994, Mr.
Dutheil served as Director for Worldwide Back-end Manufacturing, in addition
to serving as Corporate Vice President for Human Resources from 1992 until the
present.
 
   Ennio Filauro has served as Corporate Vice President, General Manager
Memory Products Group since 1990. After graduating with a degree in Electrical
Engineering from the University of Palermo, Mr. Filauro began his career in
1958 as a member of the Engineering and Quality Control Group of Raytheon
Italia. In 1968, Mr. Filauro joined SGS Microelettronica as head of Quality
Control Services at the research and development center in Castelletto, and
was subsequently responsible for the Central Production Direction of the
facilities in Rennes, Falkirk and Catania. From 1974 to 1979, Mr. Filauro
served as General Manager of the facility in Catania, and thereafter served as
Director of the Corporate Engineering Group in Agrate. He became General
Manager of the VLSI Division of SGS Microelettronica in 1985.
 
   Philippe Geyres has served as Corporate Vice President, General Manager
Programmable Products Group since 1990. Mr. Geyres graduated from the Ecole
Polytechnique in 1973 and began his career with IBM in France before joining
Schlumberger Group in 1980 as Data Processing Director. He was subsequently
appointed Deputy Director of the IC Division at Fairchild Semiconductors. Mr.
Geyres joined Thomson Semiconducteurs
 
                                      66
<PAGE>
 
in 1983 as Director of the Bipolar Integrated Circuits Division. He was
appointed Strategic Programs Director in 1987 and, later the same year, became
Corporate Vice President, Strategic Planning of the Company.
 
   Maurizio Ghirga became Corporate Vice President, Chief Financial Officer in
1987, after having served as chief financial controller of SGS
Microelettronica since 1983. Mr. Ghirga has a degree in Business
Administration from the University of Genoa. He spent more than ten years of
his career in various financial capacities at ESSO Company (an Exxon
subsidiary in Italy) and prior to joining the Company was Financial Controller
of one of the largest refinery plants in Italy and of an ESSO chemical
subsidiary.
 
   Jean-Claude Marquet has served as Corporate Vice President, Asia Pacific
Region since July 1995. After graduating in Electrical and Electronics
Engineering from the Ecole Breguet Paris, Mr. Marquet began his career in the
French National Research Organisation and later joined Alcatel. In 1969, he
joined Philips Components. He remained at Philips until 1978, when he joined
Ericsson, eventually becoming President of Ericsson's French operations. In
1985, Mr. Marquet joined Thomson Semiconducteurs as Vice President Sales and
Marketing, France. Thereafter, Mr. Marquet served as Vice President Sales and
Marketing for France and Benelux, and Vice President Asia Pacific and Director
of Sales and Marketing for the region.
 
   Pier Angelo Martinotti has served as Corporate Vice President, General
Manager New Ventures Group since 1994. A graduate in Electronic Engineering
from the Polytechnical University of Turin, Mr. Martinotti began his career at
the Company in 1965 as an Application and Marketing Engineer. In 1968, he
joined Motorola Semiconductors in the area of strategic marketing in Europe,
and in 1975 became the Marketing (Sales) Director for Europe. From 1986 to
1990, Mr. Martinotti was Chief Executive Officer of Innovative Silicon
Technology, a former subsidiary of the Company. Mr. Martinotti was appointed
Director of Corporate Strategic Planning in 1990.
 
   Joel Monnier has served as Corporate Vice President, Director of Central
Research and Development since 1989. After graduating in Electrical
Engineering from the Institut National Polytechnique of Grenoble, Ecole
Nationale Superieure de Radio Electricite, Mr. Monnier obtained a doctoral
degree in microelectronics at LETI/CENG. He began his career in the
semiconductor industry in 1968 as a researcher with CENG, and subsequently
joined the research and development laboratories of Texas Instruments in
Villeneuve Loubet, France and Houston, Texas, eventually becoming Engineering
Manager and Operation Manager at Texas Instruments. Mr. Monnier joined
Thomson-CSF in 1983 as head of the research and manufacturing unit of Thomson
Semiconducteurs. In 1987, he was appointed Vice President and Corporate
Director of Manufacturing.
 
   Piero Mosconi has served as Corporate Vice President, Treasurer since 1987.
After graduating in accounting from Monza in 1960, Mr. Mosconi joined the
faculty at the University of Milan. Mr. Mosconi worked with an Italian bank
before joining the Foreign Subsidiaries Department at SGS Microelettronica in
1964 and becoming Corporate Director of Finance in 1980.
 
   Richard Pieranunzi has served as Corporate Vice President, Americas Region
since August 1996. Mr. Pieranunzi received his BSEE from the University of
Rhode Island, and started his career in process engineering. Later, he joined
Motorola's international marketing organization, including in Europe where he
held management positions in sales and strategic marketing and applications.
Mr. Pieranunzi joined SGS Semiconducteurs in 1981 as Marketing and Sales
Manager and, upon the formation of the Company in 1987, he became Vice
President Marketing and Sales for the U.S. organization. For three years, Mr.
Pieranunzi headed the Company's Corporate Strategic Marketing and Corporate
Key Account programs.
 
   Aldo Romano has served as Corporate Vice President, General Manager
Dedicated Products Group since 1987. Mr. Romano is also Managing Director of
the Company's Italian subsidiary. A graduate in Electronic Engineering from
the University of Padua in 1963, Mr. Romano joined SGS Microelettronica in
1965 as a designer of linear ICs, becoming head of the linear IC design
laboratory in 1968 and head of Marketing and Applications in 1976. Mr. Romano
became Director of the Bipolar IC Division (which has evolved into the
Dedicated Products Group) in 1980.
 
                                      67
<PAGE>
 
   Giordano Seragnoli has served as Corporate Vice President, General Manager
Subsystems since 1987 and since 1994, Director for Worldwide Back-end
Manufacturing. After graduating in Electrical Engineering from the University
of Bologna, Mr. Seragnoli joined the Thomson Group as RF Application Designer
in 1962 and joined SGS Microelettronica in 1965. Thereafter, Mr. Seragnoli
served in various capacities within the Company, including Strategic Marketing
Manager and Subsystems Division Manager, Subsystems Division Manager (Agrate),
Technical Facilities Manager, Subsystems Division Manager and Back-End
Manager.
 
   Keizo Shibata has served as Corporate Vice President and President of the
Company's Japanese subsidiary since 1992. Mr. Shibata obtained bachelors and
masters degrees in Engineering from Osaka University and has 31 years of
experience in the semiconductor industry. Prior to joining the Company, Mr.
Shibata was employed with Toshiba Corporation since 1964 in various
capacities. From 1987 to 1988, Mr. Shibata served as Chairman of both World
Semiconductor Trade Statistics and the Trade Policy Committee of the Electric
Industry Association of Japan.
 
   Enrico Villa has served as Corporate Vice President, Region Five since
January 1, 1998. Mr. Villa has served in various capacities within the Company
since 1968 after obtaining a degree in Business Administration from the
University of Genoa and has 30 years of experience in the semiconductor
industry. He is currently a member of the European Electronics Component
Association ("EECA") for which he is now Chairman of the European
Semiconductor Council as well as Chairman for Europe at the Joint Steering
Committee of the World Semiconductor Council.
 
   As is common in the semiconductor industry, the Company's success depends
to a significant extent upon, among other factors, the continued service of
its key senior executives and research and development, engineering,
marketing, sales, manufacturing, support and other personnel, and on its
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 the
Company. The Company does not maintain insurance with respect to the loss of
any of its key personnel.
 
                ITEM 11: COMPENSATION OF DIRECTORS AND OFFICERS
 
 
   The aggregate cash compensation payable for 1997 to the members of the
Supervisory Board by the Company was approximately $307,000. The amount of
cash compensation for 1997 paid to the executive officers of the Company and
members of the Management Board as a group by the Company and its subsidiaries
was approximately $7 million.
 
   In 1989, the Company established a Corporate Executive Incentive Program
(the "EIP") that entitles selected executives and members of the Management
Board to a yearly bonus based upon the individual performance of such
executives. The maximum bonus awarded under the EIP is based upon a percentage
of the executive's or member's salary and is adjusted to reflect the overall
performance of the Company. The participants in the EIP must satisfy certain
personal objectives that are focused on customer service, profit, cash flow
and market share.
 
   The executive officers and the Management Board were also covered in 1997
under certain group life and medical insurance programs provided by the
Company. The aggregate additional amount set aside by the Company in 1997 to
provide pension, retirement or similar benefits for executive officers and the
Management Board of the Company as a group is estimated to have been
approximately $3.1 million.
 
    ITEM 12: OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
 
STOCK OPTION PLANS
 
   As of June 24, 1998, options to purchase up to an aggregate of 109,570
Common Shares were outstanding under the Company's first stock option plan
(the "1989 Stock Option Plan"). Such options are fully vested and
 
                                      68
<PAGE>
 
are exercisable at the original issue price, as adjusted to reflect the 40:1
stock split effected in connection with the Initial Public Offering, of NLG 25
per share or at the price of NLG 17.50 per share. Of such outstanding options,
31,000 are held by executive officers of the Company as a group. All options
outstanding under the 1989 Stock Option Plan expire December 18, 1999.
 
   On October 20, 1995, the Shareholders of the Company approved resolutions
authorizing the Supervisory Board for a period of five years to adopt and
administer a new stock option plan which provides for the granting to managers
and professionals of the Company of options to purchase up to a maximum of 5.5
million Common Shares (the "1995 Stock Option Plan"). The Company has granted
1,845,500 options pursuant to the 1995 Stock Option Plan, of which Options to
purchase 1,200,000 Common Shares have an exercise price per Common Share of
$36.25. As of June 24, 1998, 1,167,700 of these options were outstanding;
583,850 of such options will vest and become exercisable on March 1, 1999, and
583,850 of such options will vest and become exercisable on March 1, 2000. All
such options will expire on March 1, 2004. The remaining options to purchase
645,500 Common Shares have an exercise price per Common Share of $85.375 out
of which, as of June 24, 1998, 642,300 were outstanding. These options will
vest and become exercisable on September 12, 2001 and will expire on September
12, 2005.
 
   In June 1996, the general meeting of shareholders approved the granting of
options to members and professionals of the Supervisory Board to purchase
approximately 72,000 Common Shares of the Company over a period of three
years, beginning in 1996. On October 22, 1996, options to purchase an
aggregate of 33,000 Common Shares at an exercise price of $54.00 per Common
Share were granted by the Company to members and professionals of the
Supervisory Board. As of June 24, 1998, 1,500 options granted to members and
professionals of the Supervisory Board had been exercised. Such options are
exercisable until October 22, 2004.
 
   On September 12, 1997, additional options to purchase an aggregate of
15,000 Common Shares at an exercise price of $85.375 per Common Share were
granted by the Company to members and professionals of the Supervisory Board.
None of these options had been exercised as of June 24, 1998. Such options are
exercisable until September 12, 2005.
 
EMPLOYEE STOCK PLAN
 
   The Company has implemented an Employee Stock Plan under which employees
have subscribed for a total of 302,338 Common Shares at a 12% discount from
the public offering price used in the Share Offering ($72.1875 per Common
Share). These Shares are subject to a six-month holding period expiring on
December 10, 1998. The subscription period ended on June 10, 1998 and payment
for the Shares is expected to occur prior to the expiry of the holding period.
 
            ITEM 13: INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
 
   One of the Company's key customers is Thomson Multimedia. Thomson
Multimedia and Thomson-CSF, one of the indirect shareholders of the Company
until October 1997 (see "Item 4: Control of Registrant"), are both controlled
by Thomson S.A. The Company sells a broad range of products to Thomson
Multimedia, including dedicated products, microcontrollers and semicustom
devices, for use in televisions, video cassette recorders and satellite
receiver systems. The Company believes that all of the products that it sells
to Thomson Multimedia are sold on commercial terms no less favorable to the
Company than could be obtained with non-affiliated parties. The Company has
also formed a Groupement d'Interet Economique ("GIE") with Thomson Multimedia
to conduct joint research and development on advanced television products,
including digital television products. The Company and Thomson Multimedia
share equally the funding of the joint venture's designers, engineers and
managers.
 
   The Company has formed a joint venture research and development center with
CNET in the form of a GIE. CNET is a research laboratory that is wholly owned
by France Telecom, one of the indirect shareholders of
 
                                      69
<PAGE>
 
the Company. See "Item 1: Description of Business--Research and Development"
and "Item 4: Control of Registrant." The research center is housed at the
Company's Crolles, France manufacturing facility, and is developing submicron
process technologies. The joint venture between the Company and CNET was
created before France Telecom became an indirect shareholder of the Company.
 
   The Company has signed an agreement providing for a research and
development cooperation with GRESSI, the research and development GIE formed
by CNET and LETI, a research laboratory that is a department of CEA-Industrie,
the parent of one of the indirect shareholders of the Company. See "Item 4:
Control of Registrant." The objectives of the cooperation is to develop know-
how on innovative aspects of VLSI technology evolution which can be
transferred to industrial applications, and to address the development of
innovative process steps and process modules to be used in future generations
of VLSI products. The cooperation agreement is based upon a multi-year plan
through 1998, of which the Company bears half of the total cost.
 
   The Company participates in certain programs sponsored by the French and
Italian governments for the funding of research and development and
industrialization through direct grants as well as low interest financing. See
"Item 1: Description of Business--State Support for the Semiconductor
Industry." The shareholders of ST Holding, the corporate parent of the
Company's majority shareholder, are controlled, directly or indirectly, by the
governments of the Republics of France and Italy. See "Item 4: Control of
Registrant."
 
   Sales to shareholders of the Company and their affiliates totalled $148.2
million in 1997.
 
  From time to time, the Company may hold with its direct or indirect
shareholders, or their affiliates, certain available funds on a short-term
basis at market interest rates.
 
                                      70
<PAGE>
 
                                    PART II
 
              ITEM 14: DESCRIPTION OF SECURITIES TO BE REGISTERED
 
  Not applicable.
 
                                   PART III
 
                    ITEM 15: DEFAULT UPON SENIOR SECURITIES
 
  Not applicable.
 
          ITEM 16: CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR
                   REGISTERED SECURITIES AND USE OF PROCEEDS
 
  Not applicable.
 
                                    PART IV
 
                         ITEM 17: FINANCIAL STATEMENTS
 
  Not applicable.
 
                         ITEM 18: FINANCIAL STATEMENTS
 
  See "Item 19: Financial Statements and Exhibits" for a list of financial
statements filed pursuant to this Item 18.
 
                  ITEM 19: FINANCIAL STATEMENTS AND EXHIBITS
 
  (a) Financial Statements
 
<TABLE>
<CAPTION>
                                                                          PAGE
                                                                          ----
<S>                                                                       <C>
Report of Independent Accountants for the Years Ended December 31, 1997
 and 1996................................................................ F-1
Auditor's Report on the Year Ended December 31, 1995 .................... F-2
Consolidated Statements of Income........................................ F-3
Consolidated Balance Sheet............................................... F-4
Consolidated Statements of Cash Flows.................................... F-5
Consolidated Statement of Changes in Shareholders' Equity................ F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>
 
  (b) Exhibits
 
  The exhibits listed in the accompanying index are filed or incorporated by
reference as part of this annual report.
 
                                      71
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Supervisory Board and Shareholders of SGS-THOMSON Microelectronics N.V.
 
   In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of cash flows and of changes in
shareholders' equity present fairly, in all material respects, the financial
position of SGS-THOMSON Microelectronics N.V. and its subsidiaries at December
31, 1997 and 1996, and the results of their operations and their cash flows
for each of the two years in the period ended December 31, 1997, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in accordance
with auditing standards generally accepted in the United States of America
which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above. The
consolidated financial statements of SGS-THOMSON Microelectronics N.V. for the
year ended December 31, 1995 were audited by other independent accountants
whose report dated January 26, 1996 expressed an unqualified opinion on those
statements.
 
PRICE WATERHOUSE NEDERLAND BV
Amsterdam, The Netherlands
January 23, 1998
 
                                      F-1
<PAGE>
 
                               AUDITOR'S REPORT
 
To the Supervisory Board and the Shareholders of SGS-THOMSON Microelectronics
N.V.:
 
   We have audited the accompanying consolidated balance sheets of SGS-THOMSON
Microelectronics N.V. (a Dutch corporation) and subsidiaries as of December
31, 1995 and 1994, and the related statements of income, shareholders'
investment and cash flows for each of the three years in the period ended
December 31, 1995. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
   We conducted our audits in accordance with generally accepted auditing
standards in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
   In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of SGS-
THOMSON Microelectronics N.V. and subsidiaries as of December 31, 1995 and
1994, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1995 in conformity with generally
accepted accounting principles, as applied in the United States.
 
Arthur Andersen & Co.
Amsterdam, The Netherlands
January 26, 1996
 
                                      F-2
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
                       CONSOLIDATED STATEMENTS OF INCOME
            In thousands of U.S. dollars (except per share amounts)
 
<TABLE>
<CAPTION>
                                               YEAR ENDED DECEMBER 31,
                                         -------------------------------------
                                            1995         1996         1997
                                         -----------  -----------  -----------
<S>                                      <C>          <C>          <C>
Net sales..............................  $ 3,520,670  $ 4,078,246  $ 3,969,773
Other revenues.........................       33,749       44,114       49,372
                                         -----------  -----------  -----------
 NET REVENUES..........................    3,554,419    4,122,360    4,019,145
Cost of sales..........................   (2,096,039)  (2,414,706)  (2,457,386)
                                         -----------  -----------  -----------
 GROSS PROFIT..........................    1,458,380    1,707,654    1,561,759
Selling, general and administrative....     (413,148)    (421,012)    (454,311)
Research and development...............     (440,334)    (532,294)    (610,847)
Restructuring costs....................      (12,975)          --           --
Other income and expenses..............       59,107       45,074       23,218
                                         -----------  -----------  -----------
 OPERATING INCOME......................      651,030      799,422      519,819
Net interest expenses..................      (16,854)     (11,169)      (2,646)
Gain on disposal of investment.........           --        7,263           --
                                         -----------  -----------  -----------
INCOME BEFORE INCOME TAXES AND MINORITY
 INTERESTS.............................      634,176      795,516      517,173
Income tax expense.....................     (108,282)    (171,638)    (113,017)
                                         -----------  -----------  -----------
INCOME BEFORE MINORITY INTERESTS.......      525,894      623,878      404,156
Minority interests.....................          584        1,666        2,398
                                         -----------  -----------  -----------
NET INCOME.............................  $   526,478  $   625,544  $   406,554
                                         ===========  ===========  ===========
EARNINGS PER SHARE (BASIC).............  $      4.03  $      4.50  $      2.92
                                         ===========  ===========  ===========
EARNINGS PER SHARE (DILUTED)...........  $      4.01  $      4.49  $      2.91
                                         ===========  ===========  ===========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
 
                                      F-3
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
                           CONSOLIDATED BALANCE SHEET
                          In thousands of U.S. dollars
 
<TABLE>
<CAPTION>
                                                      AS AT DECEMBER 31,
                                                     ---------------------
                                                        1996       1997
                                                     ---------- ----------
<S>                                                  <C>        <C>         
                                    ASSETS
CURRENT ASSETS:
 Cash and cash equivalents.......................... $  551,896 $  702,157
 Marketable securities..............................      4,508         --
 Trade accounts and notes receivable................    645,923    644,017
 Inventories........................................    521,402    593,520
 Other receivables and assets.......................    418,051    413,914
                                                     ---------- ----------
  TOTAL CURRENT ASSETS..............................  2,141,780  2,353,608
Intangible assets, net..............................     17,350     26,423
Property, plant and equipment, net..................  2,839,932  3,046,813
Investments and other non-current assets............      6,450     18,895
                                                     ---------- ----------
  TOTAL ASSETS...................................... $5,005,512 $5,445,739
                                                     ========== ==========
                     LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
 Bank overdrafts.................................... $  315,873 $  365,944
 Short-term debt and current portion of long-term
  debt..............................................    112,372     58,614
 Trade accounts and notes payable...................    444,166    592,315
 Other payables and accrued liabilities.............    318,556    320,427
 Accrued and deferred income tax....................    210,805    295,207
                                                     ---------- ----------
  TOTAL CURRENT LIABILITIES.........................  1,401,772  1,632,507
Long-term debt......................................    194,910    356,407
Reserves for pension and termination indemnities....    100,685     94,938
Other non-current liabilities.......................     38,224     38,636
                                                     ---------- ----------
                                                        333,819    489,981
                                                     ---------- ----------
  TOTAL LIABILITIES.................................  1,735,591  2,122,488
  MINORITY INTERESTS................................      9,901     15,805
Capital stock.......................................  1,072,933  1,073,990
Capital surplus.....................................    930,330    930,945
Accumulated result..................................  1,209,738  1,616,292
Translation adjustment..............................     47,019   (313,781)
                                                     ---------- ----------
  SHAREHOLDERS' EQUITY..............................  3,260,020  3,307,446
                                                     ---------- ----------
  TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $5,005,512 $5,445,739
                                                     ========== ==========
  Other commitments and contingencies: Note 25
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-4
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                          In thousands of U.S. dollars
 
<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31,
                                            ----------------------------------
                                               1995        1996        1997
                                            ----------  ----------  ----------
<S>                                         <C>         <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net income...............................  $  526,478  $  625,544  $  406,554
 Add (deduct) non-cash items:
  Depreciation and amortization...........     392,390     535,908     608,123
  Gain on disposal of investment..........          --      (7,263)         --
  Other non-cash items....................      (8,707)      7,298      19,015
  Minority interest in net income of
   subsidiaries...........................        (584)     (1,666)     (2,398)
  Deferred income tax.....................      (6,365)     58,515      (3,157)
  Changes in assets and liabilities:
   Trade receivables......................    (126,603)    (71,774)    (74,721)
   Inventories............................     (91,412)    (80,517)   (149,642)
   Trade payables.........................      17,005     (38,019)     73,790
   Other assets and liabilities, net......     122,927     (47,359)    106,227
                                            ----------  ----------  ----------
NET CASH FROM OPERATING ACTIVITIES........     825,129     980,667     983,791
                                            ----------  ----------  ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
 Payment for purchases of tangible
  assets..................................  (1,001,936) (1,125,205) (1,035,434)
 Proceeds from sales investment...........          --       8,420          --
 Other investing activities...............       2,868      (5,297)    (16,059)
 Investment in marketable securities
  (net)...................................           5        (196)      4,483
                                            ----------  ----------  ----------
NET CASH USED IN INVESTING ACTIVITIES.....    (999,063) (1,122,278) (1,047,010)
                                            ----------  ----------  ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
 Proceeds from issuance of long-term
  debt....................................      11,741      84,623     250,759
 Repayment of long-term debt..............     (96,202)   (54,085)     (80,238)
 Increase (decrease) in short-term
  facilities..............................     165,298    (106,239)     68,869
 Capital increase.........................     391,321      16,671       9,669
                                            ----------  ----------  ----------
NET CASH PROVIDED FROM (USED IN) FINANCING
 ACTIVITIES...............................     472,158     (59,030)    249,059
                                            ----------  ----------  ----------
Effect of changes in exchange rates.......      (1,412)     (1,509)    (35,579)
                                            ----------  ----------  ----------
NET CASH INCREASE (DECREASE)..............     296,812    (202,150)    150,261
Cash and cash equivalents at beginning of
 the year.................................     457,234     754,046     551,896
                                            ----------  ----------  ----------
Cash and cash equivalents at end of the
 year.....................................   $ 754,046   $ 551,896   $ 702,157
                                            ==========  ==========  ==========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-5
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
           CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
                          In thousands of U.S. dollars
 
<TABLE>
<CAPTION>
                           CAPITAL   CAPITAL   ACCUMULATED TRANSLATION SHAREHOLDERS'
                            STOCK    SURPLUS     RESULT    ADJUSTMENT     EQUITY
                          ---------- --------  ----------- ----------- -------------
<S>                       <C>        <C>       <C>         <C>         <C>
Balance as of January 1,
 1995...................  $  981,500 $625,906  $   57,716   $  14,917   $1,680,039
 Capital increase.......      85,028  294,455          --          --      379,483
 Deferred compensation..          --    1,704       (155)          --        1,549
 Net income.............          --       --     526,478          --      526,478
 Translation
  adjustment............          --       --          --      74,166       74,166
                          ---------- --------  ----------   ---------   ----------
Balance as of December
 31, 1995...............   1,066,528  922,065     584,039      89,083    2,661,715
 Capital increase.......       6,405    8,847          --          --       15,252
 Deferred compensation..          --     (582)        155          --         (427)
 Net income.............          --       --     625,544          --      625,544
 Translation
  adjustment............          --       --          --     (42,064)     (42,064)
                          ---------- --------  ----------   ---------   ----------
Balance as of December
 31, 1996...............   1,072,933  930,330   1,209,738      47,019    3,260,020
 Capital increase.......       1,057      615          --          --        1,672
 Net income.............          --       --     406,554          --      406,554
 Translation
  adjustment............          --       --          --    (360,800)    (360,800)
                          ---------- --------  ----------   ---------   ----------
Balance as of December
 31, 1997...............  $1,073,990 $930,945  $1,616,292   $(313,781)  $3,307,446
                          ========== ========  ==========   =========   ==========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-6
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                     (Currency--Thousands of U.S. dollars)
 
1.THE COMPANY
 
   SGS-THOMSON Microelectronics N.V. (the "Company") was formed in 1987 by the
combination of the semiconductor business of SGS Microelettronica (then owned
by Societa Finanziara Telefonica (S.T.E.T.), an Italian corporation) and the
non-military business of Thomson Semiconducteurs (then owned by Thomson-CSF, a
French corporation) whereby each company contributed their respective
semiconductor businesses in exchange for a 50% interest in the Company.
 
   The Company is registered in The Netherlands with its statutory domicile in
Amsterdam.
 
   As of December 31, 1997, the Company was 68.90% (December 31, 1996: 68.97%)
owned by SGS-THOMSON Microelectronics II B.V., and 31.10% by the public
(December 31, 1996: 31.03%).
 
   At December 31, 1997, SGS-THOMSON Microelectronics II B.V. was 100% owned
by SGS-THOMSON Microelectronics Holding N.V. At December 31, 1997, SGS-THOMSON
Microelectronics Holding N.V. was owned as follows:
 
   --   50% by FT1CI, a French holding company, whose shareholders are CEA-
Industrie (51%) and France Telecom (49%)
 
   --   50% by M.E.I. - Microelettronica Italiana s.r.l. ("M.E.I."), an
Italian holding company, whose Shareholders are Comitato per l'intervento
nella SIR ed in settori ad alta tecnologia ("Comitato SIR") (49.9%) and
Istituto per la Ricostruzione Industriale S.p.a. (I.R.I.) (50.1%)
 
   At December 31, 1996, SGS-THOMSON Microelectronics Holding N.V. was owned
as follows:
 
   --   50% by FT2CI, a French holding company, whose shareholders in turn
were FT1CI (50.1%) and Thomson-CSF (49.9%).
 
   --   50%, (48.14% in 1995) by M.E.I.
 
   During 1997, Thomson CSF sold its entire minority interest in FT2CI (49.9%)
to FT1CI.
 
   The Company has been informed by CEA Industrie and France Telecom that
FT1CI and FT2CI have been merged at the end of 1997, with FT1CI the surviving
company in the merger. This transaction does not modify the equality in
ownership interest between the French Shareholders and the Italian
Shareholders.
 
2.SUMMARY OF ACCOUNTING POLICIES
 
2.1)PRINCIPLES OF CONSOLIDATION
 
   The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United States
of America (U.S. GAAP). The Company's consolidated financial statements
include the assets, liabilities and results of operations of its majority-
owned subsidiaries. The ownership of the other interest holders is reflected
as minority interests. All significant intercompany accounts and transactions
have been eliminated in consolidation.
 
   The initial combination of the SGS Microelettronica and Thomson
Semiconducteurs civilian semiconductor businesses was accounted for as the
creation of a joint venture. Accordingly, the assets and liabilities of the
combined entities were recorded in the books of the joint venture at their
carrying amounts at the date of combination.
 
                                      F-7
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
2.2)USE OF ESTIMATES
 
   The preparation of financial statements in accordance with U.S. GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes to the financial
statements. Actual results could differ from those estimates and may affect
amounts reported in future periods. Management believes that the estimates are
reasonable.
 
2.3)INCOME RECOGNITION
 
   SALES: Revenues on sales of semiconductor products are recognized upon
shipment of the products. A portion of the Company's sales are made to
distributors who participate in certain programs common to the semiconductor
industry whereby the distributors are allowed to return merchandise under
certain circumstances and may receive future price reductions. Provision is
made at the time of sale for estimated product returns and price protection
which may occur under programs the Company has with these customers.
 
   SUBSIDIES: Government subsidies are recognized as the related costs are
incurred, commencing when the subsidies' contract is signed with the relevant
government department or agency. Government subsidies for research and
development are included in "other income and expenses". Government subsidies
for industrialization costs (certain costs incurred to bring protoype products
to the production stage) are offset against related expenses in "cost of
sales". Government subsidies for capital expenditures are deducted from the
cost of the related fixed assets.
 
2.4)FOREIGN CURRENCY
 
   The United States dollar is the reporting currency for the Company because
the dollar is the currency of reference in terms of market pricing in the
worldwide semiconductor industry. Furthermore, there is no currency in which
the majority of transactions are denominated, and revenues from external sales
in U.S. dollars exceed revenues in any other currency.
 
   The functional currency used by each significant subsidiary throughout the
group is generally the local currency. For consolidation purposes, assets and
liabilities of these subsidiaries are translated at current rates of exchange
at the balance sheet date. Income and expense items are translated at the
average exchange rate for the period. The effects of translating the financial
position and results of operations of local functional currency are included
in shareholders' equity.
 
   Assets, liabilities, revenue, expenses, gains or losses arising from
foreign currency transactions are recorded in the functional currency of the
recording entity at the exchange rate in effect at the date of the
transaction. At each balance sheet date, recorded balances denominated in a
currency other than the recording entity's functional currency are translated
at the exchange rate prevailing at that date. The related exchange gains and
losses are recorded in the income statement.
 
   The Company covers certain portions of its foreign currency exposure
primarily through the use of forward contracts and option contracts.
Generally, gains and losses associated with currency rate changes on forward
contracts are recorded currently in "other income and expenses", while the
interest element is recognized over the life of each contract and is included
in operations. The Company utilizes foreign exchange forward contracts and
foreign currency options to protect the Company from the effect of currency
fluctuations on its probable anticipated transactions.
 
                                      F-8
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
2.5)INTANGIBLE ASSETS
 
   Intangible assets include the cost of technologies and licenses purchased
from third parties, amortized over a period ranging from five to 18 years, and
goodwill acquired in business combinations amortized over its estimated useful
life, generally five to 15 years.
 
   The Company has adopted Statement of Financial Accounting Standards No.
121, "Accounting for the impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" ("FAS 121") effective January 1, 1995. The carrying
value of long-lived assets, including intangibles, is evaluated whenever
changes in circumstances indicate the carrying amount of such assets may not
be recoverable. In performing such review for recoverability, the Company
compares the expected future cash flows to the carrying value of long-lived
assets and identifiable intangibles. If the anticipated undiscounted future
cash flows are less than the carrying amount of such assets, the Company
recognizes an impairment loss for the difference between the carrying amount
of the assets and their estimated fair value. The fair value of an intangible
asset is determined through the use of a discounted cash flow analysis.
 
2.6)PROPERTY, PLANT AND EQUIPMENT
 
   Property, plant and equipment are stated at cost, net of government
subsidies. Major renewals and improvements are capitalized; minor
replacements, maintenance and repairs are charged to current operations.
Depreciation is computed using the straight-line method over the following
estimated useful lives:
 
<TABLE>
    <S>                                                                <C>
    Buildings......................................................... 33 years
    Leasehold improvements............................................ 10 years
    Machinery and equipment........................................... 6 years
    Computer and R&D equipment........................................ 3-6 years
    Other............................................................. 2-5 years
</TABLE>
 
   Assets subject to leasing agreements and classified as capital leases are
included in property, plant and equipment and depreciated over the shorter of
the estimated useful life or the lease term.
 
2.7)INVESTMENTS
 
   The equity accounting method is used when the Company has both a 20% to 50%
equity interest and the ability to exercise significant influence over the
investee. Marketable debt and equity securities and other equity investments
are classified as "available for sale" securities and stated at fair value.
 
2.8)INVENTORIES
 
   Inventories are stated at the lower of cost or market (net realizable
value). Cost is computed on a currently adjusted standard basis which
approximates actual cost on a current average basis.
 
2.9)RESEARCH AND DEVELOPMENT
 
   Research and development costs are charged to expense as incurred. Research
and development costs include costs incurred by the Company as well as the
Company's share of costs incurred by two French research and development
interest groups. For some of its research and development programs, the
Company receives grants from Governmental agencies; these grants are
recognized in the income statement in "other income and expenses".
 
 
                                      F-9
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
2.10)START-UP COSTS
 
   Start-up costs incurred to expand the Company's manufacturing facilities
are included in "other income and expenses" in the accompanying consolidated
statement of income.
 
2.11)PENSION AND TERMINATION INDEMNITIES
 
   PENSION: Upon retirement, the Company's employees receive such benefits as
are provided by pension plan arrangements; these plans conform with local
regulations and practices of the countries in which the Company operates.
 
   TERMINATION INDEMNITIES:
 
   ITALY Italian law provides for an indemnity to be paid to personnel upon
termination of employment. The amount of indemnity is based upon the number of
years of service. The undiscounted value of the vested obligation at the
balance sheet date is recorded as a liability.
 
   FRANCE In France, an indemnity is paid to personnel only upon retirement
from the Company. The French entity recognizes the related cost and liability
with the prior years' liability being amortized over the average remaining
service period until retirement age.
 
2.12)INCOME TAXES
 
   The provision for current taxes represents the income taxes expected to be
payable for the current year. Deferred tax assets and liabilities are recorded
for all temporary differences arising between the tax and book basis of assets
and liabilities and for the benefits of tax credits and loss carryforwards.
Those deferred tax assets and liabilities are measured using the enacted tax
rates at which they are expected to be realized or paid. A valuation allowance
is provided where necessary to reduce deferred tax assets to the amount
expected to be "more likely than not" realized in the future. Tax rate changes
are reflected in income in the period such changes are enacted.
 
2.13)STOCK OPTIONS
 
   In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (FAS 123), "Accounting for Stock-
Based Compensation", which established a fair value-based method of accounting
for compensation costs related to stock option plans and other forms of stock
based compensation plans as an alternative to the intrinsic value-based method
of accounting as defined under Accounting Principles Board Opinion no. 25 (APB
25). As permitted by FAS 123, the Company decided not to elect the new method
of accounting, prescribed by FAS 123, and has provided pro forma disclosure as
if the fair value-based method prescribed by FAS 123 had been applied in
measuring compensation expense (note 11).
 
2.14)ADVERTISING COSTS
 
   Advertising costs are charged to operations when incurred. Advertising
expenses for 1995, 1996 and 1997 were $10,133, $12,686 and $14,523,
respectively.
 
2.15)EARNINGS PER SHARE
 
   In February 1997, the Financial Accounting Standard Board issued Statement
of Financial Accounting Standards (FAS No. 128), "Earnings Per Share". This
statement specifies the computation, presentation and disclosure requirements
for earnings per share for entities with publicly held common stock. The
Company has
 
                                     F-10
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
adopted the new method of calculating earnings per share which is based upon
the basic and diluted per share calculation (note 12).
 
2.16)RECLASSIFICATIONS
 
   Certain prior year amounts have been reclassified to conform with the
current year presentation.
 
2.17)RECENTLY ISSUED ACCOUNTING STANDARDS
 
   In June 1997, the United States Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" (FAS No. 130). FAS No. 130 establishes standards for reporting
comprehensive income and its components and accumulated balances. Comprehensive
income is defined as the change in equity of a business during a period from
transactions and circumstances related to non-owner sources, and includes all
changes in equity except those resulting from investment by owners and
distributions to owners. Among other disclosures, FAS No. 130 requires that all
items that are required to be recognized under current accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. FAS No. 130
is effective for financial statements for fiscal years beginning after December
15, 1997 and requires comparative information for earlier years to be restated.
Management has determined that in the Company's case, comprehensive income
consists of foreign currency translation adjustments.
 
   In June 1997, the United States Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131 "Disclosure about Segments
of an Enterprise and Related Information" (FAS  No. 131). FAS No. 131
establishes standards for the way that public enterprises report information
about operating segments in financial statements. It also establishes standards
for disclosures regarding the products and services, geographic areas and major
customers. FAS No. 131 defines operating segments as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. FAS No. 131 is effective for
financial statements for fiscal years beginning after December 15, 1997 and
requires comparative information for earlier years to be restated. Management
has not fully evaluated the impact, if any, that this standard may have on
future financial statement disclosures.
 
   In February 1998, the United States Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 132 "Employers'
Disclosures about Pension and Other Postretirement Benefits" (FAS 132). FAS 132
revises disclosure requirements for employers' pension and other retiree
benefits. The Company will adopt the provisions of SFAS No. 132 effective
December 31, 1998. FAS 132 will not affect the Company's financial position or
results of operations. The Company is currently evaluating the effect of
FAS 132 on the Company's pension disclosures.
 
 
                                      F-11
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
3.CONSOLIDATED ENTITIES
 
   The consolidated financial statements include the accounts of SGS-THOMSON
Microelectronics N.V. and the following entities as of December 31, 1997:
<TABLE>
<CAPTION>
                                                                              PERCENTAGE
                                                                              OWNERSHIP
                                                               COMMON STOCK   (DIRECT OR
      LEGAL SEAT                             NAME               (THOUSANDS)   INDIRECT)
      ----------                             ----             --------------- ----------
    <C>            <C>             <S>                        <C>             <C>
    United Kingdom London          SGS-THOMSON
                                   Microelectronics LTD....   9,900 GBP          100
                   London          Thomson Components LTD..   1,150 GBP          100
                   Bristol         SGS-THOMSON E.E.I.G.....   0 GBP              100
    Sweden         Stockholm       SGS-THOMSON
                                   Microelectronics A.B....   16,000 SEK         100
    Germany        Munich          SGS-THOMSON
                                   Microelectronics GmbH...   12,901 DEM         100
    Switzerland    Geneva          SGS-THOMSON
                                   Microelectronics S.A....   500 CHF            100
    Malta          Malta           SGS-THOMSON
                                   Microelectronics LTD....   21,590 MTP         100
    Spain          Madrid          SGS-THOMSON
                                   Microelectronics S.A....   55,000 ESP         100
    France         Paris           SGS-THOMSON
                                   Microelectronics S.A....   2,289,764 FRF      100
                   Paris           SGS-THOMSON
                                   Microelectronics
                                   S.A.S...................   250 FRF            100
    Italy                          SGS-THOMSON
                                   Microelectronics
                   Milano          S.r.l. .................   502,000,000 ITL    100
                   Catania         CORIMME.................   3,000,000 ITL      100
    Singapore                      SGS-THOMSON
                                   Microelectronics PTE
                   Singapore       LTD.....................   179,997 SGD        100
                   Singapore       SGS-THOMSON
                                   Microelectronics ASIA
                                   PACIFIC
                                   PTE LTD.................   13,982 SGD         100
    Malaysia                       SGS-THOMSON
                                   Microelectronics SDN
                   Muar            BHD.....................   196,805 MYR        100
                                   SGS-THOMSON(Malaysia)
                   Muar            SDN BHD.................   0.002 MYR          100
    Japan                          SGS-THOMSON
                   Tokyo           Microelectronics KK.....   68,000 JPY         100
    Hong Kong                      SGS-THOMSON
                   Hong Kong       Microelectronics LTD....   780 HKD            100
    Australia                      SGS-THOMSON
                                   Microelectronics PTY
                   Sydney          LTD.....................   185 AUD            100
    United States                  SGS-THOMSON
                   Dallas          Microelectronics Inc. ..   22,000 USD         100
                                   SGS-THOMSON
                                   Microelectronics (RB),
                   Rancho Bernardo Inc. ...................   1 USD              100
                                   SGS-THOMSON
                                   Microelectronics Leasing
                   Dallas          Co. Inc. ...............   1 USD              100
                                   Metaflow Technologies
                   La Jolla        Inc.....................   56 USD              68
    Brazil                         SGS-THOMSON
                   Sao Paulo       Microelectronics Ltda...   15 BRL             100
    Morocco                        SGS-THOMSON
                   Casablanca      Microelectronics S.A. ..   66,000 MAD         100
                                   Electronic Holding
                   Casablanca      S.A. ...................   3,110 MAD          100
    China                          Shenzhen STS
                                   Microelectronics Co
                   Shenzhen        LTD.....................   418,527 CNY         60
    India                          SGS-THOMSON
                                   Microelectronics PTE
                   New Delhi       LTD.....................   62,000 INR         100
    Finland                        SGS-THOMSON
                   Helsinki        Microelectronics OY.....   2,000 FIM          100
</TABLE>
 
4.CASH AND CASH EQUIVALENTS
 
   Cash and cash equivalents consists of the following:
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                                 ---------------
                                                                  1996    1997
                                                                 ------- -------
    <S>                                                          <C>     <C>
    Cash........................................................   1,579     462
    Bank accounts............................................... 548,777 653,436
    Marketable securities (with maturity under 3 months)........   1,540  48,259
                                                                 ------- -------
      TOTAL..................................................... 551,896 702,157
                                                                 ======= =======
    MARKETABLE SECURITIES (WITH MATURITY OVER 3 MONTHS).........   4,508      --
                                                                 ======= =======
</TABLE>
 
   Marketable securities consist mainly of short term cash investments. There
was no significant difference between the book value of traded marketable
securities and their fair market value as of December 31, 1996 and 1997.
 
                                     F-12
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
5.TRADE ACCOUNTS AND NOTES RECEIVABLE
 
   Trade accounts and notes receivable consist of the following:
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                               ----------------
                                                                1996     1997
                                                               -------  -------
    <S>                                                        <C>      <C>
    Trade accounts and notes receivable....................... 664,075  659,245
    Less valuation allowance.................................. (18,152) (15,228)
                                                               -------  -------
      TOTAL................................................... 645,923  644,017
                                                               =======  =======
</TABLE>
 
   During 1995, 1996 and 1997 no customer represented individually over ten
percent of consolidated net revenues.
 
6.INVENTORIES
 
   Inventories consist of the following:
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                                 ---------------
                                                                  1996    1997
                                                                 ------- -------
     <S>                                                         <C>     <C>
     Raw materials.............................................. 121,485 114,712
     Work-in-process............................................ 278,289 341,537
     Finished products.......................................... 121,628 137,271
                                                                 ------- -------
      TOTAL..................................................... 521,402 593,520
                                                                 ======= =======
</TABLE>
 
7.OTHER RECEIVABLES AND ASSETS
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                                 ---------------
                                                                  1996    1997
                                                                 ------- -------
    <S>                                                          <C>     <C>
    Receivables from government agencies*....................... 217,334 154,916
    Taxes and other government receivables......................  48,148  60,474
    Down payment to suppliers...................................   1,617     814
    Loans to employees..........................................   3,821   3,197
    Prepaid expenses............................................  14,700  14,062
    Sundry debtors..............................................  23,342  55,475
    Deferred tax................................................  65,291  96,139
    Other.......................................................  43,798  28,837
                                                                 ------- -------
     TOTAL...................................................... 418,051 413,914
                                                                 ======= =======
</TABLE>
 
*  Related to research and development contracts, industrialization contracts
   and capital expenditures.
 
8.INTANGIBLE ASSETS
 
   Intangible assets consist of the following:
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                               ----------------
                                                                1996     1997
                                                               -------  -------
    <S>                                                        <C>      <C>
    Technologies and licenses, gross..........................  56,648   72,189
    Pension transition obligation.............................   2,423       --
    Less accumulated amortization............................. (41,721) (45,766)
                                                               -------  -------
     TOTAL....................................................  17,350   26,423
                                                               =======  =======
</TABLE>
 
                                      F-13
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
9.PROPERTY, PLANT AND EQUIPMENT
 
   Property, plant and equipment consist of the following:
 
<TABLE>
<CAPTION>
    DECEMBER 31, 1996                             GROSS   DEPRECIATION    NET
    -----------------                           --------- ------------ ---------
    <S>                                         <C>       <C>          <C>
    Land and buildings.........................   456,973     (88,926)   368,047
    Machinery and equipment.................... 4,147,941  (2,057,281) 2,090,660
    Other tangible fixed assets................   221,555    (144,943)    76,612
    Construction in progress...................   304,613          --    304,613
                                                ---------  ----------  ---------
     TOTAL..................................... 5,131,082  (2,291,150) 2,839,932
</TABLE>
 
<TABLE>
<CAPTION>
    DECEMBER 31, 1997                             GROSS   DEPRECIATION    NET
    -----------------                           --------- ------------ ---------
    <S>                                         <C>       <C>          <C>
    Land and buildings.........................   490,707    (102,409)   388,298
    Machinery and equipment.................... 4,391,066  (2,138,115) 2,252,951
    Other tangible fixed assets................   307,844    (209,088)    98,756
    Construction in progress...................   306,808          --    306,808
                                                ---------  ----------  ---------
     TOTAL..................................... 5,496,425  (2,449,612) 3,046,813
                                                =========  ==========  =========
</TABLE>
 
   Included in the above categories are assets recorded under capitalized
leases with original costs totalling $8,906 in 1996 and $7,805 in 1997.
 
10.INVESTMENTS AND OTHER NON-CURRENT ASSETS
 
   Investments and other non-current assets consist of the following:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                                    ------------
                                                                    1996   1997
                                                                    ----- ------
    <S>                                                             <C>   <C>
    Investments carried at fair value.............................. 1,176 10,334
    Long-term deposits and receivables............................. 5,274  8,561
                                                                    ----- ------
     TOTAL......................................................... 6,450 18,895
                                                                    ===== ======
</TABLE>
 
   Long-term deposits and receivables consist primarily of indemnities
receivable from third parties on the sale of businesses, which bear interest
or are discounted to reflect their present value.
 
11.SHAREHOLDERS' EQUITY
 
   PUBLIC OFFERINGS OF SHARES
 
   In December 1994, the Company increased its capital stock, with an initial
public offering, through the issuance of 9,606,240 new shares of capital
stock, which resulted in an increase in capital stock and capital surplus of
$75,049 and $123,772, respectively. In connection with a secondary offering of
capital stock in October 1995, the Company issued 8,960,000 new shares of
capital stock, which resulted in an increase in capital stock and capital
surplus of $79,356 and $292,075, respectively.
 
   OUTSTANDING SHARES
 
   The authorized share capital of the Company is NLG 2,750,000,000,
consisting of 200,000,000 shares, each with a nominal value of NLG 13.75. As
of December 31, 1995, 1996 and 1997, the number of shares of
 
                                     F-14
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
capital stock outstanding at a par value of NLG 13.75 were 138,208,680 shares,
138,985,580 shares and 139,132,397 shares, respectively.
 
   STOCK OPTION PLANS
 
   In 1989, the Shareholders voted to adopt the 1989 Stock Option Plan (the
"1989 Plan") and approved the issuance of 1,634,400 options to 136 employees
to purchase capital stock at a price of NLG 25 per share. Under the 1989 Plan,
the options vest over four years and are exercisable for ten years. In 1994,
the minimum exercise price of the options was reduced to NLG 17.50. As a
result, the Company recorded a compensation charge of $18,125 in the fourth
quarter of 1994.
 
   In 1995, the Shareholders voted to adopt the 1995 Stock Option Plan (the
"1995 Plan") whereby options for up to 5,500,000 shares may be granted in
installments over a five-year period. Under the 1995 Plan, the options may be
granted to purchase shares of capital stock at a price not lower than the
market price of the shares on the date of grant, and generally vest over four
years and are exercisable over a period of eight years. In March 1996, the
Company granted 1,200,000 options to its employees at an exercise price of
$36.25 per share. In September 1997, the Company granted 645,500 options to
its employees at an exercise price of $85.375 per share.
 
   In 1996, the Shareholders voted to adopt the Supervisory Board Option Plan
whereby members of the Supervisory Board may receive, during the three-year
period 1996-1998, 3,000 options for 1996 and 1,500 options for 1997 and 1998,
to purchase shares of capital stock at the closing market price of the shares
on the date of grant. In the same three-year period, professionals of the
Supervisory Board may receive 1,500 options for 1996 and 750 options for 1997
and 1998. Under the Plan, the options vest over one year and are exercisable
for a period expiring eight years from the date of grant. In October 1996,
options to purchase 33,000 shares were granted at an exercise price of $54.00
per share. In September 1997, options to purchase 15,000 shares were granted
at an exercise price of $85.375 per share.
 
   A summary of stock option transactions for the plans follows:
 
<TABLE>
<CAPTION>
                                                            PRICE PER SHARE
                                                        -----------------------
    OPTIONS OUTSTANDING                NUMBER OF SHARES     RANGE      AVERAGE
    -------------------                ---------------- -------------- --------
    <S>                                <C>              <C>            <C>
    December 31, 1994.................    1,456,400     17.5-25    NLG 20.0 NLG
    Options exercised.................     (646,200)    17.5-25    NLG 19.6 NLG
                                          ---------
    December 31, 1995.................      810,200     17.5-25    NLG 20   NLG
    Options granted 1995 Plan.........    1,200,000             $36.25   $36.25
    Supervisory Board Plan............       33,000             $54.00   $54.00
    Options cancelled.................      (16,500)            $36.25   $36.25
    Options exercised.................     (531,790)    17.5-25    NLG 20.1 NLG
                                          ---------
    December 31, 1996.................    1,494,910     17.5-25    NLG 20.1 NLG
                                                        $ 36.25-$54.00   $36.73
    Options granted 1995 Plan.........      645,500            $85.375  $85.375
    Supervisory Board Plan............       15,000            $85.375  $85.375
    Options cancelled.................      (18,000)    $36.25-$85.375   $44.98
    Options exercised.................     (137,380)    $ 8.67-$36.25    $10.36
                                          ---------
    December 31, 1997.................    2,000,030     17.5-25    NLG 20.8 NLG
                                          =========
                                                        $36.25-$85.375   $53.19
</TABLE>
 
                                     F-15
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
   EMPLOYEE OFFERING PLAN
 
   Pursuant to a resolution of the Supervisory Board of the Company in
November 1995, the Company offered to certain of its employees worldwide the
right to acquire up to 1,000 shares of capital stock per employee, at a price
of $33.725 per share, representing a discount of five percent from the market
price. A total of 243,710 shares were sold to participating employees
worldwide as a result of the offering. Participating employees who purchased
shares in the offering and who held such shares for at least one year were
entitled to purchase, for a price of 13.75 NLG, one share for each ten shares
purchased in the offering.
 
   FAIR VALUE OF STOCK-BASED COMPENSATION
 
   As permitted under FAS No. 123, the Company has elected to continue to
follow APB 25, "Accounting for Stock Issued to Employees", and related
interpretations, in accounting for stock-based awards to employees. Under APB
25, the Company generally recognized no compensation expense with respect to
such awards.
 
   Pro forma information regarding net income and earnings per share is
required by FAS 123 for awards granted after December 31, 1994 as if the
Company had accounted for its stock-based awards to employees under the fair
value method of FAS 123. The fair value of the Company's stock based awards to
employees was estimated using a Black-Scholes option pricing model. The Black-
Scholes option valuation model was developed for use in estimating the fair
value of traded options which have no vesting restrictions and are fully
transferable. In addition, the Black-Scholes model requires the input of
highly subjective assumptions including the expected stock price volatility.
The Company's stock-based awards to employees have characteristics
significantly different from those of traded options, and changes in the
subjective input assumptions can materially affect the fair value estimate.
The fair value of the Company's stock-based awards to employees was estimated
assuming no expected dividends and the following weighted-average assumptions:
 
<TABLE>
<CAPTION>
                                                                  1995  1996  1997
                                                                  ----  ----  ----
    <S>                                                           <C>   <C>   <C>
    Expected life (years)........................................   5     5     5
    Expected stock price volatility..............................  55%   55%   40%
    Risk-free interest rate......................................   5%    5%    6%
</TABLE>
 
   For pro forma purposes, the estimated fair value of the Company's stock-
based awards to employees is amortized over the options' vesting period. The
Company's pro forma information follows:
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                         -----------------------
                                                          1995    1996    1997
                                                         ------- ------- -------
    <S>                                                  <C>     <C>     <C>
    Net Income
     As reported........................................ 526,478 625,544 406,554
     Pro forma.......................................... 526,478 621,449 399,509
    Earnings per share
     As reported........................................    4.03    4.50    2.92
     Pro forma..........................................    4.03    4.48    2.87
</TABLE>
 
   The weighted average fair value at grant date of options granted during
1996 and 1997 was $19.50 and $38.50, respectively.
 
   RETAINED EARNINGS
 
   At December 31, 1997, the amount of retained earnings available to pay
dividends under Dutch law was approximately $2,233,000 (1996: $2,187,000).
Retained earnings for purposes of this calculation are based upon generally
accepted accounting principles in The Netherlands. The Company's subsidiaries
are subject to the laws of the countries in which they are domiciled. These
laws may restrict the ability of the subsidiaries to transfer funds to the
Company. Such restrictions are not considered to be significant as of December
31, 1997.
 
                                     F-16
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
12.EARNINGS PER SHARE
 
   The Company has adopted a new method of calculating earnings per share as
required by Financial Accounting Standards (FAS) No. 128, "Earnings Per
Share".
 
   For the years ended December 31, 1995, 1996, 1997 earning per share (EPS)
was calculated as follows:
 
<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31,
                                           -----------------------------------
                                              1995        1996        1997
    Basic EPS:                             ----------- ----------- -----------
    <S>                                    <C>         <C>         <C>
    Net income............................     526,478     625,544     406,554
    Weighted average shares outstanding... 130,647,079 138,695,540 139,092,900
    EPS (basic)...........................        4.03        4.50        2.92
    Diluted EPS:
    Net income............................     526,478     625,544     406,554
    Weighted average shares outstanding... 130,647,079 138,695,540 139,092,900
    Dilutive effect of stock options......     668,567     505,586     757,696
    Number of shares used in calculating
     EPS.................................. 131,315,646 139,201,126 139,850,596
    EPS (diluted).........................        4.01        4.49        2.91
</TABLE>
 
13.RESERVES FOR PENSION AND TERMINATION INDEMNITIES
 
   Reserves for pension and termination indemnities consist of the following:
 
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                                  --------------
                                                                   1996    1997
                                                                  ------- ------
    <S>                                                           <C>     <C>
    Italy(a).....................................................  98,028 92,280
    Other countries(b)...........................................   2,657  2,658
                                                                  ------- ------
     TOTAL....................................................... 100,685 94,938
                                                                  ======= ======
</TABLE>
 
   (A)ITALY
 
   The Italian plan is a defined benefit plan whereby an indemnity is paid to
personnel upon termination of employment. Each year, the liability is adjusted
to reflect current year compensation as well as a revaluation of prior years'
accruals based on an index. The plan is unfunded and all participants are
fully vested.
 
   Changes in the undiscounted benefit consist of the following:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                               ----------------
                                                                1996     1997
                                                               -------  -------
    <S>                                                        <C>      <C>
    Accrual at the beginning of the year......................  86,733   98,028
    Accrued benefits..........................................  18,469   14,736
    Payments.................................................. (10,213)  (7,460)
    Translation adjustment....................................   3,039  (13,024)
                                                               -------  -------
    ACCRUAL AT THE END OF THE YEAR............................  98,028   92,280
                                                               =======  =======
</TABLE>
 
                                     F-17
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
   (B)OTHER COUNTRIES (FRANCE, UNITED STATES, JAPAN, UNITED KINGDOM AND
GERMANY)
 
   The Company has defined benefit pension plans in various countries.
 
   The funded status of pension plans and termination indemnities is as
follows:
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                             ----------------
                                                              1996     1997
                                                             -------  -------
    <S>                                                      <C>      <C>
    Vested benefits......................................... (47,816) (62,687)
    Non-vested benefits..................................... (10,480) (14,488)
                                                             -------  -------
    Projected benefit obligation............................ (58,296) (77,175)
    Plan assets at fair value...............................  54,562   77,455
                                                             -------  -------
    Projected benefit obligation in excess of (less than)
     plan assets............................................  (3,734)     280
    Unrecognized transition obligation......................  (4,404)  (3,649)
    Unrecognized prior service cost.........................   6,869    7,381
    Unrecognized net (gains) and losses.....................     514   (2,517)
                                                             -------  -------
    Net pension asset.......................................    (755)   1,495
                                                             =======  =======
</TABLE>
 
   The accumulated benefit obligation amounted to $76,237 as of December 31,
1997 ($57,205 as of December 31, 1996).
 
   The periodic net pension and termination indemnities cost includes the
following:
 
<TABLE>
<CAPTION>
                                   DECEMBER 31,
                               -----------------------
                                1995    1996     1997
                               ------  -------  ------
    <S>                        <C>     <C>      <C>
    Service cost of benefits
     earned during the year..   3,613    4,764   5,804
    Interest cost on
     projected benefit
     obligation..............   3,016    3,960   5,076
    Actual return on plan
     assets..................  (3,716)  (4,267) (5,114)
    Net amortization and
     deferral................     418   (1,467)  1,003
                               ------  -------  ------
     TOTAL...................   3,331    2,990   6,769
                               ======  =======  ======
 
   The assumptions used in the determination of the net pension cost for the
pension plans were as follows:
 
<CAPTION>
    ASSUMPTIONS                 1995    1996     1997
    -----------                ------  -------  ------
    <S>                        <C>     <C>      <C>
    Discount rate............   7-8.5% 6.5-8.5%  3-7.5%
    Salary increase rate.....   4-6.5%   4-6.5%  4-5.5%
    Expected rate of return
     of funds................    8-10%  6.5-10%    6-9%
</TABLE>
 
14.OTHER NON-CURRENT LIABILITIES
 
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                                   -------------
                                                                    1996   1997
                                                                   ------ ------
    <S>                                                            <C>    <C>
    Provision for claims and litigation and other risks........... 31,550 33,062
    Other long-term payables......................................  6,674  5,574
                                                                   ------ ------
     TOTAL........................................................ 38,224 38,636
                                                                   ====== ======
</TABLE>
 
                                     F-18
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
15.LONG-TERM DEBT
 
   Long-term debt consists of the following:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                               ---------------
                                                                1996    1997
                                                               ------- -------
    <S>                                                        <C>     <C>
    Secured (mainly mortgages on land, buildings and liens on
     equipment)..............................................   54,937  45,106
    Unsecured................................................  252,345 369,915
                                                               ------- -------
     TOTAL...................................................  307,282 415,021
                                                               ======= =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
    REPAYMENT SCHEDULE                                                  1997
    ------------------                                              ------------
    <S>                                                             <C>
    1998...........................................................    58,614
    1999...........................................................    50,430
    2000...........................................................   107,553
    2001...........................................................    98,093
    2002...........................................................    72,609
    Thereafter.....................................................    27,722
                                                                      -------
     TOTAL.........................................................   415,021
                                                                      =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                                 ---------------
    INTEREST RATES                                                1996    1997
    --------------                                               ------- -------
    <S>                                                          <C>     <C>
    Non-interest bearing*.......................................   5,871   4,092
    From 1 to 3%................................................  90,084  63,719
    From 3 to 6%................................................  83,402 275,163
    From 6 to 10%............................................... 120,870  68,721
    From 10 to 15%..............................................   7,055   3,326
                                                                 ------- -------
     TOTAL...................................................... 307,282 415,021
                                                                 ======= =======
</TABLE>
 
*  Non-interest bearing and certain low interest bearing borrowings relate to
   borrowings under Italian and French governmental programs.
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                                 ---------------
    CURRENCIES                                                    1996    1997
    ----------                                                   ------- -------
    <S>                                                          <C>     <C>
    U.S. dollar.................................................   6,950  20,000
    Italian lira................................................ 170,590 242,754
    French franc................................................  15,767  94,403
    Other....................................................... 113,975  57,864
                                                                 ------- -------
     TOTAL...................................................... 307,282 415,021
                                                                 ======= =======
</TABLE>
 
                                     F-19
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
   Long-term debt includes:
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                                 ---------------
                                                                  1996    1997
                                                                 ------- -------
    <S>                                                          <C>     <C>
    SGS-THOMSON Microelectronics S.A. (France)
    --4.9%Bank Loan due 2002....................................      --  33,361
    --4.884%Bank Loan due 2002..................................      --  33,361
    --4.18%Other Bank Loans.....................................  15,767  27,681
    SGS-THOMSON Microelectronics LTD (Malta)
    --6.185%Bank Loan due 1998..................................      --  20,033
    --7.05%Other Bank Loans.....................................  55,019  25,075
    SGS-THOMSON Microelectronics s.r.l. (Italy)
    --5.68%Bank Loan due 2002...................................      --  56,844
    --2.15%Government Loan due 2000.............................  76,575  53,219
    --6.13%Other Bank Loans.....................................  94,015 132,691
    SGS-THOMSON Microelectronics (other countries)
    --6.97%Other Bank Loans.....................................  65,906  32,756
                                                                 ------- -------
    Total long-term debt........................................ 307,282 415,021
    Total long-term debt, current portion....................... 112,372  58,614
                                                                 ------- -------
    Total long-term debt, less current portion.................. 194,910 356,407
                                                                 ------- -------
 
16.OTHER PAYABLES AND ACCRUED LIABILITIES
 
<CAPTION>
                                                                  DECEMBER 31,
                                                                 ---------------
                                                                  1996    1997
                                                                 ------- -------
    <S>                                                          <C>     <C>
    Taxes other than income taxes...............................  24,754  38,910
    Salaries and wages..........................................  95,553  85,809
    Social charges..............................................  49,882  52,893
    Advances received on fundings...............................  10,724  10,124
    Provision for asset writedowns..............................   5,981   4,646
    Litigation and other risks..................................   5,000  18,000
    Commercial rebates..........................................  53,214  31,585
    Royalties payable...........................................  19,612  20,769
    Other.......................................................  53,836  57,691
                                                                 ------- -------
     TOTAL...................................................... 318,556 320,427
                                                                 ======= =======
</TABLE>
 
                                      F-20
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
17.OTHER REVENUES
 
   Other revenues consist of the following:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                            --------------------
                                                             1995   1996   1997
                                                            ------ ------ ------
    <S>                                                     <C>    <C>    <C>
    Royalties and indemnities received..................... 16,549    582    956
    Licensing revenues.....................................     -- 16,693 27,598
    Miscellaneous sales....................................  7,346 18,675 17,250
    Other..................................................  9,854  8,164  3,568
                                                            ------ ------ ------
     TOTAL................................................. 33,749 44,114 49,372
                                                            ====== ====== ======
</TABLE>
 
18.PERSONNEL
 
   Labor costs consist of the following:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                     ---------------------------
                                                      1995     1996      1997
                                                     ------- --------- ---------
    <S>                                              <C>     <C>       <C>
    Salaries and wages.............................. 643,559   745,329   730,689
    Social security contribution.................... 194,650   210,611   236,609
    Other...........................................  48,251    53,838    57,929
                                                     ------- --------- ---------
    TOTAL........................................... 886,460 1,009,778 1,025,227
                                                     ======= ========= =========
</TABLE>
 
   Labor costs are allocated to cost of sales, selling, general and
administrative expenses and research and development costs. At December 31,
1997 the Company employed 28,728 persons (1996: 25,893).
 
19.OTHER INCOME AND EXPENSES
 
   Other income and expenses consist of the following:
 
<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                      -------------------------
                                                       1995     1996     1997
                                                      -------  -------  -------
    <S>                                               <C>      <C>      <C>
    Research and development funding*................  89,643   63,792   55,269
    Patents income (expense), net....................  (8,055)  (2,639)    (660)
    Exchange gain (loss), net........................   5,082   11,822   15,158
    Start-up costs................................... (26,489) (38,987) (47,867)
    Other............................................  (1,074)  11,086    1,318
                                                      -------  -------  -------
     TOTAL...........................................  59,107   45,074   23,218
                                                      =======  =======  =======
</TABLE>
 
*  Does not include certain other funding received for industrialization costs
   (which include certain costs incurred to bring prototype products to the
   production stage). Such funding and costs are netted in cost of sales in
   the income statement ($11,825 for 1995, $4,613 for 1996 and $6,192 for
   1997).
 
20.NET INTEREST EXPENSES
 
   Net interest expenses consist of the following:
 
<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                      -------------------------
                                                       1995     1996     1997
                                                      -------  -------  -------
    <S>                                               <C>      <C>      <C>
    Income...........................................  35,206   34,139   39,009
    Expenses......................................... (52,060) (45,308) (41,655)
                                                      -------  -------  -------
     TOTAL........................................... (16,854) (11,169)  (2,646)
                                                      =======  =======  =======
</TABLE>
 
 
                                     F-21
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
   Cash paid for interest was $51,156 for 1995, $40,064 for 1996 and $43,305
for 1997.
 
21.INCOME TAX
 
   Income before income tax expense is comprised of the following components:
 
<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                        -----------------------
                                                         1995    1996    1997
                                                        ------- ------- -------
    <S>                                                 <C>     <C>     <C>
    Income from domestic operations....................   4,662  31,284  (8,437)
    Income from foreign operations..................... 630,098 765,898 528,008
                                                        ------- ------- -------
    TOTAL INCOME BEFORE INCOME TAX EXPENSE............. 634,760 797,182 519,571
                                                        ======= ======= =======
</TABLE>
 
   SGS-THOMSON Microelectronics N.V. and its subsidiaries are individually
liable for income tax. Tax losses can only offset profits generated by the
taxable entity incurring such loss.
 
<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                   ----------------------------
                                                     1995      1996      1997
                                                   --------  --------  --------
    <S>                                            <C>       <C>       <C>
    Domestic......................................      --     (4,857)   (8,377)
    Foreign....................................... (114,647) (108,266) (107,797)
                                                   --------  --------  --------
    Current....................................... (114,647) (113,123) (116,174)
    Deferred......................................    6,365   (58,515)    3,157
                                                   --------  --------  --------
    INCOME TAX EXPENSE............................ (108,282) (171,638) (113,017)
                                                   ========  ========  ========
</TABLE>
 
   The principal items accounting for the differences in income taxes computed
at The Netherlands statutory rate (35%) and the effective income tax rate
comprise the following:
 
<TABLE>
<CAPTION>
                                                         DECEMBER 31,
                                                  ----------------------------
                                                    1995      1996      1997
                                                  --------  --------  --------
    <S>                                           <C>       <C>       <C>
    Income tax expense computed at statutory
     rate........................................ (221,962) (279,013) (181,850)
    Benefit (deductions) for financial reporting
     for which no current tax benefit is
     available...................................   50,601    14,894    (1,217)
    Variation in valuation allowance.............   25,528    23,935      (294)
    Other tax and credits........................   32,252     7,855      (627)
    Effect of tax rate differences...............    5,299    60,691    70,971
                                                  --------  --------  --------
    INCOME TAX EXPENSE........................... (108,282) (171,638) (113,017)
                                                  ========  ========  ========
</TABLE>
 
   Permanent differences reflect mainly the effects of the capital allowances
programs existing in certain Southeast Asian and Mediterranean countries, of
the special pioneer regimes existing in Asia Pacific regions and of the non-
deductible items.
 
   Pioneer status currently applies to one of the Company's two Singapore
factories. Under this regime all the profits of the operation under pioneer
status--calculated in accordance with applicable taxation rules and after
deduction of capital allowances--are benefiting from certain tax privileges
since a half rate taxation basis is applied when compared to the second non-
pioneer factory. In calculating deferred taxes, the Company records a
liability or asset for a temporary difference that reverses after the tax
holiday period ends, using the applicable taxation rate.
 
 
                                     F-22
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
   Deferred tax assets and liabilities consist of the following:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                               ----------------
                                                                1996     1997
                                                               -------  -------
    <S>                                                        <C>      <C>
    Tax loss carryforwards and capital allowances.............  14,976   71,967
    Other assets.............................................. 122,942  142,362
                                                               -------  -------
    Total assets, gross....................................... 137,918  214,329
    Valuation allowance.......................................  (4,156)  (4,450)
                                                               -------  -------
    DEFERRED TAX ASSETS, NET.................................. 133,762  209,879
                                                               =======  =======
    Fixed assets depreciation................................. 148,562  213,399
    Other liabilities.........................................  59,220   50,857
                                                               -------  -------
    DEFERRED TAX LIABILITIES.................................. 207,782  264,256
                                                               =======  =======
</TABLE>
 
   As a result of offsetting deferred tax assets against deferred tax
liabilities in each tax jurisdiction, the Company recorded a net deferred tax
asset of $65,291 in 1996 and $96,139 in 1997, and a net deferred tax liability
of $139,311 in 1996 and $150,516 in 1997. In 1996, the Company reduced its
valuation allowance by $23,935 and in 1997 increased it by $294.
 
   As of December 31, 1997 the Company and its subsidiaries had net operating
loss carryforwards and capital allowance expiring in the following years:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                                        1997
                                                                    ------------
    <S>                                                             <C>
    1998...........................................................    18,649
    1999...........................................................     7,006
    2000...........................................................     5,912
    2001...........................................................     6,705
    2002 and thereafter............................................   232,630
                                                                      -------
     TOTAL.........................................................   270,902
                                                                      =======
</TABLE>
 
   The Company paid $52,545 cash for income taxes in 1995, $109,277 cash for
income taxes in 1996 and $37,207 cash for income taxes in 1997.
 
22.CREDIT FACILITIES
 
   As of December 31, 1997, the aggregate amount of the Company's long-term
credit facilities was $415,021 (note 15) under which $415,021 of indebtedness
was outstanding, and additionally the aggregate amount of the Company's short-
term facilities was approximately $872,500 under which $365,944 of
indebtedness was outstanding.
 
                                     F-23
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
23.LEASE COMMITMENTS
 
   The Company leases land, building, plant and equipment under non-
cancellable lease agreements. As of December 31, 1997 the future minimum lease
payments to which the Company was committed under operating leases were as
follows:
 
<TABLE>
<CAPTION>
    YEAR
    ----
    <S>                                                                   <C>
    1998................................................................. 14,348
    1999.................................................................  7,287
    2000.................................................................  5,143
    2001.................................................................  3,551
    2002.................................................................  3,065
    Thereafter........................................................... 17,342
                                                                          ------
     TOTAL............................................................... 50,736
                                                                          ======
</TABLE>
 
24.FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
 
   Financial instruments and derivatives are used exclusively for purposes
other than trading.
 
   FORWARD EXCHANGE CONTRACTS AND CURRENCY OPTIONS
 
   The Company enters into forward contracts and foreign currency options to
protect against potentially adverse changes in foreign currency exchange rates
and to cover a portion of both its probable anticipated, but not firmly
committed, transactions and transactions with firm foreign currency
commitments.
 
   These transactions include international sales by various subsidiaries in
foreign currencies, foreign currency denominated purchases, intercompany
shipments to subsidiaries and other intercompany transactions.
 
   Such contracts outstanding as of December 31, 1997 mature mainly during
first quarter 1998, and amount to $149,500 forward sale of US$, $17,302
forward purchase of US$, $63,968 forward sale of other foreign currencies, and
$74,449 forward purchases of other foreign currencies. There were no foreign
currency options outstanding as of December 31, 1996 or 1997. Forward
contracts generally mature in 10 months or less.
 
   The principal currencies covered are the German mark, the British pound,
the Japanese yen, the French franc and the Italian lira.
 
   The risk of loss associated with purchased options is limited to premium
amounts paid for the option contracts. The risk of loss associated with
forward contracts is equal to the exchange rate differential from the time the
contract is made until the time it is settled.
 
   Realized and unrealized gains and losses on forward contracts are included
in "other income and expenses".
 
   The discount or premium on forward contracts have been amortized over the
life of the forward contract and included in "net interest expenses".
 
   CONCENTRATION OF CREDIT RISK
 
   Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
financial instruments with off-balance sheet risks (primarily forward
contracts) and trade receivables.
 
                                     F-24
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
   The Company places its cash and cash equivalents with high credit quality
financial institutions.
 
   The Company controls the credit risks associated with financial instruments
through credit approvals, investment limits and centralized monitoring
procedures but does not normally require collateral or other security from the
parties to the financial instruments with off-balance sheet risk. In the event
of a failure to honor one of the forward contracts by one of the banks with
which the Company has contracted, management believes any loss would be
limited to the exchange rate differential from the time the contract was made.
 
   Concentrations of credit risk with respect to trade receivables are limited
because the Company conducts its operations with customers located throughout
the world. Management believes that receivables are well diversified, thereby
reducing potential credit risk to the Company.
 
   The Company does not anticipate non-performance by counterparties which
could have a significant impact on its financial position or results of
operations.
 
   Foreign currency agreements:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                               ----------------
                                                                1996     1997
                                                               -------  -------
    <S>                                                        <C>      <C>
      Forward exchange contracts:
       sales.................................................. 236,860  213,468
       purchases.............................................. (70,939) (91,751)
</TABLE>
 
<TABLE>
    <S>                                                            <C>
      Forward exchange contracts.................................. REMAINING
                                                                     TERM
                                                                   ---------
                                                                    1 to 10
                                                                    months
</TABLE>
 
   FAIR VALUE OF FINANCIAL INSTRUMENTS
 
   The estimates of fair value were obtained using prevailing financial market
information from various valuation techniques as of December 31, 1997. The
methodologies used to estimate fair values are as follows:
 
   CASH AND CASH EQUIVALENTS, ACCOUNTS AND NOTES RECEIVABLE, BANK OVERDRAFTS,
SHORT-TERM BORROWINGS, ACCOUNTS AND NOTES PAYABLES
 
   The carrying amounts reflected in the consolidated financial statements are
reasonable estimates of fair value because of the relatively short period of
time between the origination of the instruments and their expected
realization.
 
   LONG-TERM DEBT AND CURRENT PORTION OF LONG-TERM DEBT
 
   The fair values of these financial instruments were determined by
estimating future cash flows on a borrowing-by-borrowing basis and discounting
these future cash flows using the Company's incremental borrowing rates for
similar types of borrowing arrangements.
 
                                     F-25
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
   FORWARD EXCHANGE CONTRACTS AND CURRENCY OPTIONS
 
   The fair value of these instruments is the estimated amount that the
Company would receive or pay to settle the related agreements as of December
31, 1996 and 1997 based upon quoted market rates and the creditworthiness of
the counterparties.
 
<TABLE>
<CAPTION>
                                                    DECEMBER 31,
                                       ---------------------------------------
                                              1996                1997
                                       ------------------- -------------------
                                       CARRYING ESTIMATED  CARRYING ESTIMATED
                                        AMOUNT  FAIR VALUE  AMOUNT  FAIR VALUE
                                       -------- ---------- -------- ----------
    <S>                                <C>      <C>        <C>      <C>
    BALANCE SHEET
    Marketable securities.............   6,048     6,048    48,259    48,259
    Bank loans (including current
     portion)......................... 286,860   270,218   415,021   405,445
    OFF-BALANCE SHEET
    Forward exchange contracts........             2,900             (13,833)
</TABLE>
 
25.OTHER COMMITMENTS AND CONTINGENCIES
 
   LITIGATION
 
   The Company is involved in various litigations incidental to the normal
conduct of its operations. These litigations mainly include the risks
associated with external patents utilization, investigations, claims from
customers and tax disputes. Management estimates that these contingencies will
not have a material effect on the financial condition or results of operations
of the Company.
 
   OTHER CONTINGENT LIABILITIES
 
   The Company's position on certain tax regulations may differ from the tax
authorities' interpretation, which could result in a tax liability. However,
the Company believes that provisions carried as at December 31, 1997 are
adequate.
 
26.RELATED PARTY TRANSACTIONS
 
   The main transactions with the shareholders, including THOMSON SA and
THOMSON CSF, and their affiliates were as follows:
 
<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                      -------------------------
                                                       1995     1996     1997
                                                      -------  -------  -------
    <S>                                               <C>      <C>      <C>
    Sales............................................ 195,352  232,057  148,172
    Research and development expenses................ (17,815) (13,262) (12,794)
    Other purchases and expenses..................... (42,237) (48,155) (29,757)
    Accounts receivable..............................  47,154   31,580   17,244
    Accounts payable.................................  11,393   10,519    9,745
</TABLE>
 
                                     F-26
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
27.SEGMENT INFORMATION
 
   The Company, operating in a single industry segment, designs, develops,
manufactures and markets a wide variety of semiconductors. Net revenues,
earnings from operations, capital expenditures and identifiable assets
classified by the major geographic areas in which the Company operates are:
 
<TABLE>
<CAPTION>
                                                                    OTHER
                                                                  CORPORATE
                                                                     AND
                              AMERICAS   ASIA PACIFIC  EUROPE    ELIMINATION    TOTAL
                              ---------  ------------ ---------  -----------  ----------
    <S>                       <C>        <C>          <C>        <C>          <C>
    1995
    INCOME STATEMENT
     Net revenues...........    846,406   1,080,428   1,627,585          --    3,554,419
     Intersegment sales.....    179,767   3,411,776   3,372,542  (6,964,085)          --
                              ---------   ---------   ---------  ----------   ----------
     Total..................  1,026,173   4,492,204   5,000,127  (6,964,085)   3,554,419
     Operating profit.......     63,348     242,113     355,208      (9,639)     651,030
     Depreciation...........    (51,263)    (90,450)   (250,677)         --     (392,390)
     Research and
      development expenses..    (48,607)     (4,875)   (386,852)         --     (440,334)
    CASH FLOW STATEMENT
     Capital expenditures...    187,517     204,694     609,725          --    1,001,936
    BALANCE SHEET
     Identifiable assets....    574,730     845,536   2,336,956     728,784    4,486,006
    OTHER INFORMATION
     Number of employees....      2,439       7,934      15,150          --       25,523
     Wages and salaries.....   (139,640)   (120,832)   (625,988)         --     (886,460)
    1996
    INCOME STATEMENT
     Net revenues...........    934,224   1,363,771   1,824,365          --    4,122,360
     Intersegment sales.....    268,688   3,764,473   5,068,912  (9,102,073)          --
                              ---------   ---------   ---------  ----------   ----------
     Total..................  1,202,912   5,128,244   6,893,277  (9,102,073)   4,122,360
     Operating profit.......      3,038     211,998     596,685     (12,299)     799,422
     Depreciation...........    (77,967)   (105,363)   (352,211)       (367)    (535,908)
     Research and
      development expenses..    (73,710)     (7,816)   (450,465)       (303)    (532,294)
    CASH FLOW STATEMENT
     Capital expenditures...    179,326     165,404     780,305         170    1,125,205
    BALANCE SHEET
     Identifiable assets....    686,455     933,115   2,848,124     537,818    5,005,512
    OTHER INFORMATION
     Number of employees....      2,555       7,570      15,768          --       25,893
     Wages and salaries.....   (166,486)   (133,471)   (709,821)         --   (1,009,778)
</TABLE>
 
                                      F-27
<PAGE>
 
                       SGS-THOMSON MICROELECTRONICS N.V.
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
                     (Currency--Thousands of U.S. dollars)
 
 
<TABLE>
<CAPTION>
                                                                    OTHER
                                                                  CORPORATE
                                                                     AND
                              AMERICAS   ASIA PACIFIC  EUROPE    ELIMINATION    TOTAL
                              ---------  ------------ ---------  -----------  ----------
    <S>                       <C>        <C>          <C>        <C>          <C>
    1997
    INCOME STATEMENT
     Net revenues...........    935,010   1,283,869   1,800,266          --    4,019,145
     Intersegment sales.....    341,578   3,436,876   4,538,097  (8,316,551)          --
                              ---------   ---------   ---------  ----------   ----------
     Total..................  1,276,588   4,720,745   6,338,363  (8,316,551)   4,019,145
     Operating profit.......         70     155,238     387,226     (22,715)     519,819
     Depreciation...........   (109,473)   (111,446)   (387,139)        (65)    (608,123)
     Research and
      development expenses..    (97,484)     (8,329)   (504,419)       (615)    (610,847)
    CASH FLOW STATEMENT
     Capital expenditures...    184,025     158,781     692,600          28    1,035,434
    BALANCE SHEET
     Identifiable assets....    789,525     973,212   2,997,917     685,085    5,445,739
    OTHER INFORMATION
     Number of employees....      2,741       8,451      17,536          --       28,728
     Wages and salaries.....   (167,495)   (141,310)   (716,422)         --   (1,025,227)
</TABLE>
 
   In the above information, sales include local sales and exports made by
operations within each area. Total sales by geographic area include sales to
unaffiliated customers and international transfers. To control costs, a
substantial portion of the Company's products are transported among the U.S.,
Asia and Europe while in the process of being manufactured and sold. Sales to
customers have little correlation with the location of manufacture. As a
global participant in the semiconductor industry, the Company's business is
subject to risks beyond its control, such as instability of foreign economies
and governments and changes in law and politics affecting trade and
investments.
 
28.SUBSEQUENT EVENTS (UNAUDITED)
 
   On May 18, 1998, the Annual General Meeting of the Company voted to change
the name of the Company to STMicroelectronics NV.
 
   On June 10, 1998, the Company completed a global offering of 3,000,000
shares of capital stock at $72.1875 per share. The net proceeds to the Company
in connection with the offering of capital stock were approximately $208
million. On June 10, 1998, the Company also completed a public offering of
$432 million aggregate initial principal amount of zero-coupon convertible
Liquid Yield Option (TM) Notes due 2008 (the "LYONs") with yield to maturity
of 1.75%. The net proceeds to the Company in connection with the LYONs
offering was approximately $423 million.
 
   In addition, in connection with the offering of shares, the shares of the
Company were approved for quotation on the Italian Stock Exchange.
 
   The Company has implemented an Employee Stock Plan whereby employees have
been given the opportunity to purchase shares of the Company's capital stock
at a 12% discount from the public offering price used in the Offering
completed June 10, 1998, subject to a six-month holding period expiring on
December 10, 1998. The subscription period ended on June 10, 1998 and payment
for the shares is expected to occur prior to the expiry of the holding period.
 
                                     F-28
<PAGE>
 
                            STMICROELECTRONICS N.V.
                       VALUATION AND QUALIFYING ACCOUNTS
                    (CURRENCY -- THOUSANDS OF U.S. DOLLARS)
 
<TABLE>
<CAPTION>
                                                 CHARGED
                          BALANCE AT             TO COSTS            BALANCE AT
                          BEGINNING  TRANSLATION   AND                 END OF
                          OF PERIOD  ADJUSTMENT  EXPENSES DEDUCTIONS   PERIOD
                          ---------- ----------- -------- ---------- ----------
<S>                       <C>        <C>         <C>      <C>        <C>
VALUATION AND QUALIFYING
ACCOUNTS
DEDUCTED FROM THE
RELATED ASSET ACCOUNTS
1997
  Inventories...........    45,176        --      68,182   (45,176)    68,182
  Accounts Receivable...    18,152     (1,902)         7    (1,029)    15,228
1996
  Inventories...........    36,500        --      45,176   (36,500)    45,176
  Accounts Receivable...    17,881       (514)     1,114      (329)    18,152
1995
  Inventories...........    29,982        --      36,500   (29,982)    36,500
  Accounts Receivable...    14,018        691      3,467      (295)    17,881
</TABLE>
 
                                      II-1
<PAGE>
 
                                 CERTAIN TERMS
 
<TABLE>
<S>                          <C>
ASD......................... application-specific discrete technology
ASIC........................ application-specific IC
ASSP........................ application-specific standard product
ATM......................... asynchronous transfer mode
BCD......................... bipolar, CMOS and DMOS process technology
BiCMOS...................... bipolar and CMOS process technology
CAD......................... computer aided design
CIM......................... computer integrated manufacturing
CMOS........................ complementary metal oxide silicon
DMOS........................ diffused metal oxide silicon
DRAMS....................... dynamic random access memory
DSP......................... digital signal processor
EEPROM...................... electrically erasable programmable read-only memory
EPROM....................... erasable programmable read-only memory
HCMOS....................... high-speed complementary metal-oxide-silicon
IC.......................... integrated circuit
IGBT........................ insulated gate bipolar transistors
ISDN........................ integrated services digital network
Kbit........................ kilobit
Mbit........................ megabit
MIPS........................ million instructions per second
MOS......................... metal oxide silicon process technology
MOSFET...................... metal oxide silicon field effect transistor
MPEG........................ motion picture experts group
NVRAM....................... nonvolatile SRAM
OEM......................... original equipment manufacturer
OTP......................... one-time programmable
PROM........................ programmable read-only memory
RAM......................... random access memory
RF.......................... radio frequency
RISC........................ reduced instruction set computing
ROM......................... read-only memory
SAM......................... serviceable available market
SLIC........................ subscriber line interface card
SPC......................... statistical process control
SRAM........................ static random access memory
STB......................... set top box
TAM......................... total available market
VLSI........................ very large scale integration
</TABLE>
 
                                      II-2
<PAGE>
 
                                   SIGNATURES
 
   Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the registrant certifies that it meets all of the requirements for filing
on Form 20-F and has duly caused this annual report to be signed on its behalf
by the undersigned, thereunto duly authorized.
 
                                          STMICROELECTRONICS N.V.
     
                                                   /s/ Pasquale Pistorio
Date: June 29, 1998                       By: _________________________________
                                            Name: Pasquale Pistorio
                                            Title: President and Chief
                                            Executive Officer     
 
 
                                      II-3
<PAGE>
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
 NAME                                              PAGE
 ----                                              ----
 <C>   <S>                                         <C>
 23(a) Consent of Arthur Andersen & Co.
 23(b) Consent of Price Waterhouse Nederland BV.
</TABLE>