20-F 1 thomson.htm THOMSON FORM 20-F

As filed with the Securities and Exchange Commission on May 12, 2006

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 20-F

(Mark One)

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934



ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005


TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________


SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell report

COMMISSION FILE NUMBER: 001-14974

THOMSON

(Exact name of Registrant as specified in its charter)

 

Not Applicable

46, quai Alphonse Le Gallo
92100 Boulogne-Billancourt - France

Republic of France

(Translation of Registrant’s name
into English)

(Address of principal executive offices)

(Jurisdiction of incorporation
or organization)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class:

Common Stock, nominal value €3.75 per share,
and American Depositary Shares,
each representing one share of Common Stock

Name of each exchange
on which registered:

New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act:
None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

Common Stock, nominal value €3.75 per share: 273,308,032

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:

Yes No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934:

Yes No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days:

Yes No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer 

Accelerated filer 

Non-accelerated filer 

Indicate by check mark which financial statement item the Registrant has elected to follow:

Item 17    Item 18

If this is an annual report, indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  No


 



 


 

 



Table of Contents

 

 

Page

 

 

Introduction

3

 

 

Forward-Looking Statements

3

 

 

Statements Regarding Competitive Position

4

 

 

Reporting Currency

5

 

 

 

 

 

 

Part I

6

 

 

Item 1 – Identity of Directors, Senior Management and Advisers

6

 

 

Item 2 – Offer Statistics and Expected Timetable

6

 

 

Item 3 – Key Information

6

 

 

Item 4  – Information on the Company

20

 

 

Item 4.A – Unresolved Staff Comments

51

 

 

Item 5 – Operating and Financial Review and Prospects

52

 

 

Item 6 – Directors, Senior Management and Employees

85

 

 

Item 7 – Major Shareholders and Related Party Transactions

108

 

 

Item 8 – Financial Information

116

 

 

Item 9 – The Offer and Listing

122

 

 

Item 10 – Additional Information

126

 

 

Item 11 – Quantitative and Qualitative Disclosures about Market Risk

144

 

 

Item 12 – Description of Securities other than Equity Securities

152

 

 

 

 

 

 

Part II

153

 

 

Item 13 – Defaults, Dividend Arrearages and Delinquencies

153

 

 

Item 14 – Material Modifications to the Rights of Security Holders and Use of Proceeds

153

 

 

Item 15 – Controls and Procedures

153

 

 

Item 16.A – Audit Committee Financial Expert

154

 

 

Item 16.B – Code of Ethics

154

 

 

Item 16.C – Principal Accountant Fees and Services

155

 

 

Item 16.D – Exemptions from the Listing Standards for Audit Committees

156

 

 

Item 16.E – Purchases of Equity Securities by the Issuer and Affiliated Purchasers

157

 

 

 

 

 

 

Part III

158

 

 

Item 17 – Financial Statements

158

 

 

Item 18 – Financial Statements

158

 

 

Item 19 – Exhibits

159

 

 

 

 

 

 

Thomson Consolidated Financial Statements

161

 

 

2 2005 FORM 20-F – THOMSON GROUP

 



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INTRODUCTION

In this Annual Report on Form 20-F, the terms the “Company”, the “Group”, “Thomson”, “we” and “our” mean THOMSON, together with its consolidated subsidiaries.

FORWARD-LOOKING STATEMENTS

In order to utilize the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995, we are providing the following cautionary statement. This Annual Report contains certain forward-looking statements with respect to our financial condition, results of operations and business and certain of our plans and objectives. These statements are based on management’s current expectations and beliefs in light of the information currently available and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. In addition to statements that are forward-looking by reason of context, other forward-looking statements may be identified by use of the terms “may”, “will”, “should”, “expects”, “plans”, “intends”, “anticipates”, “believes”, “estimates”, “projects”, “predicts” and “continue” and similar expressions identify forward-looking statements. By their nature, forward-looking statements involve risk and uncertainty because they relate to events and depend on circumstances that are anticipated to occur in the future. Such statements are also subject to assumptions concerning, among other things: our anticipated business strategies; our intention to introduce new products; anticipated trends in our business; and our ability to continue to control costs and maintain quality. We caution that these statements may, and often do, vary from actual results and the differences between these statements and actual results can be material. Some of the factors that could cause actual results and events to differ materially from those expressed or implied in any forward-looking statements are:

 

our failure to maintain contractual arrangements with our major customers and renew existing contractual arrangements with them, or material adverse changes in the financial condition or creditworthiness of our key customers and clients over the long term;

 

our ability to design, develop and sell innovative products and services, which are offered in highly competitive markets characterized by rapid technology changes and subjective and changing customer preferences;

 

economic conditions, including consumer spending, in countries in which our services, systems and equipment are sold or patents licensed, particularly in the United States, Europe and Asia;

 

our ability to protect our patents and other intellectual property rights and the outcome of any claims against us for the alleged infringement of third parties’ intellectual property rights;

 

general economic trends, changes in raw materials and employee costs and political and social uncertainty in markets where we manufacture goods, purchase components and finished goods and license patents, particularly in Latin America and Asia;

 

 

2005 FORM 20-F – THOMSON GROUP 3

 



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increased competition in video technologies, components, systems and services and finished products and services sold to customers in the media and entertainment industries;

 

technological advancements in the media and entertainment industries;

 

force majeure risks, especially related to our just-in-time inventory, supply and distribution policy;

 

challenges inherent in our repositioning strategy and Two Year Plan, as detailed in Item 4: “Information on the Company—History and Development of the Company”;

 

market risks associated with our minority interests in certain public companies, TCL Multimedia Technology Holdings and Videocon Industries, following our disengagement from our former television and Displays activities;

 

the success of certain partnerships and joint ventures that we may not control, as well as future business acquisitions, combinations or dispositions;

 

changes in exchange rates, notably between the euro and the U.S. dollar, Chinese yuan, Canadian dollar, Mexican peso, Polish zloty and British pound;

 

warranty claims, product recalls or litigation that exceed or are not covered by our available insurance coverage; and

 

capital and financial market conditions, prevailing interest rates and availability of financing.

Furthermore, a review of the reasons why actual results and developments may differ materially from the expectations disclosed or implied within forward-looking statements can be found under Item 3: “Key Information—Risk Factors” below. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to publicly update any of them in light of new information or future events. We advise you to consult any documents we may file or furnish with the U.S. Securities and Exchange Commission (“SEC”), as described under Item 10: “Additional Information—Documents on Display.”

STATEMENTS REGARDING COMPETITIVE POSITION

This Annual Report contains statements regarding our market share, market position and products and businesses. Unless otherwise noted herein, market estimates are based on the following outside sources, in some cases in combination with internal estimates:

 

Understanding & Solutions for information on CDs and DVDs (DVD Services);

 

Gesellschaft für Konsumer Markt- und Absatzforschung (“GfK”) for information on TV, VCR, DVD, audio and decoder products in the “Europe 5” market which comprises France, Germany, the United Kingdom, Italy and Spain;

 

SYNOVATE (formerly Institute for Market Research) for information on TV, VCR, DVD, audio and telephony markets in the Americas (Connectivity);

 

Kinetic Strategies and Infonetics for information on cable modems (Access Platforms & Gateways);

 

Dell’Oro for information on DSL modems and gateways;

 

Intex Management Systems (“IMS”) for information on set-top boxes; and

 

Frost & Sullivan, SCRI, TrendWatch and NAB for information on the broadcast and media solutions markets (Broadcast & Networks).

Statements contained in this Annual Report that make reference to “value market share” or market share “based on value” mean that the related market estimate is based on sales, and statements referring to “volume market share” or market share “based on volume” mean that the related market estimate is based on the number of units sold.

Market share and market position statements are generally based on sources published in the fourth quarter of 2005 or beginning 2006. Statements concerning our content services businesses operating under the Technicolor brand are based on a combination of internal estimates and external sources published mid- to late 2005.

 

 

4 2005 FORM 20-F – THOMSON GROUP

 



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REPORTING CURRENCY

Our consolidated financial statements that form part of this Annual Report on Form 20-F are presented in euro. Effective January 1, 2001, our consolidated financial statements are presented using the euro as our reporting currency.

For your convenience, this Annual Report contains translations of certain euro amounts into U.S. dollars. Unless otherwise indicated, dollar amounts have been translated from euro at the rate of €1.00 = U.S.$ 1.2607, the noon buying rate in New York City for cable transfers in euro as announced by the Federal Reserve Bank of New York for customs purposes (the “Noon Buying Rate”) on May 1, 2006.

 

 

2005 FORM 20-F – THOMSON GROUP 5

 



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PART I

ITEM 1 - IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2 - OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3 - KEY INFORMATION

A – Selected Financial Data

We have derived the following selected consolidated financial data from our consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004 in accordance with International Financial Reporting Standards as adopted by the European Union, which we refer to herein as “IFRS”. As of December 31, 2005, our consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004 would not have been different if presented under “IFRS as adopted by the European Union” or under “IFRS as published by the IASB”. You should read the following selected consolidated financial data together with Item 5: “Operating and Financial Review and Prospects” and our consolidated financial statements.

Pursuant to the SEC’s release on first-time adoption of IFRS, we have also included selected consolidated financial data for the five-year period ended December 31, 2005 prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). IFRS differs in certain significant aspects from U.S. GAAP. Notes 31 and 32 to our consolidated financial statements describe the principal differences between IFRS and U.S. GAAP as they relate to us and include a reconciliation of our net income and shareholders’ equity under IFRS to that under U.S. GAAP. We also summarize these differences in Item 5: “Operating and Financial Review and Prospects—Principal Differences Between IFRS and U.S. GAAP.”

 

 

6 2005 FORM 20-F – THOMSON GROUP

 



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Effective January 1, 2005, Thomson reorganized the Group’s activities around three principal operating divisions: Services, Systems & Equipments and Technology. Two additional segments were created to regroup our remaining activities: Displays & CE Partnerships and Corporate. Our consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004 reflect these new segments.

The results of the bulk of our Displays activities forming part of our Displays & CE Partnerships activities and of the Audio/Video and Accessories activities within Connectivity in the Systems & Equipment division are treated as a net item within discontinued operations in the consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004, and are therefore not reflected in our reported net sales. The substantial majority of the net sales shown in the Displays & CE Partnerships segment in 2004 comprise sales of our television activity and in 2005 are sales of our residual non-core manufacturing assembly operations.

Our television activity was deconsolidated effective August 1, 2004 following the creation of TTE Corporation (“TTE”) in partnership with TCL International and TCL Corporation (“TCL”), to which this activity was contributed. Accordingly, our consolidated financial statements as of and for the year ended December 31, 2004 reflect within the Displays & CE Partnerships segment seven months of Thomson as owner and operator of its television business and the remaining five months as a service provider to TTE pursuant to certain contractual arrangements. In September 2005, the sales and marketing services provided ceased, and the contractual arrangements for providing sub-contract manufacturing services were re-negotiated. Displays & CE Partnerships therefore include television sales for the first seven months of 2004 of €845 million and manufacturing and sales and marketing agency services provided to TTE during the remaining five months of 2004 representing €185 million, while in 2005 the latter amounted to €56 million.

 

 

2005 FORM 20-F – THOMSON GROUP 7

 



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At or for the years ended December 31,

 

 

 


 

 

 

2005 (1)

 

2005

 

2004

 

 

 


 


 


 

 

 

US $ millions

 

€ millions

 

€ millions

 

 

 

except share and per share data

 

INCOME STATEMENT DATA
Amounts in accordance with IFRS

 

 

 

 

 

 

 

Revenues from continuing operations

 

7,175

 

5,691

 

6,036

 

Profit (loss) from continuing operations and before tax and financial result

 

482

 

382

 

466

 

Income Taxes

 

(88

)

(70

)

(93

)

Financial result (2)

 

(68

)

(54

)

(29

)

Profit (loss) from continuing operations

 

222

 

176

 

324

 

Profit (loss) from discontinued operations

 

(944

)

(749

)

(885

)

Net income (loss)

 

(722

)

(573

)

(561

)

Earnings per Ordinary Share

 

 

 

 

 

 

 

Weighted average number of shares outstanding – basic net of treasury stock (3)

 

266,539,917

 

266,539,917

 

273,646,869

 

Earnings per share from continuing operations attributable to the equity holders of the Group

 

 

 

 

 

 

 

Basic

 

0.81

 

0.64

 

1.18

 

Diluted

 

0.42

 

0.33

 

1.11

 

Total earnings per share attributable to the equity holders of the Group

 

 

 

 

 

 

 

Basic

 

(2.74

)

(2.17

)

(2.05

)

Diluted (4)

 

(3.13

)

(2.48

)

(2.12

)

   
 
 
 

BALANCE SHEET DATA
Amounts in accordance with IFRS

 

 

 

 

 

 

 

Total non-current assets

 

6,395

 

5,072

(5)

4,142

 

Total current assets (excluding cash and cash equivalents and marketable securities)

 

3,046

 

2,416

 

2,507

 

Cash and cash equivalents and marketable securities

 

1,264

 

1,003

(6)

1,906

 

Assets classified as held for sale

 

465

 

369

(7)

 

Total assets

 

11,170

 

8,860

 

8,555

 

Total non-current liabilities

 

2,838

 

2,251

 

2,603

 

Total current liabilities

 

4,945

 

3,923

 

3,459

 

Shareholders’ equity

 

2,785

 

2,209

 

2,475

 

Minority interests

 

9

 

7

 

18

 

Liabilities associated with assets classified as held for sale

 

593

 

470

 

 

Total liabilities, shareholders’ equity and minority interests

 

11,170

 

8,860

 

8,555

 

DIVIDENDS

 

 

 

 

 

 

 

 

 


 


 


 

Dividends per share

 

0.38

 

0.30

(8)

0.285

 

 

 


 


 


 

______________

(1)

Amounts given in euros have been translated for convenience only into U.S. dollars at the rate of $ 1.2607 = €1.00, the noon buying rate in New York for cable transfers certified by the Federal Reserve Bank of New York for customs purposes on May 1, 2006.

(2)

Comprises “Interest expense” and “Other financial income (expense)”. See Note 9 to our consolidated financial statements for more information.

(3)

The decrease as of December 2005 is due to the treasury shares acquired in 2005.

(4)

See Note 31 to our consolidated financial statements for more information on the dilutive instruments affecting earnings per share on a diluted basis.

(5)

The increase from December 31, 2004 to December 31, 2005 is due primarily to an increase in goodwill (€1,756 million at December 31, 2005 compared to €1,178 million at December 31, 2004), reflecting primarily increased goodwill in connection with the 2005 acquisitions of Inventel, Cirpack, ContentGuard, Premier Retail Networks and Thales Broadcast & Multimedia (see Note 14 to our consolidated financial statements), and to an increase in investments and financial assets available for sale (€341 million at December 31, 2005 compared to €113 million at December 31, 2004), due primarily to our investment in 2005 of €240 million in Global Depositary Receipts of Videocon Industries in connection with the disposition of our Displays activities (see Item 4: “Information on the Company—Discontinued Operations”), offset in part by a decrease in Property, plant and equipment (€886 million at December 31, 2005 compared to €1,051 million at December 31, 2004) (see Note 12 to our consolidated financial statements).

(6)

The decrease from December 31, 2004 to December 31, 2005 is due primarily to a decrease in Cash and cash equivalents from €1,848 million at December 31, 2004 to €996 million at December 31, 2005. See Item 5: “Operating and Financial Review and Prospects—Liquidity and Capital Resources” and Note 21 to our consolidated financial statements.

(7)

Comprise primarily inventories and accounts receivables and other receivables of our Audio/Video and Accessories activities, which following the announcement in December 2005 to divest of these activities are treated as assets classified as held for sale. See Note 11 to our consolidated financial statements.

(8)

On February 21, 2006, the Board of Directors decided to propose to the shareholders’ meeting to be held on May 12, 2006 a distribution of 30 cents of euro per share with respect to fiscal year 2005 to be charged to a share premium account (compte de prime d’émission) within shareholders’ equity. For more information, see Item 8: “Financial Information—Dividends.”

 

 

8 2005 FORM 20-F – THOMSON GROUP

 



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The following table presents selected financial data for each of the five-years ended December 31, prepared in accordance with U.S. GAAP.

 

 

 

At or for the years ended December 31,

 

 

 


 

 

 

2005 (1)

 

2005

 

2004

 

2003 (2)

 

2002 (2)

 

2001 (2)

 

 

 


 


 


 


 


 


 

 

 

US $ millions

 

€ millions

 

 

 

 

 

except share and per share data

 

Revenues from continuing operations

 

7,161

 

5,680

 

6,028

 

8,443

 

10,189

 

10,396

 

 

 


 


 


 


 


 


 

Income from continuing operations (3)

 

96

 

76

 

213

 

(43

)

351

 

191

 

Income from discontinued operations (3)

 

(1,005

)

(797

)

(865

)

(3

)

 

 

Income before change in accounting principle (3)

 

(909

)

(721

)

(652

)

(46

)

351

 

191

 

Change in accounting principle (4)

 

 

 

(43

)

 

 

 

Net income (3)

 

(909

)

(721

)

(695

)

(46

)

351

 

191

 

 

 


 


 


 


 


 


 

Basic earnings per shares

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

0.35

 

0.28

 

0.78

 

(0.16

)

1.26

 

0.72

 

Income from discontinued operations

 

(3.77

)

(2.99

)

(3.16

)

(0.01

)

 

 

Income before change in accounting principle

 

(3.42

)

(2.71

)

(2.38

)

 

 

 

Change in accounting principle

 

 

 

(0.16

)

 

 

 

Net income

 

(3.42

)

(2.71

)

(2.54

)

(0.17

)

1.26

 

0.72

 

 

 


 


 


 


 


 


 

Diluted earnings per shares

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

0.01

 

0.01

 

0.66

 

(0.16

)

1.21

 

0.69

 

Income from discontinued operations

 

(3.43

)

(2.72

)

(3.04

)

(0.01

)

 

 

Income before change in accounting principle

 

(3.42

)

(2.71

)

(2.38

)

 

 

 

Change in accounting principle

 

 

 

(0.16

)

 

 

 

Net income

 

(3.42

)

(2.71

)

(2.54

)

(0.17

)

1.21

 

0.69

 

 

 


 


 


 


 


 


 

Shareholders’ equity

 

2,233

 

1,771

 

2,492

 

3,433

 

3,859

 

3,399

 

Total assets (5)

 

10,872

 

8,624

 

8,454

 

9,432

 

9,889

 

10,289

 

Long-term debt (5)

 

1,725

 

1,368

 

1,591

 

1,865

 

1,432

 

1,599

 

 

 


 


 


 


 


 


 

______________

(1)

Amounts given in euros have been translated for convenience only into U.S. dollars at the rate of $1.2607 = €1.00, the noon buying rate in New York for cable transfers certified by the Federal Reserve Bank of New York for customs purposes on May 1, 2006.

(2)

The figures presented above for 2001, 2002 and 2003 have not been restated for comparative information pursuant to the application of FAS 144 “Accounting for the impairment or Disposal of Long-lived assets.” As the effect of discontinued operations is shown in the year in which the reclassification has been made, previous years’ information is not restated in this table.

(3)

Attributable to controlling interests.

(4)

In accordance with the transitional provision of FIN46 Revised “Consolidation of Variable Interest Entities an interpretation of Accounting Research Bulletins #51”, we have recognized an additional charge for the first-time consolidation of two special purpose entities of €43 million, representing the cumulative effect of the change in accounting principles that is shown in our consolidated income statement under the caption “change in accounting principle”.

(5) Unaudited figures for 2003, 2002 and 2001.

 

 

2005 FORM 20-F – THOMSON GROUP 9

 



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B — Exchange Rate Information

Our shares are denominated in euro. Fluctuations in the exchange rate between the euro and the U.S. dollar will affect the U.S. dollar price of our American Depositary Shares (“ADSs”) on the New York Stock Exchange. In addition, as we intend to pay any cash dividends in euro, exchange rate fluctuations will affect the U.S. dollar amounts that owners of ADSs will receive on conversion of dividends. Furthermore, fluctuations in the exchange rate between the euro and the U.S. dollar affect the U.S. dollar equivalent of the price of our shares on Euronext Paris S.A.

The following table shows the euro/U.S. dollar exchange rate for the periods presented based on the Noon Buying Rate. We do not make any representations that euro could have been converted into dollars at the rates shown or at any other rate.

 

Month

 

Period End

 

Average Rate (1)

 

High

 

Low

 


 


 


 


 


 

 

 

€ / U.S.$

 

April 2006

 

1.2624

 

1.2273

 

1.2624

 

1.2091

 

March 2006

 

1.2139

 

1.2028

 

1.2197

 

1.1886

 

February 2006

 

1.1925

 

1.1940

 

1.2100

 

1.1860

 

January 2006

 

1.2158

 

1.2126

 

1.2287

 

1.1980

 

December 2005

 

1.1842

 

1.1861

 

1.2041

 

1.1699

 

November 2005

 

1.1790

 

1.1789

 

1.2067

 

1.1667

 

______________

(1)

The average of the Noon Buying Rates for euro on the business days of each month during the relevant period.

Source: Federal Reserve Bank of New York.

 

Month

 

Period End

 

Average Rate (1)

 

High

 

Low

 


 


 


 


 


 

 

 

€ / U.S.$

 

2005

 

1.18

 

1.24

 

1.35

 

1.17

 

2004

 

1.35

 

1.25

 

1.36

 

1.18

 

2003

 

1.26

 

1.14

 

1.26

 

1.04

 

2002

 

1.05

 

0.95

 

1.05

 

0.85

 

2001

 

0.89

 

0.89

 

0.95

 

0.84

 

______________

(1)

The average of the Noon Buying Rates for euro on the last business day of each month during the relevant period.

Source: Federal Reserve Bank of New York.

The euro/U.S. dollar exchange rate for May 1, 2006 was €1.00= U.S.$ 1.2607 based on the Noon Buying Rate on that date.

 

 

10 2005 FORM 20-F – THOMSON GROUP

 



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C — Risk Factors

This section describes some of the risks that could affect our businesses. The factors below should be considered in connection with any forward-looking statements in this document and with the cautionary statements contained in “Forward-Looking Statements” at the beginning of this document.

The risks below are not the only ones that we face. Some risks may not yet be known to us and some that we do not currently believe to be material could later turn out to be material. Any of these risks could materially affect our business, financial condition and results of operations.

Our businesses operate in concentrated markets and depend in large part on a number of major customers and the long-term maintenance of relationships and contractual arrangements with them. Our financial results may suffer if these relationships weaken or terminate, if we are unable to renew these contractual arrangements when they expire or are only able to renew them under significantly less favorable terms, or if certain of our customers face financial difficulties.

Our businesses operate in, and our strategy is to be a preferred partner of, the Media & Entertainment (“M&E”) industries, which is a concentrated market. The Group’s client base is therefore similarly concentrated. In addition to this industry concentration, relationships have historically played an important role in the M&E industries we serve, notably on the professional side of our business. As a result of the combination of these factors, several of our businesses depend on a number of major customers and our long-term relationships and contractual arrangements with them. For example, our Film Services and DVD Services activities, the largest contributors to the net sales of our Services division, currently rely on our relationships with a number of major motion picture studios. We generally negotiate exclusive, long-term contracts with these studios. Our top five studio customers accounted for 64% of the revenues of our Services division and 23% of our reported consolidated 2005 revenues. In the Access Platforms & Gateways unit within our Systems & Equipment division, a large proportion of our revenue is derived from various broadcasters, including DIRECTV and other News Corp affiliates, occasionally under long-term contractual arrangements. Our top five customers in the Systems & Equipment division accounted for 46% of the reported 2005 revenues of the division and 15% of our total reported consolidated 2005 revenues; in particular we have an important long-term contract with DIRECTV which accounted for a significant proportion of these revenues and constitutes our largest customer contract measured in terms of 2005 revenues. Our technology licensing business is dependent upon our relationships with a relatively limited number of consumer products manufacturers, to whom we license both new and mature technologies. Licensing agreements typically have a duration of five years, and our top ten licensees account for approximately 68% of our total licensing revenues in 2005. Overall, our ten largest customers account for 42% of our 2005 revenues, and these revenues are weighted towards the top few customers within this group. If we fail to maintain these relationships, these customers may reduce or cease purchases and use of our products, services and technologies, which could adversely affect our businesses and prospects. Moreover, if we fail to maintain these relationships, or if we are not able to develop relationships in new markets in which we intend to compete in the future, including markets for new technologies and expanding geographic markets such as China and India, our business, results and prospects could suffer.

In addition, although most of our major client relationships comprise multiple contractual arrangements of varying terms, in any given year certain contracts come up for renewal across each of our business lines. If we were unable to renew them under similar or more favourable terms, or if our relationship with several of these customers suffered or ended, our financial results could suffer.

From time to time, one or a small number of our customers or licensees may represent a significant percentage of our revenues. A decision by any of our major customers or licensees not to use our products, services or technologies, or their failure or inability to pay amounts owed to us in a timely manner, or at all, whether due to strategic redirections or adverse changes in their businesses or for other reasons, could have a significant effect on our operating results.

 

 

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Our revenue stream, its timing and our profit, as well as the success of our strategy outlined in our Two-Year Plan, depend in large part on our customers’ business plans and investment decisions in certain products and services, which in turn may depend on the often changing and unpredictable preferences of the public. If our customers do not commit resources to products and services that use ours and if the public does not demand or prefer our customers’ products or services, our revenues may fluctuate significantly throughout any given year and our financial results may suffer.

Our revenue stream, its timing and our profit depend on our customers’ business plans and investment decisions in certain products and services. For example, the customers of our Access Platforms & Gateways activity may determine the rate and time of service rollouts and associated products (such as set-top boxes or dual/triple-play gateways) differently than we anticipate. In the DVD and Film markets, new formats and major film releases may shift from quarter to quarter affecting the revenue stream and revenue recognition of our DVD Services and Film Services units. These types of situations occur primarily because we have no control over our customers’ business plans and investment decisions, which in turn depend largely on the often changing and unpredictable preferences of the public, which characterizes M&E industries. Feature film, television and other video and entertainment content production are inherently speculative businesses since the revenues derived from the production of such content depend primarily upon its expected and actual acceptance by the public, which is difficult to predict. The market for such content is highly competitive and competing products are often released into the marketplace at the same time. In addition, our businesses may be affected by shifts in public preferences of the medium over which this content is delivered. If the public does not prefer our customers’ content or their method of content delivery over those of our customers’ competitors, to whom we do not supply, our revenues may fluctuate significantly throughout any given year and our financial results may suffer.

The success of our strategy to be a preferred partner of the M&E industries and the on-going implementation of our strategy outlined in our Two-Year Plan depend in large part on our ability to timely and correctly identify and adapt to new or changing market trends and to develop and deliver innovative technologies, products and services for these industries in general and, in particular, for developing market segments such as electronic content management and distribution and Internet Protocol (IP) devices and solutions. If we fail to do so, we may also fail to achieve growth or the stated objectives of our Two-Year Plan, and our financial results may suffer.

The markets for our professional products, services and technologies are characterized by rapid change and technological evolution. We will need to expend considerable resources on research and development in the future in order to continue to design and deliver innovative products, services and technologies for the M&E industries, including technologies that we may license to manufacturers and other third parties and the new businesses in our Technology division focused on silicon and software solutions. Despite our efforts, we may not be able to develop and effectively market new products, services and technologies that adequately or competitively address the needs of the changing marketplace. New products, services and technologies can be subject to delays in development and may fail to operate as intended. There is no proven market for some of the advanced products, services and technologies that our businesses have begun to offer and have under development. There may be no or limited market acceptance of new products, services or technologies which we may offer, or significant competitive products, services or technologies may be successfully developed by others.

We expect that the future growth of our revenue will depend, in part, upon the growth of, and our successful participation in, new or evolving markets in the M&E industries. We have based our growth strategy on our vision of how the M&E industries may develop by 2010, including such significant long-term economic drivers as the following: some consolidation will occur in the M&E industries, while significant M&E groups and markets will emerge in Asia, particularly China; our M&E clients will have outsourced many of their activities; China and India will have become mainstream M&E markets; the transition to High Definition (HD) will be complete; mobile video will be pervasive; intellectual property will remain a key differentiator

 

 

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and significant source of direct and indirect revenues; security technologies and services to combat piracy will have been implemented; China will have become a technology standards-setter; electronic delivery of content into the home will have emerged; consumers will continue to buy pre-recorded content at retail, but will also be purchasing or renting content (events, etc.) directly from home; in addition to film print, digital delivery of movies to cinemas will have developed; network operators will have largely switched to IP technologies; all networks will have “triple play” offerings; “connected products” will be ubiquitous inside and outside the home; and home networking will have been implemented. There is a risk this vision may be incorrect and the media and entertainment market may evolve differently and present different characteristics in the future. Should this risk materialize, our business could be adversely affected and our financial results could suffer.

Based on the above assessment, in the shorter term, we have identified four primary “boosters” (Content Services, Network Services, AP&G-Telecom, and Broadcast) for revenue growth during the Two-Year Plan period, as well as two more mature business activities, namely physical media (Film Services and DVD Services within our Services division) and, in Access Platforms & Gateways, set-top boxes for satellite, cable and digital terrestrial operators. We also identified four secondary “boosters” (electronic distribution services, networks, home networking, and silicon and software solutions) with the potential for growth in the longer term. See Item 4: “Information on the Company—Our Strategy”. We may have identified economic drivers, including growth “boosters”, which may not develop or may develop at a slower pace than we expect. We may also not identify new or changing market trends at an early enough stage to capitalize on market opportunities. At times such changes can be substantial, such as the shift over the last few years from VHS tapes to DVDs for consumer playback of movies in homes and elsewhere, and the possible shift over time from the use of physical media for distribution of video content to electronic distribution. Our growth and the success of our Two-Year Plan depends to a great extent on our ability to develop and deliver innovative products, services and technologies that are widely adopted in response to changes in the M&E industry and that are compatible with the products, services or technologies introduced by other entertainment industry participants. If we fail to correctly and timely identify and assess such economic drivers and new or changing market trends or to develop and deliver such products, services and technologies, we may fail to achieve growth or the stated objectives of our Two-Year Plan, and our financial results may suffer.

The success of our strategy to be a preferred partner of the M&E industries and the on-going implementation of our strategy outlined in our Two-Year Plan depend in large part on events, conditions and trends in the M&E industries. If these industries fail to grow at the pace we project or are affected by other events, conditions or trends, our growth and business prospects may be limited, we may fail to achieve the stated objectives of our Two-Year Plan, and our financial results may suffer. For example, events, conditions and trends in the motion picture industry, such as piracy of film and video content may adversely affect our customers’ businesses and decrease their demand for our content management and distribution services, which could adversely affect our financial results.

The ultimate success of our strategy and related Two-Year Plan depend in large part on events, conditions and trends in the M&E industries, which are outside our control. Changes in the business practices, consumer demands and other industry-wide factors in the M&E industries, whether due to regulatory, technological or other developments, could adversely affect demand for our products, services and technologies.

For example, our major customers in the motion picture industry are continually threatened by the piracy of film and video content, which is made easier by technological advances and the conversion of motion pictures into digital formats, which facilitates the creation, transmission and sharing of high quality unauthorized copies of motion pictures. This development may weaken our customers’ sales. As a result, the demand by these customers for our film and video content preparation services may ultimately decrease, which could adversely affect our results.

In addition, our ability to further penetrate the M&E industries may be limited, particularly for our Film and DVD Services and set-top box activities, because of the widespread use of our

 

 

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current products, services and technologies by major industry players in these concentrated markets. This may exacerbate our dependence for future revenue growth upon growth and other events and conditions in these industries.

If the M&E industries fail to grow at the pace we project or are affected by other events, conditions or trends (such as or different from those described above), our growth and business prospects may be limited, we may fail to achieve the stated objectives of our Two-Year Plan, and our financial results may suffer.

Technological innovations can make older products and services less competitive and can have an adverse effect on the value of our existing patents and our revenues from licensing programs. Our financial results, in particular our revenues from licensing programs, may suffer, and we could be at a competitive disadvantage in our other businesses if we are unable to develop or have access, either independently or through alliances, to new and widely-used products, services and technologies in advance of our competitors.

The markets in which we operate are undergoing a technological evolution resulting from the increasing use of digital technology and an increasing overlap among video, voice and data services. Technological advances and new product and service introductions may render obsolete or significantly reduce the value of previously existing technologies, services, products and inventories. This could have a material adverse effect on our ability to sell these products and services or to make a profit from these sales. For example, the emergence of digital technology has had this effect on many products or services based on older analog technology. The emergence of new technologies could also have an adverse effect on the value of our existing patents and revenues from licensing programs. Also, within the physical digital formats, any technological shift could have an adverse effect on our ability to produce and sell such products, like DVD disks, to provide services based on digital technologies, or to make a profit from these sales. For example, we have witnessed in recent years a radical shift toward DVD disks and away from VHS cassettes and more recently some slowing in the growth rate for DVD sales volumes. Further, advances in technologies for downloading content from the Internet such as video-on-demand and similar or other technologies, which Thomson is also active in developing, may significantly reduce the demand for our DVD products or otherwise negatively affect our business.

We expect that the development of digitalization and the convergence of video, voice and data services will increase the pace and importance of technological advancement in our industry. As a result, we are investing in the development and marketing of new products, services and technologies. These investments might be made in unproven technologies or for products or technologies with no proven markets and may therefore yield limited returns.

We face strong competition in many of our businesses. Competition may push prices to unprofitable levels, which could adversely affect our financial results.

Many of the products and services we supply are subject to intense price competition. Furthermore, due to technological innovation and ease of imitation, new products tend to become standardized rapidly, leading to intense competition and price declines. We seek to innovate and to differentiate our products and services in order to minimize the effect of pricing pressures, as well as to design, build and source our products and their components in such a way as to adapt to such deflation. However, price-driven competition may result in reduction of profit margins. In order to protect our margins and improve our operating efficiency in the face of continuing price pressure, we continue to implement efficiency and restructuring plans and expect that such efforts will continue, although there is a risk that these efforts will not yield the anticipated results.

The growth elements of our strategy depend in part on expanding our product and services offering, our technologies portfolio and our geographic coverage, and hence our client base, in part through acquisitions and partnerships. This aspect of our strategy poses risks and uncertainties typical of such transactions.

 

 

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The success of our strategy depends on our ability to expand our products and services offering, technologies portfolio and geographic coverage, particularly in Asia, to broaden our client base in the M&E industries. We seek to accomplish this objective through, among other strategies, long-term partnerships and selective acquisitions. This strategy depends on identifying suitable partnership or joint venture opportunities, identifying suitable acquisition targets, financing their acquisition, obtaining the required regulatory and other approvals and integrating such acquisitions. The process of integrating an acquired company, business or technology, may create unforeseen difficulties and expenditures. The areas where may face risks include: retaining employees from businesses we acquire, cultural challenges associated with integrating employees from acquired businesses into our organization, unanticipated or unknown liabilities relating to acquired businesses, the quality of the assets we sought to acquire and the validity of any acquired patents. As a result of these acquisitions, we may also face an increase in our debt and interest expense. In addition, we face risks associated with acquisitions or partnerships or joint ventures, including the integration of numerous entities, organizations, employees and facilities and fortifying new relationships with different customers. We also encounter increasing risks in connection with the protection of our intellectual property rights. Those and other risks or potential difficulties inherent in acquisitions, partnerships and joint ventures, such as delays in implementation, unexpected costs or liabilities, disputes with partners, or not realizing operating benefits or synergies from completed transactions, may adversely affect our results, financial condition or prospects.

We rely on third-party suppliers, particularly based in China, to manufacture a substantial number of our products or sub-components, which entails financial, reputational and other risks to Thomson. In addition, we are developing or producing a number of our new products and solutions in partnership with other companies. If any of these companies were to fail to perform, we may not be able to bring our products and solutions to market successfully or on a timely basis. Also, our practices of selective co-development and of managing inventory on a just-in-time basis expose us to performance risks in respect of these suppliers, as well as certain force majeure risks.

We procure from third-party suppliers, particularly based in China, a substantial number of our products or sub-components. In addition, we consign to external suppliers extensive activities including procurement, manufacturing, logistics and other services. Reliance on outside sources increases the chances that the Group will be unable to prevent products from incorporating defective or inferior third-party technology or components. Products with such defects can adversely affect our net sales and reputation for quality products. This reliance on external suppliers may also expose Thomson to the effects of suppliers’ insufficient compliance with applicable regulations or third-party intellectual property rights, as well as to the effects of production delays or other performance failures of such suppliers, which may also have an adverse effect on our sales, profits and reputation.

In addition, we complement our internal research and development or production activity by entering into co-development agreements and research programs with strategic partners or investors or by subcontracting certain activities, including the production of many of the products that we sell, to outside providers. These arrangements involve the commitment by each company of various resources, including technology, research and development as well as personnel. If these arrangements do not develop as expected, especially those that involve proprietary components and complementary technologies, if the products or solutions developed produced by companies working with us are not developed in a timely fashion, do not meet the required quality standards or experience production shortfalls or delays or other performance failures, or if the financial standing of our partners deteriorates, our ability to develop and produce these new products and solutions successfully and on schedule may be hampered. Furthermore, these arrangements increase risks in connection with the protection of our intellectual property used in such research programs and may give rise to potential conflicts over co-developed technologies with our R&D partners.

Moreover, we manage our inventory on a just-in-time basis, which expose us to performance risks of our suppliers as well as to certain force majeure risks. As a result, in addition to delays on other performance failures of our suppliers, our operations may be disrupted by external factors beyond our control,

 

 

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including acts of God (e.g., natural disasters, environment and health conditions or calamities), labor disputes or strikes, civil disturbances, war, terrorism, or delay or failure in performance by our suppliers or transporters. Depending on the severity and duration of the disruption, our results of operations could be adversely affected.

The licensing of patents constitutes a significant source of revenue and profits for us. If sales by our licensees of products incorporating our technologies decline or if we are unable to replace expiring patents with new patents or proprietary technologies, our financial results could suffer.

We derive significant profit from the licensing of our various technologies to product manufacturers. We derived a significant portion of our operating income from our technology licensing business in fiscal year 2003, 2004 and 2005, respectively. Our top ten licensees account for approximately 68% of our total licensing revenues in 2005. Our licensing revenue is dependent on sales by our licensees of products that incorporate our technologies. We cannot control these and other manufacturers’ product development or commercialization efforts or predict their success. In addition, our license agreements, which typically require manufacturers and software developers to pay us a specified royalty for every product shipped that incorporates our technologies, do not require these manufacturers to include our technologies in any specific number or percentage of units, and only a few of these agreements guarantee us a minimum aggregate licensing fee. Accordingly, if our licensees sell fewer products incorporating our technologies, or otherwise face significant economic difficulties, our licensing revenue and profits will decline. Lower sales of products incorporating our technologies could occur for a number of reasons. Changes in consumer tastes or trends, changes in industry standards or potential weaknesses inherent in the technologies we license may affect our licensing revenue. Demand for new video products incorporating our technologies could also be adversely affected by increasing market saturation, competing products and alternate consumer entertainment options. In addition, our main licensees, for whatever reason, may not choose to or may not be able to incorporate our technologies in the future, which could in turn adversely affect our financial results.

We hold patents covering much of the technology that we license to product manufacturers, and our licensing revenue is tied in large part to the life of those patents. Our right to receive royalties related to our patents terminates with the expiration of the last patent covering the relevant technologies. However, many of our licensees choose to continue to pay royalties for continued use of our trademarks and know-how even after the licensed patents have expired, although at a reduced royalty rate. Our intellectual property portfolio results from an extensive patenting process that might be challenged by open innovation, strategic alliances, outsourced development and changes in regulations. To the extent that we do not continue to replace licensing revenue from technologies covered by expiring patents with licensing revenue based on new patents and proprietary technologies, our licensing revenue and profits could decline.

In addition, standards-setting bodies, may require the use of so-called “open standards,” meaning that the technologies necessary to meet those standards are freely available without the payment of a licensing fee or royalty. The use of open standards may reduce our opportunity to generate revenue, as open standards technologies are based upon non-proprietary technology platforms in which no one company maintains ownership over the dominant technologies.

If we are unable to protect effectively our intellectual property rights in the technologies, brands and know-how we use or license to our customers, our business could be adversely affected. We may have difficulty enforcing our intellectual property rights effectively in many important markets, such as China, including as a result of the limited recognition and enforcement of intellectual property and contractual rights in many jurisdictions outside the European Union and North America.

Our business is dependent upon our patents, trademarks, trade secrets, copyrights and other intellectual property rights. Effective intellectual property rights protection, however, may not be available under the laws of every country in which our products and services and those of our licensees are distributed. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or

 

 

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our ability to compete. In addition, protecting our intellectual property rights is costly and time consuming. We have taken steps in the past to enforce our intellectual property rights and expect to continue to do so in the future. However, it may not be practicable, effective or cost-efficient for us to enforce our intellectual property and contractual rights fully, particularly in certain countries outside the European Union and North America or where the initiation of a claim might harm our business relationships. For example, we have experienced, and expect to continue to experience, problems with Asian and other product manufacturers incorporating our technologies into their products without our authorization. If we are unable to successfully identify and stop unauthorized use of our intellectual property, we could experience increased operational and enforcement costs both inside and outside important manufacturing markets, such as China, and suffer substantial loss of licensing or other revenues and profits, which could adversely affect our financial condition and results of operations.

We generally seek patent protection for our innovations. It is possible, however, that some of these innovations may not be protectable. In addition, given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important. Moreover, we have limited or no patent protection in certain foreign jurisdictions. For example, in China we have only limited patent protection. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may later be found to be invalid or unenforceable. Moreover, we seek to maintain certain intellectual property as trade secrets. These trade secrets could be compromised by third parties, or intentionally or accidentally by our employees, which would cause us to lose the competitive advantage resulting from them.

Our business relies on intellectual property, some of which is owned by third parties. If we cease to have access to any such intellectual property or can only have such access on unfavorable terms, our business and financial results could be adversely affected. In addition, we are, and may in the future be, subject to intellectual property rights claims, which are costly to defend, could require us to pay damages and could limit our ability to use certain technologies in the future.

In addition to our proprietary technology, we also rely on certain technology that we license from third parties. We cannot provide any assurance that these third-party licenses will continue to be available to us on commercially reasonable terms or at all. The loss of or inability to maintain any of these technology licenses could adversely affect our business and financial results.

In addition, companies in the technology and M&E industries own large numbers of patents, copyrights and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. We have faced such claims in the past, we currently face such claims and we expect to face similar claims in the future. Any intellectual property claims, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management resources and attention. For example, in the past we have settled claims relating to infringement allegations and agreed to make payments in connection with such settlements. An adverse determination could require that we pay damages (including to indemnify our licensees of the related intellectual property) or stop using intellectual property found to be in violation of a third party’s rights and could prevent us from offering our products and services or licensing the intellectual property to others. In order to avoid these restrictions, we may have to seek a license for the intellectual property. This license may not be available on reasonable terms, could require us to pay significant royalties and may significantly increase our operating expenses. The intellectual property also may not be available for license to us at all. As a result, we may be required to develop alternative non-infringing intellectual property, which could require significant effort and expense. If we cannot license or develop non-infringing technologies for any infringing aspects of our business, we may be forced to limit our product and service offerings and may be unable to compete effectively. Any of these results could harm our operating results and our financial condition.

We have completed major transactions in recent years to implement our repositioning strategy to disengage from our former television and Displays activities through outright disposals or through partnerships. In connection with these transactions, we now hold minority interests in companies that we do not control and face certain risks as a result.

 

 

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In 2004 and 2005, as part of our strategy to disengage from consumer electronics markets, we entered into agreements to dispose of our former television and Displays activities. In 2004, we entered into a Combination Agreement with TCL International and TCL to combine our television manufacturing and distribution assets into TTE Corporation, a private joint venture company. In August 2005, we exercised our option to convert our 33% holding in TTE Corporation into a 29.32% interest in TCL Multimedia Technology Holdings (“TCL Multimedia Holdings” and formerly TCL International), listed on the Hong Kong Stock Exchange, substantially all of whose assets comprise its interest in TTE Corporation. Also in 2005, we disengaged from our Displays activity through a series of sales of our tube-manufacturing operations to the Videocon Group. In connection with this disposal, we agreed to invest a total of €240 million in Videocon Industries, an oil and gas company that is also active in the consumer electronic and consumer electronic components markets, and which is listed on the Luxembourg Stock Exchange. As we are minority shareholders in these entities and under the governing documents or shareholders’ agreements for these investments, certain key business decisions may be made without our approval. There is also a risk that disagreement or deadlock may arise among the shareholders of these entities resulting in decisions contrary to our interests. In addition, we are exposed to market risk as a result of these investments and, in the case of TCL Multimedia Holdings, in a company that operates in markets that we have identified as low margin or unprofitable. Therefore, if the share prices of TCL Multimedia Holdings or Videocon Industries decrease during the period in which we are shareholders, we may not be able to dispose of our interest at or above the price of our initial investment. This exposure to market risk is enhanced by the fact that we are subject to certain lock-ups and may not transfer our shares in TCL Multimedia Holdings or Videocon Industries for specified periods of time, subject to certain exceptions. For more information on these transactions, see “Information on the Company—Displays and CE Partnerships.”

Economic and geopolitical conditions may adversely affect our results and financial condition.

General economic trends in the countries in which our products and services are sold, primarily in North America, Europe and Asia, can have a significant impact on prices and demand for such products and services. Pricing pressure and soft demand in the markets in which we sell our products and services could result in further pressure on our profit margins, which could in turn adversely affect our financial results.

In addition, we source a large number of goods from emerging markets and are subject to risks inherent in these markets, including currency fluctuations, political and social uncertainty, exchange controls and expropriation of assets. These risks could disrupt our production in such countries and our ability to produce and procure goods for sale in our principal North American and European markets.

For more detailed discussions on our sales in our principal markets, refer to Item 5: “Operating and Financial Review and Prospects”, and for more information on our main production sites, refer to Item 4: “Information on the Company—Business Overview—Property, Plants and Equipment.”

Currency exchange rate fluctuations may lead to decreases in our financial results.

To the extent that we incur costs in one currency and make our sales in another, our profit margins may be affected by changes in the exchange rates between the two currencies. Most of our sales are in U.S. dollars and in euros; however, certain expenses are denominated in Mexican peso and Polish zloty, in particular those of our production facilities in Mexico and Poland. Although our general policy is to hedge against these currency transaction risks on an annual or six month basis, given the volatility of currency exchange rates and the occasional illiquidity in some emerging markets currencies together with the potential for changes in exchange control

 

 

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regulations in such emerging markets, we cannot assure you that we will be able to manage effectively these risks. Volatility in currency exchange rates may generate losses, which could have a material adverse effect on our financial condition or results of operations. For more detailed information on our hedging policies, refer to Item 11: “Quantitative and Qualitative Disclosures about Market Risk.”

Product defects resulting in a large-scale product recall or successful product liability claims against us could result in significant costs or negatively impact our reputation and could adversely affect our business results and financial condition.

We are sometimes exposed to warranty and product liability claims in cases of product performance issues. There can be no assurance that we will not experience material product liability losses arising from such claims in the future and that these will not have a negative impact on our reputation and our sales. We generally maintain insurance against many product liability risks and record warranty provisions in our accounts based on historical defect rates, but there can be no assurance that this coverage and these warranty provisions will be adequate for liabilities ultimately incurred. In addition, there is no assurance that insurance will continue to be available on terms acceptable to us. A successful claim that exceeds our available insurance coverage or a product recall could have a material adverse impact on our financial condition and results of operations.

Our success depends upon retaining key personnel and hiring qualified personnel.

Our success depends to a significant degree upon the contributions of our management team. A limited number of individuals have primary responsibility for managing our business, including our relationships with key customers and licensees. Losing the services of any key member of our team, whether from retirement, competing offers or other causes, could prevent us from executing our business strategy, cause us to lose key customer or licensee relationships, or otherwise adversely affect our operations.

Our performance also depends upon the talents and efforts of highly skilled individuals. Our products, services and technologies are complex, and our future growth and success depend to a significant extent on the skills of capable engineers and other key personnel. Continued re-training of currently competent personnel is also necessary to maintain a superior level of innovation and technological advance. The ability to recruit, retain and develop quality staff is a critical success factor for us.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our ability to operate our business, our financial results and investors’ view of us.

We have a complex business organization that is international in scope. Ensuring that we have adequate internal financial and accounting controls and procedures in place to help ensure that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We have begun the process of documenting, reviewing and, if appropriate, improving our internal controls and procedures in connection with the application of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments starting with fiscal year 2006. We may, during testing, identify material weaknesses or significant deficiencies in our internal controls over financial reporting requiring remediation, or areas for further attention or improvement. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition,

 

 

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investors’ perceptions that our internal controls are inadequate or subject to material weaknesses or significant deficiencies or are otherwise perfectible, or that we are unable to produce accurate financial statements may adversely affect our stock price.

Our share price has been volatile in recent years and is exposed to the fluctuations in the equity capital markets.

The stock market in recent years has experienced extreme price and volume fluctuations which have particularly affected the market prices of technology companies. Volatility in our share price has also been significant during this period. This volatility can result in losses for investors in a relatively short period of time.

ITEM 4 – INFORMATION ON THE COMPANY

A — History and Development of the Company

Company Profile

 

Legal and Commercial name:

THOMSON

Registered office address:

46, quai Alphonse Le Gallo

 

92100 Boulogne-Billancourt France

 

Tel.: 33 (0)1 41 86 50 00

 

Fax: 33 (0)1 41 86 58 59

 

E-mail: webmaster@thomson.net

Domicile, legal form and applicable legislation: Thomson is a French corporation (société anonyme) with a Board of Directors, governed by Title II of the French Commercial Code pertaining to corporations and by all laws and regulations pertaining to corporations.

Date of incorporation and length of life of the Company: Thomson was formed on August 24, 1985. It was registered on November 7, 1985 for a term of 99 years, expiring on November 6, 2084.

Fiscal year: January 1 to December 31.

Thomson provides technology, systems & equipment and services to help its Media & Entertainment clients – content creators, content distributors and users of its technology – realize their business goals and optimize their performance in a rapidly changing technology environment. The Group intends to become a preferred partner to the Media & Entertainment industries through its Technicolor®, Grass Valley®, RCA® and THOMSON® brands.

In fiscal year 2005, we generated net sales of approximately €5,691 million (excluding operations treated as discontinued operations), of which €5,428 million was generated by our core Services, Systems & Equipment and Technology divisions. At December 31, 2005, the Group had approximately 32,000 employees in more than thirty countries.

 

 

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Historical Background

Thomson and the other principal companies in its group, RCA and Technicolor, have a long history in the development of technologies for the broadcast of radio and television, as well as for the colorization and processing of cinema film content. These technologies remain important for the group today. Historically, Thomson’s activities and clients had been focused on consumer electronics products and on the manufacturing and assembling of components.

In the second half of 2000, the Group started to position itself within the Media & Entertainment markets to benefit from its technological expertise as these target markets evolved. As part of this repositioning strategy, the Group made several acquisitions including Technicolor®, Philips’ professional broadcast business and Grass Valley®. In addition, the Group began to dispose of the consumer electronics finished goods and components businesses that generated the bulk of its revenues prior to 2000. The Group’s former Consumer Products and Components divisions were thus reshaped in 2004 with the disposition of substantially all of our television businesses (which was deconsolidated from August 1, 2004) in return for a 33% interest in TTE and in 2005 with the disposition of the bulk of our displays activity, comprising our television tubes and related components business (referred to herein as the “Displays activity”).

The repositioning of our business has been accompanied by a significant shift in our capital structure. Seven years ago, Thomson (formerly Thomson Multimedia and prior to that, Thomson Consumer Electronics) was indirectly wholly-owned by the French State. Following a series of transactions in our share capital in the period 1998-2003, the French State’s indirect interest in Thomson was reduced and, as of March 31, 2006, amounted to approximately 1.9% of our share capital. Our investor base developed further in 2004, most notably with the strategic investment by Silver Lake Partners LLP (“Silver Lake”) in a convertible/exchangeable bond (which, based on our current issued share capital, would convert into 8.6% of our share capital diluted to take into account the conversion of the bonds). At March 31, 2006, the public owned approximately 89% of the share capital of Thomson; Thomson held approximately 6% of the share capital in the form of treasury shares; and we estimate that our employees owned approximately 3%. For more details on our share capital, please refer to Item 7: “Major Shareholders and Related Party Transactions—Distribution of Share Capital.”

Our Strategy — Preferred Partner of the Media & Entertainment Industries

Thomson’s strategy is to build on its position as one of the world leaders in video technologies and as a preferred partner of the Media & Entertainment (“M&E”) industries to take advantage of expected growth opportunities in this sector. Our stated mission is to provide the M&E industries with services, systems & equipment and technologies they need to achieve their commercial objectives and to enhance their performance in a changing technology environment.

Starting in the second half of 2004, we sought to accelerate the implementation of this strategy through three key steps: the presentation of a “Five Point Plan” by the Board of Directors on July 20, 2004, approved by the shareholders’ meeting on September 15, 2004; the definition of five strategic priorities, announced on October 21, 2004; and the development of a “Two-Year Plan” to implement these strategic priorities, defined on November 30, 2004 and approved by our Board of Directors.

The Five Point Plan encompassed the objectives to support the Group’s development with the strategic investment of U.S. $500 million by Silver Lake, an American investment company specializing in taking significant shareholdings in leading technology companies; recognize individual shareholders’ long-term loyalty through the issuance of approximately 12 million warrants (bons d’acquisition ou de souscription d’actions nouvelles, or “BASA”); further incentivize Thomson employees to deliver the Group’s strategy through the implementation of a new stock option plan; optimize the Group’s financial structure through the implementation of a €400 million share buy-back program over an 18 month period; and reinforce the management team by combining the functions of Chairman and Chief Executive Officer and appointing of Frank E. Dangeard to this position, decided by the Board of Directors on September 15, 2004. For further details, please see Item 7 “Major Shareholders and Related Party Transactions—Distribution of Share Capital”.

 

 

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Strategic Priorities

Thomson announced on October 21, 2004 five strategic priorities, which were defined based on its vision of how the M&E industries may evolve between now and 2010. For a more detailed discussion of this vision, please refer to Item 5 “Operating and Financial Review and Prospects—Overview—Key Economic Drivers.” Four of these strategic priorities continue to apply while the fifth was essentially achieved in 2005 with the Displays activity disposals:

 

1.

Broaden our Offering to Existing M&E Clients and Expand our M&E Client Base, including in Asia: The range of imaging and video systems and services that we can provide to our M&E clients has increased significantly in recent years. On the other hand, the M&E industries are highly concentrated, and the Group’s client base of content creators and content distributors follows this pattern, although the users of Thomson’s technologies are more diversified.

Accordingly, we set as a strategic priority to:

 

Expand the range of systems and services we offer to our existing M&E clients, including geographically, particularly in Asia; and

 

Expand our M&E client base by targeting (i) new categories of content creators and distributors, and (ii) M&E groups in Asia (e.g., China, India) and Europe.

With all of our clients, we are prepared to enter into long-term partnerships for the co-development of solutions tailored to their specific needs, and for the outsourcing of certain of their non-core activities. Thomson therefore expects the expansion of its business generally to take the form of

long-term contractual relationships, which are prevalent in our existing business already today.

 

2.

Focus on Video Technologies: We own or have access to many of the technologies that are key to our M&E clients’ development. We set as a strategic priority to focus on the technology needs of our M&E clients in a digital environment (create, capture, package, distribute and access visual content securely and effectively in standard and high-definition digital formats).

Accordingly, the Group intends to increase its R&D efforts, launch new R&D initiatives (including a number of Group-wide multi-year projects in wireline and wireless content distribution, digital content production and management systems, digital cinema and other fields), strengthen its R&D partnerships, develop a strategy for technology acquisitions and give more visibility to its areas of technology excellence, while continuing its commitment to intellectual property and to its licensing activities under traditional (patent- and trademark-based) or new licensing models. As part of these efforts, Thomson constituted a Scientific Council to assess Thomson’s R&D in light of external developments in video technologies and Thomson’s strategy, to challenge R&D teams on their processes, output, roadmaps, and team qualifications and to make related recommendations to Thomson’s Chairman and Chief Executive Officer.

 

3.

Seize Growth Opportunities in Electronic Content Management and Distribution: It is a strategic priority for Thomson to expand further in the digital preparation of content, the management on behalf of our M&E clients of digital content flows and the management of certain elements of video-specific infrastructure.

Electronic content management and distribution span all activities and divisions in Thomson, from post-production to broadcast equipment and media services, to access and home networking devices, and present significant growth opportunities for the Group. Certain of these activities, such as post-production, are already important contributors to the Group’s revenues and profit, while others, such as network services (advertising networks, play-out outsourcing, video-centric infrastructure management), are emerging activities within the Group. The Group intends to commit significant resources, notably in support of client-led initiatives, in the areas of security, IP-based distribution and network services.

 

4.

Lead in IP-Devices and Solutions: Distribution networks for visual content are embracing Internet Protocol (“IP”) technologies, enabling voice/data/video content to be accessed seamlessly by end-customers. Network operators focus on access devices as an important link to their end-customers, and a way to differentiate their offering.

 

 

 

 

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Accordingly, we set as a strategic priority to provide our distribution clients with the appropriate “connected” devices, device and network solutions and integration services, building on our leading position in set-top boxes, and DSL modems and our strong Integrated Circuit (“IC”) design capabilities. We also intend to leverage our core asset base of brands, physical distribution strength and consumer marketing and technology know-how to develop related home networking solutions for end-consumers and integration solutions for network operators.

 

5.

Actively seek Partnerships in Displays: We had set as a strategic priority to ensure that our Displays activity participated swiftly in the consolidation of the display industry. In 2005, this objective was achieved through our Display activity disposals to Videocon and Rioglass. These operations are reported as discontinued operations in our consolidated financial statements of and for each of the year ended December 31, 2005 and 2004 prepared in accordance with IFRS. For further information about these disposals and related costs please refer to “—Business Overview—Displays and CE Partnerships—Displays” and Item 5: “Operating and Financial Review and Prospects—Results of Operations for 2005 and 2004—Net income from discontinued operations”.

Two-Year Plan

Our Two-Year Plan seeks to set out a framework for implementation of these strategic priorities over 2005 and 2006. It was defined on November 30, 2004 and approved by our Board of Directors.

The Two-Year Plan identified areas with potential for significant revenue growth. In the framework of the plan, we identified opportunities for strong increases in revenues during the Two-Year plan period through four identified businesses, labelled primary “Boosters” for growth, summarized in the table below. Acquisitions and organic growth in these businesses generated significant additional sales for the Group in 2005. See Item 5: “Operating and Financial Review and Prospects—Results of operations for 2005 and 2004—Analysis of Net Sales”. Four further areas were identified as secondary “Boosters”, which may provide us with significant long-term growth opportunities beyond 2006 but limited growth over the two-year period ending December 31, 2006. Each of the eight “Boosters” includes geographic expansion, often in Europe but also in China and India, among other markets. These boosters have been a focus of our organic growth investments and acquisitions during 2005. We set out below these eight “Boosters” together with the division in which they operate.

 

 

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We also identified two more mature business categories: the physical media businesses (film and DVD), and set-top boxes for satellite, cable and digital terrestrial operators (within the Access Platforms & Gateways activities).

 

 

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Our Organization

In order to better focus our organization on the implementation of our strategic roadmap and Two-Year Plan, we implemented effective from January 1, 2005 a new divisional structure designed to better address the needs of our different M&E customers, which include: content makers (e.g., film studios, broadcasters, game developers and advertisers); content distributors (e.g., broadcasters, cable and satellite providers, telecommunications providers and ISPs, cinemas and retailers); and users of our technologies (e.g., consumer electronics manufacturers and IT industries). Our three core business divisions are set out below:

 

Services (44% of reported 2005 Group revenues): This division offers end-to-end management of services for our customers in the M&E industries. We offer services related to the preparation and distribution of video content, whether in the form of physical media (principally analogue film or DVD) or electronic media (e.g., Digital Cinema, Video on Demand). We also provide network services to broadcasters, retailers, cinema exhibitors and other enterprises that aim to provide their audiences/customers with video content. Thomson is the world leader in video content preparation for content owners/creators under the Technicolor® trademark. We describe the activities in this division in more detail below under the following headings:

 

Physical media: Film Services and DVD Services;

 

Content Services;

 

Network Services; and

 

Electronic Distribution Services.

 

Systems & Equipment (41% of reported 2005 Group revenues): This division plays a key role at both ends of the M&E distribution chain, interfacing with content makers through the provision of video-focused systems and equipment such as television broadcast cameras and outside broadcast vans, on one end of the chain, and with network operators, retailer and end-consumers through sales of equipment such as set-top boxes, at the other end. The activities of this division are described in more detail below under the headings:

 

Broadcast & Networks (“Grass Valley”);

 

Access Platforms & Gateways – covering Satellite, Terrestrial and Cable customers on the one hand and Telecom operators on the other; and

 

Connectivity (comprising the Communications activity following the decision to sell the Audio/Video and Accessories activities, as described below).

 

Technology (10% of reported 2005 Group revenues): We formed this division in 2005 to strengthen our focus on media technologies and to consolidate the realignment of our research and development activity with our long-term strategy. The division includes the following activities:

 

Corporate Research;

 

Licensing of patents and trademarks;

 

Silicon Solutions: Integrated Circuit (“IC”) design, tuners, and remotes; and

 

Software & Technology Solutions: Security, imaging and networking software services, and other technologies.

We also established a fourth non-core segment, Displays & CE Partnerships, which has been implementing the Group’s strategy to participate in the consolidation of the television tubes industry (although the bulk of our Displays activities are treated as discontinued operations in accordance with IFRS in our consolidated financial statements included herein as of and for each of the years ended December 31, 2005 and 2004, in light of their disposal in 2005). This segment reflects our television operations prior to their contribution to TTE and deconsolidation effective August 1, 2004 (which are not treated as discontinued operations under IFRS). In 2005, it has been responsible for managing our consumer electronics (CE) partnerships, in particular TTE, including our role as the sales and marketing agent for TTE in North America and Europe until the second half of 2005.

During 2005, we completed the disposal of the vast majority of our Displays activity, by way of two transactions covering the bulk of our tubes and glass operations with members of the Videocon Group of companies (“Videocon”) and the transfer of our Videoglass glass manufacturing operations based at Bagneaux-sur-Loing to the Spanish group, Rioglass. As a result, the Displays activities disposed of have been treated as Discontinued Operations in our financial results for each financial year 2004 and 2005. For further details on the discontinuation of

 

 

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our Displays activity and the transactions with Videocon, please refer to “—Business Overview—Discontinued Operations”.

At the end of 2005, the Displays & CE Partnerships segment comprises our substantially reduced non-core operations relating to our former television or displays activities. These are principally the sub-contract manufacturing operations for TVs situated at Angers, France and the displays components (guns and yokes) operation situated at Genlis (refer to “—Business Overview—Displays and CE Partnerships”).

Since announcing the Two-Year Plan, we have continued to review the performance and strategic fit of our businesses involving the sale of products primarily through retail outlets – principally Communications (telephony), Audio/Video consumer electronics products and related Accessories. At the start of 2005, these businesses were grouped under the heading of Connectivity in the Systems & Equipment division. On December 12, 2005 we announced that in the light of their weaker than expected performance and a review carried out following the termination of our role as sales and marketing agent for TTE and resulting separation of the Connectivity sales and marketing functions from TTE, we had decided to seek partners for the consumer Audio/Video and Accessories products activities. The Communications business has a much stronger strategic fit and will be retained and developed within the Systems & Equipment division. The Connectivity operations (other than Communications) are treated under IFRS as assets held for sale and their results included in discontinued operations, along with our residual optical modules activities which will be transferred in early 2006. For more information on our discontinued operations, refer to “—Business Overview—Discontinued Operations”.

During 2005, we have also put additional focus on centralized “Business Operations” under the leadership of Didier Trutt who was appointed Chief Operating Officer of Thomson in September 2005. Business Operations focuses particularly on efficiency of our operations and costs savings, particularly where we can gain economies of scale through centralized operations, such as sourcing and IT Services, and the Process Transformation Initiative program, as described in more detail below under “—Business Overview—Business Operations”. The costs associated with the Business Operations function are allocated to the appropriate division or treated as central overhead included in “Corporate” within our results by segment.

For certain recent developments regarding the implementation of our Two-Year Plan and Thomson’s strategy for the future, see Item 5: “ Operating and Financial Review and Prospects—Events Subsequent to December 31, 2005”.

Until January 1, 2005, prior to the re-organization described above the Group comprised four operating divisions:

 

Content and Networks – principally businesses now included in the Services and Systems & Equipment divisions;

 

Components – principally the Displays activities which were disposed of during 2005;

 

Consumer Products – principally the Connectivity businesses (which from start 2005 were included in the Systems & Equipment division) and the Television business (prior to its disposal in 2004); and

 

Licensing – comprising the Licensing business now included in the Technology division.

B — Business Overview

The table below sets forth the contribution to our consolidated net sales for 2004 and 2005 in accordance with IFRS for each of our divisions based on the organization effective January 1, 2005.

The results of the bulk of our Displays activities and those of the Audio/Video and Accessories activities are treated as a net item within discontinued operations in the consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004, and are therefore not reflected in our reported net sales. The substantial majority of the net sales shown in the Displays & CE Partnerships segment in 2004 comprise sales of our television activity and in 2005 are sales of our residual non-core manufacturing assembly operations.

 

 

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The bulk of our television activity was deconsolidated effective August 1, 2004 following the creation of TTE in partnership with TCL International and TCL Corporation, to which this activity was contributed. Accordingly, our consolidated financial statements as of and for the year ended December 31, 2004 reflect within the Displays & CE Partnerships segment seven months of Thomson as owner and operator of this television business and the remaining five months as a service provider to TTE pursuant to certain contractual arrangements. In September 2005, the sales and marketing services provided ceased and were transferred to TTE, and the contractual arrangements for providing sub-contracted manufacturing services were re-negotiated. Displays & CE Partnerships therefore include television sales for the first seven months of 2004 of €845 million and manufacturing and sales and marketing agency services provided to TTE during the remaining five months of 2004 representing €185 million, while in 2005 the latter amounted to €56 million.

 

 

 

2004

 

% of total

 

2005

 

% of total

 

 

 


 


 


 


 

 

 

(in € millions, except percentages)

 

Sales from continuing operations

 

 

 

 

 

 

 

 

 

Services

 

2,338

 

38.8

%

2,487

 

43.7

%

Systems & Equipment

 

2,109

 

34.9

%

2,355

 

41.4

%

Technology

 

498

 

8.3

%

546

 

9.6

%

Displays & CE Partnerships

 

1,068

 

17.7

%

263

 

4.6

%

Corporate

 

23

 

0.3

%

40

 

0.7

%

 

 


 


 


 


 

Total

 

6,036

 

100.0

%

5,691

 

100.0

%

 

 


 


 


 


 

Services

Our Services division generated a contribution to consolidated net sales in 2005 of €2,487 million (44% of the Group’s consolidated net sales). The division offers end-to-end management of services for our customers in the M&E industries. We offer services related to the preparation and distribution of video content, whether in the form of physical media (principally analog film or DVD) or electronic media (e.g., Digital Cinema, Video on Demand). We also provide network services to broadcasters, retailers, cinema exhibitors and other enterprises that aim to provide their audiences/customers with video content. The Services division comprises: Content Services; Film Services and DVD Services (together referred to as our “physical media” businesses); Electronic Distribution Services and Network Services Content Services encompass services provided pre-production, during production and post-production such as colorization services, visual effects (“VFX”), manipulation of digital intermediates (i.e., the digital manipulation of images and the data from which images are generated, including the correction of color, as part of the finishing process for theatrical (film) and broadcast (TV) content), subtitling, editing and creation of final masters for theatrical film and video release. Our physical media services cover Film Services and DVD Services (and residual VHS operations), including content preparation, planning, manufacturing and physical distribution services, storage (compression, archiving, indexing), digital media asset management (storage, manipulation, retrieval and streaming of video and audio content), asset rights management, anti-piracy/security solutions and technology consulting. Electronic Distribution Services was established to pursue opportunities that we expect to arise as the electronic distribution of content becomes more widespread. Network Services assembles video programming and/or manages distribution of video content through video networks to broadcasters, retailers, cinema exhibitors and other enterprises that aim to provide their audiences/customers with video content.

The Services division operates in the growing worldwide market for the capture and manipulation/distribution of video content. The division seeks growth by extending the range and depth of its product and service offerings to its existing customers, by

 

 

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supplying them with solutions that integrate multiple services and functions enabling our customers to better commercialize their content, while developing new solutions to support their transition to digital technology and developing relationships with new important customers. This growth strategy builds on the Group’s strong existing position in this business segment, its very close relationships with its M&E clients and its strong capabilities in research and innovation.

Some segments of the M&E industries are increasingly concentrated, resulting in a number of key clients, concentrated geographically in the U.S. West Coast, accounting for a substantial proportion of our services business and revenues. We have started to diversify to serve other markets such as advertising and video games. Accordingly, in line with our Two-Year Plan, we also seek to diversify our client base and expand geographically.

Operating principally under the Technicolor brand, we are a worldwide leader in the development and printing of film reels, in DVD services for content producers/owners, and one of the worldwide leaders in both Content Services, including post-production and visual effects, and the activities performed by our Network Services business.

Currently, our physical media activities contribute the majority of the division’s revenues with DVD Services contributing almost 60% and Film Services over 20%. We expect these physical media activities to remain the largest contributors to the Services division for a few more years but aim to achieve significant growth in Content Services, EDS and Network Services as the transition of content to digital format and digital/electronic distribution continues to develop and the use of video content and video networks becomes more widespread.

We recently expanded the Content Services and Network Services businesses through acquisitions as well as organically and in EDS we have started the rollout of the SkyArc digital advertising network and signed various agreements related to the proposed rollout of digital cinema services, as described below. Our strategy is to continue to develop these parts of the Services division.

The Services division has been built around the Technicolor-branded businesses, acquired in March 2001. Technicolor’s leadership position is based on more than 90 years of motion picture industry leadership, combined with access to the Group’s technology, technical excellence, global reach and scale, an integrated and secure service offering to its customers and an organization-wide focus on quality and customer service. We provide services and products on a global scale from operating locations in North America, Europe and Asia.

With the acquisition of Panasonic Disc Services in June 2002, the Group acquired contracts to perform DVD replication for Universal Studios and Paramount. In addition, following the signature of significant contracts, we began to work on Universal Studio’s worldwide film processing and Paramount’s European DVD replication business in the first half of 2003 and 20th Century Fox’s European film processing in the second half of 2003. In the second half of 2003, we completed the acquisition of Cinecolor (based in Thailand), one of the premier companies in the Austral-Asian film and post-production markets. In 2004, Thomson expanded its Canadian service offering with the acquisition of Command Post, based in Toronto and Vancouver. It also purchased Madrid Film, the largest film and digital film servicing provider in Spain, with facilities in both Madrid and Barcelona. In mid-2004, we expanded our foreign language versioning offering in Content Services with the acquisition of International Recording, a Rome-based business with a long history of servicing customers’ sound requirements. Also in 2004, we announced that we would construct our first studio-based digital intermediate facility where content can be manipulated in digital form (before conversion back to analog form where appropriate), to be located on the Sony Studios lot in Culver City, California, increasing our capacity for the digital intermediate service offering the Group launched in 2001; this facility is expected to open in the second quarter of 2006. In December 2004, we acquired The Moving Picture Company (“MPC”) specializing in VFX in Content Services.

In 2005, we have continued to grow our Network Services business, both in broadcast playout services (e.g., services such as providing live studios, graphics, audio production and post-production and transmission play-out) building on the acquisition in November 2004 of Corinthian Television Facilities

 

 

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in the United Kingdom, the addition of VCF Thématiques in October 2005 and the recent contract with TV5, as well as the purchase in August 2005 of Premier Retail Network, a leader in in-store retail networks based in the United States to develop our retail media networks.

In many parts of our Services businesses, relationships with most major customers are covered by exclusive long-term contracts. In the physical media activities, these are usually three to five years and typically cover volume and time commitments, as well as pricing and geographical territories served. In any given year certain contracts come up for renewal. Major client relationships are typically the result of multiple contractual arrangements for specific types of services, which include a fixed duration and specific terms depending on the particular geographical zone. Under the terms of certain of these contracts, we make advance payments at the commencement of the contractual relationships, which are reimbursed in line with manufactured volume over the duration of the contracts. For more information on these contracts, see Note 17 to our consolidated financial statements. Our key customers in 2005 in these businesses included major film studios such as Disney, Warner Bros., Universal Studios, DreamWorks, 20th Century Fox and Paramount, and, to a lesser extent, software and games publishers such as Microsoft and Electronic Arts. The Content Services activities also dealt with many of the same customers, but not under long-term contracts.

We continue to support and guide our customers through an industry-wide transition that is underway to digital formats and services. Based on our current and targeted customer base, we believe this transition offers opportunities, in particular in the areas of the development of high definition optical disc formats (Blu-ray and/or HD-DVD), digital cinema, digital post-production and post-post production, digital media asset management and broadcast play-out services in both our existing markets (principally the United States, Europe and Asia) and in new geographical regions.

We believe that operational and technological synergies exist between the Services division and Thomson’s other divisions for the next generation of technologies for content distribution, including systems & equipment for electronic storage and distribution and technology relating to copy protection, digital rights management, media asset management and networking.

Content Services

Through Content Services, we offer a comprehensive set of content creation, content completion and management services to M&E clients, in the theatrical (cinema), television and commercial/advertising segments. Through recent acquisitions, most notably MPC in visual effects, we expect to continue to grow our support services to the commercial advertising creative and production communities. The range of services provided includes processing of daily film rushes and high definition digital dailies during filming, negative assembling, digital intermediate color-grading services, editing and the creation of masters including those used for theatrical film release, post-theatrical release services (including video/format mastering, compression, authoring and asset management), DVD replication, broadcast television (covering all global standards such as NTSC, PAL and High Definition) or for other forms of electronic distribution. We continue to expand our digital media asset management capabilities and roll-out our global digital network to ensure rapid and secure roll-out of content.

We currently provide services in both analog and digital formats and the ability to move easily between both formats. These services support the content creators’ needs to work in both environments simultaneously. With the transition of the creative process to digital format, the secure management of digital media assets is becoming increasingly important. We have developed digital media asset management solutions allowing the same storage, management and retrieval of content for easy distribution to multiple distribution channels. The concept of a proprietary global digital network to allow rapid and secure movement of content, particularly during the time-critical production phase, is now being offered to our key customers.

In the area of content security, we have developed innovative solutions, which have been adopted by content creators. In 2003, we developed an infrastructure permitting the identification and tracking of advance screening copies of films for

 

 

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Academy Award™ nominations in the United States. In addition, Thomson developed hologram and other copy protection supports for Microsoft game content.

The content services market is fragmented with significant elements still being handled internally by some major studios. The market is, however, now beginning to consolidate in some areas with increasing proportions of particular services being outsourced by the studios to multiple suppliers who can meet their technical and service requirements. Thomson has a growing share of the content services market and has significantly enlarged its global service offerings and expertise to benefit from the growth of this very fragmented market. Our main competitors for Content Services include Ascent Media, based in the United States, and in some areas Deluxe, until recently a subsidiary of Rank plc. In the fragmented market for visual effects, ILM is a major competitor.

Film Services

After the process of creating and preparing the content is complete, our film services business offers bulk-printing services for the release of a film to cinemas. A major studio worldwide release today can require in excess of 10,000 copies of a film to be printed and delivered to cinemas for simultaneous release. Increasingly, releases are occurring simultaneously worldwide, which requires processing film prints on a large scale and in close coordination with the creative processes to handle multiple language versions in a fast and efficient manner. Through six main facilities in North America, Europe and Asia, Technicolor processed over 5.3 billion feet of film in 2005, compared to 5.1 billion feet in 2004.

In 2005, we increasingly focused our release printing operations on the facilities in Mirabel and Rome. Our Mirabel film processing facility located near Montreal, Canada, handles about 55% of the Group’s North American requirements (compared to 51% in 2004). The largest cost in this business is the cost of purchasing film reel, for which Kodak is a major supplier.

We also provide logistical support in North America, delivering prints and studio marketing materials to cinemas. We continue to pursue opportunities to expand these logistical service operations to support the worldwide release of films and to provide real time information to distributors and cinemas regarding the status of film content. Our main competitor in this business is Deluxe, which was recently sold by the Rank Group plc. There are proposals for a widespread rollout of digital cinema, particularly in the United States, as described below under “—Electronic Distribution Services”, though we expect that such a rollout will take several years.

DVD Services

Through DVD Services, we provide end-to-end packaged media services (DVD and VHS) to content owners. We prepare content and manufacture and distribute DVDs, video and game DVDs and CDs from 23 locations across North America, Europe and Australia. We also manufacture and distribute VHS cassettes. We provide a turnkey integrated solution for video and games content producers that spans mastering, manufacturing, packaging and distribution, including direct-to-retail, direct-to-consumer and returns handling, as well as procurement, information services and retail inventory management systems. In recent years, we have continued to expand distribution services in Continental Europe including Spain (2004), Scandinavia (2004) and France (2004), to augment existing distribution infrastructures based in the United Kingdom, Holland and Italy. To support this pan-European distribution network, a new information services platform (ESCO) was implemented in 2004. This network provides end-to-end supply chain services for our clients.

DVD Services continues to increase utilization of its lower-cost production facilities located in Guadalajara, Mexico and Piaseczno, Poland. Packaging and distribution in the United States is supported by a multi-region/multi-site facility platform with a concentration of such activities based in our Memphis, Tennessee facility. Our VHS duplication operations in The Netherlands, Spain and Italy were relocated to the existing VHS facility in Wembley, United Kingdom in 2004. Similarly, our VHS operations in Camarillo, California, were consolidated into our facilities in Livonia, Michigan, and Mexicali, Mexico, in 2004. Continued consolidation will be pursued in 2006.

 

 

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In December 2005, Thomson had annual capacity to produce 1.7 billion DVDs supported by 1.64 million square feet of dedicated distribution space.

DVD Services has positioned itself for the introduction of next generation/high definition DVDs, having installed dedicated HD-DVD and Blu-ray manufacturing equipment to support a launch of both formats in 2006. Growth in 2007 and beyond will depend on consumers’ demand for the formats and content offered by major studios and the consumer electronics industry. Thomson remains prepared to support and benefit from any growth based on its strong technical capability and existing infrastructure of optical disc service offerings.

The packaged media volumes continue to grow, fueled by continuing demand for video DVDs, as well as video games. The launch of Xbox 360 in 2005 is expected to provide a boost to games console volumes during 2006.

We believe we are the largest independent DVD replicator in the world based on volumes. Our largest competitor is Cinram. Our main customers include Disney, Universal Studios, DreamWorks, Paramount and Microsoft.

Electronic Distribution Services

The new Electronic Distribution Services activity was established to pursue opportunities that we expect to arise as the electronic distribution of content becomes more widespread. The scale of its operations is currently limited, but it was active during 2005 in managing the rollout of the SkyArc digital advertising network for exhibitors/cinemas which are customers of our Screenvision joint venture, as described below under “—Cinema Advertising (Screenvision)” and was also active in the launch of digital cinema under the Technicolor Digital Cinema (“TDC”) brand. In November 2005, we announced that we entered into digital cinema usage agreements with certain major Hollywood studios, including DreamWorks, Sony Pictures, Universal Pictures and WarnerBros. to accelerate the rollout digital cinema systems. Under the agreements, each of the studios has agreed to distribute content digitally throughout North America and pay “virtual print” fees for screens equipped with TDC systems. In January 2006, we announced an agreement with a major U.S. exhibitor, Century Theatres, to undertake a beta-test deployment of TDC systems in 90-120 screens in the first quarter of 2006, with a view to a broader rollout thereafter. Electronic Distribution Services is also active in exploring opportunities in electronic distribution for Video on Demand applications.

Network Services

We provide network services to broadcasters, retailers, cinema exhibitors and other enterprises that aim to provide their audiences/customers with video content. We assemble video programming and/or manage distribution through video networks on behalf of these customers. In their activities, our customers may rely on us to optimize their cost structure (paying us a fee-based revenue for an outsourced service) and/or develop their revenue (through an advertising-based model).

Our Network Services activities comprise Broadcast, Retail Media Networks and Cinema Advertising. The demand for the former is principally driven by the trend towards outsourcing broadcast playout, while the latter two are driven principally by the increase in out-of-home advertising. Our expertise in designing and managing digital centres is one of the key skills underpinning these activities.

Broadcast

Our Broadcast activity assembles programming and manages the playout of video content for broadcasters through playout facilities. Revenues are generally earned in accordance with fees specified in contracts with our customers.

During 2003, in partnership with Disney, Technicolor designed and built a broadcast play-out facility for Disney Channel Japan and is managing the operations on behalf of Disney, ranging from content preparation to broadcasting of television-related content. In 2004, we acquired the U.K.-based Corinthian Television Facilities, one of Europe’s leading independent broadcast playout facilities, which handles the playout of Disney’s channels in many of the European and Middle Eastern markets. We have recently expanded the technological capability of this facility with the construction of a multi-channel playout suite, which provides enhanced

 

 

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functionality (e.g., high definition, or “HD”), improved channel launch times and operational efficiencies. This gives us the opportunity to add further customers/channels to this facility. VCF, which provides playout services to many of the French broadcasters (including Multithématiques and Canal Plus), was acquired in October 2005. Also in October 2005, Thomson was awarded the contract to design, build and operate the new playout facility for TV5 Monde in France. In the very fragmented market of outsourced broadcast playout, our main competitor is Ascent. In January 2006, we completed the acquisition of the EDS network services contracts and teams (Convergent Media Systems). This reinforces our network installation, playout and maintenance capabilities.

Retail Media Networks

In August 2005, we expanded our Network Services activities into retail media networks through the acquisition of Premier Retail Network, the leader in the fast-growing market of out-of-home video advertising networks in retail outlets. Based in San Francisco, California, Premier Retail Network manages in-store television networks in over 6,000 locations across leading retailers mainly in the United States, most notably in WalMart and also in Sam’s Club, Costco, Albertsons, Best Buy and Circuit City. Premier Retail Network offers a comprehensive range of services including installation and management of electronic media infrastructure, conversion and preparation of electronic video content, video content aggregation, including media sales and management of thousands of playlists. According to Frost & Sullivan, Premier Retail Network is the U.S. leader based on value in the fast-growing market of out-of-home video advertising networks in retail outlets reaching over 200 million viewers every month. The objectives of the Two-Year Plan include the rapid extension of the U.S. network and European expansion. Main advertising competitors are television and cable networks and other media outlets.

Cinema Advertising (Screenvision)

Since 2001, we have developed our screen-advertising activities in two 50:50 joint ventures with Carlton Communications (now ITV). Through both Screenvision Europe and Screenvision U.S., we are engaged in the business of cinema screen-advertising across Continental Europe and the United States, respectively. The contracts with cinema owners or operators vary in length from approximately three to five years. In return for granting exclusive rights to our screen-advertising operations, the cinema owner or operator receives a share of the revenues from advertisers, and in certain cases may be supported by a minimum revenue guarantee. In addition to selling advertising on the cinema screen, our joint venture operations have also developed supplementary revenue streams for cinema owners or operators. Revenues are also generated from promotional activity in cinema foyers and poster and other display units have been installed in cinemas allowing advertisers further opportunities to target the valuable and captive cinema-going audiences. Our main exhibitor contracts include UGC, Loews and Carmike. Our main customers include advertising agencies and advertisers.

In 2005, we commenced the roll-out of digital technology in the screen-advertising industry, with the deployment of the SkyArc™ digital advertising management system in approximately 1,500 screens by the end of 2005. Screenvision plans to deploy this system in an initial phase covering 5,000 screens by year-end 2006. The deployment is being managed by our Electronic Distribution Services activity, as described above, which is also managing the system for Screenvision.

We hold a leading market position in the United States. Our key territories in Europe include France, Spain, Portugal, Belgium and the Netherlands. Our cinema screen advertising businesses compete with similar sales operations controlled by independent cinema owners or operators. Our competitors include National Cinemedia (NCM), which is part of the Regal entertainment group, a major exhibitor, CMS, supported by Kodak servers in the United States, and Mediavision in Europe.

Systems & Equipment

The Systems & Equipment division provides equipment and services for the capture and processing of video content and for the distribution and delivery to the end consumer of content, particularly video content but also increasingly double and triple play solutions (voice/data and voice/data/video respectively). The main customers of the division are broadcasters and network operators. We also distribute

 

 

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some products through retail channels. Principal products include studio and professional cameras, film imaging and signal processing equipment, head-end encoders/decoders, broadcast servers, routers, softswitches, set-top boxes (single, double and triple play), modems, customer premises equipment (CPE), and telephony products. The manufacture of many of these products is outsourced, with a lower proportion for more complex broadcast products and very high proportion in access products and CPE equipment.

These businesses are described below in more detail under three headings:

 

Broadcast & Networks (“Grass Valley”);

 

Access Platforms & Gateways; and

 

Connectivity, including the Communications activities. In December 2005, the Group announced a planned divestiture of the Consumer Audio/Video and Accessories businesses. Accordingly, they are classified as discontinued operations in our consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004 and described under section “—Discontinued Operations” below.

Broadcast & Networks (“Grass Valley”)

Broadcast & Networks (“Grass Valley”) provides products, systems design and integration expertise, as well as professional services for the global broadcast, film production, professional audio/video users and network provider industries (including cable, satellite and terrestrial broadcast and telecommunications).

The business has been expanded significantly over recent years through the acquisition of Grass Valley Group in March 2002 and subsequent development of its product offering. The product range was expanded further during 2005 with the acquisition of the Thales Broadband & Multimedia (“TBM”) business, which was completed in December 2005. This complementary business will allow for systems integration for IPTV service, providing network operators with asset management, delivery optimization, and head and middleware solutions. TBM strengthens our offering in video content distribution using Internet Protocol solutions (IPTV), video-on-demand and mobile television, as well as digital television and radio transmission systems and equipment. The business is being expanded further with the successful friendly takeover offer launched in late 2005 to acquire Canopus, a Japan-based leader in high-definition desktop video editing software. This transaction, which was completed in January 2006, also expands our offering significantly to the professional audio/video segment.

Broadcast & Networks (“Grass Valley”) accounted for around 20% of the revenues of the Systems & Equipment division reported for 2005 and is expected to account for a significantly higher percentage in 2006 due to both organic growth and contributions from the acquisitions of Canopus and TBM. Canopus had annual revenues in excess of €50 million at the time of acquisition and TBM had revenues of €154 million for the twelve months period ended December 31, 2005.

We offer one of the industry’s broadest set of solutions for media & entertainment clients, including high-definition and standard definition cameras for outside broadcast and studio use; PC-based software for news, sports and feature production; storage and playback devices; digital video vision mixers and routing switchers; products for converting and synchronizing digital signals within broadcast facilities; and software for monitoring products within broadcast facilities. For the film industry specifically, we provide digital cinematography cameras (notably the Viper camera which has been increasingly used for feature films, for example “Collateral”) and a complete set of digital post-production products. In addition, we offer a set of advanced video compression and distribution products and network management software for network and pay-TV operators.

Broadcast & Networks (“Grass Valley”) is now well-positioned to exploit growth opportunities generated by technology shifts in the field of digital media acquisition, production and creation, management and distribution.

 

 

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The markets in which the Systems & Equipment division operates are being influenced by a number of key trends, notably the following:

 

a quest for higher quality evidenced by the accelerating migration to the high definition (“HD”) format, particularly in the United States;

 

the integration of Internet Protocol (IP) and IT technologies with advanced video technologies in content capture, processing and distribution; and

 

the broadening of the market as the use of video becomes more pervasive, particularly in the corporate or “Enterprise” environment.

In Broadcast & Networks, these trends are affecting both the high-end professional market and also the larger ProA/V that we are increasingly addressing.

The evolution from video tape-based to digital disk-based newsrooms continued in 2005. In this market, Broadcast & Networks (“Grass Valley”) continued to see increased adoption of its digital video servers for storage and playback, as well as for its standard PC-based software for news content and feature production for small- to large-scale news operations worldwide. The acquisition of Canopus with its strength in editing is expected to further strengthen our offering in this area.

We have continued to invest in MPEG 4-based platforms for highly efficient HD compression. A key objective of global media leaders is to create and produce the highest quality content in the most efficient manner possible. This is a key trend worldwide, from well-established broadcasters to those operating in emerging digital media markets such as China and adjacent markets, such as ProA/V users in corporate and university media centres, distance learning and governmental networks. We continue to pursue digital affordability by combining IT, standard PC and networking software and broadcast-quality video technologies to deliver a set of lower-cost products. In 2005, Broadcast & Networks (“Grass Valley”) introduced several new products and diversified its distribution network to reach this expanded customer base, most notably with our Infinity product range which addresses the needs of professional audio/video specialists with digital camcorder and digital news production facilities.

Broadcasters’ ongoing drive to create and distribute the highest quality content in the most efficient manner has also created new maintenance, professional services and support opportunities for Broadcast & Networks (“Grass Valley”). In 2005, Broadcast & Networks (“Grass Valley”) continued to enlarge its revenue base from service agreements with its main customers, ranging from equipment supply to maintenance.

Broadcast & Networks (“Grass Valley”) operates in more than 22 countries and has received 19 Emmy Awards for its products. Major production sites are based in Nevada City, California, Breda (Netherlands), Weiterstadt (Germany) and Rennes (France). Our research and development is mainly performed internally, while large-scale volume production is outsourced to two contract manufacturing partners.

We believe Broadcast & Networks (“Grass Valley”) is the second largest supplier of equipment to the broadcast, film, and professional video markets based on volume and value. It also continues to hold a leading position in the compressed broadcast video server market based on volume and value, supporting highly efficient workflows in the areas of converging IT and video, and digital media asset management. We believe Broadcast & Networks (“Grass Valley”) is ranked second in digital news production based on volume and value, which continues to be driven by the market movement from tape-based systems to digital workflow environments. Primary competitors in the Broadcast market include Sony, Panasonic and Avid. Professional audio visual competitors include Sony and Pinnacle (purchased by Avid in 2005).

Network operators (cable, satellite and terrestrial television and telecommunications) continue to seek to expand their product range and also look to Broadcast & Networks (“Grass Valley”) to provide both turnkey and specific customized products and solutions. We have responded to this demand by offering compression, transmission and processing solutions that satisfy customers’ technical and budgetary requirements. Potential growth areas within this market include IPTV, Video-on-Demand and the ability to insert advertising into media transmissions using digital technology. Key competitors in the network operators market include Harmonic, Tandberg, Scientific Atlanta and Motorola.

 

 

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Access Platforms & Gateways (“AP&G”)

Through our AP&G activities, we develop technologies and products for broadband network operators who deliver their content, video and data to consumers and professional broadcasters. AP&G’s organization is customer-driven, comprising satellite, terrestrial and cable activities on the one hand and telecommunications activities on the other. AP&G accounted for approximately two-thirds of the revenues of the Systems & Equipment division reported for 2005.

Our Satellite, Territorial and Cable activity primarily designs and sells digital satellite set-top boxes to satellite operators, digital terrestrial set-top boxes to retailers, and cable modems and cable set-top boxes to major cable network operators.

Our Telecom activity prior to 2005 comprised offerings such as DSL gateways and modems for the residential and small-office, home-office (“SOHO”) markets (marketed under the SpeedTouch™ brand) and telephone handsets. In 2005, the Telecom activity has been expanded through the acquisition in March 2005 of Inventel, a company specializing in the design and supply of innovative voice and data solutions to telecom operators and internet service providers (ISPs), most notably multiple-play gateways like the France Telecom Livebox™, and in April 2005 of Cirpack, one of the European leaders in the supply of softswitches to telecom operators and ISPs. These acquisitions complemented our existing expertise in developing access products for delivering video over IP networks (IP set-top boxes).

The mission of AP&G is to partner with broadband network operators to enhance the delivery of digital entertainment, data and voice to their residential and business customers. Thomson is one of the leading global broadband solutions providers, offering a full spectrum of customized solutions which integrate hardware, software and services. We are a leader in the field of digital audio/video compression (MPEG2, mp3 and MPEG4), video modulation/distribution network technology customization/integration and broadband modems. We were one of the first to enter broadband entertainment more than ten years ago with the development of the direct broadcast satellite industry. In the following years, we have refined our technical expertise with leading products, powerful brand names and extensive distribution networks providing solutions to operators, which, in turn, provide services to end-users.

Operationally, we have continued the move toward a contract manufacturing (“CM”) supply environment, with the transition of products from several of our own manufacturing facilities to CMs. Essentially all of our telecommunications products are manufactured by sub-contracting partners, while we now outsource manufacturing of a vast majority of our STC products. We retain manufacturing capabilities in South America and Europe.

We continue to further our technological, integration and distribution expertise with new developments in advanced compression technologies (MPEG4, H.264 and mp3PRO), advanced security and encryption, home networking and emerging broadband technologies (ADSL 2.0, 2+). Worldwide, consumers are increasingly demanding a wider variety of entertainment options, requiring operators to expand their network capacities. In addition, consumers expect more high definition programming that consumes far more delivery capacity. In order to deliver more HDTV content and more channels, network operators will need to implement next generation digital compression technologies.

We seek to differentiate ourselves from the competition by offering a broad, technologically-advanced range of products, by our expertise and experience in the sector and our growing global reach. Through partnering with the world’s largest network operators and retailers, we seek to provide end-to-end solutions enabling our customers to capitalize upon market opportunities.

Satellite, Terrestrial and Cable

Thomson is the world leader in digital set-top boxes (“STBs”) based on value, with volumes significantly exceeding those of its closest competitors. Thomson offers a wide range of access platforms, including STBs with hard disc recording capability (DVRs/PVRs), in addition to standard, more affordable products provided to expand the basic subscriber base. Aided by our 2004 agreement with our largest customer DIRECTV, as described below, we believe we are the industry leader based

 

 

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on value market share in the growing U.S. market. Elsewhere in the Americas, we have continued gaining market share based on increased volumes with DIRECTV Latin America, Sky Mexico and Sky Brazil.

DIRECTV has been a customer of the Group since 1994 but the level of business associated with DIRECTV grew significantly in 2004. In mid-2004, we announced a definitive agreement with The DIRECTV Group, Inc., which is associated with the News Corporation group of companies and was the parent company of Hughes Network Systems, Inc. (“HNS”), for the long-term development and supply of digital satellite STBs. As part of the transaction, Thomson acquired HNS’ set-top box manufacturing assets. Under the terms of the supply agreement, Thomson will be involved in the technology development of new STB models during the contract period and will manufacture a full range of receivers including DIRECTV-brand high definition and digital video recorder (“DVR”) receivers. Thomson will be the lead supplier of DIRECTV System set-top receivers accounting for half of its needs. DIRECTV can earn a rebate of $57 million from Thomson if Thomson’s aggregate sales of DIRECTV’s STBs are at least U.S.$4 billion over the initial five-year contract term plus an optional one year extension period. Furthermore, Thomson will be liable on a pro rata basis for an additional rebate payment to DIRECTV up to U.S$63 million if Thomson’s aggregate sales of DIRECTV STBs are in excess of U.S.$4 billion and up to U.S.$5.7 billion. DIRECTV also received from Thomson U.S.$250 million cash upon close of the sale of HNS’ set-top box manufacturing assets, which occurred in June 2004. During 2004, DIRECTV evolved its business model to change to controlling distribution in-house rather than primarily utilizing the retail channel.

In Europe, we continue to develop our business with BSkyB. Specifically, we supply the Sky Digibox and Sky+ PVR and will begin supplying their MPEG-4 HD platform during 2006. We continued our longstanding relationships with other leading satellite operators, including Canal Satellite, TPS, Sogecable and Viasat.

The Group’s main competitors in STBs include Humax, Pace, Philips and ADB.

In cable, Thomson believes it holds the second- or third-ranking global position in cable modems based on volume, with strong positions in Europe and North America. In addition to modems, our wide product range includes wireless cable gateways and embedded voice-over-IP gateway solutions, and we are well-positioned to build on our position in cable. We continue to capitalize on our change in business model in 2004 within cable modems, lowering our cost base through a close partnership with an Asian supplier. In addition to building on our strong market position in cable products in Europe, we continued to develop our cable set-top box business (“CSTB”). Thanks to our expertise in digital video and compression technologies, competitive cost position and customization skills, our CSTB offerings are chosen by many cable network operators in Europe, the Middle East, Latin America and China. With strong interest from operators for “double-play” (video and data or data and voice) and “triple-play” (video, data and voice) boxes, we benefit from increasing synergies between our cable modems and CSTB businesses. Three key strategic customer agreements were reached during 2005. UnitedGlobalCom, Inc. (UGC) selected Thomson as a key supplier and leading technology partner for its rollout of analogue to digital transition to its cable customers in The Netherlands. UGC expects to deploy over 2 million digital CSTB to support the growth of digital television in Dutch markets. Also during 2005, Thomson was selected by Kabel Deutschland GmbH as a key partner in the rollout of similar digital television CSTB in Germany. Further evidencing Thomson’s global scope, China’s Dalian Tiantu chose Thomson as a key supplier for its transition from analogue to digital cable. Key customers include Comcast, Time Warner Cable, Liberty Global’s European affiliates, Eltisalat and NetBrazil.

Operationally, we have taken measures to ensure high-quality supplies for our customers, primarily through our relationships with several global CMs. From a product perspective, we have the economy of scale to provide high-volume, high-quality product to meet our customers’ current needs in the Americas, Europe and Asia. Given our strong relationship with network operators, we are able to leverage our expertise in these technologies to partner with them in developing and delivering new products which offer enhanced video and audio quality, primarily through the expansion of high definition broadcast delivery. Our capabilities also enable us to develop more

 

 

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sophisticated products encompassing the ability to record content.

Telecom

AP&G’s telecommunications (“Telecom”) business serves telecom customers around the globe and offers products in telephony, mobility, high-speed DSL modems, IP STBs and multiple play home gateways. Following the acquisition in April 2005 of Cirpack, we also offer softswitch platforms, which provide operators with key capabilities to optimize content delivery and a key link between AP&G’s support of the content creators (via Grass Valley) and end-user access. We can provide our customers with specific solutions for their needs such as telephone handsets (including those for IP-based networks) to telecom operators and internet service providers, DSL modems increasingly with value-added gateway and wireless networking capabilities, or IP STBs, which enable the delivery of fully-featured video entertainment over existing DSL lines. In addition, our mobility business markets handheld audio and video devices which will connect to wireless networks to deliver data, audio and video entertainment, and web access to mobile users. Our acquisition of Inventel in March 2005 has significantly strengthened our position in home gateways for telecom operators and ISPs and wireless technologies, although with the growth in multiple play gateways there has been a consequential weakening in the traditional modem business. However, our core modem and gateway business posted a significant increase in revenue compared to 2004. Building upon our strength in providing telecom network operators with a triple-play (voice, data and video) solution, our Telecom business is poised to offer a 4-play (voice, data, video using wireless technologies) solution as well by adding mobility capabilities.

Reflecting the evolution of the Telecom business we announced in December 2005, the creation of an Advanced Product Development Group to accelerate the development and deployment of broadband service delivery platforms and home networking solutions, with the rest of the Telecom business focused on triple play gateways (encompassing data, voice-over-IP, and IP video products and solutions), Telephony & Mobility and Next Generation Networks (based on Cirpack activities).

Our Telecom business continues to benefit from key positions established with European telecommunications providers, with our DECT and WiFi telephone ranges and voice over IP product development. Key customers include major European telcos including British Telecom, France Telecom, KPN and Telefonica. Special features (e.g., voice mail and caller ID) support value-added services provided by our telecommunications customers. We view the Telecom business as a major growth driver within AP&G. We estimate that its addressable market presents around half of the addressable market for AP&G as a whole. Our main competitors in telecom products include Siemens, Safran (Sagem) and Philips. In cable modems, our main competitors include Motorola and Scientific Atlanta.

Thomson remains a global leader in DSL modems based on volumes with strong market share in major markets around the globe, particularly in Europe. Our range of technologies and products includes wired and wireless gateways, ADSL/ADSL2/2+, SHDSL, VDSL product and value-added software.

Our DSL product family has been expanded to include value-adding gateway and wireless networking products that provide our customers with a versatile, robust and secure broadband connection, particularly following the Inventel acquisition in March 2005. These products are increasingly operator customized and branded by the operator. Inventel has had particular success in 2005 in supplying the Livebox™ for France Telecom, with sales recently passing the one million box mark and is now also selling the AOLbox™, another voice and data home gateway with IPTV connectivity.

We continue to develop and market IP STBs that allow for the delivery of video entertainment over broadband DSL IP networks. This represents a new market and business opportunity for DSL network operators by enabling them to broaden their service offerings to consumers. Many of the proposed rollouts of video services over IP are still in the trial phase but we are supplying boxes to many of these trials. Broadcast & Networks (“Grass Valley”) also supply head-end encoders for use with IPTV services and following their recent acquisition of TBM (described above) we have significantly strengthened our capabilities in related software and middleware. We believe we

 

 

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are well-positioned for growth in both Broadcast & Networks and AP&G-Telecom as telecom operators and ISPs rollout triple and 4-play services. Our unique combination of solutions also presents us with opportunity within the new market of corporate video applications.

Connectivity

At the start of 2005, Connectivity grouped together the following three activities: Communications, Accessories and Audio/Video.

As the Group continues to explore the sale of non-strategic assets, it was announced on December 12, 2005, that the Group would pursue a divestiture of the Accessories and Audio/Video business. These activities are treated as discontinued operations in the consolidated financial statements as of and for the year ended December 31, 2005 and 2004 until completion of the disposal. These activities are described briefly below under “—Discontinued Operations”. The Communications business has a strong position in its markets and continues to align its offering toward connected products designed to meet the specifications of telecom operators.

With regard to future developments in the area of home networking which we still consider to be a longer term growth opportunity for the Group, we have determined that we would be able to develop the appropriate product offering within the Systems & Equipment division in close conjunction with our Telecom business and our operator clients.

Communications

Thomson’s Communications business sells residential, small office, and home office communications devices such as telephone handsets and answering machines under the GE™, RCA™, Alcatel™ and THOMSON® brand names.

In North America, we believe we hold the number one position based on value market share. In 2005, the communications industry declined, as the industry continues to shift to 5.8GHz and multi-handset communications products. In Europe, we sell telephones under the Alcatel™ brand name in France and the THOMSON® brand name in the rest of Europe. Approximately 85% of the products sold in our four main European markets were DECT (Digital Enhanced Cordless Telecommunications) products.

Our main distributors are national retail chains in the United States such as WalMart, Best Buy, Target, and Circuit City and, in Europe, groups such as MediaMarkt, Carrefour, FNAC and Kesa. Our main competitors include Panasonic, Uniden and V-Tech.

Technology

The Technology division comprises four activities: Research, Licensing, Silicon Solutions, Software & Technology Solutions. The Technology division reported consolidated net sales of €546 million.

Research comprises the Group’s corporate research activities and is treated as a cost centre within the Technology division. This operation interacts closely with the other divisions but further product development is undertaken within the relevant division and the costs accounted for in that division. The bulk of the Technology division’s net sales are generated by the Licensing activities (€449 million in 2005), but we intend to grow the Silicon Solutions and Software Technology Solutions businesses over the next few years.

Corporate Research

Thomson maintains a longstanding commitment to investing in a broad range of research initiatives to support and expand its product and service offerings and licensing programs in order to create competitive advantages and to establish new markets.

Most of the long-term research is managed centrally through Thomson’s Research department, which employs approximately 430 people mainly in eight research centres on three continents as of December 31, 2005. The largest center, located in Rennes, France, has a staff of 165. The other centres are located in Paris (France), Hanover and Villingen (Germany), Burbank, Indianapolis, and Princeton (United States) and Beijing (China). The Paris research center was established in October 2005.

 

 

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Product development is carried out within the activities of Thomson’s other divisions.

As part of our Two-Year Plan presented on November 30, 2004, Thomson constituted a Scientific Council to assess Thomson’s Research in light of external developments in video technologies and Thomson’s strategy, challenge the research teams on their processes, output, roadmaps, and team qualifications and make recommendations to Thomson’s Chairman and Chief Executive Officer.

During 2005, we have focused on the efficiency of our research activities. We intend to continue to increase our focus on increasing the quality and output of our research to maximize the financial benefits to the group of such research, while closely monitoring its cost. We also intend to grow our research activities in Beijing and to start an advanced development team in Bangalore.

Historically, Thomson’s research and development efforts covered a wide spectrum of technologies associated with a consumer electronics company. Over the recent years, research efforts have been redirected towards projects serving the short- and long-term needs of the M&E industries, utilizing core competencies and knowledge gained both through close relationships with Thomson’s current client base and our involvement in the development of earlier video technology. Thomson’s objective is to develop new technologies to meet clients’ needs as they face the growth of their digital activities. At the same time, it intends to expand its intellectual property portfolio, enhance product integration in cooperation with its business units, and reduce the time required to bring products and solutions from design to production and eventually to market.

To respond to customer needs, Thomson focuses on six key technology domains for the M&E industries: video and audio compression; networking and communications; security; storage and recording; signal acquisition and processing; and imaging. We also currently operate four system programs: content production and management (CP&M) for cinema; CP&M for broadcast; electronic content distribution (ECD) on broadband networks; and ECD on mobile networks. During 2005, one of our previous system programs, Digital Cinema, was moved into the service rollout phase.

In order to address customers’ vision of media and content, Thomson R&D focuses on content digitization through compression technology. Examples of products and services include hardware and software codes for compression, Grass Valley encoding products and compressed movies on DVD. Video is emerging as the key strategic application in the service provider bundle of consumer entertainment, communication and online services. Compression and decompression are fundamental to the transmission of audio and video content over all types of digital networks.

Thomson is a leader in compression technology. Compression enables more programs within a given channel bandwidth, allows the delivery of high quality video and audio on bandwidth-constrained networks (e.g., 3G mobile) and fits larger content (e.g., high definition movies) onto a DVD or a device of limited capacity. Thomson has been a pioneer in this field through MPEG video compression and its original deployment with DIRECTV, as well as in audio compression with mp3 and its derivatives. Recently, Thomson has played a leading role in the finalization of MPEG 4 AVC/H.264 video compression, which is the new and highly efficient extension to the MPEG-4 standard, and continues to contribute innovative technologies to new extensions such as scalable video coding. Advanced compression methods such as AVC/H.264 or mp3 harness silicon processing to deliver higher data rates for video and audio in bandwidth and storage critical applications. Leveraging its expertise in compression and IC design, Thomson has been developing the next generation of encoders and decoders that incorporate the latest MPEG technology.

In the area of content digitization, Thomson focuses on two technology domains: storage & recording and signal processing. Examples of such products and services include optical storage and pre-recorded DVDs. Optical storage continues to be the least expensive format to store 5 to 50 Giga Octets content. Being a pioneer in optical recording enabled Thomson to develop key intellectual property on CD and DVD recording technology and formats, ultimately leading to a manufacturing cost advantage in DVD replication. Our position in optical

 

 

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recording also generated a significant ongoing royalty stream from our optical portfolio.

Thomson focuses on image capture, processing, and manipulation technologies that address the wide range of image qualities and applications found in the M&E industries, including movie formats, standard and high-definition television, and mobile video. Applications encompass conventional and digital cinema, broadcast studios, home cinema and the Internet. Thomson’s research and development focuses on delivering highly flexible image capture and processing equipment, and developing processing technologies that guarantee the highest image quality and reliability at all stages of the image production and distribution chain such as color correction, high dynamic range and preservation of film grain.

Thomson develops advanced storage and networking solutions for post-production and studio infrastructures, such as a dockable solid-state recorder and a hard disk portable storage unit for digital high-definition cameras, very high bandwidth storage area networks, and high bandwidth wireless technology for television cameras and studios.

Thomson’s security program covers a range of applications that are important to content producers, content owners and network operators. Thomson develops technology and systems solutions addressing workflow security in production and post-production environments, anti-piracy mechanisms, video and audio watermarking, protection for broadband and mobile content delivery.

In order to address customers’ need to deliver content from multiple sources through a diverse range of networks, Thomson develops critical enabling technologies such as streaming, caching, and network overlays. In addition to its traditional focus on satellite, terrestrial and cable networking technologies, Thomson develops quality of service and distribution solutions for video content delivery over heterogeneous networks including the Internet, cellular networks and wireless local area networks.

Optimized system integration of compression, security and networking technologies will allow consumers to receive video content on both wired and wireless devices with both convenience and reliable image quality.

Thomson’s research activities leverage our core competence and knowledge of the needs of consumers, content providers, and distributors to develop innovative digital home networking, home media servers and content protection solutions. The forthcoming digital home network architecture and wireless transmission technologies are under development to allow the exchange of digital content via different platforms, with particular attention paid to the emergence of products based on hard-disk drives, which are bringing considerable improvements to the end-consumer experience and opening up new opportunities for content providers and network operators.

Thomson’s internal research activity is complemented by subcontracting certain research activities to outside providers, as well as by entering into research or co-development activities with strategic partners. For example, Thomson developed the mp3 digital compression standard and several recent extensions in cooperation with the Fraunhofer Institute and Coding Technologies.

Other key research and development partners include research institutes such as INRIA (Institut National de Recherche en Informatique et Automatique) in France and HHI (Heinrich Hertz Institute) in Germany, and universities in France, Germany, and the USA. To access key technologies and accelerate the transition toward digital technologies, products and services, Thomson also makes selective minority investments in companies with leading technologies considered beneficial to its product lines. In addition, its internal research and development is supplemented by appropriate intellectual property acquisitions.

Licensing

In 2005, Thomson’s licensing activities generated €449 million in consolidated net sales (8.3% of the Group’s consolidated net sales). At December 31, 2005, this division employed 194 people based in France, Germany, Switzerland, Japan, South Korea, China, Taiwan and the United States.

 

 

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We have made it a strategic priority to protect and monetize our intellectual property. Our strong patents portfolio in video technologies combined with our licensing expertise constitute significant competitive advantages. The Licensing operations were brought together in early 1999 with the integration of the RCA.TL patent and license management business transferred from General Electric Co. to the Group on January 1, 1999 with the licensing organization already existing within Thomson. Since 2005, trademark licensing activities are also part of the licensing activities, with several contracts relating to the Thomson and RCA brands.

The licensing team works closely with Thomson’s research and development centres to identify ideas that may be potential patent candidates, to draft patent applications and to detect uses of our patents by third parties. As of December 31, 2005, we held close to 50,000 patents and applications worldwide, derived from more than 7,080 inventions. In 2005, we filed 665 priority applications (an increase of 13% from 2004), which are applications in respect of new inventions that are filed for the first time.

We believe that our patent portfolio is well-balanced between new technologies and mature technologies. Among the new patented technologies, the Group has significant positions in the areas of digital decoders, high-definition and digital television sets, optical module patents for CD and DVD players, MPEG video compression, the mp3 audio compression format, interactive TV technologies, storage technologies and new screen technologies such as liquid crystal display and plasma. The Group also holds strong positions in patents of mature technologies, including colour television sets, colour television tubes, VCRs and camcorders.

We develop licensing programs rather than licensing individual patents. Under our licensing programs, a licensor can obtain a license to use all of our intellectual property as it relates to a particular application (including patents which may be filed subsequent to granting of the license).

We currently have well over 800 licensing agreements across 23 major licensing programs relating to a diversified mix of video products and services. We have licensing agreements with almost all consumer electronics companies in the Americas, Europe and Asia. Licensing agreements with our top ten licensees accounted for approximately 68% of our total licensing revenues in 2005. The licensing agreements are typically renewable and have an average duration of five years; royalties are primarily based on sales volumes.

In recent years, we have successfully migrated the proportion of licensing income derived from digital technology-based programs compared to analogue-based programs, as the underlying product markets have evolved. In 2005, 75% of licensing revenues was generated from digital technology-based programs.

In 2005, the licensing program generating the most revenue was MPEG-2, which is licensed through the MPEGLA consortium pooling in which we participate. This program contributed around 20% of our Technology division revenues. We expect this program to remain a significant contributor to our licensing revenues for several years.

Our licensing activities require relatively little infrastructure and have a limited cost base. Our strategy for the licensing activities is to develop our intellectual property portfolio, through widespread, but targeted, patent applications and through the acquisition of additional patents that have strong commercial and technical complementarities with our existing portfolio. Furthermore, we continue to increase the number of licensees through a more systematic enforcement of existing patents, especially in emerging markets where production facilities have been relocated but also in Europe and the United States, and through the launch of new licensing programs in China around flat displays and digital and interactive television patents. However, the results of this enforcement strategy will depend in part on the level of recognition and protection of intellectual property rights provided by local law, particularly in emerging markets.

Since July 2002, we have participated in the MPEGLA consortium pooling that manages the licensing patents essential to the MPEG-2 video compression standard. We decide whether to join pools on a case-by-case basis. The benefit of participating or not in a pool is regularly reviewed, based on our assessment

 

 

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of the strength of our relevant patent portfolio and potential for exploiting such intellectual property independently.

Finally, we are leveraging our expertise in licensing through portfolio licensing services to third parties. Thus, in connection with the TTE partnership, Thomson provides patent management and licensing services to TTE.

For information on certain risks to which our licensing business is subject, please refer to “Key Information—Risk Factors.”

Silicon Solutions

Through the Silicon Solutions activities, we design and develop silicon components to monetize in-house technological innovations and leverage our expertise in the use of silicon in video related applications. Such components are used in DSL modems and gateways, digital set-top boxes (decoders), CD players, professional cameras and encoders. We produce components for both our Systems & Equipment division and for sale to other manufacturers. We have many years experience in silicon and believe we can effectively expand this business over the next few years.

We have an in-house integrated circuit design team, which designs several of the essential integrated circuit components used in our products, from professional to consumer equipment, sometimes in partnership with selected semi-conductor vendors. Integrated circuits are key components of digital products from the perspective of cost, performance and time to market. Our integrated circuit design team employs more than 200 engineers with specialized skills in digital, analogue, mixed digital-analogue, and radio frequency signal processing. This team operates out of four facilities located in Indianapolis (U.S.), Rennes (France), Villingen (Germany) and Edegem (Belgium). A facility located in Beijing is also supporting this activity with its expertise in front-end design.

The production of integrated circuits is achieved through a manufacturing sub-contracting business model.

Silicon Solutions also includes our tuners and remote control units activities. Our manufacturing site in Batam, Indonesia (which employs over 800 full-time employees and 1,800 part-time employees) produces both tuners and remotes for the internal needs of our decoders and broadcast activities and for external manufacturers as well. In 2005, we continued to pursue the development of analogue and digital tuners for deployment in set-top boxes, television sets and DVD recorders. Moreover, we started manufacturing in China through a sub-contracting agreement with Flextronics in order to progressively serve the domestic Chinese market for digital cable tuners. We continue to hold our position among the worldwide leaders based on volume in the field of digital terrestrial tuners. The Tuners business is carried out at three main sites: Boulogne (France), Villingen (Germany) and Singapore with manufacturing located at Batam (Indonesia). More than 30 engineers are developing tuner products.

The remotes business reaches the retail market through wholesalers, the CE manufacturers and pay-TV operators who directly select and order the remotes to be used with their set-top boxes. The bulk of the remotes business is conducted from Singapore, with 14 people in research and development, with manufacturing located at Batam (Indonesia).

Software & Technology Solutions

Effective January 1, 2005, this business unit aims to develop and commercialize proprietary technologies, primarily by leveraging Thomson Corporate Research innovations, with a specific initial focus on content security.

We see significant potential in this business which is expanding from watermarking into other content security-related topics such as content protection/digital rights management (“DRM”), web monitoring, anti-camcorder systems. We intend to build on initial successes in watermarking to establish a market leading position. Digital watermarking is the technology which embeds invisible, indestructible and fully trackable pieces of information within a digital object. Watermarking enables, for instance, identification of the owner, origin or recipient of an identified digital content and there are market applications in post-production, broadcast distribution or other media and entertainment-related domains.

 

 

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In February 2005, Thomson acquired the German company, MediaSec Technologies GmbH, a pioneer in digital watermarking and copy detection technologies, with a strong portfolio of patents and software products. In 2005, Thomson acquired the French company, Nextamp SA, a market leader in development of watermarking products for post-production and broadcast applications.

The watermarking technology finds applications in stand-alone watermark embedders and decoders, enabled video servers (e.g., digital cinema, Video-on-Demand), enabled media asset management systems and enabled set-top boxes. It may be commercialized through the Technology division (stand-alone products, software modules, technology licensing) and/or through the Systems & Equipment division.

In March 2005, our content security activity was reinforced with a strategic investment in ContentGuard, a developer of DRM intellectual property. DRM describes an advanced form of conditional access with additional intelligence that provides the ability to attach viewing time limit or number of views to content (movies, music and other digital content) while protecting that content from unauthorized copying and counterfeiting. This unique partnership with Microsoft and Time Warner brings together content, technology and media services to deploy more rapidly DRM-enabled business models.

Content security also entered in a partnership with the French company, Advestigo, to provide Web monitoring services to Media & Entertainment customers. This service allows one to track and identify occurrences of copyrighted content on certain distribution networks, such as peer-to-peer networks.

Displays & CE Partnerships

CE Partnerships

On January 28, 2004, Thomson, TCL International and TCL Corporation entered into a Combination Agreement to combine their respective television manufacturing businesses and assets into TTE, a company formed for the development, manufacturing and distribution of television sets. TTE became fully operational on August 1, 2004. In consideration for a 33% shareholding interest in TTE Corporation, Thomson contributed into TTE certain television production plants, including its television manufacturing plants and businesses in Mexico, Poland and Thailand. Thomson also contributed its television research and development centres worldwide and certain other assets constituting substantially all of the former Thomson’s television manufacturing business, except for its manufacturing site located in Angers, France which remains within Thomson’s Displays and CE Partnerships segment as a sub-contract manufacturer for TTE. The sub-contract manufacturing agreement is in force until the end of 2009. Aside from its traditional manufacturing activities, the Angers site has started to develop new activities with France Telecom, Cirpack and Inventel.

Under certain agreements entered into in connection with the Combination Agreement, Thomson became a preferred supplier to TTE of tubes and other selected components in China and elsewhere in the world. Such preferred supplier arrangement has since been transferred to Videocon Industries in connection with the disposal of our Displays activities. See “—Displays” below. Furthermore, the component sales, service contracts and parts distribution business as well as the distribution of Telefunken, Brandt and GE branded televisions in Latin America and Europe remained with Thomson. In addition, Thomson acted as the exclusive sales and marketing agent to TTE for distribution into North America and the European Union countries and provided TTE with other value-added services such as product design, client coverage, logistics, quality certification and after-sales services and some value-added build-to-order manufacturing services. In July 2005, Thomson and TTE agreed to unwind this sales and marketing arrangement, and Thomson transferred approximately half of its worldwide sales and marketing network to TTE between September and December 2005.

In addition, in connection with the Combination Agreement, Thomson had granted to TTE a license on certain of its brands and its intellectual property related to the television manufacturing business, while Thomson remains responsible for the licensing of TTE’s intellectual property related to the TV business. On July 14, 2005, Thomson and TTE revised the arrangement regarding trademark fees payable by TTE to Thomson, to provide for an increase in royalty rates to

 

 

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compensate in part for revenues lost as the result of the unwinding of the sales and marketing arrangement with TTE.

Thomson also entered into a receivables purchase and sale agreement with TTE, effective for up to two years, and assumed certain of TTE’s restructuring costs up to a maximum of €33 million. Thomson has no other obligation to provide any financing support to TTE or for its benefit to any person. Further, Thomson granted TCL International the option to acquire up to 2.5 million Thomson shares at a price of €18.12 per share.

The parties to the Combination Agreement and TTE also entered into a shareholders’ agreement, which was cancelled and replaced in connection with the exercise on August 10, 2005 by Thomson of its option to convert its 33% holding in TTE Corporation, a private joint venture company, into a 29.32% interest in TCL Multimedia Technology Holdings (“TCL Multimedia Holdings”), listed on the Hong Kong Stock Exchange substantially all of whose assets comprise its interest in TTE Corporation. The new shareholders’ agreement between Thomson and TCL (which is substantially similar to the previous one) includes undertakings not to compete with TTE’s television business and restrictions on Thomson’s ability to transfer its interest in TCL Multimedia Holdings for up to a period of five years from the closing date of the Combination Agreement.

Displays

On October 21, 2004, Thomson identified the disposal of its Displays activity as one of its Five Strategic Priorities as part of the Two-Year Plan. As the objective was fulfilled in the course of 2005, most of the former assets of the Displays activity have been treated as discontinued operations in the consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004, as described below under “—Discontinued Operations”.

Reported as continuing activities within the Displays activity are manufacturing operations producing components (yokes and metal parts for cathode ray tubes), principally located in Genlis (France). The Genlis site mainly focuses on high-end R&D activities and on critical and sustainable cathode manufacturing. Preferred supplier agreements have been entered into with the manufacturing assets purchased by Videocon in 2005.

Discontinued Operations

In 2005, Thomson achieved the key steps in its disengagement from its tubes manufacturing activity. As a result, the assets specified below are treated as discontinued operations in consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004:

 

On February 28, 2005, Thomson completed the transfer of its cathode-ray tube plant at Anagni, Italy to the Videocon Group.

 

On September 30, 2005, Thomson completed the transfer of its tubes assembly assets in Poland, China and Mexico, a research laboratory in Italy and sale, marketing and administrative functions in Boulogne, France to Eagle Corporation, a special purpose vehicle owned by the Videocon Group. Upon completion of the transaction, Thomson received a payment of €240 million in cash from Eagle Corporation for Thomson’s tubes activities and related technologies. Simultaneously, Thomson invested €240 million in Videocon Industries, an oil and gas company that is also active in the consumer electronic and consumer electronic components markets, through the subscription in a private placement of Global Depository Receipts (each representing one underlying share of Videocon Industries) (“GDRs”) listed on the Luxembourg Stock Exchange. Payment was made in full on September 30, 2005, while the GDR allocation was effected in two tranches: 28,650,000 GDRs on September 30, 2005 and 217,200 GDRs on December 21, 2005. All GDRs were purchased at a price of U.S.$10 each. Following this investment, Thomson holds approximately 13.1% of the share capital of Videocon Industries. In connection with this investment, Thomson entered into a shareholders’ agreement with Videocon Industries and its shareholders, which restricts Thomson’s ability to transfer its interest in Videocon Industries for a period of three years, subject to certain exceptions. See Item 5: “Operating and Financial Review and Prospects—Evolution of division structure—Changes in scope of consolidation in 2005—Main disposals”

 

 

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for a description of these exceptions to the share transfer restrictions. Pursuant to the agreement entered into with the Videocon Group, Thomson also transferred to Videocon the preferential displays supply agreement entered into with TTE in August 2004.

 

On December 23, 2005, Thomson completed the transfer of its glass manufacturing facility at Bagneaux-sur-Loing, France, to the Spanish group, Rioglass.

For a description of the financial implications resulting from these disposals, see Item 5: “Operating and Financial Review and Prospects—Results of Operations for 2005 and 2004—Net Income From Discontinued Operations.”

 

On December 12, 2005, Thomson announced that it had decided to seek partners for the Audio/Video and Accessories activities within Connectivity. As a result, those activities are reported as discontinued operations in our consolidated financial statements as of and for each of the years ended December 31, 2005 and 2004.

Audio/Video includes audio products such as digital audio players, compact disc players and clock radios, as well as home cinema products and DVD devices, including DVD recorders marketed under the GE™ and RCA® brand names in the Americas and under the THOMSON® brand in Europe. New products introduced in 2005 included an mp3 player that measures heart pulse and calculates calories burned, a 5 GB hard-drive based Micro Jukebox for music with a colour screen for photos, and a second generation of the LyraTM Audio/Video Jukebox. During 2005, competition in these markets continued to intensify as Chinese manufacturers made significant inroads supplying less established brands and “private label” customers, and in mp3 players particularly from Apple iPod products.

 

Our Accessories activity provides universal accessory products and services to leading retailers in North America and Europe. Our main clients are national chain stores in the United States such as Best Buy, Walmart, The Home Depot and RadioShack. In Europe, we distribute our products through groups such as Carrefour, Auchan and Mediamarkt. Through our extensive brand portfolio (such as RCA, THOMSON, Acoustic Research, Jensen, Spikemaster and Advent), we have broadened our distribution in our key markets. We have strong positions in remote control units, TV antennae, and wireless headphones and speakers, and have strengthened our position in audio/video cabling and power surge protector products. Our Acoustic Research Digital MediaBridge product enables users to stream music, high-definition photos and videos from their PC to a television utilizing an existing WiFi home network.

Thomson sold to the Taiwanese company, Foxconn, its optical pick-up manufacturing activity in 2004. In 2005, Thomson agreed to transfer to the German company, Harman Becker, its remaining research and product development assets and employees in this business in the first quarter of 2006.

Business Operations

In order to support its Two-Year Plan, Thomson established a global Business Operations function focusing on improving the operational and financial performances of its divisions by deploying cross-divisional programs and optimizing certain global central functions such as Sourcing and IT.

Process Transformation Initiative (PTI)

Thomson launched, in late 2004, the Process Transformation Initiative in order to improve the performance level of our key processes and to improve operational efficiency and effectiveness. Within Business Operations, the corporate Program Office is responsible for the day-to-day management of the Process Transformation Initiative programs and for the coordination of the best practices distribution across the Group. In 2005, initiatives were launched in new-product introduction, inventory management, manufacturing, logistics and the support functions area. As of December 2005, more than 65 projects were active, resulting already in various financial gains due to pure cost savings, spending avoidance and better productivity of resources. These first results are promising and demonstrate the importance of the PTI approach for the future performance of the Group.

 

 

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Information Technology

Thomson has a centralized IT organization with dedicated teams per division (Services, Systems & Equipment and Technology) and a team which is developing and sustaining technologies and applications common to the three divisions. In addition, we reinforced in 2005 the IT functions across our divisions through the following:

 

several quality processes have been implemented or strengthened such as project portfolio management, projects cutover and launch readiness assessments. This ensures that projects deliver solid systems on reliable platforms;

 

a dashboard with technical key performance indicators oriented to value added generated by IT has been implemented for the Technology division. Such dashboard, which allows for an optimized allocation of available resources to the most valuable IT projects and initiatives, will be adapted and implemented in 2006 for other divisions;

 

resource for risk management and security of the systems have been increased in 2005. Business continuity plans and disaster recovery plans are progressing significantly through the Group; and

 

compliance of the systems is now addressed by a specific team responsible for coordinating all actions across the whole IT organization, improving and expanding the coverage of these complex aspects.

In 2005, a two-year IT plan was initiated. It translates in terms of technologies, applications and IT resources the needs generated by the two-year business plans for our divisions with the objectives to generate value, to anticipate future developments and to improve the cost structure through better consolidation, standardization and synergies among divisions where possible. The IT strategy for each division will be reviewed annually through the update of the two-year IT plan. In parallel, we have defined and implemented governance rules in order to better qualify with the divisions the IT projects according to a set criteria, which is mutually agreed with each business.

The IT organization continues to supply services to certain activities recently disposed of by Thomson, including with respect to activities transferred to TTE and Videocon. We are currently in discussions with both TTE and Videocon concerning the transfer of all IT services currently provided to them by Thomson.

Sourcing

Thomson has a centralized Sourcing organization with dedicated teams per business unit (70% of total Sourcing resources) and central Competence Centres working on global and common activities. Our employees are present both in countries where suppliers are located (particularly Asia) and where our businesses are located (R&D, Operations, Product Management). They select and manage our network of suppliers of raw materials, components, finished goods, services and equipment. Their objective is to optimize supply arrangements and benefit from global volumes and common vendors, the standardization and deployment of best practices throughout the different operational divisions, while staying in close touch with the business units’ needs. In addition, Thomson has built relationships with key suppliers like Kodak, Elcoteq, Solectron, Benchmark, DHL, Géodis, Broadcom, STMicroelectronics, thus strengthening its position for the purchase of raw materials, contract manufacturing, logistic services and key integrated circuits.

Thomson has obtained, in 2005, significant price reductions linked to the sourcing performance and to the increased competition among our suppliers. We have been able to increase the portion of the manufacturing outsourcing for our decoder activity from 10% in 2004 to 70% in 2005. We have also focused on expanding upstream sourcing activities in coordination with our R&D activities across the Group in order to optimize cutting edge technology with sourcing requirements based around standard platforms. We have implemented our agreement with IBM regarding the provision by IBM of key procurement services in order to benefit from larger scale of purchases, for indirect supplies such as business travel, office

 

 

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supplies, manufacturing maintenance, information technology and marketing and advertising.

We believe that the termination of any one of our supply contracts would not materially endanger our operations or financial condition. The principal suppliers of the Group in 2005 are of five types:

 

suppliers of components or primary materials for Systems & Equipment and Services activities (STMicroelectronics, Broadcom, Kodak, Bayer, Viva);

 

suppliers of components or sub-assembly parts for our Technology division (Infineon, TSMC);

 

suppliers of finished products for the Connectivity unit within the Systems & Equipment division, which are primarily Asian-based suppliers (CCT, Chase Glory, Tonic, T-Say Jebsee);

 

contract manufacturers for various products such as Satellite, Terrestrial and Cable decoders and Telecom and Broadcast & Networks equipment (Elcoteq, Solectron, Celestica, Askey, Foxconn, Benchmark);

 

suppliers of logistical services (DHL, Schneider Logistics and Geodis Logistics).

Licenses and Trademarks

We believe that we own or have licenses in the technology necessary to compete in the markets for our products and systems. Since the practice in these markets has historically been to provide licenses on reasonable and equitable terms, we expect to continue to have access to the licenses necessary to manufacture and sell our products.

We also believe we have licenses in and are able to use the trademarks that are necessary to our business.

We acquired ownership of the RCA® brand name in 2002 after having used it for 15 years under a license conceded with respect to certain regions and products pursuant to certain agreements in 1987 with General Electric. In March 2001, we acquired the Technicolor assets and businesses, including the Technicolor® trademark. During 2001, we purchased the THOMSON® names and all attached rights from TSA and Thales S.A. For more details on these contracts, refer to Item 7: “Major Shareholders and Related Party Transactions—Related Party Transactions.” In March 2002, we acquired Grass Valley Group, Inc., which owns the Grass Valley® trademark.

In July 2003, Thomson acquired from the American company Recoton Inc. the trademarks of Recoton™, Ambico™, Discwasher™ and Sole Control™ in the accessories business.

Thomson has also granted a 20-year exclusive license (until August 1, 2024 ) to TTE to produce and market television sets under the RCA® and THOMSON® brands principally in the United States and the European Union, as well as certain other regions.

In 2005, we acquired Nextamp, Inventel, MediaSec and Cirpack assets and business, including the Nextamp™, Inventel™, MediaSec™ and Cirpack™ trademarks.

In 2005, Thomson granted a non-exclusive worldwide license to Eagle Corporation Limited (Videocon Group) to use the Thomson trademark in relation to colour tubes for televisions.

C — Organizational Structure

Please refer to Note 30 to our consolidated financial statements for a list of Thomson’s subsidiaries.

D — Property, Plants and Equipment

Industrial Facilities and Locations

We have developed an industrial organization with important manufacturing and distribution operations in order to deliver our product and service offerings to our customers. In addition, we rely on outsourcing for the manufacturing of some of our finished products.

Our objective is to continually improve the location and the organization of our manufacturing operations to reduce our production costs, minimize our stock levels and improve our leadtimes. Over the last few years, we have implemented an outsourcing policy for the manufacturing of some of our

 

 

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finished products such as decoders, modems, audio and communication products, accessories and DVD players. We rely on third-party competencies for the manufacturing of a significant proportion of standardized products in order to focus our resources on the conception and commercialization of high-end components, products, and services. At the end of 2005, we had facilities involved in the production and distribution of DVDs and VHS tapes, in motion picture film processing, and in the production of set-top decoders, audio products, and electronic components.

The table below shows our industrial facilities by division at the end of 2005. We own or lease all of these facilities, including the Chinese facility, which we hold pursuant to a long-term lease due to local legal requirements. We also lease our office buildings in Boulogne, France and Indianapolis, Indiana, USA. For more information on these leases, see the discussion under Item 5: “Operating and Financial Review and Prospects––Liquidity and Capital Resources”, as well as Note 34 to our consolidated financial statements.

PRINCIPAL INDUSTRIAL FACILITIES

 

Division(1)

 

Products


 


Services:

 

 

Camarillo (California, USA)

 

DVD

Guadalajara (Mexico)

 

DVD

Livonia (Michigan, USA)

 

DVD and VHS

Memphis (USA)

 

DVD and VHS

Mexicali (Mexico)

 

DVD and VHS

Mirabel (Canada)

 

Film

Montreal (Canada)

 

Film

New York (USA)

 

Film

North Hollywood (California, USA)

 

Film

Cwmbran (UK)

 

DVD

Madrid (Spain)

 

Film

Piaseczno (Poland)

 

DVD

Rome (Italy)

 

Film

West Drayton (UK)

 

Film

Bangkok (Thailand)

 

Film

Melbourne (Australia)

 

DVD

Sydney (Australia)

 

DVD and VHS

Systems & Equipment:

 

 

Breda (the Netherlands)

 

Broadcast

Dongguan (China)(2)

 

Connectivity

Nevada City (California, USA)

 

Broadcast

Weiterstadt (Germany)

 

Broadcast

Manaus (Brazil)

 

Decoders

Technology:

 

 

Batam (Indonesia)

 

Tuners and Remotes

Displays & CE Partnerships:

 

 

Angers (France)

 

Manufacturing

Genlis (France)

 

Manufacturing

______________

(1)

Facilities which serve more than one division are listed according to their principal divisional affiliation.

(2)

This facility remains active but is included in our consolidated financial statements as assets held for sale as part of the Audio/Video and Accessories activities.

 

 

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Environmental Matters

As a global leader in providing a diverse range of video technologies, systems, equipment, and services to consumers and professionals in the M&E industries, Thomson seeks to establish and apply consistent environmental standards in its facilities worldwide. Such standards should not only assist each of our locations in meeting all requirements of the country in which it is located, but may also enable each to develop programs that go beyond local regulatory requirements. To support and encourage environmental leadership, Thomson has established a number of programs and initiatives to assist the Group in achieving these standards. These programs are led and implemented by the Group’s environmental department, Corporate EH&S Organization, which is based at the Group’s headquarters in Boulogne, France. The four most significant of these are described below:

 

1)

Corporate Environmental, Health and Safety (EH&S) Charter: The EH&S Charter, updated in 2005, along with its appropriate supporting policies and guidelines, is the cornerstone of our EH&S program. It defines key management principles designed to protect human health and the environment, to help us meet our legal and corporate responsibilities, and to provide a measure of guidance for each of our locations’ activities and operations. The EH&S Charter has been translated into four languages and is displayed at each industrial site and is available on-line at all locations via an internal EH&S website.

 

2)

EH&S audits: Our EH&S audits are a key part of Thomson’s efforts to improve EH&S management and performance, and to prevent accidents from occurring. In addition to the establishment of internal audits within each manufacturing, packaging, and film lab site, a comprehensive corporate audit program was implemented in 1996. Auditors are both internal and external personnel who have been trained and are experienced in auditing. The aim of the audit program is to review our industrial locations’ compliance with Corporate EH&S Policies and Guidelines and specific applicable EH&S laws and regulations. The audit program has also been demonstrated to be a valuable tool for increasing awareness of personnel throughout the organization, identifying “best practices”, communicating successful initiatives among plants, creating opportunities for different approaches to problem solving, and exposing our EH&S personnel to broader aspects of our multi-faceted business. In 2005, 11 locations were audited as part of our objective of auditing each industrial location at least every three years.

 

3)

Implementation of an Environmental Management System (EMS): An EMS is a continual cycle of planning, implementing, evaluating and improving practices, processes and procedures to meet environmental obligations and to successfully integrate environmental concerns into normal business practices. ISO 14001 is the most widely accepted international standard for an EMS. To receive certification, organizations are required to develop detailed plans and procedures to identify, evaluate, quantify, prioritize and monitor environmental impacts of its activities. In 2001, Thomson’s Executive Committee identified the facilities that would benefit the most by implementing an EMS and required completion of ISO 14001 certification by December 31, 2004. Currently, all of our locations have completed the ISO 14001 certification process, and 3 additional sites have been identified to work toward certification in 2006.

 

4)

Annual Performance Measurement Process: A process was implemented in 1997 to allow for the consistent measurement and reporting of key management programs and requirements within each of our industrial locations, and their progress toward environmental, safety and resource conservation improvement goals. This process establishes benchmark criteria, helping us create consistent global focus and action on key programs, requirements and initiatives. Measured criteria include the establishment of internal EH&S audits and inspections, development of emergency preparation and response plans and associated training and drills, development of EH&S Committees, identification and completion of EH&S related employee training, and each location’s progress toward zero work-related injuries and lost workdays, reducing environmental impacts to air, water and land, and reducing the consumption of water, energy, or raw materials.

Furthermore, Thomson’s Corporate EH&S Organization monitors and responds to new governmental law and regulation on a Group-wide basis. For example, in Europe, projects are on schedule for compliance with the EU Restriction of

 

 

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Hazardous Substances in Electrical and Electronic Equipment (RoHS) Directive and the EU Waste Electrical and Electronic Equipment (WEEE) Directive. Also, in the Americas, several countries, provinces, and states have introduced legislation concerning restriction of hazardous substances, landfill bans, or end-of-life recycling, and certain laws have been enacted in this area that became effective in 2005, including parts of Mexico, some U.S. states and some Canadian provinces, which the Group believes will not have a material effect on our business or financial position.

A certain number of Thomson’s current and previously owned manufacturing sites have an extended history of industrial use. Soil and groundwater contamination, which occurred at some sites, may occur or be discovered at other sites in the future. Industrial emissions at sites that Thomson has built or acquired expose the Group to remediation costs. The Group has identified certain sites at which chemical contamination has required or will require remedial measures.

Soil and groundwater contamination was detected near a former production facility acquired from General Electric and owned by Thomson from 1987 to 1992 in Taoyuan, Taiwan. Production activities at this site ceased after being sold by the Group. Thomson is currently working with the local Taoyuan Environmental Protection Bureau to perform an investigation and feasibility study relating to potential groundwater contamination issues. In accordance with an agreement for the acquisition of General Electric Company’s consumer electronics business in 1987, General Electric Company has assumed or indemnified Thomson with respect to certain liabilities arising from this site, and should assume or indemnify the Group with respect to certain liabilities that could arise from the period prior to Thomson’s acquisition of the property.

The Group believes that the amounts reserved and the contractual guaranties provided by its contracts for the acquisition of certain production assets will enable it to cover its safety, health, and environmental obligations to a reasonable degree. Potential problems cannot be predicted with certainty, however, and it cannot be assumed that these reserve amounts will be adequate to cover the related costs and liabilities in full. In addition, future developments such as changes in governments or in safety and health laws or the discovery of new risks could result in increased costs and liabilities that could have a material effect on the Group’s financial condition or results of operations. Based on current information and the provisions established for the uncertainties described above, the Group does not believe it is exposed to any material adverse effects on its business, financial condition or result of operations arising from its environmental, health, and safety obligations and related risks.

Insurance

Thomson has insurance policies to cover its principal risks, which are purchased from various insurance companies.

Moreover, Thomson has in place a program of prevention and protection of its production sites in order to reduce its risk exposure to its assets and financial losses that may be caused if such risks are realized. The insurance policies subscribed locally by the units of the Group are supplemented by a worldwide program that enhances local insurance cover with corporate umbrella coverage covering certain differences in conditions and in limits of the local coverage.

The level of deductibles is adapted according to the assets and the risks of the operational units. Property damage and consequential business interruption are covered to a limit of €200 million per occurrence. The general commercial and product liability insurance policy covers liability up to a limit of €115 million. The policy is “all risks except” standard exclusions. Due to the transfer of part of our Displays activities in 2005, the values to be covered for exposed risks have been adjusted accordingly. For further information on the discontinuation of our Displays activities, please refer to “—Discontinued Operations”.

The insurance plan also covers transportation, material damage and employer’s liability insurance where required. Thomson also subscribes to directors and officer’s liability insurance and environmental pollution insurance policy. Additional policies are maintained where necessary to comply with applicable laws or to provide additional coverage for particular circumstances and activities. Accordingly, we maintain independent automobile

 

 

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and personal liability policies in the jurisdictions in which they are required.

We intend to continue our practice of obtaining global insurance coverage, increasing coverage where necessary and reducing costs through self-insurance where appropriate. We do not anticipate any difficulty in obtaining adequate levels of insurance in the future. Currently, the Group does not have in place any captive insurance company.

ITEM 4.A - UNRESOLVED STAFF COMMENTS

None.

 

 

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ITEM 5 - OPERATING AND FINANCIAL REVIEW AND PROSPECTS

You should read these comments on our operating and financial results in conjunction with our audited consolidated financial statements and the related notes and other financial information included elsewhere herein. Our audited consolidated financial statements have been prepared in accordance with IFRS, which differ in certain material respects from U.S. GAAP. Note 40 to our consolidated financial statements describe the principal differences between IFRS and U.S. GAAP as they relate to us and reconcile our net income and shareholders’ equity. We also summarize these differences below in “—Overview—Principal Differences between IFRS and U.S. GAAP.” Pursuant to the SEC’s release (No. 33-8567) on first-time adoption of IFRS, the following analysis and discussion of operating and financial review and prospects is provided for each of years ended December 31, 2005 and 2004.

Overview

Thomson’s core business is to provide the M&E industries with the services, systems and equipment, and technologies they need to achieve their commercial objectives and to optimize their performance in a changing technology environment for video and imaging. We have developed leading positions at the intersection of entertainment, media and technology and offer complete solutions to content providers, network operators, manufacturers and distributors. With the implementation of our five strategic priorities and our Two-Year Plan, we seek to build upon these positions to become the preferred partner of the M&E industries. For a more detailed description of our strategy and objectives of our Two-Year Plan, please refer to Item 4: “Information on the Company—Our Strategy—Preferred Partner of the Media & Entertainment Industries.”

Effective January 1, 2005, we reorganized our businesses in three divisions representing our core business, Services, Systems & Equipment, and Technology, with a fourth activity covering our non-core activities, Displays & CE Partnerships. For a more detailed description of the reorganization of our businesses, see Item 4: “Information on the Company—Our Organization” and for a description of the products and services provided by each of our segments, see Item 4: “Information on the Company—Business Overview,” respectively.

Key Economic Drivers

Our strategic priorities and our Two-Year Plan objectives described under Item 4: “Information on the Company—Our Organization” are based on our vision of how the M&E industries may develop by 2010. We believe the most significant long-term trends include the following:

 

Some consolidation will occur in the M&E industries, while significant M&E groups and markets will emerge in Asia, particularly China;

 

Our M&E clients will have outsourced many of their activities;

 

China and India will have become mainstream M&E markets;

 

The transition to High Definition (HD) will be complete;

 

Mobile video will be pervasive;

 

Intellectual property will remain a key differentiator and significant source of direct and indirect revenues;

 

Security technologies and services to combat content piracy will have been implemented;

 

China will have become a technology standards-setter;

 

Electronic delivery of content into the home will have emerged. Consumers will continue to buy pre-recorded content at retail, but will also be purchasing or renting content (events, etc.) directly from home;

 

 

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In addition to film print, digital delivery of movies to cinemas will have developed;

 

Network operators will have largely switched to IP technologies;

 

All networks will have “triple play” offerings;

 

“Connected products” will be ubiquitous inside and outside the home; and

 

Home networking will have been implemented.

These long-term trends represent the Group’s vision of how the M&E industries may develop by 2010 and they influence how the Group is allocating and plans to allocate its resources. They also influenced the identification of the growth “boosters” in the framework of its Two-Year Plan, as described in Item 4: “Information on the Company—Our Strategy—Preferred Partner of the Media & Entertainment Industries”. The Two-Year Plan focuses the Group on the development and delivery of innovative products, services and technologies that are, and become, widely adopted in response to these anticipated long-term trends in the M&E industries.

Summary of Results

In 2005, consolidated net sales from continuing operations amounted to €5,691 million, compared with €6,036 million in 2004, a decrease of €345 million, or 5.7%, resulting primarily from the negative effect on the revenues from our Displays and CE Partnerships activities of the deconsolidation starting from August 1, 2004 of our TV business contributed to TTE, which accounted for net sales of €845 million for the period then ended in 2004. This decrease was offset in part by the contribution to consolidated net sales from continuing operations of the balance of our business, which grew by €460 million, or 9.3%, as discussed in more detail under “—Analysis of Net Sales” below.

Thomson’s profit from continuing operations before tax and financial result was €382 million in 2005, representing 6.7% of revenues from continuing activities, compared with €466 million for 2004.

This result reflects depreciation and amortization related to continuing activities (including amortization of contract advances and customer relationships) of €442 million (2004: €399 million).

Research and development expenses, net of external funding, amounted to €234 million in 2005, or 4.1% of net sales in 2005, compared with 3.4% in 2004. Out of the total spending on research and development in 2005, €88 million was within the Technology division, which includes the Group’s corporate research operations.

Restructuring charges in continuing operations amounted to €51 million in 2005, compared with €70 million in 2004.

Finance costs amounted to €54 million in 2005 (2004: €29 million), including a net non-cash gain of 83 million on the mark-to-market of the embedded option in the Silver Lake convertible bond. The share of loss from associates was €82 million (2004: €20 million), including a non-cash impairment charge of €63 million relating to the Group’s holding in TCL Multimedia, as discussed further under “—Critical Accounting Policies—Impairment test of our equity investment in TCL Multimedia. The income tax charge was €70 million (2004: €93 million). The Group’s profit from continuing activities was therefore €176 million (2004: €324 million).

Certain activities were treated as discontinued operations pursuant to IFRS 5 in 2005 and 2004, principally the Displays activities disposed of during 2005 in two separate transactions with the Videocon group of companies and in the glass operations transaction with Rioglass, our optical modules activity, and the Audio/Video and Accessories businesses, which are held for sale following the announcement on December 12, 2005 of the decision to seek purchasers for these businesses. The loss from discontinued operations totaled €749 million in 2005, compared to a loss of €885 million in 2004. Of this €749 million, €676 million is losses related to our disposed activities from Displays & CE Partnerships.

As a result, the Group recorded a net loss of €573 million, compared to a net loss of €561 million in 2004. Thomson’s net loss per share on a non-diluted basis was €2.17 in 2005,

 

 

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compared to net loss per share of €2.05 in 2004. The net losses for 2004 and 2005 are not fully comparable due to the first time application in 2005 of IAS 32 and IAS 39.

For more information on our 2005 results, see “—Results of operations for 2005 and 2004” below.

On April 20, 2006, Thomson announced its revenue for the first quarter of 2006. For more information about our first quarter 2006 results and the full text of that announcement, refer to our report on Form 6-K filed with the U.S. Securities and Exchange Commission on April 20, 2006, certain parts of which are incorporated herein by reference and included as Exhibit 99.1 to this report.

Seasonality

Our net sales across our divisions have historically tended to be higher in the second half of the year than in the first half, reflecting the business activity of our end customers, notably during the autumn selling season and year-end holidays.

The net sales of our Services businesses in the second half of 2005 totaled approximately €1.4 billion, representing 57% of the division’s 2005 net sales, compared to approximately €1.3 billion in the second half of 2004, representing 55% of the division’s 2004 net sales. The net sales of our Systems & Equipment businesses in the second half of 2005 totaled approximately €1.3 billion, representing 54% of the division’s 2005 net sales, compared to 60% in 2004. The net sales of our Technology businesses in the second half of 2005 totaled approximately €287 million, representing 53% of the division’s 2005 net sales, compared to 57% in 2004.

The impact of seasonality has historically tended to be higher in terms of profitability than sales (based on profit from continuing operations before tax and financial result referred to herein as “profit from continuing operations”), driven by the fact that costs are spread more evenly than sales over the year. Our consolidated profit from continuing operations totaled €237 million in the second half of 2005, or 62% of our 2005 consolidated profit from continuing operations, compared with 75% in the last six months of 2004. Presented separately, the profit from continuing operations of the Services division in the second half of 2005 represented 68% of total year profit from continuing operations for this division, compared to 75% in 2004 over the same period. The profit from continuing operations costs of the Systems & Equipment division in the second half of 2005 represented 64% of total year profit from continuing operations for this division, compared to 81% in 2004 over the same period.

Effect of exchange rate fluctuations

We estimate that the impact of translating revenues of operating entities that are denominated in currencies other than euro into euro had a positive impact of €40 million on our net sales as expressed in euro in 2005. We estimate that the impact of translating the operating results of operating entities that are denominated in currencies other than euro into euro had a positive impact of €1.3 million in 2005 on our profit from continuing operations before taxes and financial result as expressed in euro in 2005.

In the section entitled “—Results of Operations for 2005 and 2004”, certain net sales figures at the Group and segment levels are presented where indicated on a comparable basis at constant exchange rates. To this end, the actual figures of the earlier financial year in the respective year-on-year comparison are restated to eliminate exchange rate effects by applying for the more recent year the average exchange rate used for the income statement for the earlier financial year. We believe this presentation of changes in net sales, adjusted to reflect exchange rate fluctuations, for this year-on-year comparison are helpful for analyzing the performance of the Group. The table sets forth the exchange rate effect on our net sales from continuing operations on a consolidated and segment-by-segment basis.

 

 

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2004
net sales at
2004
exchange rates

 

2005
net sales at
2004
exchange rates

 

Exchange
rate

impact

 

2005 net
sales at 2005
exchange rates

 

Change in %
at constant
2004
exchange rates

 

Change in %
without adjusting
for constant
exchange rates

 

 

 


 


 


 


 


 


 

 

 

Sales in € millions (except % data)

 

Continuing operations

 

6,036

 

5,651

 

40

 

5,691

 

(6.4

)

(5.7

)

Of which:

 

 

 

 

 

 

 

 

 

 

 

 

 

Services

 

2,338

 

2,466

 

21

 

2,487

 

5.5

 

6.4

 

Systems & Equipment

 

2,109

 

2,337

 

17

 

2,355

 

10.8

 

11.7

 

Technology

 

498

 

545

 

1.4

 

546

 

9.4

 

9.6

 

Corporate

 

23

 

40

 

0.3

 

40

 

76.6

 

77.8

 

Displays & CE Partnerships

 

1,068

 

263

 

0.5

 

263

 

(75.4

)

(75.4

)

Geographic breakdown of net sales

The table below sets forth our 2005 and 2004 net sales of continuing operations broken down by destination and classified by the location of the entity that invoices the customer. As illustrated below, our most important markets are the United States and Europe, each accounting for 44% of our 2005 net sales.

 

Net sales of continuing operations by destination

 

2005

 

2004

 


 


 


 

United States

 

44

%

48

%

Europe

 

44

%

42

%

Asia

 

5

%

4

%

Others

 

7

%

6

%

Events Subsequent to December 31, 2005

Acquisitions

On December 5, 2005, Thomson signed an agreement to acquire 33.3% of the issued and outstanding shares of Canopus Co., Ltd, a Japan-based leader in high definition desktop video editing software. The transaction was subject to governmental authorizations and satisfactory due diligence. The purchase price (Yen 3.8 billion equivalent to €27.5 million) was paid on January 26, 2006 partially in cash and by a delivery of 821,917 Thomson treasury shares. In parallel, Thomson launched a public tender offer for the remaining Canopus shares. The closing occurred on January 26, 2006, with Thomson acquiring control of 94.31% of Canopus for an additional consideration of Yen 8.3 billion (equivalent to an additional €60 million using the exchange rate of December 31, 2005). Canopus was fully consolidated starting from January 26, 2006.

On January 13, 2006, we re-enforced our network installation, playout and maintenance capabilities, through the acquisition of Convergent Media Systems for approximately $37 million (equivalent to €31 million using the exchange rate of December 31, 2005), subject to an increase by up to $7 million dependent upon the performance of the acquired company in

 

 

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2006 and 2007. Thomson consolidated this activity starting from January 13, 2006.

Two-Year Plan Update and 2008 Vision for Thomson

As announced on April 20, 2006, the divestment of the Audio/Video and Accessories activities is on-track for announcement in the first half of 2006. Accordingly, Thomson considers that by the end of the second quarter of 2006, the Group’s Two-Year Plan to create a platform for future growth will have been implemented.

Thomson and its Board of Directors have started to examine the next phase of the Group’s development, with a view to creating clear leadership in digital video technologies for Thomson in 2008. This objective needs to be backed up by adequate financial resources and talent.

The Board of Directors intends that its objectives be met while having appropriate regard for the interests of the Group’s clients and employees, and its debt and equity holders.

In the above context and as announced on May 2, 2006, Thomson is looking at opportunities which could accelerate its expansion in digital and electronic media as part of building a 2008 strategy. The Board of Directors has started to assess a wide range of options available to it, in order to determine the optimal method of financing of the Group’s next development phase, consistent with the interests of its stakeholders.

The financing options being assessed include a combination of debt and equity consistent with the Group’s financial profile, including a financing in the public equity markets, and a strategic transaction financed in the private markets, which Silver Lake is involved in examining. The Board of Directors has set up a Special Committee of independent directors, chaired by Paul Murray and with independent financial and legal assistance, to advise the Board of Directors on any proposal made in this context.

There can be no guarantee that the assessment of any of the above-mentioned opportunities will lead to a transaction. The assessment of the financing options is still preliminary and therefore any outcome is highly uncertain. Thomson will only make further comments when, and if, there are material developments in these areas.

Critical Accounting Policies

Thomson’s principal accounting policies are described in Note 2 to our consolidated financial statements. Certain of Thomson’s accounting policies require the application of judgment by management in selecting appropriate assumptions for calculating financial estimates which inherently contain some degree of uncertainty. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the reported carrying values of assets and liabilities and the reported amounts of revenues and expenses. Actual results may differ from these estimates under different assumptions or conditions. Thomson’s management believes the following are the critical accounting policies and related judgments and estimates used in the preparation of its consolidated financial statements under IFRS.

Tangible and intangible assets with finite useful lives

The Group records intangible assets with finite useful lives (mainly customer relationships, software, development projects and certain rights on intellectual property acquired) relating to operations and to production facilities under “Intangible assets, net” and tangible fixed assets under “Property, plant and equipments” (“PPE”). Significant estimates and assumptions are required to decide (i) the expected useful lives of these assets for purposes of their depreciation and (ii) whether there is any impairment of their value requiring a write-down of their carrying amount. Estimates that are used to determine the expected

 

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useful lives of fixed assets are defined in the Group’s accounting policies manual and are consistently applied throughout the Group. Such periods range from twenty to forty years for buildings, from one to twelve years for plants and equipment and from four to ten years for other tangible assets, excluding land that has an indefinite useful life. Development projects are capitalized and amortized over their economic useful lives, which usually do not exceed five years.

For the year ended December 31, 2005, the Group recognized depreciation expense amounting to €208 million related to tangible fixed assets and amortization expense of €125 million for intangible assets with finite useful lives (these figures include depreciation expense booked in the loss from discontinued operations). As of December 31, 2005, the net carrying amount of PPE and intangible assets with finite useful lives amounted to €886 million and €1,150 million, respectively.

Tangible and intangible assets having a finite useful life are tested for impairment at the balance sheet date only if events or circumstances indicate that they might be impaired. The main evidence indicating that an asset may be impaired includes the existence of significant changes in the operational environment of the assets, a significant decline in the expected economic performance of the assets, or a significant decline in the revenues or in the market share of the Group. The impairment test consists of comparing the carrying amount of the asset with its recoverable amount. The recoverable amount of the asset is the higher of its fair value less costs to sell and its value in use.

In order to ensure that its assets are carried at no more than their recoverable amount, Thomson evaluates on a regular basis certain indicators that would result, if applicable, in the calculation of an impairment test.

The recoverable amount of an asset or group of assets may require the Group to use estimates and mainly to assess the future cash flows expected to arise from the asset or group of assets and a suitable discount rate in order to calculate present value.

Any negative change in relation to the operating performance or the expected future cash flow of individual assets or group of assets will change the expected recoverable amount of these assets or groups of assets and therefore may require a write-down of their carrying amount.

Impairment tests of goodwill and intangible assets with indefinite useful lives

Goodwill and intangible assets having an indefinite useful life are tested annually for impairment in September and whenever circumstances indicate that they might be impaired. The impairment test consists of comparing the carrying amount of the asset with its recoverable amount. The recoverable amount of the asset is the higher of its fair value less costs to sell and its value in use.

When reviewing goodwill and other indefinite-lived intangible assets for impairment, management. is required to make material judgments and estimates when performing impairment tests.

Thomson’s management believes its policies relating to such impairment testing are critical accounting policies involving critical accounting estimates because determining the recoverable amount of reporting units requires (1) determining the appropriate discount rate to be used to discount future expected cash flow of the cash generating unit, (2) estimating the value of the operating cash flow including their terminal value, (3) estimating the growth rate of the revenues generated by the assets tested for impairment and (4) estimating the operating margin rates of underlying assets for related future periods.

These assumptions used by the Group for the determination of the recoverable amount of its assets are described in Note 13 to our consolidated financial statements and are based on actual historical experience and external data. In estimating the future revenues growth rates, operating margin rates and operational cash flow generated by a particular asset, the Group used its internal budget for each reporting unit, which is updated every

 

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six months and which models cash flows for the next five-year period.

As of December 31, 2005, the net book value of goodwill and indefinite-lived intangible assets (trademarks) amounted to €1,756 million and €257 million, respectively.

Thomson performed an annual impairment test in 2005, which did not result in any impairment charge of these assets.

Based on differences observed between the carrying amount and recoverable amount of goodwill and indefinite-lived intangible assets, the increase by one point in the discount rate or the decrease by one point of the perpetual growth rate would not have resulted in an impairment loss.

Deferred tax

Deferred tax assets are recorded:

 

for all deductible temporary differences, to the extent that it is probable that future taxable income will be available against which these temporary differences can be utilized; and

 

for the carry forward of unused tax losses and unused tax credits, to the extent that it is probable that future taxable income will be available against which the unused tax losses and credits can be utilized.

The recoverable amount of the deferred tax assets is reviewed at each balance sheet date and reduced when it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of the deferred tax assets to be utilized.

Management judgment is therefore required to determine the Group’s deferred tax assets and liabilities and the extent to which deferred tax assets can be recognized. When a specific subsidiary has a history of recent losses, future positive taxable income is assumed improbable, unless the asset recognition can be supported for reasons such as (1) the losses having resulted from exceptional circumstances which will not re-occur in a nearby future, and/or (2) the expectation of exceptional gains and (3) future income to be derived from long-term contracts. We have considered tax-planning in assessing whether deferred tax assets should be recognized.

As of December 31, 2005, the Group has recorded a €162 million deferred tax liability and €379 million of deferred tax assets reflecting management’s estimates.

Post-employment benefits

The Group’s determination of its pension and post-retirement benefits obligations and expense for post-employment benefit plans is dependent on the use of certain assumptions used by actuaries in calculating such amounts. These assumptions are described in Note 26 to our consolidated financial statements and include, among others, the discount rate, expected long-term rate of return on plan assets and annual rate of increase in future compensation levels. Our assumptions regarding pension and post-retirement benefits obligations include, among others, discount rates and rates of future increase in compensation and are based on actual historical experience and external data.

The assumptions regarding the expected long-term rate of return on plan assets are determined by taking into account, for each country where the Group has a plan, the distribution of investments and the long-term rate of return expected for each of its components. The capital markets experience fluctuations that cause downward/upward pressure and higher volatility. As a result, short-term valuation of related plan assets are decreasing/increasing, causing a corresponding increase/decrease of the present value of the pension and post-retirement obligation. While Thomson’s management believes that the assumptions used are appropriate, significant differences in actual experiences or significant changes in the assumptions used may materially affect our pension and post-retirement benefits obligations under such plans and the related future expense.

As of December 31, 2005, the post-employment benefits liability amounted to €939 million, while the present value of the obligation amounted to €1,112 million and the fair value of plan assets amounted to €183 million. For the year ended December 31, 2005, the Group recognized €52 million of expenses related to such liability.

 

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The effect of a one point increase in the assumed health care cost trend rate would increase the accumulated medical post-retirement benefits as of December 31, 2005 by €40.5 million at December 31, 2005 closing rate, and the service and financial components of the 2005 post-retirement benefit expenses by €3 million at December 31, 2005 closing rate.

The effect of a one point decrease in the assumed health care cost trend rate would decrease the accumulated medical post-retirement benefits as of December 31, 2005 by €34.5 million at December 31, 2005 closing rate, and the service and financial components of the 2005 post-retirement benefit expense by €2 million at December 31, 2005 closing rate.

Capital gain on exchange of non-monetary assets

On July 31, 2004, Thomson entered into a transaction with TCL, by which Thomson has contributed its TV manufacturing business to a new incorporated entity, TCL-Thomson Electronics (TTE), in exchange of a non-controlling interest in this entity. TCL had the control of TTE from that date.

Thomson has assessed the capital gain resulting from this transaction as the difference between the fair value and the carrying amount of the exchanged assets less the portion of that gain represented by the economic interest retained by the Group.

In order to determine the fair value of this disposed business, the Group’s management used certain valuation techniques and set up a measurement process that has involved an external appraiser using several methodologies, of which one is based on external available information. The assumptions retained have impacted the fair value of the business and the amount of capital gain recognized.

Impairment test of our equity investment in TCL Multimedia

The Group reviews for impairment an investment in associate when a triggering event occurs during a period. The criteria used to determine whether there is a triggering event is based on the fair value of the investment, when available, compared to its carrying amount. Then in the case management estimates a triggering event occurred, management needs to assess the recoverable amount of the related investment. As defined under IFRS, the recoverable amount is the higher of (i) the fair value and (ii) the value in use.

As a consequence, Thomson’s management is required to (i) estimate whether a triggering event occurred during the period under review and (ii) assess the recoverable amount of the investment, when required. Management has therefore to make significant judgment when assessing the recoverable amount of its investment accounted for using the equity method in TCL Multimedia.

As of December 31, 2005, Thomson’s management determined that a triggering event occurred because the market value of its investment in TCL Multimedia was below its carrying amount. Thomson’s management has therefore assessed the recoverable amount of this investment.

In order to determine the value in use of its investment in TCL Multimedia, Thomson calculated, based on information provided by the management of TCL Multimedia, the present value of future cash flows expected to be derived from the business of TCL Multimedia through its current business. In order to assess the present value of related cash flows, Thomson used a 9.2% discount rate and a perpetual growth rate of 2.3%.

As a result of the impairment test, Thomson recognized a €63 million impairment for the period ended December 31, 2005 on the carrying amount of its investment in TCL Multimedia (net book value as of December 31, 2005 of €193 million).

Provisions and litigations

Thomson’s management makes judgments about provisions and contingencies, including the probability of pending and potential future litigation outcomes that in nature are dependent on future events that are inherently uncertain. In making its determinations of likely outcomes of litigation and tax matters,

 

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etc., management considers the evaluation of outside counsel knowledgeable about each matter, as well as known outcomes in case law. Refer to Note 35 for a description of the significant litigation.

Measurement of conversion option embedded in certain convertible debt

On September 16, 2004, Thomson issued subordinated bonds that are (1) redeemable in U.S. dollars or (2) convertible into newly issued ordinary shares or existing ordinary shares (or a combination of both), which, at the option of the bondholders, may be delivered in the form of American Depositary Shares evidencing such ordinary shares (the “Bonds”). As required by IAS 32 and 39, the embedded conversion option has been bifurcated and accounted for separately within non-current liabilities.

The conversion option and the debt component are recognized at fair value at inception. Subsequent changes in the fair value of the embedded derivative have been recognized in the statement of operations under IFRS.

As such, Thomson’s management is required to make significant estimates in order to measure the fair value of the conversion option that has been bifurcated from the bonds.

The measurement process comprises the determination, using an instrument measurement model, such as the Black & Scholes or Binomial models. The main inputs relate to a discounted volatility of Thomson shares on the stock market, the closing prices of Thomson shares and the exchange rate as of the measurement date.

The fair value of the embedded conversion option bifurcated from the debt component of the convertible debt instrument amounted to €45 million at inception. Subsequent changes in fair value required Thomson to recognize a net non-cash financial gain amounting to €83 million in 2005 (comprising a gain of €94 million and a loss of €11 million related to the negative impact of exchange rates) and a loss amounting to €84 million in 2004. However, since IAS 32 and 39 apply only from January 1, 2005, the loss incurred from inception to December 31, 2004 has been charged against equity.

Accounting options pursuant to IFRS used by the Group

As permitted by IFRS 1 “First time adoption of international financial reporting standards,” the Group has opted to apply the options and exemptions stated below. For a more detailed analysis of such options, see Note 38 to our consolidated financial statements.

Business combinations

The Group has opted not to restate past business combinations in accordance with IFRS 3 that occurred before January 1, 2004.

Cumulative translation differences

The Group elected to recognize cumulative translation differences of the foreign subsidiaries into opening retained earnings as of January 1, 2004, after having accounted for the IFRS adjustments on the opening shareholders’ equity (total impact of this reclassification amounts to €612 million from “cumulative translation adjustments” to “retained earnings”). All cumulative translation differences for all foreign operations have therefore been deemed to be zero at the IFRS transition date. The gain or loss on a subsequent disposal of any foreign operation excludes translation differences that arose before the date of transition to IFRS but includes later translation differences.

Cumulative actuarial gains and losses on pensions and other post-employment benefit plans

Cumulative unrecognized actuarial losses on pensions and other post-employment benefit plans at January 1, 2004 have been recognized against equity in the opening balance sheet for €248 million instead of being amortized over the remaining years of services of employees according to the “corridor” method. The application of this option has no impact on the method elected by the Group for the future accounting of the actuarial gains and losses on employee benefits.

 

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Measurement of certain items of tangible and intangible assets at fair value

Under certain circumstances, the Group elected to apply the IFRS 1 option, which enables the Group to measure several tangible assets at their fair value at the IFRS transition date. This method has been used only to value the television assets which were transferred to TTE in July 2004. This fair value corresponds to the deemed cost under IFRS at the IFRS transition date. It had a negative impact of €17 million on the opening net equity, which corresponds to the difference between the €128 million of assets carrying value and €111 million fair value.

Stock options and other share-based payments

According to IFRS 1, the Group elected to apply IFRS 2 “Share based Payments” to all equity instruments granted after November 7, 2002 and for which the rights had not vested as of December 31, 2004.

The following options and exemptions provided by IFRS 1 have not been applied by the Group or are not relevant for Thomson’s activities:

 

1)

Compound financial instruments option, designation of previously recognised financial instruments option and fair value measurement of financial assets or financial liabilities option. Thomson has not used these exemptions provided by IFRS 1 as the Group applies IAS 32 and 39 from January 1, 2005.

 

2)

Assets and liabilities of subsidiaries option and changes in existing decommissioning, restoration and similar liabilities included in the cost of property, plant and equipment option. Thomson has not applied these options because they were not relevant to Thomson’s activities.

Transition to IFRS and Changes in Accounting Principles

In accordance with the Regulation 1606/2002 of the European Parliament dated July 19, 2002 regarding the application of international accounting standards, the Group has prepared its consolidated financial statements in compliance with IFRS effective as of December 31, 2005 and approved by the European Union as of February 21, 2006.

The Group’s consolidated financial statements are covered by IFRS 1 “First Time Adoption of IFRS” because they are part of the period covered by Thomson’s first IFRS financial statements. Our consolidated financial statements have been prepared in accordance with those IFRS standards and IFRIC interpretations effective as of December 31, 2005 and approved by the European Union as of February 21, 2006. In addition to the standards that must be applied as of December 2005, the Group has opted for early adoption of the following standard and IFRIC interpretation:

 

IFRIC 6 “Liabilities arising from Participating in a Specific Market — Waste Electrical and Electronic Equipment”. IFRIC 6 clarifies the accounting for liabilities for waste management costs.

 

The December 2004 amendment to IAS 19 “Employee Benefits”. This standard introduces a further option regarding the recognition of actuarial gains and losses for defined benefit pension plans. It now allows actuarial gains and losses to be recognised, in full, in a statement of recognised income and expense outside the income statement, which implies that actuarial gains and losses can be recognised directly in equity. It also requires additional disclosures.

For a description of the accounting principles applied by the Group and the impact of the adoption of IFRS on our consolidated financial statements, see Notes 2 and 38, respectively, to our consolidated financial statements.

 

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The table below sets forth the main impacts on shareholders’ equity and 2004 results of the Group as a result of the adoption of IFRS.

 

 

 

As of
January 1, 2004

 

Net
Income

 

Other

 

Currency
Translation
Adjustments

 

As of
December 31, 2004

 

As of
January 1, 2005

 

 

 


 


 


 


 


 


 

 

 

(in  millions)

 

Shareholders’ equity under French GAAP

 

3,583

 

(636

)

(171

)

(106

)

2,670

 

2,670

 

Customer relationship

 

(58

)

(23

)

 

6

 

(75

)

(75

)

Restructuring costs for business combinations

 

 

(29

)

 

2

 

(27

)

(27

)

Goodwill amortization

 

 

100

 

 

(5

)

95

 

95

 

Consolidation scope - Special Purpose entities

 

(43

)

 

43

 

 

 

 

Transaction costs - TTE Transaction

 

(9

)

4

 

 

 

(5

)

(5

)

Fair value of property, plant and equipment

 

(17

)

2

 

 

 

(15

)

(15

)

Capital gain on transferred assets

 

 

12

 

 

(1

)

11

 

11

 

Revenue recognition – Patent licensing

 

(27

)

24

 

 

 

(3

)

(3

)

Rebates received

 

 

(4

)

 

 

(4

)

(4

)

Capitalization of development costs, net

 

16

 

14

 

 

 

30

 

30

 

Employee benefits

 

(152

)

(25

)

(23

)

8

 

(192

)

(192

)

Share-based payment

 

 

(3

)

3

 

 

 

 

IAS 32 / 39 impacts

 

 

 

 

 

 

(86

)

Other IFRS adjustments

 

4

 

(7

)

 

(1

)

(4

)

(4

)

Total IFRS adjustments before tax

 

(286

)

65

 

23

 

9

 

(189

)

(275

)

 

 


 


 


 


 


 


 

Tax effect

 

(17

)

12

 

 

(1

)

(6

)

(6

)

Total IFRS adjustments

 

(303

)

77

 

23

 

8

 

(195

)

(281

)

 

 


 


 


 


 


 


 

Shareholders’ equity under IFRS

 

3,280

 

(559

)

(148

)

(98

)

2,475

 

2,389

 

 

 


 


 


 


 


 


 

Principal Differences Between IFRS and U.S. GAAP

The principal differences between IFRS and U.S. GAAP affecting our consolidated financial statements mainly relate to the following topics:

Main differences between IFRS and U.S. GAAP

Development projects

The IFRS accounting policy for development projects is disclosed in Note 2 to our consolidated financial statements. Under IFRS, development projects are recognized as intangible assets for their costs when certain criteria are met (IAS 38 “Intangible Assets”), and otherwise the related costs are expensed as incurred.

Under U.S. GAAP, capitalization of development costs is prohibited (SFAS 2 “Accounting for Research and Development Costs”), unless they pertain to specific elements of internally generated computer software (SFAS 86 “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed”).

As a result, all costs incurred related to development projects that do not relate to internally generated computer software and that have been capitalized under IFRS have been expensed as incurred under U.S. GAAP. As a consequence, amortization expenses related to those capitalized development projects booked under IFRS have been reversed under U.S GAAP.

 

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Accounting of our subordinated perpetual debt

Under IFRS, our perpetual subordinated debt issued in September 2005 has been accounted as a component of the shareholders’ equity because it meets the definition of shareholders’ equity, mainly due to the fact that it is not redeemable and interest is due only in the case Thomson pays dividends to its shareholders. Under U.S. GAAP, such financial instrument does not meet the definition of equity but the definition of a financial debt.

In addition, and mainly due to the different nature of the instrument under IFRS and U.S. GAAP, interest costs are not recognized in the income statement at the same time. Under IFRS, interest to be paid after the Shareholders’ Meeting has approved the distribution of dividends is accrued within the period in respect of which such dividends are delivered. Under U.S. GAAP, interest accrues during each period, regardless when the shareholders’ meeting approves any distribution of dividends.

Accounting for “conventional convertible debt”

Split accounting for convertible debt is required under IFRS, implying recognition of interest expense using the effective rate thereof. By contrast, interest expense is recognized based on the nominal interest rate under U.S. GAAP and no split accounting is required. Under IFRS, IAS 39 “Financial Instruments: Recognition and Measurement” requires split accounting when a financial instrument (a convertible debt) contains both a liability component and an equity component, like an option to convert part or all of the repayment obligation into Thomson shares.

Under U.S. GAAP, conventional convertible debt (i.e., all of Thomson’s convertible debt, except that issued to Silver Lake Partners LLC as further described in Note 24 to our consolidated financial statements) does not imply the recognition of an embedded derivative. As such, the debt is recognized on the balance sheet at its nominal value and, therefore, only interest calculated based on the nominal interest rate is recognized. This difference affects the financial income (loss) of the Group under U.S. GAAP compared to IFRS (with certain exception due to the potential effect of issue discounts granted and/or costs of issuance).

Pension and other post-employment benefits

Differences are mainly due to (1) the impact of the exception provided by IFRS 1 “First Time Adoption” as mentioned below under “—Differences due to specific exemptions under IFRS 1”, (2) the additional minimum pension liabilities recognized under U.S. GAAP that do not exist in IFRS and (3) the option of IAS 19 “Employee Benefits”, as revised, to recognize actuarial gains or losses immediately against equity whereas it is amortized using the corridor method under U.S. GAAP.

Under U.S. GAAP, all IFRS impacts on shareholders’ equity were reversed, and the actuarial gains and losses, at the IFRS transition date and those created on subsequent years, continue to be amortized over the employee’s remaining service period. In addition, under U.S. GAAP, the minimum pension liability is charged to other comprehensive income when the accumulated benefit obligation (“ABO”) exceeds the fair value of the plan assets.

Stock options and other share-based payments

The IFRS accounting treatment for stock-based compensation is disclosed in Note 2 to our consolidated financial statements under “Share-based payments”, which indicates that equity-settled share-based payments are measured at fair value at the grant date. They are accounted for as a compensation expense on a straight-line basis over the vesting period of the plans (usually 3 to 4 years), based on the Group’s estimate of the number of options that will be exercised.

In addition, when share-based payments are cash-settled, a liability equal to the portion of the goods or services received is recognized at fair value and re-measured at each balance sheet date.

Under U.S. GAAP, all stock options plans are accounted for by Thomson using the intrinsic value as prescribed by APB 25 “Accounting for Stock issued to Employees”. When stock plans are amended, which occurred in connection with the public tender offer made by Thomson in September 2004, U.S. GAAP requires accounting based on fair value of option granted, with subsequent re-measurement at each balance sheet date of the then determined fair value, with change in fair value being recorded against income.

 

 

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As a result, the income statement impact related to share-based payment may significantly differ between IFRS and U.S. GAAP.

Profit from operating sale-and-leaseback transactions

IFRS requires this profit to be recognized up-front when the sale is at market conditions, whereas U.S. GAAP requires it to be amortized over the lease term, except for portions of those gains that exceed the present value of the minimum lease payment.

Certain gains on past sale and operating leasebacks have been recognized at the date of the transaction under IFRS because the sale prices were determined to be at fair value.

Under U.S GAAP, related gains shall be deferred and amortized over the lease term, except for portions of those gains that exceed the present value of the minimum lease payment.

As a result and until the end of the related lease terms, capital gain from sale and lease back transactions of the Group under U.S. GAAP will be higher than under IFRS.

Commitments to purchase minority interests

Under IFRS, commitments to purchase minority interests are recognized as a financial debt for the fair value of the repurchase consideration under the put option, offset by minority interests, and, for the balance, as goodwill as described further in Note 2 to our consolidated financial statements.

Under U.S. GAAP, similar commitments are recognized only when the commitments are assessed as a forward contract, i.e., put and call options should be symmetric in terms of value and timing. In such case, the call holder accounts for the transaction as a financing of the minority interest and, consequently, consolidates the subsidiary using the percentage of interest that would be acquired after the call or the put instrument is exercised, and, therefore, no difference with IFRS exists except for the accounting of net income attributable to minority interests that remains to be shown on the face of the statement of operations under IFRS. In other cases under U.S. GAAP, no liability should be recognized related to any commitment given unless it is probable that a liability exists.

Certain timing differences between IFRS and U.S. GAAP related to the recognition of restructuring liabilities

The Group applies the provisions of IAS 37 “Provision, Contingent Liabilities and Contingent Assets” in order to assess restructuring liability at the closing date. This standard defines certain criteria to be met in order to provide for costs of a restructuring plan.

Under U.S. GAAP, the criteria for recognizing a restructuring liability are more stringent than under IFRS, since the U.S. GAAP standard provides additional criteria to recognize a liability in comparison with IAS 37. Thus, SFAS 146 “Accounting for Costs Associated with Exit or Disposal Activities” requires that the communication of the reorganization plan include sufficient detail to enable employees to determine the type and amount of benefits they will receive if they are terminated.

In addition, SFAS 146 requires the costs to terminate a contract to be provided for at the date the third party is notified of such decision or at the cease-use date in the case of a lease agreement. By contrast, under IFRS, the accrual is to be recorded at the announcement that the facility will be vacated.

Furthermore, the provisions of EITF 95-3 “Recognition of Liabilities in Connection with a Purchase Business Combination” allow costs of a restructuring plan of an acquired entity to be charged against goodwill, when certain conditions are met. Under IFRS, no such restructuring plan costs are charged against goodwill, but they are expensed in the period the plan is announced.

Recognition of the non-contingent part of certain guarantees given

Under U.S. GAAP, FIN 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Guarantees for the Indebtedness of Others” requires the recognition of the fair value of certain guarantees given as a liability at the date the guarantee is granted for their non-contingent part.

 

 

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Under IFRS, such commitment cannot be provided for because it does not meet the present obligation criteria required to accrue for a liability.

Deferred taxes

Under IFRS, the recognition of deferred taxes assets arising from the tax loss carry-forward of an acquiring company that will offset taxable income of an acquired entity in a certain period are charged against tax income in that period.

Under U.S. GAAP, such recognition is recorded in goodwill.

Differences due to specific exemptions provided by IFRS 1

Business combinations

Under IFRS, the Group has opted not to restate past business combinations that were recognized before January 1, 2004. Consequently, business combinations consummated before that date have a different treatment under IFRS and U.S. GAAP.

In addition, under U.S. GAAP, SFAS 142 “Goodwill and Other Intangible Assets” requires no amortization of goodwill to be recorded after January 1, 2002, whereas, in application of IFRS 3 “Business Combination” and the related exemption provided by IFRS 1, business combinations consummated prior to January 1, 2004, have not been restated and consequently, accumulated amortization of goodwill recognized under French GAAP as of that date, still exist under IFRS.

As a result, net book values of all goodwill on business combinations consummated before January 1, 2004 are different under both standards, which creates a difference in the cumulative translation adjustment, if any, and, in the case we sell a business, in the related capital gain (loss).

Cumulative translation adjustments

Under IFRS, the Group elected to recognize all cumulative translation adjustments of the foreign subsidiaries into opening retained earnings as of January 1, 2004. All cumulative translation adjustments for all foreign operations have, therefore, been deemed to be zero at that date. The gain or loss on a subsequent disposal of any foreign operation will exclude translation adjustments that arose before the IFRS transition date but will include later translation adjustments.

Under U.S. GAAP, cumulative translation adjustments continue to be accounted on a cumulative basis, and, as such, shall have a different balance at each balance sheet date under U.S. GAAP compared to IFRS.

As a consequence, gains or losses on disposal of any foreign operations completed since the transition date to IFRS will include under IFRS recycling of translation adjustments that have been recognized since the transition date. Under U.S. GAAP, they will include the recycling of all translation adjustments recognized since the acquisition or incorporation of the related foreign operations. As such, related capital gains (losses) may differ significantly under both standards.

Cumulative actuarial gains and losses on pension and other post-employment benefit plans

Under IFRS, following the exemptions of IFRS 1, the Group recognized all unrecognized actuarial gains and losses existing as of January 1, 2004 against shareholders’ equity.

Under U.S. GAAP, and unrecognized actuarial gains and losses existing as of the IFRS transition date and those realized in subsequent years continue to be amortized over the employee’s remaining service period.

Recognition of certain long-lived assets at fair value

On a discretionary basis and as permitted by IFRS 1, which enables to recognize certain long lived assets at their fair value at the IFRS transition date, the Group has re-measured and recognized certain long lived assets at their then fair value. This method has been retained to re-measure certain long lived assets of the television manufacturing business transferred to TTE in July 2004.

Under U.S. GAAP, reevaluation of long lived assets is not permitted. This implies a different capital loss recognized under IFRS and U.S. GAAP standards on the transfer of our television manufacturing business to TTE in July 2004.

 

 

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Stock options and other share-based payments

The IFRS accounting treatment for stock-based compensation as disclosed above requires equity-settled share-based payments to be measured at fair value at the grant date.

As permitted by IFRS 1, we have opted to exclude all stock options plans granted before November 7, 2002 and fully vested before January 1, 2005 from the application of IFRS 2, and as such, these options are accounted for by Thomson using a provision of French GAAP that allows no recognition of compensation expense.

Under U.S. GAAP, all stock options plans are accounted for by Thomson using the intrinsic value as prescribed by APB 25 “Accounting for Stock issued to Employees”. As a result, the impact on our income statement related to share-based payment may significantly differ between IFRS and U.S. GAAP.

The differences as explained above may affect income tax and therefore deferred income tax.

For more detailed information about the foregoing differences between IFRS and US GAAP, as well as certain additional differences between IFRS and US GAAP as they apply to Thomson, please refer to Note 40 to our consolidated financial statements.

Evolution of division structure

Changes in scope of consolidation in 2005

(a) Main acquisitions

 

On February 4, 2005, Thomson purchased 100% of the German company, MediaSec Technologies GmbH, a pioneer in digital watermarking and copy detection technologies, with a strong portfolio of patents and software products for €4 million. This acquisition has been accounted for using the purchase method. This company is fully consolidated in the Technology division from that date.

 

On March 14, 2005, Thomson acquired a 25% interest in ContentGuard Holdings, Inc., a developer of Digital Rights Management (DRM) technologies, for USD 27 million and controls 33% of the voting rights pursuant to a shareholders’ agreement with the other two shareholders, Microsoft and Time Warner. This company is consolidated in the Technology division under the proportionate consolidation method from that date.

 

On March 29, 2005, Thomson acquired 100% of Inventel (France), a leading provider of innovative voice and data solutions to telecom operators and Internet Service Providers (ISP). Combining Inventel’s expertise with Thomson’s world leading positions in DSL and video technologies and solutions is expected to enable the Group to expand its customer base, market reach and ranges of multiple-play gateways.

The total purchase price amounted to €146 million in cash and shares consisting of:

 

€81 million in cash paid on the closing date (March 29, 2005);

 

€65 million paid or to be paid in Thomson shares:

 

2,351,648 shares delivered at the closing date (valued at €49 million based on a share price of €20.72 per share),

 

712,498 shares to be delivered in different installments from 2006 to 2008 and subject to certain price adjustments (€14 million based on a share price of €20.72 per share), and

 

a maximum of 87,074 shares are to be delivered on June 30, 2006 and 2007 depending on specified earn-out conditions (€2 million based on a share price of €20.72 per share).

Thomson may be required to make a subsequent payment in its shares to the sellers as compensation for any reduction below a specified threshold in the value of shares to be delivered.

In addition, options to purchase a maximum of 1,760,000 shares were granted to the sellers with an exercise price of €20.72 per share depending on certain retention conditions, 50% of which vest from July 1, 2006 to September 30, 2007 and 50% vest from July 1, 2007 to February 29, 2008. The number of option shares is capped to yield total contingent consideration not exceeding €8.8 million on each of the two vesting dates based on the then current market value of Thomson’s shares.

 

 

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The company is fully consolidated in the Systems & Equipment division from March 29, 2005.

 

On April 20, 2005, Thomson acquired 100% of Cirpack, a French based company which possesses key softswitch technology expertise that allows telecom operators to drive voice, data and video convergence in IP networks. The total purchase price amounted to €82 million in cash and shares consisting of:

 

€40 million paid in cash at the closing date (April 20, 2005); and

 

€42 million to be paid in Thomson shares based on a share price of €20.23 per share as follows:

 

1,050,878 shares to be delivered on April 20, 2006,

 

1,050,878 shares to be delivered on April 20, 2007.

Thomson may, at its option, pay either or both instalments of 1,050,878 shares described above in cash at €20.23 per share or at the then share price of its shares, if higher.

Thomson may be required to make a subsequent payment in its shares to the seller as compensation for any reduction below a specified threshold in the value of shares to be delivered.

In addition, options to purchase a maximum of 2,101,756 Thomson shares were granted to the sellers with an exercise price of €20.23 per share depending on certain retention conditions, 50% of which vest on April 20, 2006 and 50% vest on April 20, 2007. The number of shares to be remitted on exercise is reduced to cap the potential gain at €14 million based on the then share price of Thomson shares.

The company is fully consolidated in the Systems & Equipment division from April 20, 2005.

 

On June 17, 2005, Thomson acquired for a total consideration of €7 million paid in cash 73% of Nextamp, a French company based in Rennes specialized in the protection of video content with technologies known as watermarking. This technology allows the encryption of a digital code in the video content which allows identification of the original source of any copy. An additional 1% has been acquired in September 2005. The remainder of the 16% will be purchased at a later date and at the latest on June 30, 2006 at a price depending on the evolution of the results of the company in 2005. The purchase price will be also increased by the issuance of specific warrant (Bons de Créateur d’Entreprise / BCE).

The total cost of the planned purchase is expected to amount to €9 million. This acquisition follows a first step by Thomson made in 2004 with the acquisition of 10% of the capital.

The company is fully consolidated in the Technology division from June 17, 2005 and the amount due to minority shareholders is recorded as a debt and the counterpart is a debit in goodwill and in minority interests.

 

On August 26, 2005, Thomson acquired 100% of Premier Retail Network, a leader in the fast-growing market of out-of-home video advertising networks. This acquisition furthers Thomson’s expansion into the implementation and management of video networks for a broad range of customers spanning broadcasters, cinemas and now retailers. The purchase price amounted to $299 million paid in cash. Premier Retail Network forms part of Thomson’s Network Services business unit in the Services division and is fully consolidated from August 26, 2005.

 

On October 27, 2005, Thomson acquired 51% of VCF Thématiques. The investment took the form of a capital increase by €17 million and allows Thomson and the previous owner of VCF Thématiques, the VCF Group, a subsidiary of Euro Media TV, to further develop their broadcast playout activities. VCF Thématiques is a leading provider of playout services to TV channels in France, broadcasting more than 1,000 hours of programs a day.

According to the shareholders’ agreement, Thomson may purchase and may be required to purchase the remainder of the 49% from June 2006, at a price depending on the evolution of the results of the company. The optional amount due to the minority shareholder is recorded as a debt estimated at around €16 million.

The company will be part of Thomson’s Network Services business unit in the Services division. It is fully consolidated from October 27, 2005.

 

On December 31, 2005, Thomson purchased 100% of Thales Broadcast & Multimedia (TBM) for an amount paid of approximately €133 million (of which €64 million for the repayment of current accounts due by acquired affiliates to Thales). The price is subject to adjustment depending on the level of working capital and cash at the acquisition date, as determined in the contract. This acquisition in the Systems &

 

 

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Equipment division follows the announcement of a strategic partnership between Thomson and Thales, specifically in the domain of high-video content management.

(b) Main disposals

 

On February 28, 2005, Thomson transferred its tube production site at Anagni, Italy, to the Indian Group, Videocon, for a consideration of €10 and committed to recapitalize the sold company with €103 million in cash as of the transaction date and a further €85 million one year after.

 

On June 28, 2005, Thomson signed an agreement for the sale of its Displays activities in China (Foshan and Dongguan sites), Mexico (Mexicali) and Poland (Piaseczno), as well as some related research and development and sales, marketing and administrative functions, to the Indian group, Videocon.

The definitive agreement occurred on September 30, 2005. Thomson received a cash payment of €240 million for its Displays activities and technology. Thomson has also invested €240 million in Videocon Industries, a company mainly active in oil and gas, consumer electronics products and consumer electronics components. This investment was effected in the form of global depositary receipts (“GDRs”) listed on the Luxembourg Stock Exchange. The price is subject to adjustment clauses normal for this type of agreement.

The shareholders’ agreement between Thomson, Videocon Industries and certain members of the already existing shareholders of Videocon Industries, signed on September 30, 2005, provides certain rights and obligations among the parties, for so long as Thomson holds at least 3% of the outstanding shares of Videocon Industries. Thomson may not transfer any GDRs it has acquired until September 30, 2008, subject to certain exceptions, which are notably (1) Thomson may monetize or hedge the risk associated with the shares in accordance with customary market practice, or otherwise use the shares to support a financing, in each case so long as it retains title to the shares until September 30, 2008, (2) Thomson may enter into share lending arrangements and (3) Thomson may sell up to 10% of its holding under various conditions.

The total impact of this disposal is a consolidated loss totalling €97 million.

 

On June 30, 2005, Thomson entered into an agreement to sell its tubes glass activity, Videoglass, situated at Bagneaux-sur-Loing, France, to the Spanish glass group, Rioglass. Rioglass, which specializes in glass parts for the car and transport industries, will establish a glass-conversion activity for the automotive industry on the site.

The definitive agreement was entered into on December 23, 2005. Thomson is committed to certain future payments to Rioglass that have been recorded in Thomson 2005 consolidated financial statements. The total impact of this disposal is a consolidated loss totalling €89 million.

All of the above disposals relate to operations treated under IFRS 5 as discontinued operations. For further information on our discontinued operations, refer to Note 11 to our consolidated financial statements.

(c) Other 2005 changes

 

In connection with the Combination Agreement with TCL International and TCL to create TTE, Thomson exercised its option to convert its 33% investment in TTE into a 29.32% interest in TCL Multimedia Technology Holdings Ltd, the parent of TTE. The exchange occurred on August 10, 2005.

This transaction has been characterized as an exchange without commercial substance and therefore accounted for at carrying value, without generating gain or loss. The investment is still accounted for under the equity method.

The investment is subject to a full lock-up period until July 2007. After that date, Thomson is allowed, depending on various conditions, to sell between 25% and 33% of its shares in 2007/2008 and between 25% and 33% of its shares in 2008/2009. After July 2009, no lock-up clause will remain.

Changes in scope of consolidation in 2004

(a) Main acquisitions

 

On January 7, 2004, Thomson completed the acquisition of the Tubes division of the Chinese company Xinyuan Highway Development (known by the name of “Fortune”). This activity was fully consolidated from that date. Concurrently with this operation, Thomson increased its ownership in Thomson Guangdong Display Co. Ltd. to 77%. (This operation was

 

 

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subsequently included in the sale of Displays assets to Videocon on September 30, 2005 referred to above.)

 

On April 20, 2004, Thomson acquired International Recording, a Rome-based company specializing in creating multiple foreign language versions for theatrical and broadcast content, as well as for video games. This company was fully consolidated from that date.

 

On May 12, 2004, Thomson acquired Command post, a leading Canadian provider of video/audio post-production and film services for the North American motion picture industry. This company was fully consolidated from that date.

 

On May 15, 2004, Thomson acquired the video division of ParkerVision, a pioneer of live television production automation systems. This activity was fully consolidated from that date.

 

On June 11, 2004, Thomson acquired from Beijing C&W Electronics (Group) Co. Ltd. the 45% minority interest in Thomson Zhao Wei Multimedia Co., Ltd., a Chinese company. Thomson already held the other 55% and had joint control. This company then formed part of Thomson’s television business contributed to TTE as of July 31, 2004.

 

On June 16, 2004, Thomson acquired from Alcatel a 25% minority interest in Nextream S.A. Thomson already held the other 75%, together with management control. Nextream, which was fully consolidated, is now 100% held by the Group.

 

On June 18, 2004, Thomson acquired Madrid Film SL, also known as Madrid Film Group, the largest film and post-production operation in Spain. This company was fully consolidated from that date.

 

On June 24, 2004, Thomson acquired the set-top box manufacturing assets of Hughes Network Systems (the manufacturing activity of DirecTV Group) and signed an agreement for the long-term development and supply of digital satellite set-top boxes to Hughes Network Systems. This activity was fully consolidated from that date.

 

On July 19, 2004, Thomson acquired Gyration, a Silicon Valley technology company that has developed a line of next-generation user-interface (UI) devices using proprietary technology based on gyroscopes. The technology is currently incorporated in a variety of hand-held UI devices, mainly for personal computers (PCs). This company was fully consolidated from that date.

 

On July 31, 2004, Thomson and TCL combined their respective TV assets in a new company, TTE, of which Thomson held 33% and TCL 67% following the transaction. Following the transaction, Thomson had neither control nor joint control of TTE and accounted for its investment in TTE under the equity method from August 1, 2004. The television activity contributed to TTE was fully consolidated before July 31, 2004. Thomson accounted for the contribution of its television business as a disposal and recorded the 33% interest in TTE as an acquisition. As described above in “Changes in scope of consolidation in 2005—Other 2005 Changes”, in August 2005 Thomson exercised its option to convert its 33% interest in TTE into a 29.32% interest in TCL Multimedia Technology Holdings Ltd.

 

On October 27, 2004, Thomson acquired 77.61% in Corinthian Television Facilities Limited (UK). Corinthian is one of Europe’s leading broadcast television facilities companies providing live studios, graphics, video, audio production and post-production and transmission playout to major international broadcasters through long term contracts. This company was fully consolidated from that date.

 

On November 4, 2004, Thomson acquired a 50% interest in Beijing Nokia CITIC Digital Technology Co Ltd. This company is mainly engaged in the production of digital multimedia terminals for reception of digital broadcasting and interactive services via satellite, cable, terrestrial and telecom networks and related products and systems for digital Internet services. The company was consolidated under the proportionate consolidation method from that date.

 

On November 18, 2004, Thomson acquired EADS DCS (Defense and Communication Systems) Video Over Internet Protocol (IP) activity, specialised in the integration of video over IP systems, which enables seamless access to voice, data and video content. This activity was fully consolidated from that date.

 

On December 9, 2004, Thomson acquired The Moving Picture Company (MPC). MPC is a London (UK) provider of visual effects and post-production services to both the motion picture and commercial advertising industries. This company was fully consolidated from that date.

 

 

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(b) Main disposals

 

On March 23, 2004, Thomson sold to the Taiwanese company, Foxconn, its optical pick-up manufacturing activity located in China within Thomson OKMCO Shenzen Co. Ltd. As of December 31, 2005, Thomson’s research, product development and selling activities in this business were considered assets held for sale as these activities form part of our discontinued operations. See Note 11 to our consolidated financial statements.

 

On June 25, 2004, in order to complete the agreements signed in 2003 concerning Canal Plus Technologies and the sale of the MediaGuard™ business to Kudelski, Thomson sold to Kudelski 50% of its shares into Canal Plus Technologies to form a joint venture in the field of the conditional access systems patents, which was consolidated under the proportionate consolidation method from that date.

 

On July 31, 2004, Thomson and TCL combined their respective TV assets into TTE. Thomson contributed its industrial TV assets mainly located in Mexico, Poland and Thailand as well as its R&D centres located in the U.S., Germany and Singapore. TTE licenses certain intellectual property from Thomson (trademarks and patents), prior to the renegotiation of contractual arrangements in 2005, exclusively used Thomson’s services for the distribution of televisions in Europe and the United States with Thomson acting as agent. See Item 4: “Information on the Company—Displays and CE Partnerships—Displays” for more information on these arrangements.

 

On September 22, 2004, Thomson sold its 19.9% interest in Total Technology Company Limited. Before that date, the company was consolidated under the equity method.

 

On December 10, 2004, Thomson sold its 36% interest in Keymro. The company, which had been consolidated under the proportionate consolidation method, was no longer consolidated as of such date.

 

On December 31, 2004, Thomson sold Thomson Servicios Corporativos S.A de C.V, a set-top box manufacturing company in Mexico to Elcoteq. Prior to December 31, 2004, the activity was fully consolidated.

Notification of participations acquired in the share capital of French companies

Under article L. 233-6 of the French Commercial Code, we disclosed that in 2005:

 

on March 29, 2005, the Group acquired 100% of Inventel;

 

on April 20, 2005, the Group acquired 100% of Cirpack;

 

on June 17 and September 19, 2005, Thomson acquired 74% of Nextamp;

 

on October 27, 2005, the Group acquired 51% of VCF Thématiques; and

 

on December 31, 2005, Thomson acquired 100% of Thales Broadcast & Multimedia SA.

Under article L. 223-6 of the French Commercial Code, we disclosed that in 2004:

 

in September 2004, Thomson acquired an interest of 10% in the share capital of Nextamp;

 

on January 29, 2004, Thomson acquired 3.19% of the share capital of Nagra Thomson Licensing (formerly Canal+ Technologies) from Sony Venture Capital Europe. On March 19, 2004, Thomson acquired 1.37% of the share capital of the same company from Sun Microsystems, increasing its interest in the company to 100% of its share capital. On June 25, 2004, Thomson sold 50% of Nagra Thomson Licensing to the Kudelski group; and

 

on June 16, 2004, Thomson, which was a 75% shareholder of Nextstream S.A., acquired the remaining 25% from Alcatel. Nextream is currently 100% held by the Group.

Results of operations for 2005 and 2004

The Group’s revenues and profit from continuing operations before tax and financial result for the years 2005 and 2004 are presented below for continuing operations – Services, Systems & Equipment, Technology and Displays & CE Partnerships. The results of discontinued operations, principally the Displays activities and Audio/Video and Accessories businesses are presented below separately under “—Net income from discontinued operations”.

 

 

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Analysis of Net Sales

In 2005, consolidated net sales from continuing operations amounted to €5,691 million, compared with €6,036 million in 2004, a decrease of €345 million or 5.7% (6.4% at constant 2004 exchange rates reflecting a positive currency impact of €40 million), resulting primarily from the elimination of revenues within our Displays and CE Partnerships segment resulting from the deconsolidation from August 1, 2004 of our TV business contributed to TTE, which accounted for net sales of €845 million for the period then ended in 2004. The contribution to consolidated net sales from continuing operations of the balance of our business grew by €460 million or 9.3% (8.5% at constant 2004 exchange rates reflecting a positive currency impact of €40 million).

The growth achieved by the more mature businesses identified in the Two-Year Plan (DVD and Film Services in the Services division and Set-Top Boxes, i.e. the AP&G-Satellite, Terrestrial & Cable activities, in Systems & Equipment) in 2005 was reduced by the disappointing performance of DVD Services and, to a lesser extent, Set-Top Boxes in the fourth quarter and in December in particular, although Film Services had a strong fourth quarter. Over the full year, revenues from these activities grew by €47 million reflecting a positive currency impact of €25 million (despite a €103 million decline in VHS sales at constant 2004 exchange rates). Revenues from our Licensing business grew by €20 million (with no year-on-year currency impact affecting this business).

Revenue growth for the full year was accordingly derived principally from the “Booster” businesses that we identified as areas with significant growth potential in our Two-Year Plan, in particular Content Services, Network Services, Broadcast & Network and AP&G-Telecom. The “Boosters” contributed revenue growth of €335 million at constant 2004 exchange rates. The businesses acquired in 2005 contributed €192 million to our consolidated net sales, principally due to the acquisitions in Network Services of VCF Thématiques (October 2005) and Premier Retail Network (August 2005) and in AP&G-Telecom of Cirpack (April 2005) and Inventel (March 2005). Acquisitions made in 2004 (mainly Corinthian in Network Services in November 2004 and the Moving Picture Company (“MPC”) in Content Services in December 2004) added €123 million to consolidated net sales in 2005, compared to €28 million in 2004. The recent acquisitions of Thales Broadcast & Multimedia and Canopus within our Broadcast & Networks activity will only contribute to 2006 revenues. The organic growth of these activities was augmented by the full-year consolidation impact in 2005 of businesses acquired in 2004 in the Services division.

Services

Consolidated net sales for the Services division totaled €2,487 million in 2005 compared with €2,338 million in 2004, representing an increase of 6.4%. This increase includes a positive impact of exchange rate variations of €21 million. Consolidated net sales of the Services division increased by 5.5% at constant 2004 exchange rates. The growth was driven primarily by significant growth in the Content Services and Network Services activities which more than offset the continued decline in VHS net sales. Acquisitions made in 2004 (mainly Corinthian and MPC) added €116 million to consolidated net sales in 2005, compared to €20 million in 2004. Acquisitions made in 2005 contributed €51 million to the 2005 consolidated net sales (mainly accounted for by the Premier Retail Network and VCF Thématiques acquisitions).

In our physical media businesses, there was volume growth in both DVD Services and Film Services. The number of DVDs replicated in 2005 amounted to 1.34 billion, an increase of 7% mainly driven by significant growth in Europe, while North America’s growth was more modest due to a disappointing fourth quarter in 2005. Major titles and catalog volumes were relatively slow in the fourth quarter. Because of the more mature market environment in DVD Services faced in late 2005, compared to the previous higher growth environment, we have adjusted our DVD overall market volume growth expectations for 2006 to less than 10%, rather than above 10% previously. VHS volumes continued to decline, as expected, decreasing by 68% to 49 million units. Film Services showed 4% growth in 2005 with approximately 5.3 billion feet of film processed, compared to 5.1 billion feet in 2004, with a strong last quarter of 2005 thanks to an improved film release slate. Volume growth in DVD Services (7%) and Film Services (4%) was partially offset by pricing pressure across many of our Services businesses. Physical media sales (DVD and Film)

 

 

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accounted for approximately 80% of total sales in the Services division in 2005 compared to approximately 90% in 2004.

In 2005, net sales from our Content Services activities grew significantly, reflecting organic growth and growth in particular in the visual effects services with the full-year consolidation impact of MPC, which was acquired in December 2004.

In our Network Services activities, sales in 2005 doubled compared with 2004 as we expanded our activities with retail, institutional and cinema clients, notably with the integration and development of Premier Retail Network, which was acquired August 2005. We also continued to further develop the Broadcast playout business with the full year operation of Corinthian Television in the United Kingdom (first consolidated in November 2004), the integration of VCF Thématiques acquired in October 2005 and the award of the TV5 Monde contract.

In 2005, we commenced the roll-out of digital technology in the screen-advertising industry, with the deployment of the SkyArc™ digital advertising management system in 1,500 screens at the end of 2005. Our Electronic Distribution Services activity is managing this deployment, as well as managing the system for Screenvision.

Systems & Equipment

Consolidated net sales for the Systems & Equipment division increased by €246 million, or 11.6%, to €2,355 million in 2005 from €2,109 million in 2004. This increase includes a positive impact of exchange rate variations of €17 million. Consolidated net sales of this Systems & Equipment division increased by 10.8% at constant 2004 exchange rates.

The increase in sales of our Systems & Equipment businesses came from continuing growth in our Set-Top Box activities, the integration of Inventel and Cirpack which were acquired in 2005 and generated sales of €138 million, partially offset by a decline in our basic DSL modems sales and from the organic growth of the Broadcast & Networks (“Grass Valley”) business.

The Audio/Video and Accessories activities within Connectivity are considered as assets held for sale following the announcement on December 12, 2005 of our intention to seek for partners in such activities and are also treated as discontinued operations under IFRS. Accordingly, no revenues were reported within Systems & Equipment division for these activities for the years ended December 31, 2005 or 2004. The impact of these activities on our result are thus included below in “—Net Income from discontinued operations”.

Access Platforms & Gateways

Satellite, Terrestrial and Cable

Revenues grew strongly in 2005 with the sale of 12.2 million set-top boxes and cable modems worldwide in 2005, compared with 11.8 million units sold in 2004. This growth was primarily due to increased sales volumes in the first half of 2005 (approximately 6 million units compared to approximately 3 million units in first half 2004), principally related to the effect of additional volumes from DIRECTV under the supply agreement signed in June 2004. Sales in the latter part of the year were adversely affected by technical and production issues, including some components shortages. In the second half of 2005, sales were lower than the second half of the prior year (which were particularly strong) and were also affected by the slower rate and timing of some service rollouts by our customers. Second half volumes were 6.2 million units in 2005 compared to 8.8 millions units in second half 2004.

DIRECTV remained the largest customer of this business. In addition, however, the business unit expanded its footprint in other markets, gaining new customers and market shares in Europe (including Satellite, Terrestrial and Cable) and notably in the Middle East and Asia-Pacific regions. In Asia, our STB business is continuing to develop as operators rollout their services. Deliveries of products for Astro, the Malaysian satellite broadcaster, continued to grow in 2005. The strategy in Asia is to pursue opportunities we expect may arise as Asian cable and satellite operators will enhance featured pay and digital TV. Thomson brought featured products to market with the introduction of HD and DVR/PVR products to Pay-TV operator’s networks and expects to develop sales of such products in 2006. This increased proportion of featured set-top boxes helped compensate for unit price reduction.

 

 

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Telecom

In the growing Telecom area, our business significantly expanded its offering to telecom operators seeking to broaden their customer offerings. Thomson’s leadership position in IP devices and solutions has been further strengthened by the continuing ramp-up of our double-play products, in particular the Inventel LiveBox (for France Telecom), which reached cumulative sales of one million units in October 2005, and the AOL box. The acquisition of Inventel significantly expanded our presence in this high-growth segment. Cirpack, a soft-switch supplier acquired in 2005, is also showing significant post-acquisition growth sales, towards the year-end through the addition of cable customers as well as several contracts in Eastern Europe. These developments enabled Thomson to expand its market share in these growing telecom markets and Voice-over-IP Customer Premises Equipment for cable operators.

The growth in double- and triple-play products which have integrated DSL modems has more than compensated a decline in basic DSL modems.

Broadcast & Networks (“Grass Valley”)

The business unit continued to gain market share during the year, notably in networks and systems integration, and initial orders for products aimed at the ProAV (professional audio-video)

market were promising. The business is positioned for further growth in the extended broadcast & ProAV market with the well-received launch of new products, such as the Infinity Series™ range. Revenue growth was above 10%, and higher than this in the second half, with nearly all this growth being organic, and the business ended the period with increased order backlog.

The acquisitions announced in December 2005 of Canopus and Thales Broadcast & Multimedia will only contribute to our 2006 revenues.

Connectivity—Communications

In 2005, although the communications industry declined as a whole, our Communications business maintained its level of sales. Communications saw significant price erosion in 2005, but was able to offset this decline with a balance of increased volumes and improved mix of sales of higher-priced products.

Revenues from this business unit exclude those of our Audio/Video and Accessories businesses, which are considered discontinued operations under IFRS. For a description of these activities, see Item 4: “Information on the Company—Discontinued Operations.”

Technology

Consolidated net sales for the Technology division amounted to €546 million in 2005, compared with €498 million in 2004, an increase of 9.7%, mainly driven by an increase of €20 million in the Licensing activity and an increase in the continuing activities of Silicon Solutions. Currency effects had no significant impact on consolidated net sales in 2005.

Consolidated net sales for the Licensing activity amounted to €449 million in 2005 compared with €428 million in 2004, an increase of 4.8%, reflecting our continuing success in monetizing our intellectual property through licensing programs. Revenues related to digital-based licensing programs represented approximately 75% of total revenues of the division compared to 70% in 2004, and were particularly strong in the MPEG2 and mp3 programs. This reflects the growth of our digital licensing programs in terms of the volumes of existing contracts and the number of new contracts finalized during the year. The most significant contributor to our Licensing revenues in 2005 was the MPEG2 program (administrated through the MPEGLA pool), which increased to account for around 20% of the Technology division’s revenues in 2005. Programs relating to digital TV increased significantly compared to 2004. In 2005, the Group continued to develop its licensing portfolio: the Group had 888 licensing contracts in place at year-end 2005 compared to 878 at year-end 2004.

The difference between estimated and actual revenue figures derived from cash collection for the years ended December 31, 2005 and 2004, measured as a percentage of the total Licensing revenues, amounted to an excess of actual over estimated revenue of 2.3% and 1.4%, respectively.

 

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The Silicon Solutions activity’s net sales (which exclude the discontinued optical modules operations) increased strongly in 2005 compared to 2004. Contributing to this growth, remotes showed stronger growth than tuners, while the expanded silicon components business made its first external sales of integrated circuits.

Our new Software & Technology Solutions activity generated its first revenues in 2005, reflecting our strategy to develop these activities particularly in content security where the acquisitions of MediaSec, Nextamp and ContentGuard in 2005 contributed €1.9 million to consolidated net sales.

The net sales from the discontinued operations in the Technology division are not included in the net sales for the division reported under IFRS.

Displays & CE Partnerships

The sales for our non-core Displays & CE Partnerships activities amounted to €263 million for 2005. This figure is not comparable with the net sales of €1,068 million for 2004 which includes €845 million of sales by our former television activity, which was deconsolidated from August 1, 2004 in connection with the creation of TTE and which are not treated as discontinued operations under IFRS. In the remaining five months of 2004, our manufacturing and sales and marketing agency services provided to TTE contributed €185 million to sales in 2004, while these services contributed €56 million to sales in 2005 until Thomson’s role as sales and marketing agent for TTE ceased in September 2005, as these services were transferred to TTE. Other sales in 2005 derived from certain minor residual television-related/after-sales businesses and the residual sub-contract manufacturing operations, based principally at our site in Angers, France, which primarily supplies TTE, and at our site in Genlis, France, which manufactures certain display components.

Profit from continuing operations before tax and financial result

Cost of sales amounted to €4,322 million in 2005, or 75.9% of net sales, a decrease of 6.7% compared with cost of net sales of €4,634 million in 2004, or 76.8% of net sales. This decrease is largely due to the TTE deconsolidation, partly offset by the expansion of Services and Systems & Equipment activities.

As a result, gross margin was €1,369 million in 2005, or 24.1% of net sales, compared with €1,402 million in 2004, or 23.2% of net sales. This result reflects, among other factors, depreciation and amortization related to continuing activities (including amortization of contract advances and customer relationships) of €442 million (2004: €399 million).

Selling and marketing expenses amounted to €282 million, or 5% of net sales in 2005, a decrease of 13.5% compared with €326 million or 5.4% of net sales in 2004. This decrease is largely due to TTE deconsolidation and partly offset by increased costs in our Core businesses, mainly in the Systems & Equipment division (AP&G and Broadcast & Networks activities).

Administrative expenses amounted to €373 million, or 6.6% of net sales in 2005, compared with €336 million or 5.6% of net sales in 2004. This is due to increased costs mainly in the Services division and Corporate, only partly offset by the favourable impact of TTE deconsolidation.

Other expenses (excluding selling and marketing and general and administrative expenses) amounted to €98 million in 2005, of which restructuring charges accounted for €51 million, due principally to termination costs from headcount reduction (see Item 6: “Directors, Senior Management and Employees—Employees Thomson Workforce”), as well as write-offs of long-lived assets for €16 million (including the write-off of assets of the TV plant in Angers for €10 million). Other expenses amounted to €70 million in 2004, resulting from restructuring charges of €70 million, due principally to termination costs from headcount reduction, as well as goodwill impairment of €12 million and write-off of long-lived assets €9 million.

Research and development expenditure (net of external funding) reached €234 million in 2005, or 4.1% of sales, compared to 3.4% in 2004. Out of the total spending on research and development in 2005, €88 million was incurred by the Technology division, compared to €53 million in 2004.

 

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See Note 8 to our consolidated financial statements for more information on our research and development expenditures.

As a result of the evolution of these expenses combined with a decrease of 5.7% in revenues (including the positive effect of exchange rate fluctuations), profit from continuing operations before tax and financial result reached €382 million in 2005, or 6.7% of net sales, a decrease of 18% compared with €466 million in 2004, or 7.7% of net sales. At constant 2004 exchange rates, 2005 profit from continuing operations before tax and financial result reached €381 million, reflecting a positive currency impact of €1.3 million. The decrease of €84 million is evenly spread across the Services, Systems & Equipment and Technology divisions.

Services

Profit from continuing operations before tax and financial result for the Services division amounted to €205 million in 2005 compared with €227 million in 2004, a decrease of 10%. The division’s 2005 profit margin was 8.2% compared with a 2004 profit margin of 9.7%.

The division’s profitability was negatively impacted by DVD Services, with continued sharp VHS volume declines throughout the year and weak DVD volumes in the fourth quarter. Other contributing factors to this increase included the full year impact of some raw material (including polycarbonate) cost increases, DVD price pressures and the increase in amortization and, in particular, depreciation of tangible assets for the Services division. These developments were partially offset by continuing cost-control measures and process transformation initiatives, including continued shift of production to low-cost plants and economies of scale due to increased DVD volumes in Europe.

Film margins were stable. Volume increases in Film Services were balanced by pricing pressure, while further volume shifts to lower costs facilities and efficiency improvements were beneficial.

Network Services and Content Services activities generated additional profit compared with 2004 through continued growth and successful integration of current-year and prior-year acquisitions.

Electronic Distribution Services activities reflect the cost of initial investment in our digital cinema initiative (with plans for a beta-test deployment in 2006 with a view to a broader rollout thereafter).

Limited restructuring programs during 2005 included the downsizing of certain VHS duplication and DVD replication operations in Europe and in Canada, along with site optimization and relocation actions within Film Services. Restructuring is being pursued in the first half of 2006, and the profitability of Services in 2006 is expected to be more weighted than usual towards the second half of the year.

Systems & Equipment

Profit from continuing operations before tax and financial result for the Systems & Equipment division amounted to €102 million in 2005 compared with €121 million in 2004, a decrease of 16%. The division’s 2005 operating margin was 4.4% compared with a 2004 operating margin of 5.7%.

The division’s profitability was negatively impacted during the year by lower contribution from Access Platforms & Gateways. This reflects increased investment during 2005 in research and development expenses. In addition, the Set-Top Box operations in Satellite, Terrestrial and Cable experienced a slower rate and delayed timing of service rollouts in set-top boxes as well as price deflation, which were not fully offset by cost base savings and product mix improvement. The profitability of the Telecom operations was adversely affected by the decline in the traditional DSL modem business, compensated in the later part of the year by improving profitability particularly from next generation dual/triple play products. The division’s profitability was also negatively affected by the increase in depreciation and amortization, in particular depreciation of capitalized research and development expenses.

The contribution to profit from Broadcast & Networks (“Grass Valley”) improved in 2005 versus 2004, despite increased costs related to product introductions and research and development expenses.

The profitability of our Communications business remained stable in 2005.

 

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Profitability for continued operations excludes the Audio/Video and Accessories businesses, which are treated as discontinued operations. For more information on discontinued operations, see “—Discontinued Operations” below.

Technology

Profit from continuing operations before tax and financial result amounted to €277 million in 2005, compared to €302 million in 2004, a decrease of 8.3%, and showed a margin of 50.7% in 2005 compared with 60.7% in 2004. In 2005, the profits from continuing operations before tax and financial result of our Licensing business accounted for €361 million compared to €349 million in 2004, an increase of €12 million. The profit margin for licensing was 80.6% in 2005 compared with a margin of 81.6% in 2004. The other continuing operations generated an increased loss before tax and financial result, principally as a result of the overall increase in research costs within the division together with other costs incurred to establish the new businesses of Software & Technology Solutions and the silicon business in Silicon Solutions. The most significant costs were research and development costs related to integrated circuits.

The total research costs which are accounted for within the Technology division reached €88 million in 2005, an increase of €35 million in 2004.

Displays & CE Partnerships

Loss from continuing operations before taxes and financial costs amounted to €123 million, compared to a loss of €109 million in 2004. The most significant contributor to this loss in 2005 was the operating loss at our Angers operations, including payments made to TTE under the sub-contract manufacturing agreement. The losses incurred in 2004 resulted most notably from the operating losses of our television manufacturing activities prior to their disposal to TTE in August 2004.

Losses for the segment in 2006 are expected to be significantly lower, resulting from, among other factors, the renegotiation of the terms of the contract with TTE for services provided by the Angers operation.

Profit from continuing operations before tax and financial result under U.S. GAAP

Under U.S. GAAP, profit from continuing operations before tax and financial result was €280 million and €408 million for the periods ended December 31, 2005 and 2004 respectively. The main differences compared to IFRS, under which the corresponding amounts were €382 million and €466 million respectively, are summarized below and detailed in Note 40 to our consolidated financial statements.

 

Development costs are expensed as incurred under U.S GAAP, whereas they are capitalized under IFRS under certain conditions. This difference leads to additional development expenses under U.S. GAAP compare to IFRS amounting to €46 million and €16 million for the periods ended December 31, 2005 and 2004, respectively.

 

Pension and other post employment benefit costs differ under IFRS and U.S. GAAP, mainly due to certain exemptions applicable to the first time application of IFRS and to the treatment under IFRS of recognizing actuarial gains and losses against net equity. Under U.S. GAAP such costs are amortized over the average remaining service period of the relevant employees and reflected in the income statement. The impact of this difference on our profit from continuing operations is an additional expense amounting to €49 million and €42 million for the periods ended December 31, 2005 and 2004 respectively.

Please refer to Note 40 to our consolidated financial statements for a further discussion of the principal differences between IFRS and U.S. GAAP.

Financial Result

The financial result amounted to €(54) million in 2005 compared to €(29) million in 2004, comprising both net interest income (expense) and other financial income (expense).

Net interest income (expense)

Net interest expense reached €78 million in 2005 from €2 million in 2004. The sharp rise in net interest expense between 2004 and 2005 is due to a significant increase in net debt and to

 

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the impact of the implementation of the IAS 39 accounting standard in 2005. This standard required the use of effective interest rates instead of nominal interest rates for purposes of calculation of interest expense. It is also due in part to the effect of the reclassifications in 2005 into net interest income and expense of certain prepaid bank fees previously included in other financial expense.

Other financial income (expense)

Other financial income totaled €24 million in 2005, compared to a €27 million charge in 2004, mainly due to the revaluation of the embedded derivative contained in the Silver Lake convertible bonds and the effect of the reclassifications in 2005 into net interest income and expense of certain prepaid bank fees previously included in other financial expense. The fair value of this incorporated derivative is linked to the market value of Thomson shares and to the change in the U.S. dollar/euro exchange rate. This resulted in a net €83 million (non-cash) gain. These impacts were partly offset by adverse exchange impacts in 2005 compared to 2004. Please refer to Note 9 to our consolidated financial statements for additional information on other financial result.

Income Tax

Pursuant to the provisions of the French Tax Code (article 209 quinquies) and in accordance with a tax agreement from the French Tax Authorities dated November 6, 2002, Thomson benefits from a worldwide consolidation regime for French income tax purposes.

This regime provides that the basis for computation of parent company income tax includes the taxable income of French and foreign entities more than 50% owned by it, directly or indirectly. Within certain limits, it also allows for the reduction of the taxable income of profitable entities within this group by offsetting taxable losses of other entities within the same group. Further, it allows for the application as a credit to income taxes due in France of taxes due in their respective jurisdictions by foreign entities more than 50% owned, directly or indirectly, by the parent company.

This regime applied to Thomson from January 1, 2001 until December 31, 2005 and has not been renewed. Therefore the last tax return under this regime for the year 2005 will be filed in November 2006. The impacts of this regime are reflected in the 2005 and previous years accounts.

In 2005, the Group’s total income tax expense on continuing operations, including both current and deferred taxes, amounted to €70 million compared to €93 million in 2004.

The Group’s current tax charge amounted to €42 million in 2005, compared with €91 million in 2004. This tax charge is notably the result of current taxes due in the United Kingdom, Mexico, Australia, Canada and the Netherlands, as well as withholding taxes on income earned by our Licensing division, which, because of the existing tax losses, cannot be credited against taxes payable in France and in the United States and is therefore booked as an income tax charge. In 2004, the current income tax charge amounted to €21 million in France (reflecting withholding taxes on licensing revenue) and €70 million abroad, mainly in the United Kingdom, Mexico, Australia and the Netherlands.

In 2005, Thomson booked a net deferred tax charge of €28 million, mainly due to a partial recognition of deferred tax assets in respect of Thomson’s French losses due to the disposal of Displays taking into consideration the anticipated profits of the Telecom and Licensing businesses for €51 million, and the de-recognition of €77 million of deferred tax assets in the United States reflecting lower than previously anticipated profitability in that country.

In 2004, Thomson booked a net deferred tax liability of €2 million. The recognition of deferred tax assets in respect of Thomson’s U.S. operations amounted to €83 million. A €57 million allowance on deferred tax assets was booked in France because of the anticipated impact of the 2005 French tax law which reduces the capital gains tax rates and also removes the ability of Thomson to offset capital losses (as opposed to current income losses) against applicable “long-term” income (notably Licensing income). For more information, see Note 10 to our consolidated financial statements.

 

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Share of profit (loss) from associates

In 2005, the loss from associates was €82 million (2004: €20 million), which primarily reflected a non-cash impairment charge of €63 million relating to the Group’s holding in TCL Multimedia as a result of the fair value of our investment in TCL Multimedia being below its carrying amount. See “—Critical Accounting Policies—Impairment test of our equity investment in TCL Multimedia” for more information regarding this impairment charge.

Net income from continuing activities

As a result of the factors discussed above, the Group recorded a net income from continuing activities of €176 million in 2005, compared with €324 million in 2004.

Profit (loss) from discontinued operations

The loss from discontinued operations amounted to €749 million in 2005 compared to €885 million in 2004. The principal contributors to these losses were the various Displays & CE Partnerships activities disposed of or otherwise discontinued during the year, with aggregate losses of €676 million in 2005 compared to €875 million in 2004. Operating losses for these activities amounted to €192 million in 2005 (2004: €82 million), while restructuring and non-current exit costs were €463 million in 2005 (2004: €759 million). The net loss also includes financial and tax costs amounting to €22 million (€34 million in 2004). As previously announced over the course of 2005, operating losses from these activities were significantly greater than expected at the beginning of 2005.

Operating losses from our Displays & CE Partnerships activities in 2005 result primarily from market conditions in the cathode ray tubes industry which was characterized by (i) weak volume demand in all geographic areas (including China) and in the segments in which the Group operates, particularly as a result of the growing success of LCD and plasma televisions, which do not use cathode ray tubes and (ii) significant acceleration in the decrease of cathode ray tubes prices. Continued efforts by the Group to reduce raw materials supply costs, improve productivity and reduce its cost structure offset only in minor part the negative impact of these adverse market conditions.

In 2005, the main components of the restructuring and non-current exit costs comprised (i) payments relating to the reindustrialization of the Anagni site of €188 million, (ii) a total loss of €97 million in connection with the disposal of our Displays activity to the Videocon Group and (iii) a total consolidated loss of €89 million provided for by the Company in connection with the disposal of its Bagneaux site to Rioglass.

In 2004, the main components of the restructuring and non-current exit costs related to Thomson’s decision in 2004 to dispose of its Displays activity, which resulted in a non-cash impairment charge of €530 million. Thomson also recorded restructuring costs, to a lesser extent, relating to its closure in 2004 of the tube plant in Marion, Indiana, and our television glass plant for cathode ray tubes in Circleville, Ohio.

In 2005, losses from our optical modules business disposed of were €34 million (2004: loss of €28 million), while losses from the Audio/Video and Accessories businesses held for sale at the end of 2005 totaled €39 million, including tax and finance costs of €13 million (2004: profit of €18 million).

Net income of the Group

Income due to minority interests amounted to €1million in 2005 (2004 loss €2 million). As a result of the factors discussed above, the Group recorded a net loss of €574 million in 2005, compared with a net loss of €559 million in 2004. Net loss per share was €2.17 in 2005, compared to net loss per share of €2.05 in 2004.

Net income under U.S. GAAP

Under U.S. GAAP, we recorded a net loss of €721 million and €695 million for the years ended December 31, 2005 and 2004 respectively, compared with a net loss under IFRS of €574 million and €559 million respectively for the same periods.

 

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The difference in net income under U.S. GAAP compared to IFRS mainly related to the factors affecting profit from continuing operations before taxes and financial result under U.S. GAAP (as described above), the impact of deferred tax accounting treatment under U.S. GAAP in connection with business combinations and the effect of recycling cumulative translation adjustments in the context of disposals of operations.

For more details see notes 40 to our consolidated financial statements.

Liquidity and Capital Resources

Cash Flows

 

 

2005

 

2004

 

 


 


 

 

 

(in € millions)  

 

Net operating cash generated from continuing activities

 

623

 

555

 

Net operating cash used in discontinued operations

 

(323

)

(125

)

Net investing cash used in continuing activities

 

(890

)

(858

)

Net investing cash used in discontinued operations

 

(6

)

(131

)

Net financing cash generated from continuing activities

 

(285

)

3

 

Net financing cash used in discontinued operations

 

12

 

2

 

Net (decrease)/increase in cash and cash equivalents

 

(869

)

(554

)

Cash and cash equivalents at December 31, 2005

 

996

 

1,848

 

Net cash provided by operating activities

Net operating cash generated from continuing operations amounted to €623 million in 2005, €68 million above the 2004 amount.

Profit from continuing operations in 2005 was €176 million, compared to €324 million in 2004. After adjustments to reconcile profit from continuing operations to cash (including depreciation and amortization of €442 million, compared to €399 million in 2004), cash generated from continuing operations was €740 million, compared to €700 million in 2004. Cash generated from continuing operations reflects, among other factors, changes in working capital and other assets and liabilities which used €42 million in 2005, compared to €82 million in 2004. This number includes a reduction in working capital of €79 million in 2005, compared to an increase in working capital of €45 million in 2004 – and reflects a net cash outflow from other assets and liabilities (including contract advances) of €121 million in 2005, compared to €37 million in 2004. The latter increase results principally from lower cash inflows in 2005 from movements in other assets and liabilities in the Technology division, compared to 2004. Cash generated from continuing operations also reflects cash used in restructuring of continuing operations of €51 million in 2005, compared with €80 million in 2004.

Net operating cash generated from continuing operations also reflects the following items:

 

net interest (corresponding to net interest paid and received) paid increased to €50 million, compared to €25 million in 2004;

 

cash taxes paid amounted to €67 million in 2005, compared with €120 million in 2004.

Net operating cash used in discontinued operations was €323 million in 2005, compared to €125 million in 2004.

Net cash used in investing activities

The increase in net investing cash used in continuing activities from €858 million in 2004 to €890 million in 2005 was driven primarily by cash outflow for acquisitions (net of cash acquired) and investments in operating entities of €710 million in 2005,

 

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compared to €586 million in 2004. The €710 million in 2005 includes our investment of €240 million in the acquisition of GDRs of Videocon Industries in connection with our disposal of our Tubes activities. Other major acquisitions in 2005 included the acquisition of Premier Retail Network (cash outflow of €248 million), Inventel (2005 cash outflow of €82 million) and Cirpak (2005 cash outflow of €40 million). In 2004, major acquisitions included the acquisition of Hughes Network Systems (cash outflow of €204 million), while the transfer of substantially all of our television activities to TTE had a negative cash flow effect of €115 million. See Note 33 of our consolidated financial statements for more information regarding the cash impact of these acquisitions.

Net investing cash used in continuing activities also reflects net tangible and intangible capital expenditures amounting to €284 million in 2005, compared with €273 million in 2004. The most significant investments were made in Service activities and aimed at increasing our DVD replication and distribution capacities and on Systems & Equipment activities, mainly in Research & Development.

These increases in net investing cash used in continuing activities were offset in part by proceeds earned from the sale of interests in certain investment funds in France (Organismes de Placement Collectif en Valeurs Mobilières, or “OPCVM”) of €52 million in 2005 compared to a cash outflow of €58 million from purchases of interests in such funds in 2004.

Net investing cash used in discontinued operations decreased in 2005 to €6 million from €131 million in 2004.

Net cash used by financing activities

Net financing cash used in continuing operations was €285 million in 2005, compared with net financing cash generated of €3 million in 2004. This increase in net cash used reflected the redemption by the Group of €588 million (excluding interest) of convertible bonds maturing in 2008 following the exercise by the bondholders of their right of early redemption. This increase also reflected our active share buy-back activities and other transactions in our share capital in 2005 amounting to €283 million compared to €58 million for share repurchases in 2004. This increase in financing cash used in continuing activities was offset in part by proceeds of €492 million from the issuance of a deeply subordinated hybrid bond in 2005 and proceeds essentially from the issuance of French commercial papers of €600 million, offset in part by repayments of borrowings of €427 million, including the unwinding of our synthetic lease in January 2005 relating to our factory in Mexicali, Mexico for an amount of U.S.$226 million.

In 2004, net financing cash generated by continuing activities primarily reflected proceeds from the issuance of convertible bonds for €403 million, comprising the issuance of convertible bonds for U.S.$500 million due 2010 to Silver Lake. In addition, we recorded proceeds from other borrowings of €272 million, which were more than offset by the repayments of borrowings of €540 million, including the repurchase for €182 million (including €11 million of accrued interest and premium) of convertible bonds maturing in 2006 and the unwinding and early repayment of a €138 million capital lease initially maturing in 2006.

Net financing cash generated by discontinued operations was €12 million in 2005, compared to €2 million in 2004.

As a result of the factors discussed above, we experienced a net decrease of cash and cash equivalents of €869 million in 2005 compared to a decrease of €554 million in 2004. Cash and cash equivalents amounted to €1,848 million at the end of 2004, compared to €996 million at the end of 2005.

Financial resources

At the end of 2005, we had a net debt position (financial debt plus debt related to acquisitions minus cash and cash equivalents) of €1,464 million, compared with a net debt position of €737 million at the end of 2004. The financial net debt position (corresponding to the difference between (i) the current and non-current borrowings and (ii) cash and cash equivalents including marketable securities), excluding acquisition-related obligations (debt related to the acquisition of Technicolor paid in 2004 and to the 2005 acquisition of Thales Broadcast & Multimedia), amounted to €1,319 million in 2005, compared to €595 million in 2004.

 

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Financial debt totaled €2,322 million at the end of 2005 (including convertible/exchangeable bonds for €1,071 million, French commercial paper for €528 million and senior notes placed privately with institutional investors for the equivalent of €392 million), of which €1,464 million is due within one year, compared with €2,501 million at the end of 2004 (including convertible/exchangeable bonds for €1,578 million, and senior notes placed privately with institutional investors for the equivalent of €346 million), of which €904 million was due within one year. See Note 24 to our consolidated financial statements for further analysis of and information on our outstanding borrowings. For a discussion of our exposure to interest rate fluctuations and currency exposure in connection with financial debt, see “Item 11: Quantitative and Qualitative Disclosures About Market Risk.”

At the end of 2005, we had committed undrawn credit facilities of €1,750 million with a consortium of banks. These facilities serve as a backup to our French commercial paper program. Furthermore, we have negotiated uncommitted credit lines from unaffiliated third-party lenders amounting to €895 million, of which €114 million were used as of December 31, 2005 for borrowings.

Our financial debt of €2,322 million excludes our 5.75% (5.85% yield to first call date) €500 million deeply subordinated bonds issued in September 2005. We issued these bonds to anticipate the repayment of our €677 million (including the coupon) convertible/exchangeable bonds. Because of their perpetual and subordinated nature, these bonds are recorded under IFRS in shareholders’ equity for the net value received of €492 million (representing the issue price minus the offering discount and fees). On any interest payment date, payment of interest is optional only if Thomson does not declare and pay a dividend at the most recent Shareholders’ Meeting and it has not repurchased its shares in the preceding six months. The bonds are perpetual and have no stated maturity date; they may, however, be redeemed at the issuer’s option in certain conditions, in particular (i) on or after September 25, 2015, (ii) at any time in the event of a change of control of Thomson or (iii) as a result of certain tax reasons. For more information on these bonds, see Note 22 to our consolidated financial statements. These bonds provide that if there is a change of control and the rating for our senior unsecured obligations is downgraded by one full notch by either Moody’s or S&P such that the reduction results in a rating below Baa3 by Moody’s or BBB- by S&P, then Thomson may redeem the bond at no penalty. However, should Thomson decide not to redeem, the coupon rate increases by 5 percentage points.

In July 2002, Standard & Poor’s (“S&P”) announced a long-term credit rating on our senior unsecured debt facilities and convertible bonds of BBB+ and a short-term rating of A-2 with stable outlook. In November 2005, S&P modified its outlook from stable to negative. In March 2006, S&P downgraded the long-term rating to BBB with negative outlook and the short-term rating to A-3. S&P also downgraded the rating of our deeply subordinated bonds from BBB- to BB+. In October 2004, Moody’s assigned a long-term issuer rating to Thomson of Baa1 with a stable outlook. In March 2006, Moody’s downgraded this rating to Baa2 with a negative outlook. In addition, Moody’s also downgraded its rating of our deeply subordinated bonds issued in September 2005 to Ba1 from Baa3.

Two of Thomson’s financing agreements have covenants pertaining to Thomson’s consolidated financial situation. These financings comprise the senior notes issued in private placements to institutional investors for a total amount of €392 million and a €46 million Mexican capital lease, which are each subject to two financial covenants: (a) maintenance of a minimum ratio of profit from continuing operations and before tax, finance and restructuring costs to net interest expense of 3 to 1 and (b) a maximum ratio of net debt to net worth of 1 to 1. At December 31, 2005, Thomson is in compliance with all of these financial covenants. Following a renegotiation in June 2005, our €1.75 billion credit facility is no longer subject to any financial covenants.

In addition to our debt position as described above, we also have reserves for post-employment benefits that Thomson provides its employees, which amounted to €939 million at December 31, 2005 compared to €850 million at December 31, 2004. This increase resulted primarily from (i) a €68 million increase due to a change in actuarial assumptions and included in the statement of recognized income and expense, (ii) a decrease of €26 million resulting from the disposal of certain

 

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activities in 2005 and (iii) a €70 million increase resulting from currency translation adjustments. For more information on our reserves for post-employment benefits, see Note 26 to our consolidated financial statements.

Since December 31, 2005, Thomson has made certain cash payments including the repayment of €677 million convertible/exchangeable bonds in January 2006 and obligations relating to various acquisitions and disposals for an aggregate amount of €375 million, namely the acquisitions of Thales Broadcast & Media, Canopus and Convergent Media Systems and the disposals of our Tubes activities at Agnani and our glass plant in Bagneaux. Certain of these payments are described further in “—Contractual Obligations and Commercial Commitments including Off-Balance Sheet Arrangements—Unconditional Contractual Obligations and Commercial Commitments.”

We expect to fund the continued active development of the Group using our available cash and our cash flow from operating activities and to the extent appropriate, through borrowings from our available credit facilities or by accessing the capital markets. For more information on our liquidity position, see “Item 11. Quantitative and Qualitative Disclosures About Market Risk—Liquidity Situation.”

Contractual Obligations and Commercial Commitments including Off-Balance Sheet Arrangements

Unconditional Contractual Obligations and Commercial Commitments

The table presented below provides information regarding contractual obligations and commercial commitments for the year ended December 31, 2005 for which the company is obliged to make future cash payments. Some of these commitments are not included on our balance sheet as indicated in the table. The table does not include contingent liabilities or commitments. These are, however, described below under the heading “—Conditional Contractual Obligations and Commercial Commitments” and in Note 34 to our consolidated financial statements. When an obligation leading to future payments can be cancelled through a penalty payment, the future payments included in the tables are those that management has determined most likely to occur given the two alternatives.

Guarantees given by entities of the Group securing debt, capital leases, operating leases or any other obligations or commitments of other entities of the Group are not included as the related obligations are already included in the table below.

 

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Amount of commitments expiring per period

 

 

 

 

 

 

 


 

Unconditional commitments

 

December 31,
2004 Total

 

December 31,
2005 Total

 

Less than
1
 year

 

> 1 and =
<
 3 years

 

> 3 and
= 5 years

 

After 5 years

 


 


 


 


 


 


 


 

 

 

(in € millions)

 

Financial debt (1)

 

2,501

 

2,322

 

1,464

 

21

 

515

 

322

 

Of which capital lease liability (2)

 

71

 

70

 

11

 

18

 

18

 

23

 

Payables on acquisition and disposal
of companies (1)

 

84

 

312

 

312

 

 

 

 

Unconditional future payments – not
included on our balance sheet

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases (2)

 

510

 

438

 

90

 

140

 

89

 

119

 

Other (3)

 

68

 

142

 

92

 

40

 

8

 

2

 

Royalties (4)

 

1

 

1

 

1

 

 

 

 

Unconditional purchase obligations – not included on our balance sheet

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial investments (5)

 

16

 

32

 

31

 

1

 

 

 

Property, plant and equipment

 

9

 

1

 

1

 

 

 

 

Commercial purchase obligations (6)

 

165

 

129

 

85

 

37

 

7

 

 

 

 


 


 


 


 


 


 

TOTAL

 

3,354

 

3,377

 

2,076

 

239

 

619

 

443

 

 

 


 


 


 


 


 


 

______________

(1)

Only financial debt and payables on acquisition and disposal of companies are reported in these respective categories of contractual obligations. They are recorded in this table for their principal amounts and accrued interest. Future interest expense and the impact of interest rate swaps are not reported under these items. Currency swaps, hedging operations and foreign exchange options are described below in the table under “—Conditional Contractual Obligations and Commercial Commitments”. The payable of €84 million as of December 31, 2004 related to our acquisition of Technicolor was repaid in March 2005.

The payable of €312 million as of December 31, 2005 relates to the acquisition of Thales Broadcast & Multimedia (€133 million net and paid in January 2006) and the put granted on minority interests in various companies (€36 million), of which €16 million relates to VCF Thématiques, together with the obligation to pay specific amounts to Videocon and Rioglass, respectively, in connection with our disposal of our Displays and glass plants in Agnani (€85 million and paid in March 2006) and Bagneaux (€58 million, of which €39 million has been paid in 2006 as of the date hereof), respectively.

(2)

The decrease of commitments related to operating leases in 2005 is due to the disposition of our Displays activity, offset in part by fluctuations in the U.S. dollar/euro exchange rate.

(3)

Other unconditional future payments relate to information technology service agreements, general sponsoring agreements entered into in the United States, guarantees given in connection with assets disposals covering €15 million, and other contractual commitments.

(4)

Royalties to be paid for which the amount is determined on a per unit sold basis are not included, except if a fixed minimum amount will be charged. These are mainly related to licensing fee agreements.

(5)

In December 2005, Thomson entered into an agreement for the acquisition of at least 33.3% of the issued and outstanding shares of Canopus Co. Ltd, a Japan-based leader in high-definition desktop video editing software, and launched a public tender offer for the remaining Canopus shares. The total value of the private transaction combined with the pending tender offer would represent approximately €91 million for 100% shares. Therefore, as of December 31, 2005 a commitment of €30 million is reported, which was paid in January 2006.

(6)

Include commitments to buy advertising space for €56 million in Screenvision activity and other unconditional commercial purchase obligations to suppliers for specific Thomson outsourced products for an amount of €53 million.

The table above excludes potential future payments related to the acquisitions of Inventel and Cirpack in 2005, as well as payments of interest and principal on our deeply subordinated bonds issued in September 2005:

 

With respect to Inventel and Cirpack, the acquisition price was structured to include both cash and share components. In each case, the consideration comprised an initial payment on the respective closing date in 2005 and deferred cash or share payments in 2006 and 2007 (and, in the case of Inventel, 2008). As Thomson is expected to make such deferred payments in its shares, the effect of such payment is not included in the table above. For more information on these acquisitions, including the approximate value of these deferred payments, see “—Results of Operations for 2005 and 2004— Changes in scope of consolidation.”

 

As discussed above in “—Liquidity and Capital Resources”, Thomson issued 5.75% (5.85% yield to first call date) €500 million deeply subordinated bonds in 2005. Because

 

 

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of the perpetual and subordinated nature of the bonds issued in September 2005, they are recorded under IFRS in shareholders’ equity for the net value received of €492 million (representing the issue price minus the offering discount and fees). As these bonds are not recognized as debt under IFRS and as they are perpetual obligations with no specified maturity date, our obligations related to such bonds are not included in the table above. For more information on these bonds, including a description of certain redemption events and the effect of a change of control and specified rating downgrades, see “—Liquidity and Capital Resources—Financial Resources” and Note 22 to our consolidated financial statements.

The disposal of our tubes business in 2005 has decreased significantly some of the contingent obligations under operating leases which existed in 2004 on our tubes plants in Mexicali (Mexico) and Foshan (China).

Conditional Contractual Obligations and Commercial Commitments

The table below includes only contingent liabilities or commitments, all of which are not included in our balance sheet. These are disclosed in detail in Note 34 to our consolidated financial statements.

 

 

 

 

 

 

 

Amount of commitments expiring per period

 

 

 

 

 

 

 


 

Conditional commitments

 

December 31,
2004 Total

 

December 31,
2005 Total

 

Less than
1 year

 

> 1 and =
< 3 years

 

> 3 and
= 5 years

 

After 5 years

 


 


 


 


 


 


 


 

 

 

(in € millions)

 

Guarantees given:

 

 

 

 

 

 

 

 

 

 

 

 

 

- to suppliers

 

25

 

24

 

15

 

8

 

 

1

 

- for legal court proceedings and custom duties (1)

 

65

 

62

 

24

 

8

 

1

 

29

 

- other (2)

 

200

 

206

 

36

 

52

 

28

 

90

 

Standby letters of credit (3)

 

68

 

79

 

79

 

 

 

 

Other commitments (4)

 

81

 

208

 

105

 

69

 

15

 

19

 

 

 


 


 


 


 


 


 

Total

 

439

 

579

 

259

 

137

 

44

 

139

 

 

 


 


 


 


 


 


 

______________

(1)

These guarantees comprise:

 

-

Guarantees for customs duties amounting to €43 million and comprising mainly duty deferral guarantees, required by the customs administration to benefit from a derogatory customs regime. Imported goods are normally taxed when they enter the territory. In the case of regular import flows, customs may grant a derogatory regime, under which a cumulated duty payment is made after a determined one-month credit period. The carrying value of this guarantee is to cover the duties to be paid during the credit period.

 

-

The Group also grants to customs administrations various operational guarantees to exempt from duties goods transiting through custom warehouses for re-exportation, and transit guarantees so that taxes are paid on goods only at their final destination in the import country.

 

-

Guarantees given for legal court proceedings amount to €19 million, including a €12 million bank guarantee that Thomson gave to the Italian direct tax office in order to be allowed to pay by installment its tax debt resulting from the reassessment of its taxable income from 1993 to 1998.

(2)

Under the terms of long-term contracts that may exist mainly in its Broadcast activity in System & Equipment division, the Group must generally provide to its clients performance guarantees issued by banks. For the twelve months period ended December 31, 2005 and as of December 31, 2004 these guarantees amount to €34 million, and €9 million respectively. This amount also includes guaranties granted by the Group in connection with certain transactions, particularly relating to TTE, MediaGuard and Foxconn for an aggregate amount of approximately €155 million.

(3)

Standby letters of credit relate mainly to guarantees in favour of suppliers.

(4)

Conditional obligations include contingent earn-out payment related to the purchase of 20% of Technicolor Digital Cinema L.L.C. and other obligations. In 2005, Thomson granted to banks of Videocon a guarantee for an amount of €59 million, and reciprocally the Group received from Videocon a guarantee for the same amount (€59 million). In 2005, it also included a guarantee given to banks to secure our debt to Rioglass in an amount of €43 million guaranteeing, among other things, a portion of our obligation of €58 million in 2006 to support the Bagneaux facility as described above under “—Unconditional Contractual Obligations and Commercial Commitments.

There is no known event, demand, commitment, trend or uncertainty that is reasonably likely to result in the termination, or material reduction in availability to the Company, of the off-balance sheet arrangements described above in “—Unconditional Contractual Obligations and Commercial Commitments” and “—Conditional Contractual Obligations and Commercial Commitments”.

 

 

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ITEM 6 - DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A – Directors and Senior Management

Preparation and organization of the Board of Directors’ activities

The Group has implemented the principal recommendations regarding corporate governance for French companies, most notably as outlined in the Viénot Reports of 1995 and 1999 and in the Bouton Report of September 2002. These recommendations focus primarily on the composition of the Board of Directors and their committees, which should combine director independence and expertise in the company’s businesses. The recommendations also focus on the functioning of the Board of Directors and establishing procedures to provide on-going and timely information in advance of board meetings. These recommendations were incorporated in the “Internal Board Regulations” (Règlement Intérieur) of the Board of Directors.

Following an amendment to the Company’s by-laws (statuts) as approved by its shareholders on May 7, 2004, the number of Company shares required to be held by each director has increased. Each director now personally holds at least 2,000 shares of the Company.

Composition of the Board of Directors and its Committees

The Board of Directors consisted of 14 members as of December 31, 2005. The composition of the Board of Directors changed during 2005 with the resignation of Thierry Breton on February 27, 2005 and the resignation of Igor Landau on December 15, 2005.

Rémy Sautter, initially appointed as an observer (censeur) and non-voting member of Thomson’s Board of Directors on October 12, 2005, became a Director on January 12, 2006 through the French procedure of co-option in replacement of Igor Landau. Rémy Sautter is Chairman of the Supervisory Board of Ediradio/RTL Radio and Vice Chairman of the U.K.-based company FIVE.

As of December 31, 2005, the Board of Directors comprised nine “independent” directors (Christian Blanc, Éric Bourdais de Charbonnière, Eddy Hartenstein, Pierre Lescure, Didier Lombard, Paul Murray, Marcel Roulet, David Roux and Henry Vigil). The independence of the directors is evaluated according to the following criteria and definition outlined in the Bouton Report: “a director is independent when he or she has no relationship of any kind whatsoever with the company, its Group, or the management of either, that is such as to colour his or her judgment.” Due to their prior professional experience, these directors have considerable knowledge of the Group’s businesses and markets. Two of these directors have extended financial experience in multinational groups. Four directors are Group employees: two were elected by Group employees as employee representatives on the Board of Directors (Jean de Rotalier and Catherine Cavallari), and two were elected as representatives of employee shareholders (Loïc Desmouceaux and Gérard Meymarian). Four Directors are of non-French nationalities: three are American and one is British.

The following table lists the members of the Board of Directors, their main occupations, date of their initial appointment and the expiration date of their current term.

 

 

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Name

 

Principal occupation
or employment

 

Appointed
to Board

 

Term
expires

 

Other Business Activities
outside Thomson


 


 


 


 


Frank E. Dangeard (2)

 

Chairman and Chief Executive Officer of Thomson since
September 15, 2004

 

Chairman since October 2002 (Board member since March 1999)

 

2008*

 

Board member of Orange
(France Telecom Group), EDF and Calyon

Christian Blanc (1)(3)(7)

 

Member of the French
Parliament

 

June 2001

 

2009*

 

Board member of Cap Gemini, Coface and JC Decaux

Éric Bourdais
de Charbonnière (1)(4)

 

Chairman of the Supervisory Board of Michelin

 

December 2003

 

2007*

 

Member of Supervisory Board of Oddo & Cie and ING Group,
Board member of Associés en Finance

Catherine Cavallari

 

Controlling Technology
Operations, Thomson

 

June 2002

 

June 2007

 

N/A

Loïc Desmouceaux

 

Prospective Marketing
Manager and Strategic
Development, Thomson

 

May 2003

 

2008*

 

Permanent representative of Sovemarco Europe SA,
Company board member of Sellenium SA,
Board member of Desamais Distribution SA

Eddy W. Hartenstein
(1)(3)(7)

 

 

 

September 2002
(member of Board since March 1999)

 

2008*

 

Until January 2005, Vice Chairman and Board member of the
DIRECTV Group, Board member and Chairman of
DIRECTV Enterprises Inc., DIRECTV International, Inc.,
DIRECTV Merchandising, Inc., and DIRECTV Operations, Inc.
Board member of DIRECTV Latin America
Board Member of SanDisk Corporation,
XM Satellite Radio and Consumer Electronics Association
Chairman and CEO of HD Acquisition Partners, LLC

Pierre Lescure (1)(3)

 

Producer

 

September 2002

 

2008*

 

Board member of Havas, Kudelski and Chabalier & Associates
Press Agency S.A., Chairman of AnnaRose Production SAS
and Le Monde Presse SAS, Member of Supervisory Board of
Lagardère, Le Monde and Société Éditrice du Monde

Didier Lombard (1)(3)

 

Chairman and
CEO of France Telecom

 

May 2004

 

2008*

 

Chairman of the Board of Orange, Board Member of Thales,
Member of Supervisory Board of Radiall and STMicroelectronics

Gerard Meymarian

 

Vice President, Audio/Video
and Accessories,
Europe Organization, Thomson

 

May 2003

 

2008*

 

N/A

Paul Murray (1)(5)

 

Partner of Tangent LLP

 

June 2003

 

2006*

 

Board Member of Taylor Nelson Sofres PLC (UK)

Jean de Rotalier

 

Marketing Manager, Audio Video and Accessories, Thomson