Item 5. Operating and Financial Review and Prospects

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Item 5. Operating and Financial Review and Prospects

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Critical Accounting Estimates

The preparation of financial statements and related disclosures in accordance with U.S. GAAP requires our management to make judgments, assumptions and estimates that affect the amounts reported in our Consolidated Financial Statements and the accompanying notes. Our management bases its estimates and judgments on historical experience, current economic and industry conditions and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

The methods, estimates, and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our consolidated financial statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our most critical accounting estimates include:

	•		the valuation of inventory, which impacts gross margin;

	•		the assessment of recoverability of goodwill, identified intangible assets and tangible fixed assets, which impacts gross margin or operating expenses when we record asset impairments or accelerate their depreciation or amortization;

	•		revenue recognition, which impacts our results of operations;

	•		the recognition of current and deferred income taxes (including the measurement of uncertain tax positions), which impacts our provision for income taxes;

	•		the assumptions used in the determination of postretirement benefit obligations, which impacts operating expenses;

	•		the assumptions used in the determination of share based compensation, which impacts gross margin and operating expenses; and

	•		the recognition and measurement of loss contingencies, which impacts gross margin or operating expenses when we recognize a loss contingency or revise the estimates for a loss contingency.

In the following section, we discuss these policies further, as well as the estimates and judgments involved.

Inventories

Inventories are valued at the lower of cost or market. We regularly review our inventories and write down our inventories for estimated losses due to obsolescence. This allowance is determined for groups of products based on sales of our products in the recent past and/or expected future demand. Future demand is affected by market conditions, technological obsolescence, new products and strategic plans, each of which is subject to change with little or no forewarning. In estimating obsolescence, we utilize information that includes projecting future demand.

The need for strategic inventory levels to ensure competitive delivery performance to our customers are balanced against the risk of inventory obsolescence due to rapidly changing technology and customer requirements.

The change in our reserves for inventories was primarily due to the normal review and accrual of obsolete or excess inventory. If actual future demand or market conditions are less favorable than those projected by our management, additional inventory write-downs may be required.

Goodwill

Goodwill is required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired. Such events or changes in circumstances can be significant changes in business climate, operating performance or competition, or upon the disposition of a significant portion of a reporting unit. A significant amount of judgment is involved in determining if an indicator of impairment has occurred between annual test dates. This impairment review compares the fair value for each reporting unit containing goodwill to its carrying value. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions, including projected future cash flows, discount rates based on weighted average cost of capital and future economic and market conditions. We base our fair-value estimates on assumptions we believe to be reasonable. Actual cash flow amounts for future periods may differ from estimates used in impairment testing.

For the annual impairment assessment in 2016, we determined that for each of our reporting units, it was more likely than not that the fair value of the reporting units exceeded the carrying value. During the fourth quarter of each of the prior two fiscal years, we have completed our annual impairment assessments and concluded that goodwill was not impaired in any of these years.

Impairment or disposal of identified intangible assets and tangible fixed assets

We perform reviews of property, plant and equipment, and certain identifiable intangibles, excluding goodwill, to determine if facts and circumstances indicate that the useful life is shorter than what we had originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances exist, we assess the recoverability of the long-lived assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values based on the expected discounted future cash flows attributable to the assets or based on appraisals. Impairment losses, if any, are based on the excess of the carrying amount over the fair value of those assets.

The assumptions and estimates used to determine future values and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our forecasts for specific product lines. In 2016, we recognized an impairment charge of $89 million relative to IPR&D that was acquired from Freescale . In 2015, we recognized disposals of intangibles relative to our sale of the Bipolar and RF Power Businesses. In 2014, no impairments or disposal of identified intangible assets and tangible fixed assets were required to be recognized.

Revenue recognition

The Company’s revenue is derived from sales to distributors, made-to-order sales to Original Equipment Manufacturers (“OEMs”) and similar customers.

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or the service has been provided, the sales price is fixed or determinable, and collection is reasonably assured, based on the terms and conditions of the sales contract. For made-to-order sales, these criteria are met at the time the product is shipped and delivered to the customer and title and risk have passed to the customer. Acceptance of the product by the customer is generally not contractually required, since, for made-to-order customers, design approval occurs before manufacturing and subsequently delivery follows without further acceptance protocols. Payment terms used are those that are customary in the particular geographic market. When management has established that all aforementioned conditions for revenue recognition have been met and no further post-shipment obligations exist, revenue is recognized.

For sales to distributors, revenue is recognized upon sale to the distributor (sell-in accounting). We record reductions to sales associated with reserves for allowances for collectibility, discounts, price protection, product returns and distributor incentive programs at the time the related sale is recognized. The establishment of such reserves is dependent on a variety of factors, including contractual terms, analysis of historical data, current economic conditions, industry demand and both the current and forecasted pricing environments. The process of evaluating these factors is highly subjective and requires significant estimates, including, but not limited to, forecasted demand, returns, pricing assumptions and inventory levels. In future periods, additional provisions may be necessary due to a deterioration in the semiconductor pricing environment, reductions in anticipated demand for semiconductor products and/or lack of market acceptance for new products. If these factors result in a significant adjustment to our reserves, they could significantly impact our future operating results.

Distributor reserves estimate the impact of credits granted to distributors under certain programs common in the semiconductor industry whereby distributors receive certain price adjustments to meet individual competitive opportunities, or are allowed to return or scrap a limited amount of product in accordance with contractual terms agreed upon with the distributor, or receive price protection credits when our standard published prices are lowered from the price the distributor paid for product still in its inventory. The Company’s policy is to use a rolling historical experience rate, as well as a prospective view of products and pricing in the distribution channel for distributors who participate in our volume rebate incentive program, in order to estimate the proper provision for this program at the end of any given reporting period. We continually monitor the actual claimed allowances against our estimates, and we adjust our estimates as appropriate to reflect trends in pricing environments and inventory levels. Distributor reserves are also adjusted when recent historical data does not represent anticipated future activity.

Income taxes

Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts. Measurement of deferred tax assets and liabilities is based upon the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax liabilities for withholding taxes on dividends from subsidiaries are recognized in situations where the company does not consider the earnings indefinitely reinvested and to the extent that these withholding taxes are not expected to be refundable.

Deferred tax assets, including assets arising from loss carryforwards, are recognized, net of a valuation allowance, if based upon the available evidence it is more likely than not that the asset will be realized.

The income tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained upon examination by the relevant taxing authorities. The income tax benefit recognized is measured based on the largest benefit that is more than 50% likely to be realized upon resolution of the uncertainty. Unrecognized tax benefits are presented as a reduction to the deferred tax asset for related net operating loss carryforwards, unless these would not be available, in which case the uncertain tax benefits are presented together with the related interest and penalties as a liability, under accrued liabilities and other non-current liabilities based on the timing of the expected payment. Penalties are recorded as income tax expense, whereas interest is reported as financial expense in the statement of operations.

Postretirement benefits

The Company’s employees participate in pension and other postretirement benefit plans in many countries. The costs of pension and other postretirement benefits and related assets and liabilities with respect to the Company’s employees participating in defined-benefit plans are based upon actuarial valuations.

The projected defined-benefit obligation is calculated annually by qualified actuaries using the projected unit credit method. For the Company’s major plans, the discount rate is derived from market yields on high quality corporate bonds. Plans in countries without a deep corporate bond market use a discount rate based on the local government bond rates.

In calculating obligation and expense, the Company is required to select actuarial assumptions. These assumptions include discount rate, expected long-term rate of return on plan assets and rates of increase in compensation costs determined based on current market conditions, historical information and consultation with and input from our actuaries. Changes in the key assumptions can have a significant impact to the projected benefit obligations, funding requirements and periodic pension cost incurred. A sensitivity analysis is provided in note 15, “Postretirement Benefit Plans”.

The Company determines the fair value of plan assets based on quoted prices or comparable prices for non-quoted assets. For a defined-benefit pension plan, the benefit obligation is the projected benefit obligation; for any other postretirement defined benefit plan it is the accumulated postretirement benefit obligation.

Share-based compensation

We recognize compensation expense for all share-based awards based on the grant-date estimated fair values, net of an estimated forfeiture rate. We use the Black-Scholes option pricing model to determine the estimated fair value for certain awards. Share-based compensation cost for restricted share units (“RSU“s) with time-based vesting is measured based on the closing fair market value of our common stock on the date of the grant, reduced by the present value of the estimated expected future dividends, and then multiplied by the number of RSUs granted. Share-based compensation cost for performance-based share units (“PSU“s) granted with performance or market conditions is measured using a Monte Carlo simulation model on the date of grant.

Our valuation models and generally accepted valuation techniques require us to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the volatility of our stock price, expected dividend yield, employee turnover rates and employee stock option exercise behaviors. Due to the lack of extensive history as a public company, the computation of the expected volatility assumptions used in the Black-Scholes calculations for grants was based on historical volatilities and implied volatilities of our peer group companies. When establishing the expected life assumption, we used the ‘simplified’ method prescribed in ASC Topic 718 for companies that do not have adequate historical data. The risk-free interest rate is measured as the prevailing yield for a U.S. Treasury security with a maturity similar to the expected life assumption. We also estimate a forfeiture rate at the time of grant and revise this rate in subsequent periods if actual forfeitures or vesting differ from the original estimates.

We evaluate the assumptions used to value our awards on a quarterly basis. If factors change and we employ different assumptions, share-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellation of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense.

Litigation and claims

We are regularly involved as plaintiffs or defendants in claims and litigation relating to matters such as commercial transactions and intellectual property rights. In addition, our divestments sometimes result in, or are followed by, claims or litigation by either party. From time to time, we also are subject to alleged patent infringement claims. We rigorously defend ourselves against these alleged patent infringement claims. There can be no assurance that the Company’s accruals will be sufficient to cover the extent of its potential exposure to losses. Historically, legal actions have not had a material adverse effect on the Company’s business, results of operations or financial condition.

The estimated aggregate range of reasonably possible losses is based on currently available information in relation to the claims that have arisen and on the Company’s best estimate of such losses for those cases for which such estimate can be made. For certain claims, the Company believes that an estimate cannot currently be made. The estimated aggregate range requires significant judgment, given the varying stages of the proceedings (including the fact that many of them are currently in preliminary stages), the existence of multiple defendants (including the Company) in such claims whose share of liability has yet to be determined, the numerous yet-unresolved issues in many of the claims, and the attendant uncertainty of the various potential outcomes of such claims. Accordingly, the Company’s estimate will change from time to time, and actual losses may be more than the current estimate.

Use of Certain Non-GAAP Financial Measures

Net debt is a non-GAAP financial measure and represents total debt (short-term and long-term) after deduction of cash and cash equivalents. Management believes this measure is an appropriate reflection of our net leverage.

We understand that, although net debt is used by investors and securities analysts in their evaluation of companies, this concept has limitations as an analytical tool and it should not be used as an alternative to any other measure in accordance with U.S. GAAP.

A. Operating Results

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

Results of Operations

The following table presents the composition of operating income for the years ended December 31, 2016 and 2015.


($ in millions, unless otherwise stated)	2016			2015
Revenue		9,498			6,101
% nominal growth		55.7			8.0
Gross profit		4,069			2,787
Research and development		(1,560	)		(890	)
Selling, general and administrative (SG&A)		(1,141	)		(922	)
Amortization of acquisition-related intangible assets		(1,527	)		(223	)
Other income (expense)		9			1,263

Operating income (loss)		(150	)		2,015

Revenue

The following table presents revenue by segment for the years ended December 31, 2016 and 2015.


	2016					2015
($ in millions, unless otherwise stated)	Revenue		% nominal growth			Revenue		% nominal growth
High Performance Mixed Signal (“HPMS”)		8,086		71.3			4,720		12.2
Standard Products (“SP”)		1,220		(1.7	)		1,241		(2.7	)
Corporate and Other		192		37.1			140		(14.6	)

Total		9,498		55.7			6,101		8.0

Revenue increased by $3,397 million to $9,498 million in 2016 compared to $6,101 million in 2015, a nominal increase of 55.7%, reflecting the inclusion of the operations of Freescale.

Our HPMS segment reported an increase in revenue of $3,366 million to $8,086 million in 2016 compared to $4,720 million in 2015, resulting in 71.3% nominal growth. The increase was primarily due to incremental revenue from the acquired Freescale businesses from December 7, 2015, onward, partly offset by the divestment of RF Power on December 7, 2015.

Revenue for our SP segment decreased $21 million to $1,220 million in 2016, compared to $1,241 million in 2015. The decrease was primarily attributable to the transfer of the Bipolar Power business line activities into a joint venture (WeEn Semiconductors) with JAC Capital in China.

Revenue for Corporate and Other amounted to $192 million in 2016, compared to $140 million in 2015 and mainly related to our manufacturing operations.

Gross Profit

The following table presents gross profit by segment for the years ended December 31, 2016 and 2015.


	2016				2015
($ in millions, unless otherwise stated)	Gross Profit		% of segment revenue		Gross Profit		% of segment revenue
HPMS		3,625		44.8		2,367		50.1
SP		437		35.8		417		33.6
Corporate and Other		7		3.6		3		2.1

Total		4,069		42.8		2,787		45.7

Gross profit in 2016 was $4,069 million, or 42.8% of revenue compared to $2,787 million, or 45.7% of revenue in 2015. The increase of $1,282 million was primarily driven by the inclusion of the operating activity of Freescale partly offset by the effects of PPA, and to a lesser extent, stock based compensation expense. The decrease in the gross profit percentage was primarily driven by the effect of purchase accounting in our HPMS segment.

Our HPMS segment had a gross profit of $3,625 million, or 44.8% of revenue in 2016, compared to $2,367 million, or 50.1% of revenue in 2015. The decrease in the gross profit percentage of 5.3 points as a percentage of revenue was primarily driven by the effects of purchase accounting in two areas—inventory of $448 million (2015: $149 million) and property, plant and equipment of $209 million (2015: $15 million), both as a result of the acquisition of Freescale, and to a lesser extent, restructuring activity ($12 million) and stock based compensation expense ($42 million).

Gross profit in our SP segment was $437 million, or 35.8% of revenue in 2016, compared to $417 million, or 33.6% of revenue in 2015. The increase in the gross profit percentage of 2.2 points was a result of lower depreciation expense as a result of the fixed assets of the SP business being classified as held for sale and depreciation being discontinued on those fixed assets.

Operating Expenses

The following table presents operating expenses by segment for the years ended December 31, 2016 and 2015.


	2016				2015
($ in millions, unless otherwise stated)	Operating expenses		% of segment revenue		Operating expenses		% of segment revenue
HPMS		3,937		48.7		1,674		35.5
SP		168		13.8		223		18.0
Corporate and Other		123		—		138		—

Total		4,228		44.5		2,035		33.4

The following table below presents the composition of operating expenses by line item in the statement of operations.


($ in millions, unless otherwise stated)	2016		2015
Research and development		1,560		890
Selling, general and administrative		1,141		922
Amortization of acquisition-related intangible assets		1,527		223

Operating expenses		4,228		2,035

Operating expenses were $4,228 million, or 44.5% of revenue in 2016, compared to $2,035 million, or 33.4% of revenue in 2015, an increase of $2,193 million, or an increase of 11.1 points as a percentage of revenue. The increase in operating expenses was primarily due to the acquisition of Freescale: the inclusion of their operating activity from December 7, 2015 onward and the related amortization of acquisition related intangibles of $1,430 million (2015: $105 million).

In our HPMS segment, operating expenses amounted to $3,937 million, or 48.7% of revenue in 2016, compared to $1,674 million, or 35.5% of revenue in 2015. The increase was primarily driven by the acquisition of Freescale: the inclusion of their operating activity from December 7, 2015 onward and the related amortization of acquisition related intangibles of $ 1,430 million (2015: $105 million), which includes an impairment charge of $89 million (2015: nil) relative to IPR&D that was acquired from Freescale.

Operating expenses in our SP segment decreased to $168 million, or 13.8% of revenue in 2016 compared to $223 million or 18.0% of revenue in 2015. The decrease in operating expenses was primarily driven by a continued strong focus on cost controls and the effect of the divestment of the Bipolar activities.

Restructuring Charges

Total restructuring and restructuring related costs amounted to $68 million in 2016, compared to $264 million in 2015.

In 2016, the restructuring charges were for various specific targeted actions and were comprised of employee severance costs. In 2015, the restructuring charges mainly related to the acquisition of Freescale and were comprised of severance costs of $239 million, and other exit costs of $27 million.

Other Income (Expense)

The following table presents other income (expense) for the years ended December 31, 2016 and 2015.


($ in millions, unless otherwise stated)		2016				2015
Other income (expense)			9				1,263

Other income (expense) reflects income of $9 million for 2016 compared to $1,263 million of income in 2015. Included in 2015 is the gain on the sale of NXP’s Bipolar Power business line and RF Power business to JAC Capital in the fourth quarter of 2015.

Financial Income (Expense)


($ in millions)		For the years ended December 31,
	2016				2015
Interest income			11			6
Interest expense			(408	)		(227	)
Foreign exchange rate results			(15	)		(193	)
Net gain (loss) on extinguishment of debt			(32	)		—
Change in fair value of the warrant liability			—			(31	)
Other			(9	)		(84	)

Total			(453	)		(529	)

Financial income (expense) was an expense of $453 million in 2016, compared to an expense of $529 million in 2015. The decrease in financial income (expense) is primarily attributable to (i) a more favorable impact of foreign exchange rate results, (ii) lower other financial income and expense related items than in 2015, offset by (iii) the increase in interest expense, net, as a result of the debt that we assumed in the acquisition of Freescale and by (iv) a $32 million loss on the early extinguishment of debt due to certain financing activities completed during 2016. Beginning on January 1, 2016, as a result of the acquisition of Freescale, NXP concluded that the functional currency of the holding company was USD. With this change in functional currency, the U.S. dollar-denominated notes held by NXP no longer need to be re-measured, resulting in less foreign exchange rate results in our operations and the warrants were reclassified to stockholders’ equity, and mark-to-market accounting was no longer applicable.

Benefit (Provision) for Income Taxes

The effective tax rate reflects the impact of tax incentives, a portion of our earnings being taxed in foreign jurisdictions at rates different than the Netherlands statutory tax rate and the mix of income and losses in various jurisdictions. We recorded a tax benefit of $851 million in 2016, which reflects a benefit of 141.1% compared with a benefit of $104 million (7.0%) for 2015.

ASC 740, Income Taxes, requires that we consider all available evidence in forming a judgement regarding the valuation allowance as of December 31, 2016, including events that occur subsequent to year end but prior to the issuance of the financial statements. As a result of the February 6, 2017 disposition of SP, we concluded that the valuation allowance should be reduced by $395 million as of December 31, 2016, as the SP divestiture provided an objectively verifiable source of income against which tax losses can be utilized. As a result, we recognized an additional benefit of $392 million in the benefit (provision) for income taxes in the consolidated statement of operations and an additional $7 million in capital in excess of par value in the consolidated balance sheet in the fourth quarter. In the second quarter, the valuation allowance in the U.S. was reduced by $107 million as a result of our determination that sufficient positive evidence existed to support a more likely than not determination that the U.S. deferred tax assets were realizable.

As a result, the significant change in our effective tax rate was primarily due to the reversals of valuation allowances in the Netherlands and Germany as a result of the SP divestiture, a reversal of the valuation allowance in the U.S. related to the Company’s determination that sufficient positive evidence existed to support a more likely than not determination that the U.S. deferred tax assets were realizable, and the impact of purchase accounting as a result of the acquisition of Freescale, slightly offset by the impact of the inclusion of the operations of Freescale, which resulted in significant amortization expense for acquired intangibles, additional depreciation expense as a result of the fair value adjustments on tangible assets and a significant impact to the mix of income and losses between jurisdictions. In addition, the tax expense related to transactions associated with internal restructurings resulting from the Freescale acquisition represented a higher percentage of earnings before tax for 2016 as compared to 2015.

As previously discussed, on February 6, 2017 we divested Standard Products, receiving $2.75 billion in cash proceeds. In relation to the gain that will be realized, the Company currently estimates that we will incur approximately $450 million of capital gains taxes that will come due in increments during 2017, 2018 and 2019. Cash payments for income taxes that are relative to our ongoing operations are expected to remain at approximately $30 to $35 million per quarter during 2017. In relation to the gain we expect additional cash payments for income taxes to be approximately $30 million in the first quarter of 2017 and approximately $90 million in each of the second, third and fourth quarters of 2017. For the years ended December 31, 2018 and 2019, we currently estimate in each year additional cash payments for income taxes relative to this gain of approximately $75 million.

Results Relating to Equity-accounted Investees

Results relating to the equity-accounted investees amounted to a gain of $11 million in 2016, compared to a gain of $9 million in 2015.

Non-controlling Interests

Non-controlling interests are related to the third party share in the results of consolidated companies, predominantly SSMC. Their share of non-controlling interests amounted to a profit of $59 million in 2016, compared to a profit of $73 million in 2015.

Year Ended December 31, 2015 Compared to Year Ended December 31, 2014

Results of Operations

The following table presents the composition of operating income for the years ended December 31, 2015 and 2014.


($ in millions, unless otherwise stated)	2015			2014
Revenue		6,101			5,647
% nominal growth		8.0			17.3
Gross profit		2,787			2,640
Research and development		(890	)		(763	)
Selling, general and administrative (SG&A)		(922	)		(686	)
Amortization of acquisition-related intangible assets		(223	)		(152	)
Other income (expense)		1,263			10

Operating income		2,015			1,049

Revenue

The following table presents revenue by segment for the years ended December 31, 2015 and 2014.


	2015					2014
($ in millions, unless otherwise stated)	Revenue		% nominal growth			Revenue		% nominal growth
High Performance Mixed Signal (“HPMS”)		4,720		12.2			4,208		19.1
Standard Products (“SP”)		1,241		(2.7	)		1,275		11.4
Corporate and Other		140		(14.6	)		164		19.7

Total		6,101		8.0			5,647		17.3

Revenue increased by $454 million to $6,101 million in 2015 compared to $5,647 million in 2014, a nominal increase of 8.0%. The increase was driven by growth in our HPMS segment, offset by a decrease in SP and Corporate and Other.

Our HPMS segment saw an increase in revenue of $512 million to $4,720 million in 2015 compared to $4,208 million in 2014. The increase was primarily driven by the acquisition of Freescale and the inclusion of their activity from December 7, 2015, onward, increased demand in Secure Connected Devices with the ramp up of mobile transactions in high-end smartphone and tablet platforms and increased demand in Automotive, driven mainly by car entertainment products. These increases were partially offset by the divestment of RF Power on December 7, 2015. Our Secure Identification Solutions business remained essentially flat year on year.

Revenue for our SP segment decreased by $34 million to $1,241 million in 2015, compared to $1,275 million in 2014. The decrease was primarily due to decreased demand in general applications.

Revenue for Corporate and Other amounted to $140 million in 2015, compared to $164 million in 2014 and mainly related to our manufacturing operations.

Gross Profit

The following table presents gross profit by segment for the years ended December 31, 2015 and 2014.


	2015				2014
($ in millions, unless otherwise stated)	Gross Profit		% of segment revenue		Gross Profit		% of segment revenue
HPMS		2,367		50.1		2,253		53.5
SP		417		33.6		382		30.0
Corporate and Other		3		2.1		5		3.0

Total		2,787		45.7		2,640		46.8

Gross profit in 2015 was $2,787 million, or 45.7% of revenue compared to $2,640 million, or 46.8% of revenue in 2014, an increase of $147 million. Our gross profit is heavily influenced by customer mix, product mix and manufacturing costs.

Our HPMS segment had a gross profit of $2,367 million, or 50.1% of revenue in 2015, compared to $2,253 million, or 53.5% of revenue in 2014. The decrease in the gross profit percentage of 3.4 points as a percentage of revenue was primarily driven by the impact of purchase accounting on inventory of $149 million and property, plant and equipment of $15 million, as a result of the merger with Freescale.

Gross profit in our SP segment was $417 million, or 33.6% of revenue in 2015, compared to $382 million, or 30.0% of revenue in 2014. The increase in the gross profit percentage of 3.6 points was primarily driven by a more beneficial product mix and improved manufacturing costs.

Operating Expenses

The following table presents operating expenses by segment for the years ended December 31, 2015 and 2014.


	2015				2014
($ in millions, unless otherwise stated)	Operating expenses		% of segment revenue		Operating expenses		% of segment revenue
HPMS		1,674		35.5		1,278		30.4
SP		223		18.0		262		20.5
Corporate and Other		138		—		61		—

Total		2,035		33.4		1,601		28.4

The following table below presents the composition of operating expenses by line item in the statement of operations.


($ in millions, unless otherwise stated)	2015		2014
Research and development		890		763
Selling, general and administrative		922		686
Amortization of acquisition-related intangible assets		223		152

Operating expenses		2,035		1,601

Operating expenses were $2,035 million, or 33.4% of revenue in 2015, compared to $1,601 million, or 28.4% of revenue in 2014, an increase of $434 million, or an increase of 5.0 points as a percentage of revenue. The increase in operating expenses was primarily due to the acquisition of Freescale: the inclusion of their activity from December 7, 2015 onward and the related amortization of acquisition related intangibles of $105 million, the restructuring charge of $226 million, the charge for the acceleration of share-based compensation costs of $49 million for employees terminated in relation to the Merger and $42 million of merger-related costs.

In our HPMS segment, operating expenses amounted to $1,674 million, or 35.5% of revenue in 2015, compared to $1,278 million, or 30.4% of revenue in 2014. The increase was primarily driven by the acquisition of Freescale—the inclusion of their activity from December 7, 2015 onward and the related amortization of acquisition related intangibles of $105 million, the restructuring charge of $226 million and the charge for the acceleration of share-based compensation costs of $49 million for employees terminated in relation to the Merger.

Operating expenses in our SP segment decreased to $223 million, or 18.0% of revenue in 2015 compared to $262 million or 20.5% of revenue in 2014. The decrease in operating expenses was mainly driven by a strong focus on cost control to compensate for the decrease in revenue.

Operating expenses in Corporate and Other increased by $77 million to $138 million in 2015 compared to $61 million in 2014. The increase compared to the prior year period was primarily due to merger-related costs in connection with the acquisition of Freescale as noted above.

Restructuring Charges

Total restructuring and restructuring related costs amounted to $264 million in 2015 compared to $57 million in 2014.

In 2015, restructuring charges included employee severance costs of $239 million, and other exit costs of $27 million. The majority of these costs related to the acquisition of Freescale.

In 2014, we had restructuring charges, which related to a workforce reduction charge as a result of redundancy at our ICN 8 wafer fab in Nijmegen of $16 million and at our wafer fab in Hamburg of $5 million. The remaining restructuring and restructuring related costs were for the cumulative impact of specific targeted actions.

Other Income (Expense)

The following table presents other income (expense) for the years ended December 31, 2015 and 2014.


($ in millions, unless otherwise stated)		2015				2014
Other income (expense)			1,263				10

Other income (expense) reflects income of $1,263 million for 2015 compared to $10 million of income in 2014. Included in 2015 is the gain on the sale of NXP’s Bipolar Power business line and RF Power business to JAC Capital in the fourth quarter average of 2015. We established a 49% owned joint venture (JV) with JAC Capital to combine NXP’s advanced technology from its Bipolar Power business line with JAC Capital’s connections in the Chinese manufacturing network and distribution channels. The results of the Bipolar Power business were previously consolidated in the reportable segment SP. The new joint venture will be reported in Corporate and Other going forward. The results of the RF Power business were previously consolidated in the reportable segment HPMS.

Financial Income (Expense)


($ in millions)		For the years ended December 31,
	2015				2014
Interest income			6			3
Interest expense			(227	)		(158	)
Foreign exchange rate results			(193	)		(246	)
Net gain (loss) on extinguishment of debt			—			(3	)
Change in fair value of the warrant liability			(31	)		(2	)
Other			(84	)		(64	)

Total			(529	)		(410	)

Financial income (expense) was an expense of $529 million in 2015, compared to an expense of $410 million in 2014. In 2015, financial income (expense) included a loss of $193 million as a result of changes in foreign exchange rates mainly applicable to the re-measurement of our U.S. dollar-denominated notes and short-term loans, which reside in a euro functional currency entity, compared to a loss of $246 million in 2014. Net interest expense amounted to $221 million in 2015 compared to $155 million in 2014. The increase in net interest expense was due to interest on our outstanding Term Loans, the Cash Convertible Senior Notes and the Secured Notes that we assumed in the acquisition of Freescale, together with the amortization of related debt issuance costs and the accretion of the debt discount on the newly issued Term Loan B and on the Cash Convertible Senior Notes. Starting in 2016, we expect to incur significantly higher aggregate interest expense due to the full annual effect of the borrowings we incurred to acquire Freescale, including the impact of purchase accounting on such debt. The related debt issuance costs will be charged to interest expense using the effective interest method over the respective borrowing terms. The change in fair value of the warrant liability, an expense of $31 million, resulted from the mark-to-market adjustment on the Warrant liability due to the increase in NXP’s share price over the 12-month period (2014: $2 million). In 2015, other included expenses of $71 million related to the financing activities for the acquisition of Freescale. As of January 1, 2016, as a result of the acquisition of Freescale, NXP has concluded that the functional currency of the holding company is USD. Beginning from January 1, 2016, the warrants will now be classified in stockholders’ equity, and mark-to-market accounting will no longer be applicable. In addition our U.S. dollar-denominated notes and short-term loans will no longer need to be re-measured.

Benefit (Provision) for Income Taxes

The effective tax rate was (7.0)% for 2015 compared with 6.3% for 2014. Our effective tax rate reflects the impact of our earnings being taxed in foreign jurisdictions at rates below the Netherlands statutory rate of 25.0%, and the relative mix of income and losses in these foreign jurisdictions including those where a full valuation allowance is recorded, in addition to tax incentives in certain jurisdictions. We recognized a benefit from income taxes of $104 million in 2015 compared with a provision for income taxes of $40 million in 2014. In 2015 we recognized a benefit from income taxes compared to a tax expense in 2014 due to increased tax benefits for R&D tax allowances & incentives, tax benefits from a change in the valuation allowance and the impact of purchase accounting on intangible assets in relation to the acquisition of Freescale.

Results Relating to Equity-accounted Investees

Results relating to the equity-accounted investees amounted to a gain of $9 million in 2015, compared to a gain of $8 million in 2014.

Non-controlling Interests

Non-controlling interests are related to the third party share in the results of consolidated companies, predominantly SSMC. Their share of non-controlling interests amounted to a profit of $73 million in 2015, compared to a profit of $68 million in 2014.

B. Liquidity and Capital Resources

Liquidity and Capital Resources

As of December 31, 2016, our cash balance was $1,894 million, of which $316 million was held by SSMC, our consolidated joint venture company with TSMC. Under the terms of our joint venture agreement with TSMC, a portion of this cash can be distributed by way of a dividend to us, but 38.8% of the dividend will be paid to our joint venture partner. In 2016, a dividend of $325 million was distributed, of which $126 million was distributed to the joint venture partner.

Taking into account the available undrawn amount under the RCF Agreement, we had access to $2,494 million of liquidity as of December 31, 2016.

Our capital expenditures were $389 million in 2016, compared to $341 million in 2015.

The total amount of cash used for financing activities amounted to $1,392 million.

As of December 31, 2016, we had an undrawn availability of $600 million remaining under the RCF Agreement.

For the year ended December 31, 2016, we incurred total net interest expense of $397 million compared to $221 million during 2015. The weighted average interest rates on our debt instruments as of December 31, 2016 and December 31, 2015 were 3.7% and 3.9%, respectively.

We repurchased 15.5 million shares of our common stock pursuant to our share buyback program during 2016 at a weighted average price of $82.36 per share.

Our sources of liquidity include cash on hand, cash flow from operations and amounts available under the RCF Agreement. We believe that, based on our current level of operations as reflected in our results of operations for the year ended December 31, 2016, these sources of liquidity will be sufficient to fund our operations, capital expenditures, and debt service for at least the next twelve months.

From time to time, we engage in discussions with third parties regarding potential acquisitions of, or investments in, businesses, technologies and product lines, such as our recent acquisition Freescale. Any such transaction could require significant use of our cash and cash equivalents, or require us to arrange for new debt and equity financing to fund the transaction. Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions. In the future, we may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay principal, premium, if any, and interest on our indebtedness. Our business may not generate sufficient cash flow from operations, or we may not have enough capacity under the RCF Agreement, or from other sources in an amount sufficient to enable us to repay our indebtedness, including the RCF Agreement, the Unsecured Notes or to fund our other liquidity needs, including working capital and capital expenditure requirements. In any such case, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. See Part I, Item 3D. Risk Factors. The Purchase Agreement restricts us from engaging in certain actions without Buyer’s approval, including material acquisitions outside the ordinary course of business.

Cash Flow from Operating Activities

In 2016 our operating activities provided $2,303 million in cash. This was primarily the result of net income of $259 million, adjustments to reconcile the net income of $1,673 million and changes in operating assets and liabilities of $371 million. The net income includes non-cash items, such as depreciation and amortization of $2,205 million, share-based compensation of $338 million, amortization of the discount on debt and debt issuance costs of $50 million, a loss on extinguishment of debt of $32 million and changes in deferred taxes of $925 million.

In 2015 our operating activities provided $1,330 million in cash. This was primarily the result of net income of $1,599 million and changes in operating assets and liabilities of $56 million. Net income includes non-cash items, such as the gain on the sale of assets of $1,263 million, depreciation and amortization of $517 million and share-based compensation of $216 million.

In 2014 our operating activities provided $1,468 million in cash. This was primarily the result of net income of $607 million and changes in operating assets and liabilities of $82 million. Net income includes non-cash items, such as depreciation and amortization, of $778 million.

Cash Flow from Investing Activities

Net cash used for investing activities amounted to $627 million in 2016 and principally consisted of cash outflows for purchases of interests in business (net of cash) of $202 million, capital expenditures of $389 million and $59 million for the purchase of identified intangible assets, mainly related to the purchase of licenses, partly offset by proceeds of $20 million from the sale of business (net of cash).

Net cash used for investing activities amounted to $430 million in 2015 and principally consisted of cash outflows for purchases of interests in business (net of cash) of $1,692 million, capital expenditures of $341 million and $12 million for the purchase of identified intangible assets, mainly related to the purchase of software offset by proceeds of $1,605 million from the sale of business (net of cash).

Net cash used for investing activities amounted to $387 million in 2014 and principally consisted of cash outflows for capital expenditures of $329 million and $36 million for the purchase of identified intangible assets, mainly related to the purchase of software.

Cash Flow from Financing Activities

Net cash used for financing activities was $1,392 million in 2016, $449 million in 2015 and $554 million in 2014. The cash flows related to financing transactions in 2016, 2015 and 2014 are primarily related to the financing activities described below under the captions 2016 Financing Activities, 2015 Financing Activities and 2014 Financing Activities, respectively.

In addition to the financing activities described below, net cash used for financing activities by year included:


	Year ended December 31,
	2016			2015			2014
Net (repayments) borrowings under revolving credit facility		—			—			(150	)
Proceeds from the sale of warrants		—			—			134
Cash paid for Notes hedge derivatives		—			—			(208	)
Dividends paid to non-controlling interests		(126	)		(51	)		(50	)
Cash proceeds from exercise of stock options		115			51			145
Purchase of treasury shares		(1,280	)		(475	)		(1,435	)
Excess tax benefits from share-based compensation plans		5			—			—

2016 Financing Activities

2020 Term Loan

On September 22, 2016, NXP entered into a new $1,440 million aggregate principal amount Senior Secured Term Loan Facility due December 7, 2020. Concurrently, NXP repaid the $1,440 million principal amount Senior Secured Term Loan Facility due December 7, 2020.

2022 Senior Unsecured Notes

On August 11, 2016, NXP B.V., together with NXP Funding LLC, issued U.S. dollar-denominated 3.875% Senior Unsecured Notes with an aggregate principal amount of $1,000 million, due September 1, 2022. The interest is payable semi-annually on March 1 and September 1 of each year, beginning on March 1, 2017. The Notes were issued at par and were recorded at their fair value of $1,000 million on the accompanying Consolidated Balance Sheet. NXP used the net proceeds from the offering of the Notes to redeem the remaining $960 million aggregate principal amount of its outstanding Senior Secured Notes due 2022 and to pay for certain costs and expenses related thereto.

2021 Additional Senior Unsecured Notes

On August 1, 2016, NXP B.V., together with NXP Funding LLC, issued an aggregate principal amount of $500 million of 4.125% Senior Unsecured Notes due 2021 (the “Additional Notes”). The Additional Notes were issued at a price of 101.875% and are of the same class as the existing 4.125% Senior Notes due 2021 originally issued on May 23, 2016. NXP used the net proceeds from the offering of the Additional Notes to redeem $200 million aggregate principal amount of its outstanding Senior Notes due 2016 and used the remainder of the proceeds for general corporate purposes.

2021 and 2023 Senior Unsecured Notes

On May 23, 2016, NXP B.V. together with NXP Funding LLC issued U.S. dollar-denominated 4.125% and 4.625% Senior Unsecured Notes with aggregate principal amounts of $850 million, due June 1, 2021 and $900 million, due June 1, 2023. The interest is payable semi-annually on June 1 and December 1 of each year, beginning on December 1, 2016. These Notes were issued at par and were recorded at their fair value of $850 million and $900 million, respectively, on the accompanying Consolidated Balance Sheet. NXP used the net proceeds from the offering of the Notes and cash on hand to repay $1,250 million aggregate principal amount of its existing Secured Term Loan B due 2020 and $500 million aggregate principal amount of its outstanding Senior Secured Notes due 2021.

2016 Senior Unsecured Notes

On February 23, April 27 and August 1, 2016, NXP B.V., together with NXP Funding LLC, issued redemption notices for an aggregate principal amount of $200 million, $100 million and $200 million, respectively, of its outstanding 3.5% Senior Unsecured Notes due 2016. The funds from this redemption came from available surplus cash.

2015 Financing Activities

RCF Agreement

On December 7, 2015, NXP B.V. and NXP Funding LLC, entered into a $600 million revolving credit facility agreement (the “RCF Agreement”). There are currently no borrowings under this facility.

Secured Bridge Term Credit Agreement

On December 7, 2015, NXP B.V. and NXP Funding LLC, entered into a $1,000 million secured bridge term credit facility agreement (the “Secured Bridge Term Credit Agreement”). The Secured Bridge Term Credit Agreement was repaid in full on December 16, 2015.

Secured Notes

In connection with the Merger, the Indenture, dated as of May 31, 2013 (the “2021 Freescale Indenture”), by and among Freescale Semiconductor, Inc. (the “Freescale Issuer”), an indirect, wholly-owned subsidiary of Freescale, Freescale Semiconductor Holdings II, Ltd., Freescale Semiconductor Holdings III, Ltd., Freescale Semiconductor Holdings IV, Ltd., Freescale Semiconductor Holdings V, Inc. and SigmaTel LLC (the “Freescale Indenture Guarantors”) and The Bank of New York Mellon Trust Company, N.A., as trustee (the “2021 Freescale Trustee”), governing Freescale’s 5.00% Senior Secured Notes due 2021 (the “2021 Freescale Notes”) and the Indenture, dated as of November 1, 2013 (the “2022 Freescale Indenture” and, together with the 2021 Freescale Indenture, the “Freescale Indentures”), by and among the Freescale Issuer, the Freescale Indenture Guarantors and Wells Fargo Bank, National Association, as trustee (the “2022 Freescale Trustee”, together with the 2021 Freescale Trustee, the “Freescale Trustees”), governing Freescale’s 6.00% Senior Secured Notes due 2022 (the “2022 Freescale Notes” and, together with the 2021 Freescale Notes, the “Secured Notes”) were amended and restated on December 7, 2015 (the “A&R Freescale Indentures”). In accordance with the A&R Freescale Indentures, among other things, (x) certain amendments previously approved by the holders of the Freescale Notes as part of the consents solicitations that launched on March 23, 2015 and closed on April 2, 2015 became operative and (y) the NXP B.V., NXP Funding LLC, NXP Semiconductors Netherlands B.V., NXP Semiconductors UK Limited, NXP Semiconductors USA, Inc., NXP Semiconductors Germany GmbH, NXP Semiconductors Hong Kong Limited, NXP Semiconductors Philippines Inc., NXP Semiconductors Singapore Pte. Ltd., NXP Semiconductors Taiwan Ltd. and NXP Manufacturing (Thailand) Ltd. entered into and acceded to the A&R Freescale Indentures as additional guarantors.

2020 Senior Unsecured Notes and 2022 Senior Unsecured Notes

On June 9, 2015 our subsidiary, NXP B.V. together with NXP Funding LLC issued U.S dollar-denominated 4.125% and 4.625% Senior Unsecured Notes with an aggregate principal amounts of $600 million due 2020 and $400 million due 2022, respectively (the “2020 Senior Unsecured Notes” and the “2022 Senior Unsecured Notes”). The 2020 Senior Unsecured Notes bear interest at a rate of 4.125% per year, while the 2022 Senior Unsecured Notes bear interest at a rate of 4.625% per year, payable semi-annually on June 15 and December 15 of each year, beginning on December 15, 2015. The 2020 Senior Unsecured Notes will mature on June 15, 2020. The 2022 Senior Unsecured Notes will mature on June 15, 2022. The 2020 Senior Unsecured Notes and the 2022 Senior Unsecured Notes were issued at par and were recorded at their fair value of $600 million and $400 million, respectively, on the accompanying Consolidated Balance Sheet.

Term Loan B

On December 7, 2015, NXP B.V. and NXP Funding LLC, in connection with the Merger entered into a $2,700 million secured term credit agreement (the “Secured Term Credit Agreement”). The term loan under the Secured Term Credit Agreement was issued at 99.25% of par and was recorded at a fair value of $2,680 million on the accompanying Consolidated Balance Sheet.

The net proceeds of the 2020 Senior Unsecured Notes and 2022 Senior Unsecured Notes, together with the net proceeds of the Term Loan B, the Secured Bridge Term Credit Agreement, cash-on-hand and/or other available financing resources, were used to (i) pay the cash consideration in connection with the acquisition of Freescale, (ii) effect the repayment of certain amounts under Freescale’s outstanding credit facility and (iii) pay certain transaction costs.

2014 Financing Activities

2017 Term Loan

On February 18, 2014, our subsidiary, NXP B.V. together with NXP Funding LLC entered into a new $400 million aggregate principal amount Senior Secured Term Loan Facility due March 4, 2017 (the “2017 Term Loan”). Concurrently, NXP repaid the $486 million principal amount Senior Secured Term Loan Facility due March 4, 2017. A $100 million draw-down under our existing Revolving Credit Facility and $5 million of cash on hand were used to settle the combined transactions, as well as pay the related call premium of $5 million and accrued interest of $4 million.

2019 Cash Convertible Senior Notes

On November 24, 2014, NXP issued 2019 Cash Convertible Senior Notes with an aggregate principal amount of $1,150 million, which mature December 1, 2019. The 2019 Cash Convertible Senior Notes were issued at par and were recorded at their fair value of $1,150 million on the accompanying Consolidated Balance Sheet. We used the net proceeds of $1,134 million (i) to fund the cost of

entering into the cash convertible note hedge transactions (the cost of which were partially offset by the proceeds that NXP received from entering into warrant transactions) with certain hedge counterparties, as described below, (ii) to repay up to €225 million in respect of intercompany loans to our subsidiary NXP B.V., (iii) to fund the repurchase of $150 million of our common stock in privately negotiated transactions conducted concurrently with the pricing of the 2019 Cash Convertible Senior Notes, and (iv) for general corporate purposes, including additional share repurchases and potential acquisitions.

In connection with the pricing of the 2019 Cash Convertible Senior Notes, NXP entered into separate privately negotiated cash convertible note hedge and warrant transactions with counterparties that include the initial purchasers of the 2019 Cash Convertible Senior Notes or their respective affiliates (the “hedge counterparties”). The cash convertible note hedge transactions will be cash settled upon exercise and are expected generally to offset any cash payments NXP is required to make in excess of the principal amount of the 2019 Cash Convertible Senior Notes upon conversion. The warrant transactions will be net share settled upon exercise and could therefore have a dilutive effect with respect to NXP’s common stock to the extent that the market price per share of NXP’s common stock exceeds the strike price of the warrants. The strike price of the warrant transactions will initially be $133.32 per share, which represents a premium of 75% over the last reported sale price of NXP’s common stock on November 24, 2014, and is subject to certain adjustments under the terms of the warrant transactions.

Debt Position

Short-term Debt

As of December 31, 2016, our short-term debt amounted to $421 million.

As of December 31, 2015, our short-term debt of $556 million included other short-term bank borrowings of $6 million, related to a local bank loan in China.

Long-term Debt

As of December 31, 2016, we had outstanding debt of:


($ in millions)	December 31, 2015		Accrual/release Original Issuance/Debt Discount and Debt Issuance Cost			Debt Exchanges/ Repurchases/New Borrowings			Other(17)			December 31, 2016
U.S. dollar-denominated secured term credit agreement due March 2017 (1)		386		2			—			(388	)		—
U.S. dollar-denominated secured term credit agreement due January 2020 (2)		382		1			—			(4	)		379
U.S. dollar-denominated secured term credit agreement due December 2020 (3)		2,632		23			(1,264	)		14			1,405
U.S. dollar-denominated 3.75% senior unsecured notes due June 2018 (4)		746		2			—			—			748
U.S. dollar-denominated 4.125% senior unsecured notes due June 2020 (5)		594		1			—			—			595
U.S. dollar-denominated 5.75% senior unsecured notes due February 2021 (6)		496		1			—			—			497
U.S. dollar-denominated 5.00% senior secured notes due May 2021 (7)		519		—			(500	)		(19	)		—
U.S. dollar-denominated 6.00% senior secured notes due January 2022 (8)		1,022		—			(960	)		(62	)		—
U.S. dollar-denominated 4.125% senior unsecured notes due June 2021 (9)		—		(1	)		1,350			—			1,349
U.S. dollar-denominated 4.625% senior unsecured notes due June 2022 (10)		396		1			—			—			397
U.S. dollar-denominated 4.625% senior unsecured notes due June 2023 (11)		—		(7	)		900			—			893
U.S. dollar-denominated 3.875% senior unsecured notes due June 2023 (12)		—		(7	)		1,000			—			993
U.S. dollar-denominated 5.75% senior unsecured notes due March 2023 (13)		496		—			—			—			496
U.S. dollar-denominated 1.00% cash convertible senior notes due December 2019 (14)		972		42			—			—			1,014

		8,641		58			526			(459	)		8,766
RCF Agreement (15)		—											—
Other long-term debt (16)		15		—			—			(15	)		—

Total long-term debt		8,656		58			526			(474	)		8,766

(1)	On February 18, 2014, we entered into the 2017 Term Loan for an aggregate principal amount of $400 million at a rate of interest of LIBOR plus 2.00% with a floor of 0.75%.

(2)	On November 27, 2013, we entered into the 2020 Term Loan for an aggregate principal amount of $400 million at a rate of interest of LIBOR plus 2.50% with a floor of 0.75%.

(3)	On September 22, 2016, we entered into a new Term Loan F for an aggregate principal amount of $1,440 million at a rate of interest of LIBOR plus 2.50% with a floor of 0.00%.

(4)	On May 20, 2013, we issued $750 million aggregate principal amount of 3.75% Senior Unsecured Notes due 2018.

(5)	On June 9, 2015, we issued $600 million aggregate principal amount of 4.125% Senior Unsecured Notes due 2020.

(6)	On February 14, 2013, we issued $500 million aggregate principal amount of 5.75% Senior Unsecured Notes due 2021.

(7)	On December 7, 2015, we entered into the A&R Indenture governing the 2021 Freescale Notes, Freescale’s 5.00% Senior Secured Notes due 2021. The notes were fully redeemed in 2016.

(8)	On December 7, 2015, we entered into the A&R Indenture governing the 2022 Freescale Notes, Freescale’s 6.00% Senior Secured Notes due 2022. The notes were fully redeemed in 2016.

(9)	On May 23, 2016, and August 1, 2016, we issued $850 million and $500 million, respectively, aggregate principal amount of 4.125% Senior Unsecured Notes due 2021.

(10)	On June 9, 2015, we issued $400 million aggregate principal amount of 4.625% Senior Unsecured Notes due 2022.

(11)	On May 23, 2016, we issued $900 million aggregate principal amount of 4.625% Senior Unsecured Notes due 2023.

(12)	On August 11, 2016, we issued $1,000 million aggregate principal amount of 3.875% Senior Unsecured Notes due 2022.

(13)	On March 15, 2013, we issued $500 million aggregate principal amount of 5.75% Senior Unsecured Notes due 2023.

(14)	On November 24, 2014, we issued $1,150 million aggregate principal amount of 1.00% Cash Convertible Senior Notes due 2019.

(15)	On December 7, 2015, we entered into a $600 million Revolving Credit Facility agreement due 2020.

(16)	Other long-term debt consists primarily of capital lease obligations.

(17)	Other mainly relates to the reclassification of the current portion of long-term debt and the purchase price accounting step-up of the Freescale Notes.

We may from time to time continue to seek to retire or purchase our outstanding debt through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions or otherwise. See the discussion in the “Liquidity and Capital Resources” section in Part I, Item 5A. Operating Results and Part II, Item 10C. Material Contracts.

Certain Terms of the 2019 Cash Convertible Senior Notes

We have issued $1,150 million aggregate principal amount of 2019 Cash Convertible Senior Notes, which bear interest at 1.00% per annum and mature on December 1, 2019, unless earlier converted, repurchased or redeemed. The 2019 Cash Convertible Senior Notes pay interest on June 1 and December 1 of each year, beginning on June 1, 2015. The 2019 Cash Convertible Senior Notes are senior unsecured obligations of NXP Semiconductor N.V. and will be settled solely in cash upon conversion. We may not redeem the 2019 Cash Convertible Senior Notes prior to their maturity date other than following the occurrence of certain tax law changes as set forth in the indenture governing the 2019 Cash Convertible Senior Notes (the “Convertible Notes Indenture”). Upon the occurrence of certain events which constitute a “fundamental change” under the Convertible Notes Indenture, such as certain change of control, the holders of 2019 Cash Convertible Senior Notes may require us to repurchase for cash all or part of their 2019 Cash Convertible Senior Notes at a price equal to 100% of the principal amount thereof plus accrued and unpaid interest.

Prior to September 1, 2019, holders may convert their 2019 Cash Convertible Senior Notes only upon satisfaction of certain conditions specified in the Convertible Notes Indentures. On or after September 1, 2019 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may, at their option, convert their 2019 Cash Convertible Senior Notes solely into cash at any time.

Upon conversion, in lieu of receiving any shares of our common stock, a holder will receive, per $1,000 principal amount of 2019 Cash Convertible Senior Notes being converted, an amount in cash equal to the settlement amount, determined as described in the Convertible Notes Indenture. The conversion rate will initially be 9.7236 shares of our common stock per $1,000 principal amount (equivalent to an initial conversion price of $102.84 per share). The conversion rate for the 2019 Cash Convertible Senior Notes is subject to customary anti-dilution adjustments and will also be adjusted for any fundamental change or tax redemption, each as described in the Convertible Notes Indenture.

Concurrently with the issuance of the 2019 Cash Convertible Senior Notes, we entered into cash convertible note hedge and warrant transactions. For further information on the cash convertible note hedge and warrant transactions, please see “—Financial Instruments.”

Cash Convertible Note Hedge Transactions and Warrant Transactions

On November 24, 2014 and November 25, 2014, in connection with our issuances of the 2019 Cash Convertible Senior Notes, we entered into cash convertible note hedge transactions with affiliates of the initial purchasers of the 2019 Cash Convertible Senior Notes (in such capacity, the “Option Counterparties”) to offset any cash payment we are required to make in excess of the principal amount of the 2019 Cash Convertible Senior Notes.

In these transactions, we paid $208 million for call options relating to, subject to customary anti-dilution adjustments, 11.18 million shares of NXP’s common stock (which is equal to the number of shares that initially underlie the 2019 Cash Convertible Senior Notes), with a strike price of $102.84 per share. The Option Counterparties or their respective affiliates may enter into, or unwind, various over-the-counter derivatives and/or purchase or sell our common stock in open market and/or privately negotiated transactions prior to maturity of the 2019 Cash Convertible Senior Notes, including during any observation period for the settlement of conversions of the 2019 Cash Convertible Senior Notes, or upon any repurchase of the 2019 Cash Convertible Senior Notes by us, which could adversely impact the price of our common stock and of the 2019 Cash Convertible Senior Notes.

Separately, we sold warrants to the Option Counterparties for $134 million giving them the right to purchase from us, subject to customary anti-dilution adjustments, 11.18 million shares of NXP’s common stock, with a strike price of $133.32 per share. The warrants will have a dilutive effect with respect to our common stock to the extent that the market price per share of our common stock exceeds the strike price of the warrants on or prior to the expiration date of the warrants.

C. Research and Development, Patents and Licenses, etc.

Research and Development

We believe that our future success depends on our ability to both improve our existing products and to develop new products for both existing and new markets. We direct our research and development efforts largely to the development of new High Performance Mixed Signal semiconductor solutions where we see significant opportunities for growth. We target applications that require stringent overall system and subsystem performance. As new and challenging applications proliferate, we believe that many of these applications will benefit from our solutions. We have assembled a global team of highly skilled semiconductor and embedded software design engineers with expertise in RF, analog, power management, interface, security and digital processing. As of December 31, 2016, we had 8,520 employees in research and development, of which 8,151 support our High Performance Mixed Signal businesses and 369 support our Standard Products businesses. Our research and development expenses were $1,560 million in 2016 (of which 95% related to our High Performance Mixed Signal businesses) and $890 million in 2015.

To outpace market growth we invest in research and development to extend or create leading market positions, with an emphasis on fast growing sizable market segments, such as identification and smart mobile, and emerging markets, such as the Internet of Things and automotive solid state lighting. Finally, we invest a few percent of our total research and development expenditures in research activities that develop fundamental new technologies or product categories that could contribute significantly to our company growth in the future.

We annually perform a fundamental review of our business portfolio and our related new product and technology development opportunities in order to decide on changes in the allocation of our research and development resources. For products targeting established markets, we evaluate our research and development expenditures based on clear business need and risk assessments. For break-through technologies and new market opportunities, we look at the strategic fit and synergies with the rest of our portfolio and the size of the potential addressable market. Overall, we allocate our research and development to maintain a healthy mix of emerging growth and mature businesses.

Intellectual Property

The creation and use of intellectual property is a key aspect of our strategy to differentiate ourselves in the marketplace. We seek to protect our proprietary technologies by obtaining patents, trademarks, domain names, retaining trade secrets and defending, enforcing and utilizing our intellectual property rights, where appropriate. We believe this strategy allows us to preserve the advantages of our products and technologies, and helps us to improve the return on our investment in research and development. We have a broad portfolio of 9,000 patent families (each patent family including all patents and patent applications originating from the same invention). To protect certain confidential technical information and software, we rely on copyright and trade secret law and enter into confidentiality agreements as applicable. In situations where we believe that a third party has infringed on our intellectual property, we enforce our rights through all available legal means to the extent that we determine the benefits of such actions to outweigh any costs and risks involved.

We own a number of trademarks that are used in the conduct of our business. Where we consider it desirable, we develop names for our new products and secure trademark protection. Our trademarks allow us to further distinguish our company and our products and are important in our relationships with customers, suppliers, partners and end-users.

While our patents, trademarks, trade secrets and other intellectual property rights constitute valuable assets, we do not view any individual right or asset as being material to our operations as a whole. We believe it is the combination of our patents and other intellectual property rights and assets that creates an advantage for our business.

In addition to obtaining our own patents and other intellectual property rights, we have entered into licensing agreements and other arrangements authorizing us to use intellectual property rights, confidential technical information, software and related technology owned by third parties. We also engage, in certain instances, in licensing and selling of certain of our own patents and technology.

D. Trend Information

Within the overall umbrella of Secure Connections for a Smarter World, NXP addresses four key macro growth trends: Intelligent Devices, Mobility, Hyper-connectivity and Security that drive applications such as the Connected Car, Portable & Wearable and the Internet of Things, with Security being a requirement across all applications. Our innovative solutions are used in a wide range of applications. Many electronic payment and government ID services are enabled by our secure identification solutions and with the transition of those services to new form factors in secure connected devices, there is strong market demand for embedded security solutions such as mobile payment, cyber-security and authentication. Fast innovation in smart phones & tablets drives demand for our secure interface and power solutions while always-on requirements in secure connected devices further drive demand for our advanced mobile audio, sensing and connectivity solutions, with advanced magnetic induction radios for implantable medical devices such as hearing aids as an example. Cities, buildings and industrial production systems all want to become smart, connected and secure; they provide fertile new markets for our broad range of microcontrollers smart grid, intelligent logistics and industrial security solutions. Next generation networks which deliver the increasing demand for data are enabled by our new high-performance RF power amplifier products allow wireless network operators to expand network capacity with fewer base stations and Digital Networks. Our new high-performance RF power amplifier products allow wireless network operators to expand network capacity with fewer base stations. The automotive industry brings fast trends in advanced driver assistance, seamless consumer electronics experience and energy efficiency, and we respond to those by delivering solutions for secure car access, car entertainment and in-vehicle networking. In addition, we leverage our core competencies to innovate in the transition to highly and eventually fully automated cars with ground breaking solutions in secure vehicle-to-infrastructure & vehicle-to-vehicle and radar.

We believe that we are strategically positioned to capture rapid growth in emerging markets through our strong position in Asia Pacific (excluding Japan), which represented 62% of our revenue in 2016, compared to 69% of our revenue in 2015. In particular, Greater China represented 42% of our revenue in 2016, compared to 53% of our revenue in 2015.

E. Off-balance Sheet Arrangements

As of December 31, 2016, we had no material off-balance sheet arrangements.

F. Tabular Disclosure of Contractual Obligations

Presented below is a summary of our contractual obligations as of December 31, 2016.


($ in millions)	Total		2017		2018		2019		2020		2021		2022 and thereafter
Long-term and short-term debt (1)		9,361		406		768		1,167		2,370		1,850		2,800
Capital lease obligations		15		15		—		—		—		—		—
Operating leases		113		33		23		17		12		5		23
Interest on the notes (2)		1,514		338		319		306		267		156		128
Long-term purchase contracts		550		397		43		48		14		14		34

Total contractual cash obligations (2)(3)(4)		11,553		1,189		1,153		1,538		2,663		2,025		2,985

(1)	The amounts noted herein represent contractual payments of principal only.

(2)	The cash interest on the notes was determined on the basis of LIBOR interest rates for floating rate instruments and on the basis of contractual agreed interest rates for other debt instruments.

(3)	As of December 31, 2016, we had reserves of $158 million recorded for uncertain tax positions, including interest and penalties. We are not including this amount in the long-term contractual obligations table presented because of the difficulty in making reasonably reliable estimates of the timing of cash settlements, if any, with the respective taxing authorities.

(4)	Certain of these obligations are denominated in currencies other than U.S. dollars, and have been translated from foreign currencies into U.S. dollars based on an aggregate average rate of $1.1065 per €1.00, in effect at December 31, 2016. As a result, the actual payments will vary based on any change in exchange rate.

Our debt instruments had accrued interest of $48 million as of December 31, 2016 (December 31, 2015: $46 million).

In addition to the above obligations, we enter into a variety of agreements in the normal course of business, containing provisions that certain penalties may be charged if we do not fulfill our commitments. It is not possible to predict with certainty the maximum potential amount of future payments under these or similar provisions due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular case. Historically, payments pursuant to such provisions have not been material and we believe that any future payments required pursuant to such provisions would not have a material adverse effect on our consolidated financial condition. However, such payments may be material to our consolidated statement of operations for a specific period.

We sponsor pension plans in many countries in accordance with legal requirements, customs and the local situation in the countries involved. These are defined-benefit pension plans, defined contribution pension plans and multi-employer plans. Contributions to funded pension plans are made as necessary, to provide sufficient assets to meet future benefits payable to plan participants. These contributions are determined by various factors, including funded status, legal and tax considerations and local customs. The expected cash outflows in 2016 and subsequent years are uncertain and may change as a consequence of statutory funding requirements as well as changes in actual versus currently assumed discount rates, estimations of compensation increases and returns on pension plan assets.

G. Safe Harbor

This Annual Report includes forward-looking statements. When used in this Annual Report, the words “anticipate”, “believe”, “estimate”, “forecast”, “expect”, “intend”, “plan” and “project” and similar expressions, as they relate to us, our management or third parties, identify forward-looking statements. Forward-looking statements include statements regarding our business strategy, financial condition, results of operations and market data, as well as any other statements that are not historical facts. These statements reflect beliefs of our management, as well as assumptions made by our management and information currently available to us. Although we believe that these beliefs and assumptions are reasonable, these statements are subject to numerous factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those projected. These factors, risks and uncertainties expressly qualify all subsequent oral and written forward-looking statements attributable to us or persons acting on our behalf and include, in addition to those listed under Part I, Item 3D. Risk Factors and elsewhere in this Report, the following:

•		our ability to complete merger and acquisition-related activity and risks and uncertainties associated with the pending offer by Qualcomm River Holdings B.V., a wholly-owned subsidiary of QUALCOMM Incorporated, to purchase all of NXP’s outstanding common shares;

•		the diversion of management time on transaction-related issues;

•		the outcome of regulatory reviews of the transaction;

•		market demand and semiconductor industry conditions;

•		our ability to successfully introduce new technologies and products;

•		the demand for the goods into which our products are incorporated;

•		our ability to generate sufficient cash, raise sufficient capital or refinance our debt at or before maturity to meet both our debt service and research and development and capital investment requirements;

•		our ability to accurately estimate demand and match our production capacity accordingly;

•		our ability to obtain supplies from third-party producers;

•		our access to production from third-party outsourcing partners, and any events that might affect their business or our relationship with them;

•		our ability to secure adequate and timely supply of equipment and materials from suppliers;

•		our ability to avoid operational problems and product defects and, if such issues were to arise, to rectify them quickly;

•		our ability to form strategic partnerships and joint ventures and successfully cooperate with our alliance partners;

•		our ability to win competitive bid selection processes;

•		our ability to develop products for use in our customers’ equipment and products;

•		our ability to successfully hire and retain key management and senior product engineers; and

•		our ability to maintain good relationships with our suppliers.

We do not assume any obligation to update any forward-looking statements and disclaim any obligation to update our view of any risks or uncertainties described herein or to publicly announce the result of any revisions to the forward-looking statements made in this Report, except as required by law.

In addition, this Report contains information concerning the semiconductor industry and business segments generally, which is forward-looking in nature and is based on a variety of assumptions regarding the ways in which the semiconductor industry, our market and business segments will develop. We have based these assumptions on information currently available to us, including through the market research and industry reports referred to in this Report. Although we believe that this information is reliable, we have not independently verified and cannot guarantee its accuracy or completeness. If any one or more of these assumptions turn out to be incorrect, actual market results may differ from those predicted. While we do not know what impact any such differences may have on our business, if there are such differences, they could have a material adverse effect on our future results of operations and financial condition, and the trading price of our common stock.

Previous: Item 4A. Unresolved Staff Comments · Next: Item 6. Directors, Senior Management and Employees

Item 5. Operating and Financial Review and Prospects

Item 5. Operating and Financial Review and Prospects

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