Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with our audited historical consolidated financial statements, including the notes thereto, which are included elsewhere in this Form 10-K. Management’s Discussion and Analysis of Financial Condition and Results of Operations contains statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risk, uncertainties, and other factors. Actual results could differ materially because of the factors discussed in “Risk Factors” included elsewhere in this Form 10-K.

Executive Overview

This executive overview presents summarized information regarding our industry, markets, business, and operating trends only. For further information relating to the information summarized herein, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in its entirety.

Industry Overview

According to WSTS (an industry research firm), worldwide semiconductor industry sales were $468.8 billion in 2018, an increase of approximately 13.7% from $412.2 billion in 2017. We participate in unit and revenue surveys and use data summarized by WSTS to evaluate overall semiconductor market trends and also to track our progress against the market in the areas we provide semiconductor components. The following table sets forth total worldwide semiconductor industry revenue and revenue in our Serviceable Addressable Market (“SAM”) since 2014:


Year Ended December 31,	Worldwide Semiconductor Industry Sales (1)		Percentage Change		Serviceable Addressable Market Sales (1) (2)		Percentage Change
	(in billions)				(in billions)
2018	$	468.8		13.7 %	$	82.0		10.2 %
2017	$	412.2		21.6 %	$	74.4		12.6 %
2016	$	338.9		1.1 %	$	66.1		5.4 %
2015	$	335.2		(0.2)%	$	62.7		(1.9)%
2014	$	335.8		9.9 %	$	63.9		11.5 %

(1)	Based on shipment information published by WSTS. We believe the data provided by WSTS is reliable, but we have not independently verified it. WSTS periodically revises its information. We assume no obligation to update such information.

(2)

From time to time, we reassess the WSTS product categories that our SAM comprises. For comparison purposes, the information for 2014 through 2017 in the table above has been revised from previously-reported SAM sales to reflect our current assessment. Our SAM comprises mainly the following WSTS product categories: (a) discrete products, which includes diodes, small signal transistors, power transistors and modules, rectifiers and thyristors; (b) image sensors; (c) general purpose analog; (d) application specific analog for computer, automotive, and industrial; and (e) MOS general purpose logic. Our SAM is derived using the most recent information available, excluding foundry exposure, at the time of the filing of each respective period’s annual report and is revised in subsequent periods to reflect final results.

As indicated above, worldwide semiconductor sales increased from $335.8 billion in 2014 to $468.8 billion in 2018. The increase of 13.7% from 2017 to 2018 was the result of increased demand for semiconductor products. Sales in our SAM increased from $63.9 billion in 2014 to $82.0 billion in 2018. The increase of 10.2% from 2017 to 2018 is consistent with the trend in the worldwide semiconductor market.

ON Semiconductor Overview

Our new product development efforts continue to be focused on building solutions in product areas that appeal to customers in focused market segments and across multiple high-growth applications. We collaborate with our customers to identify desired innovations in electronic systems in each end-market that we serve. This enables us to participate in the fastest growing sectors of the market. We also innovate in advanced packaging technologies to support ongoing size reduction in electronic systems and in advanced thermal packaging to support high performance power conversion applications. It is our practice to regularly re-evaluate our research and development spending, to assess the deployment of resources and to review the funding of high-growth technologies. We deploy people and capital with the goal of maximizing our investment in research and development in order to facilitate continued growth by targeting innovative products and solutions for high growth applications that position us to outperform the industry. Our design expertise in analog, digital, mixed signal and imaging ICs, combined with our extensive portfolio of standard products enable the company to offer comprehensive, value-added solutions to our global customers for their electronics systems.

We believe that some of the key factors and trends affecting our results of operations include, but not limited to:

	•		Macroeconomic conditions affecting the semiconductor industry;

	•		The cyclicality and seasonality of the semiconductor industry;

	•		The global economic climate;

	•		Our significant indebtedness, including the indebtedness incurred in connection with our acquisition of Fairchild;

	•		The impact of U.S. corporate tax reform and an uncertain corporate tax environment abroad;

	•		An uncertain political climate and related impacts on global trade, such as tariffs on imports into the U.S. from China;

	•		The effects of trends in the automotive and industrial end-markets on our revenue; and

	•		Competitive conditions, and in particular, consolidation, within our industry.

Recent ON Semiconductor Results

Our total revenue for the year ended December 31, 2018 was $5,878.3 million, an increase of approximately 6.0% from $5,543.1 million from the year ended December 31, 2017. The increase was primarily attributable to an increase in revenue in our Power Solutions Group and Analog Solutions Group as a result of better demand. During 2018, we reported net income attributable to ON Semiconductor of $627.4 million compared to $810.7 million in 2017. Net income attributable to ON Semiconductor for the year ended December 31, 2017 was positively impacted by $449.9 million relating to the U.S. tax reform as well as the change in revenue recognition from sell-through to sell-in for shipment to our distributors. Excluding the impact of these items, the improved results for 2018 were attributable to healthy end-user demand for our products and contributions from the acquired Fairchild business. Our gross margin increased by approximately 140 basis points to 38.1% in 2018 from 36.7% in 2017. The increase in gross margin was primarily due to more favorable product mix.

Business and Macroeconomic Environment Influence on Cost Savings and Restructuring Activities

We have historically pursued, and expect to continue to pursue, cost-saving initiatives to align our overall cost structure, capital investments and other expenditures with our expected revenue, spending and capacity levels based on our current sales and manufacturing projections. We have recognized efficiencies from previously implemented restructuring activities and programs and continue to implement profitability enhancement programs to improve our cost structure. The semiconductor industry has traditionally been highly cyclical and has often experienced significant downturns in connection with, or in anticipation of, declines in general economic conditions. We have historically taken significant actions to align our overall cost structure with our expectations of market conditions and by focusing on synergies-related cost reductions arising from each of our acquisitions. However, there can be no assurances that we will adequately forecast economic conditions or that we will effectively align our cost structure, capital investments and other expenditures with our revenue, spending and capacity levels in the future.

See “Results of Operations—Restructuring, asset impairments and other, net” below, along with Note 7: “Restructuring, Asset Impairments and Other, Net” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for information relating to our most recent cost-saving initiatives.

Results of Operations

Our results of operations for the years ended December 31, 2018 and December 31, 2017 include the full year results, and our results of operations for the year ended December 2016 include the partial year results from our acquisition of Fairchild on September 19, 2016. Our results of operations for the year ended December 31, 2018 include the partial year results, from our acquisition of SensL on May 8, 2018.

Operating Results

The following table summarizes certain information relating to our operating results that has been derived from our audited consolidated financial statements (in millions):


	Year ended December 31,									Dollar Change

	2018			2017			2016			2017 to 2018			2016 to 2017
Revenue	$	5,878.3		$	5,543.1		$	3,906.9		$	335.2		$	1,636.2
Cost of revenue (exclusive of amortization shown below)		3,639.6			3,507.5			2,606.4			132.1			901.1

Gross profit		2,238.7			2,035.6			1,300.5			203.1			735.1
Operating expenses:
Research and development		650.7			594.7			446.8			56.0			147.9
Selling and marketing		324.7			316.6			236.7			8.1			79.9
General and administrative		293.3			285.0			230.0			8.3			55.0
Amortization of acquisition-related intangible assets		111.7			123.8			104.8			(12.1	)		19.0
Restructuring, asset impairments and other, net		4.3			20.8			33.2			(16.5	)		(12.4	)
Goodwill and intangible asset impairment		6.8			13.1			2.2			(6.3	)		10.9

Total operating expenses		1,391.5			1,354.0			1,053.7			37.5			300.3

Operating income		847.2			681.6			246.8			165.6			434.8

Other income (expense), net:
Interest expense		(128.2	)		(141.2	)		(145.3	)		13.0			4.1
Interest income		6.1			3.0			4.5			3.1			(1.5	)
Loss on debt refinancing and prepayment		(4.6	)		(47.2	)		(6.3	)		42.6			(40.9	)
Gain on divestiture of business		5.0			12.5			92.2			(7.5	)		(79.7	)
Licensing income		36.6			47.6			—			(11.0	)		47.6
Other expense		(7.1	)		(8.8	)		(11.3	)		1.7			2.5

Other income (expense), net		(92.2	)		(134.1	)		(66.2	)		41.9			(67.9	)

Income before income taxes		755.0			547.5			180.6			207.5			366.9
Income tax benefit (provision)		(125.1	)		265.5			3.9			(390.6	)		261.6

Net income		629.9			813.0			184.5			(183.1	)		628.5
Less: Net income attributable to non-controlling interest		(2.5	)		(2.3	)		(2.4	)		(0.2	)		0.1

Net income attributable to ON Semiconductor Corporation	$	627.4		$	810.7		$	182.1		$	(183.3	)	$	628.6

Revenue

Revenue was $5,878.3 million, $5,543.1 million and $3,906.9 million for 2018, 2017 and 2016, respectively.

Prior to the first quarter of 2017, we recognized revenue from distributors under the sell-through method as we did not have the ability to estimate the effects of returns and allowances. Beginning in the first quarter of 2017, we were able to estimate upfront the effects of returns and allowances and record revenue at the time of shipments to our distributors. This change resulted in us recognizing an additional $155.1 million in revenue during the first quarter of 2017, which resulted in an increase of $59.0 million to gross profit and income before income taxes for such period. The impact of this change is reflected in the discussion below.

The increase of $335.2 million, or approximately 6%, in revenue in 2018 compared to 2017 was primarily attributable to approximately 8% and 6% increases in revenue in our Power Solutions Group and Analog Solutions Group, respectively, as a result of better demand for these products. Excluding the one-time impact of the change in revenue recognition for the year ended December 31, 2017 amounting to $155.1 million, revenue increased $490.3 million, or approximately 9%.

The increase in revenue from 2017 compared to 2016 of $1,636.2 million, or approximately 42%, was primarily attributable to approximately 65% and 32% increases in revenue in our Power Solutions Group and Analog Solutions Group, respectively, as a result of increased demand for these products. The year 2017 included an entire twelve-month period of Fairchild revenue and $155.1 million in revenue due to the change in revenue recognition on distributor sales. Excluding the one-time impact of the change in revenue recognition for the year ended December 31, 2017, revenue increased $1,481.1 million, or approximately 38%.

Revenue by reportable segment for each were as follows (dollars in millions):


	2018		As a % of Revenue (1)		2017		As a % of Revenue (1)		2016		As a % of Revenue (1)
Power Solutions Group	$	3,038.2		51.7%	$	2,819.3		50.9%	$	1,708.6		43.7%
Analog Solutions Group		2,071.2		35.2%		1,950.9		35.2%		1,481.5		37.9%
Intelligent Sensing Group		768.9		13.1%		772.9		13.9%		716.8		18.3%

Total revenue	$	5,878.3			$	5,543.1			$	3,906.9

(1) Certain of the amounts may not total due to rounding of individual amounts.

Revenue from the Power Solutions Group

Revenue from the Power Solutions Group increased by $218.9 million, or approximately 8%, during 2018 compared to 2017, and increased by $1,110.7 million, or approximately 65%, during 2017 compared to 2016. Excluding the $107.8 million increase in revenue due to the change in revenue recognition on distributor sales during the year ended December 31, 2017, revenue increased by $326.7 million or 12% in 2018 compared to 2017.

The 2018 increase was primarily attributable to an increase in revenue of $165.9 million in our Power MOSFET division due to increased demand, an increase in revenue of our High Power division by $83.8 million due to entry into new markets, and to a lesser extent, $30.0 million increase in our Integrated Circuits division and $28.5 million increase in our Protection and Signal division also due to better demand.

The 2017 increase was primarily attributable to the acquisition of Fairchild, which had a full year contribution in 2017, as well as a $107.8 million impact due to the change in revenue recognition on distributor sales during the first quarter of 2017. These two factors contributed to increases in substantially all of the divisions within this segment, which resulted in a $417.8 million increase in revenue in our Power MOSFET division, a $327.8 million increase in revenue in our High Power division, and, to a lesser extent, $132.9 million increase in revenue in our Integrated Circuits division and $120.7 million increase in revenue in our Protection and Signal division.

Revenue from the Analog Solutions Group

Revenue from the Analog Solutions Group increased by $120.3 million, or approximately 6%, during 2018 compared to 2017 and increased by $469.4 million, or approximately 32%, during 2017 compared to 2016. Excluding the $42.1 million increase in revenue due to the change in revenue recognition on distributor sales during the year ended December 31, 2017, revenue increased by $162.4 million or 9% in 2018 compared to 2017.

The 2018 increase was primarily attributable to revenue in our Mobile and Computing Division increasing by $78.5 million, revenue in our Signal, Wireless and Medical Division increasing by $30.5 million and revenue in our Automotive Division increasing by $52.8 million, all due to increase in demand in the markets served.

The 2017 increase was primarily attributable to the acquisition of Fairchild, which had a full year contribution in 2017, as well as a $42.1 million impact due to the change in revenue recognition on distributor sales during the first quarter of 2017. These two factors contributed to increases in substantially all of the divisions within this segment, which resulted in a $150.6 million increase in revenue in our Mobile Solutions division, a $100.3 million increase in revenue in our Automotive division, a $97.5 million increase in revenue in our then Digital and DC/DC division and a $81.3 million increase in revenue in our Industrial and Offline Power division.

Revenue from the Intelligent Sensing Group

Revenue from the Intelligent Sensing Group decreased by $4.0 million, or approximately 1%, during 2018 compared to 2017 and increased by $56.1 million, or approximately 8%, during 2017 compared to 2016.

The 2018 decrease was primarily attributable to a decrease in our Consumer Solutions Division revenue by $52.6 million, primarily as a result of the exit of the Mobile CIS business and a $7.8 million decrease in our Industrial Solutions Division due to our de-emphasis of certain lower margin product lines as well as decreased demand, offset by an increase in our Automotive Solutions Division revenue by $56.6 million due to better demand in the markets served.

The 2017 increase was primarily attributable to an $84.9 million, or 29%, increase in revenue in our Automotive Solutions division, which was partially offset by a $39.6 million, or approximately 13%, decrease in revenue in our Consumer Solutions division as a result of the exit of the Mobile CIS business which occurred during the fourth quarter of 2016. For further information on the Mobile CIS business exit, see Note 5: “Acquisitions, Divestitures and Licensing Transactions”.

Revenue by Geographic Location

Revenue by geographic location, including local sales made by operations within each area, based on sales billed from the respective country, are as follows (dollars in millions):


	2018		As a % of Revenue (1)		2017		As a % of Revenue (1)		2016		As a % of Revenue (1)
Singapore	$	1,955.0		33.3%	$	1,466.9		26.5%	$	1,110.4		28.4%
Hong Kong		1,489.1		25.3%		1,785.0		32.2%		1,086.8		27.8%
United Kingdom		946.5		16.1%		668.8		12.1%		541.1		13.8%
United States		862.7		14.7%		748.8		13.5%		588.4		15.1%
Other		625.0		10.6%		873.6		15.8%		580.2		14.9%

Total	$	5,878.3			$	5,543.1			$	3,906.9

(1)	Certain of the amounts may not total due to rounding of individual amounts.

Gross Profit and Gross Margin (exclusive of amortization of acquisition-related intangible assets described below)

Our gross profit by reportable segment for each was as follows (dollars in millions):


	2018			As a % of Segment Revenue (1)		2017			As a % of Segment Revenue (1)		2016			As a % of Segment Revenue (1)
Power Solutions Group	$	1,110.1			36.5 %	$	959.8			34.0 %	$	567.5			33.2 %
Analog Solutions Group		878.3			42.4 %		817.8			41.9 %		590.2			39.8 %
Intelligent Sensing Group		317.1			41.2 %		302.6			39.2 %		237.7			33.2 %

Gross profit for all segments (2)	$	2,305.5				$	2,080.2				$	1,395.4
Unallocated manufacturing costs (3)		(66.8	)		(1.1)%		(44.6	)		(0.8)%		(94.9	)		(2.4)%

Total gross profit	$	2,238.7			38.1 %	$	2,035.6			36.7 %	$	1,300.5			33.3 %

(1) Certain of the amounts may not total due to rounding of individual amounts.

(2) Gross profit for the years ended December 31, 2017 and 2016 has been retrospectively adjusted due to the adoption of ASU 2017-07. See Note 1: “Background and Basis of Presentation” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

(3) Unallocated manufacturing costs are being shown as a percentage of total revenue (includes expensing of the fair market value step-up of inventory of $67.5 million during 2016, $13.6 million during 2017, and $1.0 million during 2018).

Our gross profit was $2,238.7 million, $2,035.6 million and $1,300.5 million for 2018, 2017 and 2016, respectively. The gross profit increase of $203.1 million, or approximately 10%, for 2018 compared to 2017 was primarily due to an increase in gross profit in our Power Solutions Group and Analog Solutions Group. Gross profit for the year ended December 31, 2017 was positively impacted by $59.0 million due to the change in revenue recognition on distributor sales and negatively impacted by $13.6 million of expensing fair market value of inventory step-up from the Fairchild Acquisition. Excluding these items, gross profit increased by $248.5 million, or 12%, for the year ended December 31, 2018.

The gross profit increase of $735.1 million, or approximately 57%, for 2017 compared to 2016 was primarily due to an increase in gross profit in our Power Solutions Group and Analog Solutions Group, which included a full-year of contributions from the acquired Fairchild business and the positive impact due to the change in revenue recognition on distributor sales. Gross profit improvement in the Intelligent Sensing Group of $64.9 million was due to increased revenue in high margin automotive and industrial markets offsetting decreased revenue on the exit of the Mobile CIS business.

Gross margin increased to approximately 38.1% during 2018 compared to approximately 36.7% during 2017. The increase was due to a combination of operational leverage as a result of better demand, entry into new markets, and product mix and was offset by slightly lower factory utilization.

Gross margin increased to approximately 36.7% during 2017 compared to approximately 33.3% during 2016. Excluding the expensing of the fair market value of inventory step-up from the Fairchild acquisition, gross margin increased to approximately 36.9% during 2017 compared to approximately 35.0% during 2016. The increase was primarily due to higher factory utilization, product mix, which included the mix shift in imaging products to higher margin automotive and industrial imaging products, and the exit of the lower margin Mobile CIS business.

Operating Expenses

Research and Development

Research and development expenses were $650.7 million, $594.7 million and $446.8 million for 2018, 2017 and 2016, respectively representing approximately 11% of revenue for each of the years.

The increase in research and development expenses of $56.0 million, or approximately 9%, during 2018 compared to 2017 was primarily in the area of payroll and payroll related costs due to additional headcount as well as an increase in the cost of materials utilized in research and development, offset by a decrease in variable compensation.

The increase in research and development expenses of $147.9 million, or approximately 33%, during 2017 compared to 2016 was primarily associated with the acquisition of Fairchild, which added several categories of research and development expenses. Research and development expenses unrelated to Fairchild increased primarily in the area of payroll, including incentive compensation and payroll related costs as well as an overall increase in variable compensation for the combined company.

Selling and Marketing

Selling and marketing expenses were $324.7 million, $316.6 million and $236.7 million for 2018, 2017 and 2016, respectively representing approximately 6% of revenue for each of the years.

The increase in selling and marketing expenses of $8.1 million, or approximately 3%, during 2018 compared to 2017 did not relate to any significant expense driver.

The increase in selling and marketing expenses of $79.9 million, or approximately 34%, during 2017 compared to 2016 was primarily associated with the acquisition of Fairchild, primarily in the area of payroll, including incentive compensation and payroll related costs as well as an overall increase in variable compensation for the combined company. There were also increases in expenses related to commissions and advertising.

General and Administrative

General and administrative expenses were $293.3 million, $285.0 million and $230.0 million, representing approximately 5%, 5% and 6% of revenue, for 2018, 2017 and 2016, respectively.

The increase in general and administrative expenses of $8.3 million, or approximately 3%, during 2018 compared to 2017 did not relate to any significant expense driver.

The increase in general and administrative expenses of $55.0 million, or approximately 24%, during 2017 compared to 2016 was primarily associated with the acquisition of Fairchild, primarily in the area of payroll, including incentive compensation and payroll related costs, as well as an overall increase in variable compensation for the combined company.

Amortization of Acquisition—Related Intangible Assets

Amortization of acquisition-related intangible assets was $111.7 million, $123.8 million and $104.8 million for 2018, 2017 and 2016, respectively. The decrease of $12.1 million during 2018 compared to 2017 was primarily due to the additional amortization of $8.1 million recorded during the year ended December 31, 2017, representing the value of the technology transferred under a licensing transaction.

The increase in amortization during 2017 compared to 2016 was primarily associated with the amortization of our intangible assets acquired from the Fairchild acquisition, partially offset by the declining amortization of our Aptina intangible assets.

See Note 5: “Acquisitions, Divestitures and Licensing Transactions” and Note 6: “Goodwill and Intangible Assets” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information with respect to intangible assets.

Restructuring, Asset Impairments and Other, Net

Restructuring, asset impairments and other, net was $4.3 million, $20.8 million and $33.2 million for 2018, 2017 and 2016, respectively. The information below summarizes the major activities in each year.

2018

During 2018, we recorded approximately $4.3 million of net charges attributable to the asset impairments and severance charges relating to the restructuring programs in effect during the period.

2017

During 2017, we recorded approximately $20.8 million of net charges related to our restructuring programs, consisting primarily of $9.7 million of post-Fairchild acquisition restructuring costs, $2.2 million of the former System Solutions Group voluntary workforce reduction program costs, $7.3 million of asset impairment charges primarily for assets held-for-sale and $3.7 million of other costs, partially offset by a reversal of $2.1 million relating to manufacturing relocation program costs.

2016

During 2016, we recorded approximately $33.2 million of net charges related to our restructuring programs, consisting primarily of $25.7 million of post-Fairchild acquisition restructuring costs, $5.3 million of the former System Solutions Group segment voluntary workforce reduction program costs, and $2.1 million of manufacturing relocation program costs.

For additional information, see Note 7: “Restructuring, Asset Impairments and Other, Net” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

Goodwill and Intangible Asset Impairment

Goodwill and intangible asset impairments were $6.8 million, $13.1 million and $2.2 million for 2018, 2017 and 2016, respectively. The information below summarizes the major activities in each year.

2018

During 2018, we recorded $3.3 million of goodwill impairment charges and $3.5 million relating to the impairment in the value of one project as a result of the indefinite-lived impairment test performed during the fourth quarter of 2018.

2017

During 2017, we recorded $13.1 million of intangible asset impairment charges consisting of $7.7 million relating to abandoned IPRD projects and $5.4 million relating to the impairment in the value of certain IPRD projects as a result of the indefinite-lived impairment test performed during the fourth quarter of 2017.

2016

During 2016, we canceled certain of our previously capitalized IPRD projects and recorded intangible asset impairment charges of $2.2 million.

See Note 6: “Goodwill and Intangible Assets” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information.

Other Income and Expenses

Interest Expense

Interest expense decreased by $13.0 million, or approximately 9%, to $128.2 million during 2018 compared to $141.2 million in 2017, primarily due to repayments of outstanding balances offset by a marginal increase in the interest rate of the Term Loan “B” Facility. Interest expense decreased by $4.1 million, or approximately 2.8%, to $141.2 million during 2017, down from $145.3 million in 2016, primarily due to the interest rate reduction under our Amended Credit Agreement. We recorded amortization of debt discount to interest expense of $36.1 million, $30.8 million and $26.0 million for 2018, 2017 and 2016, respectively. Our average gross amount of long-term debt balance (including current maturities) during 2018, 2017 and 2016 was $3,057.0 million, $3,490.9 million and $2,661.3 million, respectively. Our weighted average interest rate on our gross amount of long-term debt (including current maturities) was approximately 4.2%, 4.0% and 5.5% per annum in 2018, 2017 and 2016, respectively. See “Liquidity and Capital Resources—Key Financing and Capital Events” below and Note 9: “Long-Term Debt” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for a description of our indebtedness and our refinancing activities.

Loss on Debt Refinancing and Prepayment

2018

Loss on debt refinancing and prepayment decreased by $42.6 million from $47.2 million in 2017 to $4.6 million in 2018. We recorded a debt extinguishment charge of $2.6 million related to refinancing of the Term Loan “B” Facility and expensed $2.0 million of unamortized debt discount and issuance costs attributable to the partial pay-down of the Term Loan “B” Facility during 2018.

2017

Loss on debt refinancing and prepayment increased by $40.9 million from $6.3 million in 2016 to $47.2 million in 2017. The loss relates to the: (1) expensing of $26.2 million of unamortized debt discount and issuance costs attributed to the partial pay down of $575.0 million and the repricing of the Term Loan “B” Facility for the Second Amendment (as defined below); (2) expensing of $6.7 million of unamortized debt discount costs attributed to the partial pay down of $200.0 million of Term Loan “B” Facility; and (3) expensing of $14.3 million of unamortized debt discount and unamortized issuance costs attributed to the partial pay down of $400.0 million and the repricing of Term Loan “B” Facility for the Third Amendment (as defined below).

2016

Loss on debt refinancing and prepayment was $6.3 million in 2016, due to the execution of the First Amendment (as defined below), which resulted in a debt extinguishment charge of $4.7 million, and the termination and replacement of our previous senior revolving credit facility by the Revolving Credit Facility, which resulted in a debt modification and write-off of $1.6 million in unamortized debt issuance costs.

See Note 9: “Long-Term Debt” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information.

Gain on Divestiture of Business

Gain on divestiture of business was $5.0 million, $12.5 million and $92.2 million for 2018, 2017 and 2016, respectively. The information below summarizes the major activities in each year.

2018

Gain on divestiture of business was $5.0 million during 2018. On June 25, 2018, we divested the transient voltage suppressing diodes business we acquired from Fairchild to TSC America, Inc. and recorded a gain of $4.6 million.

2017

Gain on divestiture of business was $12.5 million during 2017. On September 29, 2017, we sold Xsens Holding B.V. to mCube Hong Kong Limited (“mCube”) for cash consideration of $26.0 million and recorded a gain of $12.5 million after writing off the carrying value of the assets and liabilities sold of $7.0 million and goodwill of $6.5 million.

2016

Gain on divestiture of business was $92.2 million during 2016. On August 29, 2016, we sold two lines of business for $104.0 million to Littelfuse, Inc., (“Littelfuse”). In connection with the sale, we recorded a gain of $92.2 million after, among other things, transferring inventory of $4.1 million to Littelfuse, writing off goodwill of $3.4 million, and deferring $4.3 million of the proceeds to be recognized in the future.

For additional information, see Note 5: “Acquisitions, Divestitures and Licensing Transactions” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

Licensing Income

Licensing income was $36.6 million, $47.6 million and zero for 2018, 2017 and 2016, respectively. The information below summarizes the major activities in each year.

2018

Licensing income was $36.6 million for 2018 primarily due to the achievement of the established criteria based on which income was recognized under the various licensing agreements. We have completed recognizing licensing income under existing agreements as of December 31, 2018.

2017

Licensing income was $47.6 million for 2017 compared to zero for 2016. Approximately $45.1 million was attributable to payments received under an asset purchase agreement with HSET Electronic Tech (Hong Kong) Limited in connection with our licensing of certain patents related to the Mobile CIS business. The remaining $2.5 million was received from various other licensing agreements.

See Note 5: “Acquisitions, Divestitures and Licensing Transactions” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for more information.

Other Expense

Other expense decreased by $1.7 million, from expense of $8.8 million in 2017 to $7.1 million in 2018. Other expense decreased by $2.5 million, from expense of $11.3 million in 2016 to $8.8 million in 2017. The change from year to year is attributable to fluctuations in foreign currencies against the U.S. dollar for the periods presented, net of the impact from our hedging activity, pension related gain and losses and an adjustment to contingent consideration.

Income Tax (Provision) Benefit

We recorded an income tax provision of $125.1 million, an income tax benefit of $265.5 million and an income tax benefit of $3.9 million in 2018, 2017 and 2016, respectively.

The income tax provision for the year ended December 31, 2018 consisted primarily of $180.0 million for income and withholding taxes of certain of our foreign and domestic current year operations and $35.2 million related to the finalization of the Company’s tax impacts of U.S. tax reform. These expenses were offset by a one-time benefit of $48.2 million related to U.S. tax method changes made during the year that impacted the Company’s Global Intangible Low Tax Income (“GILTI”) inclusion, a benefit of $17.1 million relating to an increase in deferred tax assets expected to be realized in the foreseeable future due to the liquidation of a foreign subsidiary, a benefit of $14.0 million relating to the lapse of the statute of limitations on certain unrecognized tax benefits, a benefit of $7.6 million relating to equity award excess tax benefits and a benefit of $3.2 million relating to changes in valuation allowance.

The income tax benefit for 2017 consisted primarily of the provisional benefit of $449.9 million related to the estimated impact of U.S. tax reform and related effects and a discrete benefit of $13.2 million relating to equity award excess tax benefits. These benefits were offset by $186.8 million for income and withholding taxes of certain of our foreign and domestic current year operations and $10.8 million relating to the establishment of an additional valuation allowance on certain foreign deferred tax assets.

The income tax benefit for 2016 consisted primarily of the reversal of $359.8 million of our previously established valuation allowance against part of our U.S. federal and foreign deferred tax assets and the release of $1.9 million for reserves and interest for uncertain tax positions in foreign taxing jurisdictions which were effectively settled or for which the statute lapsed during 2016. This was partially offset by $310.8 million related to the reversal of the prior years’ indefinite reinvestment assertion, $43.5 million for income and withholding taxes of certain of our foreign and domestic operations and $3.5 million of new reserves and interest on existing reserves for uncertain tax positions in foreign taxing jurisdictions.

Our effective tax rate for 2018 was 16.6%, which differs from the U.S. federal statutory income tax rate of 21% primarily due to U.S. tax method changes made during the year that impacted the Company’s GILTI inclusion. Our effective tax rate for 2017 was a benefit of 48.5%, which differs from the U.S. federal statutory income tax rate of 35% primarily due to U.S. tax reform codified under the Tax Act. Our effective tax rate for 2016 was a benefit of 2.2%, which differs from the U.S. federal statutory income tax rate of 35% primarily due to the release of our U.S. and Japan valuation allowances, partially offset by the reversal of the prior years’ indefinite reinvestment assertion.

We expect our effective tax rate, before discrete items, to be between 23% and 27% until we fully utilize all of our U.S. federal net operating losses. The primary difference between our effective tax rate and the federal statutory rate of 21% is due to foreign taxes for which the Company will not receive a U.S. tax credit as a result of U.S. tax reform until our U.S. federal net operating losses are fully utilized. Once our U.S. federal net operating losses are fully utilized, we expect our future effective tax rate, before discrete items, to approximate, or be lower than, the federal statutory rate of 21%. We anticipate our U.S. federal net operating losses and credits will be fully utilized by 2021.

Our cash tax, as a percentage of income before income taxes (“Cash Tax Rate”), is significantly lower than our effective tax rate due to the current utilization of our U.S. federal net operating losses and credits. We expect our future Cash Tax Rate to approximate our effective tax rate once our U.S. federal net operating losses and credits are fully utilized.

We continue to maintain a full valuation allowance on our U.S. state deferred tax assets and a valuation allowance on foreign net operating losses and tax credits in certain other foreign jurisdictions, a substantial portion of which relate to Japan net operating losses which are projected to expire prior to utilization.

For additional information, see Note 16: “Income Taxes” in the notes to the audited consolidated financial statements included elsewhere in this Form 10-K.

Liquidity and Capital Resources

This section includes a discussion and analysis of our cash requirements, off-balance sheet arrangements, contingencies, sources and uses of cash, operations, working capital and long-term assets and liabilities.

Contractual Obligations

Our principal outstanding contractual obligations relate to our long-term debt, capital leases, operating leases and purchase obligations. The following table summarizes our contractual obligations at December 31, 2018 and the effect such obligations are expected to have on our liquidity and cash flow in the future (in millions):


	Payments Due by Period

Contractual obligations (1)	Total		2019		2020		2021		2022		2023		Thereafter
Long-term debt, excluding capital leases (2)	$	3,256.8	$	223.4	$	773.3	$	470.5	$	58.5	$	1,731.1	$	—
Capital leases (2)		0.9		0.8		0.1		—		—		—		—
Operating leases (3)		160.8		36.8		27.6		21.9		16.8		12.3		45.4
Purchase obligations (3):
Capital purchase obligations		103.1		100.5		1.7		0.7		0.2		—		—
Inventory and external manufacturing purchase obligations		262.7		219.6		13.4		6.7		6.1		6.0		10.9
Information technology, communication and mainframe support services		34.2		16.2		11.0		6.6		0.3		0.1		—
Other		63.3		37.4		12.1		9.0		2.7		2.1		—

Total contractual obligations	$	3,881.8	$	634.7	$	839.2	$	515.4	$	84.6	$	1,751.6	$	56.3

(1)	The table above excludes approximately $17.8 million of liabilities related to unrecognized tax benefits because we are unable to reasonably estimate the timing of the settlement of such liabilities.

(2)	Includes interest payments at applicable rates as of December 31, 2018.

(3)	These represent our off-balance sheet arrangements (See “Liquidity and Capital Resources—Off-Balance Sheet Arrangements” for a description of our off-balance sheet arrangements).

The table also excludes our pension obligations. We expect to make cash contributions to comply with local funding requirements and required benefit payments of approximately $15.3 million and $4.7 million, respectively, in 2019. This future payment estimate assumes we continue to meet our statutory funding requirements. The timing and amount of contributions may be impacted by a number of factors, including the funded status of the plans. Beyond 2019, the actual amounts required to be contributed are dependent upon, among other things, interest rates, underlying asset returns and the impact of legislative or regulatory actions related to pension funding obligations. See Note 12: “Employee Benefit Plans” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for more information on our pension obligations.

Our balance of cash and cash equivalents was $1,069.6 million as of December 31, 2018. We believe that our cash flows from operations, coupled with our existing cash and cash equivalents, will be adequate to fund our operating and capital needs for at least the next 12 months. Total cash and cash equivalents at December 31, 2018 include approximately $448.7 million available in the United States. We require a substantial amount of cash in the United States for operating requirements, debt service, debt repayments and acquisitions. While we hold a significant amount of cash and cash equivalents outside the United States in various foreign subsidiaries, we have the ability to obtain cash in the United States in order to cover our domestic needs, through distributions from our foreign subsidiaries, by utilizing existing credit facilities or through new bank loans or debt obligations.

See Note 9: “Long-Term Debt,” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for a discussion of our long-term debt. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” included elsewhere in this Form 10-K for a discussion of restrictions on our ability to pay dividends and our stock repurchase activities.

Off-Balance Sheet Arrangements

In the ordinary course of business, we enter into various operating leases for buildings, equipment including our mainframe computer system, desktop computers, communications, foundry equipment and service agreements relating to this equipment.

In the ordinary course of business, we provide standby letters of credit or other guarantee instruments to certain parties in connection with certain transactions including, but not limited to: material purchase commitments, agreements to mitigate collection risk, leases, utilities or customs guarantees. As of December 31, 2018, our Revolving Credit Facility included $15.0 million of availability for the issuance of letters of credit. There were $1.0 million letters of credit outstanding under our Revolving Credit Facility as of December 31, 2018, which reduces our borrowing capacity dollar-for-dollar. As of December 31, 2018, we also had outstanding guarantees and letters of credit outside of our Revolving Credit Facility in the amount of $6.1 million at December 31, 2018.

As part of securing financing in the ordinary course of business, we issued guarantees related to certain of our subsidiaries’ capital lease obligations, equipment financing, lines of credit and real estate mortgages, which totaled $68.6 million as of December 31, 2018. Based on historical experience and information currently available, we believe that we will not be required to make payments under the standby letters of credit or guarantee arrangements for the foreseeable future.

For our operating leases, we expect to make cash payments and similarly incur expenses totaling $160.8 million as payments come due. We have not recorded any liability in connection with these operating leases, letters of credit and guarantee arrangements. We will record the associated lease obligations as a liability when we adopt the provisions of the New Leasing Standard (as defined below). See Note 4: “Recent Accounting Pronouncements”, “Note 9:” “Long-Term Debt,” and Note 13: “Commitments and Contingencies” in the notes to our audited consolidated financial statements found elsewhere in this Form 10-K for additional information.

Contingencies

We are a party to a variety of agreements entered into in the ordinary course of business pursuant to which we may be obligated to indemnify other parties for certain liabilities that arise out of or relate to the subject matter of the agreements. Some of the agreements entered into by us require us to indemnify the other party against losses due to IP infringement, environmental contamination and other property damage, personal injury, our failure to comply with applicable laws, our negligence or willful misconduct or our breach of representations, warranties or covenants related to such matters as title to sold assets.

We face risk of exposure to warranty and product liability claims in the event that our products fail to perform as expected or such failure of our products results, or is alleged to result, in economic damage, bodily injury or property damage. In addition, if any of our designed products are alleged to be defective, we may be required to participate in their recall. Depending on the significance of any particular customer and other relevant factors, we may agree to provide more favorable rights to such customer for valid defective product claims.

We maintain directors’ and officers’ insurance policies that indemnify our directors and officers against various liabilities, including certain liabilities under the Exchange Act, that might be incurred by any director or officer in his or her capacity as such.

The Fairchild Agreement provides for indemnification and insurance rights in favor of Fairchild’s then current and former directors, officers and employees. Specifically, the Company has agreed that, for no fewer than six years following the Fairchild acquisition, the Company will: (a) indemnify and hold harmless each such indemnitee against losses and expenses (including advancement of attorneys’ fees and expenses) in connection with any proceeding asserted against the indemnified party in connection with such person’s servings as a director, officer, employee or other fiduciary of Fairchild or its subsidiaries prior to the effective time of the acquisition; (b) maintain in effect all provisions of the certificate of incorporation or bylaws of Fairchild or any of its subsidiaries or any other agreements of Fairchild or any of its subsidiaries with any indemnified party regarding elimination of liability, indemnification of officers, directors and employees and advancement of expenses in existence on the date of the Fairchild Agreement for acts or omissions occurring prior to the effective time of the acquisition and; (c) subject to certain qualifications, provide to Fairchild’s then current directors and officers an insurance and indemnification policy that provides coverage for events occurring prior to the effective time of the acquisition that is no less favorable than Fairchild’s then-existing policy, or, if insurance coverage that is no less favorable is unavailable, the best available coverage.

While our future obligations under certain agreements may contain limitations on liability for indemnification, other agreements do not contain such limitations and under such agreements it is not possible to predict the maximum potential amount of future payments due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under any of these indemnities have not had a material effect on our business, financial condition, results of operations or cash flows, and we do not believe that any amounts that we may be required to pay under these indemnities in the future will be material to our business, financial condition, results of operations or cash flows.

See “Legal Proceedings” and Note 13: “Commitments and Contingencies” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for possible contingencies related to legal matters. See also “Business—Government Regulation” for information on certain environmental matters.

Sources and Uses of Cash

We require cash to fund our operating expenses and working capital requirements, including outlays for strategic acquisitions and investments, for research and development, to make capital expenditures, to repurchase our common stock and other Company securities, and to pay debt service, including principal and interest and capital lease payments. We expect interest expense to remain significant in future periods as we continue to service the debt incurred in connection with the Fairchild Transaction. Our principal sources of liquidity are cash on hand, cash generated from operations and funds from external borrowings and equity issuances. In the near term, we expect to fund our primary cash requirements through cash generated from operations and with cash and cash equivalents on hand. We also have the ability to utilize our Revolving Credit Facility.

As part of our business strategy, we review acquisition and divestiture opportunities and proposals on a regular basis. During 2018, we completed the acquisition of SensL and the divestiture of the transient voltage suppressing diodes business we acquired from Fairchild. See Note 5: “Acquisitions, Divestitures and Licensing Transactions” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information.

We believe that the key factors that could affect our internal and external sources of cash include:

	•		Factors that affect our results of operations and cash flows, including the impact on our business and operations as a result of changes in demand for our products, competitive pricing pressures, effective management of our manufacturing capacity, our ability to achieve further reductions in operating expenses, the impact of our restructuring programs on our production and cost efficiency and our ability to make the research and development expenditures required to remain competitive in our business; and

	•		Factors that affect our access to bank financing and the debt and equity capital markets that could impair our ability to obtain needed financing on acceptable terms or to respond to business opportunities and developments as they arise, including interest rate fluctuations, macroeconomic conditions, sudden reductions in the general availability of lending from banks or the related increase in cost to obtain bank financing, and our ability to maintain compliance with covenants under our debt agreements in effect from time to time.

Our ability to service our long-term debt, including our 1.625% Notes, 1.00% Notes, Revolving Credit Facility and Term Loan “B” Facility, to remain in compliance with the various covenants contained in our debt agreements and to fund working capital, capital expenditures and business development efforts will depend on our ability to generate cash from operating activities, which is subject to, among other things, our future operating performance, as well as to general economic, financial, competitive, legislative, regulatory and other conditions, some of which may be beyond our control.

If we fail to generate sufficient cash from operations, we may need to raise additional equity or borrow additional funds to achieve our longer term objectives. There can be no assurance that such equity or borrowings will be available or, if available, will be at rates or prices acceptable to us. We believe that cash flow from operating activities coupled with existing cash and cash equivalents and existing credit facilities will be adequate to fund our operating and capital needs, as well as enable us to maintain compliance with our various debt agreements, through at least the next 12 months. To the extent that results or events differ from our financial projections or business plans, our liquidity may be adversely impacted.

During the ordinary course of business, we evaluate our cash requirements and, if necessary, adjust our expenditures for inventory, operating expenditures and capital expenditures to reflect the current market conditions and our projected sales and demand. Our capital expenditures are primarily directed toward production equipment and capacity expansion. Our capital expenditure levels can materially influence our available cash for other initiatives. For example, during 2018, we paid approximately $514.8 million for capital expenditures, while in 2017 we paid approximately $387.5 million. While our capital expenditures have historically been approximately 6% to 7% of annual revenue, we incurred capital expenditures of approximately 8% to 9% of annual revenue in 2018 and expect to incur similar amounts in 2019 to adjust to a higher growth environment and to further improve our manufacturing cost structure. Future capital expenditures may be impacted by events and transactions that are not currently forecasted.

On April 15, 2016, in connection with the Fairchild Transaction, we entered into the Amended Credit Agreement which initially provided for a $600 million Revolving Credit Facility and a $2.2 billion Term Loan “B” Facility.

On September 30, 2016, we entered into the First Amendment (as defined below) pursuant to which, among other things, we increased the amount that may be borrowed under the Term Loan “B” Facility by $200.0 million to $2.4 billion, the proceeds of which were used to pay off the $200.0 million outstanding balance under the Revolving Credit Facility.

On March 31, 2017, we completed the private unregistered offering of $575.0 million aggregate principal amount of the 1.625% Notes, which amount includes the full exercise of the initial purchasers’ option to purchase additional 1.625% Notes. The net proceeds from the offering of the 1.625% Notes were used to repay $562.1 million of borrowings outstanding under the Term Loan “B” Facility.

On November 30, 2017, we entered into the Third Amendment (as defined below) pursuant to which, among other things, we increased the amount that may be borrowed under the Revolving Credit Facility to $1.0 billion. In connection with the Third Amendment, we prepaid $400.0 million of borrowings under the Term Loan “B” Facility, bringing the outstanding borrowings under the Term Loan “B” Facility to approximately $1.2 billion.

As of December 31, 2018, there was $1,134.5 million outstanding under the Term Loan “B” Facility and $400.0 million outstanding under the Revolving Credit Facility. The associated interest expense related to the Term Loan “B” Facility has had, and will continue to have, a material impact on our results of operations throughout the term of the Amended Credit Agreement.

We repurchased common stock worth approximately $315.0 million under the 2014 Share Repurchase Program during the year ended December 31, 2018. We repurchased shares worth $25.0 million of our common stock under the 2014 Share Repurchase Program in connection with the offering of the 1.625% Notes during the year ended December 31, 2017.

Cash Management

Our ability to manage cash is limited, as our primary cash inflows and outflows are dictated by the terms of our sales and supply agreements, contractual obligations, debt instruments and legal and regulatory requirements. While we have some flexibility with respect to the timing of capital equipment purchases, we must invest in capital equipment on a timely basis to allow us to maintain our manufacturing efficiency and support our platforms of new products.

Primary Cash Flow Sources

Our long-term cash generation is dependent on the ability of our operations to generate cash. Our cash flows from operating activities were $1,274.2 million, $1,094.2 million, and $581.1 million for the years ended December 31, 2018, 2017 and 2016, respectively.

Our cash flows provided by operating activities for the year ended December 31, 2018 increased by approximately $180.0 million, or approximately 16.5%, compared to the year ended December 31, 2017. The increase was primarily attributable to better cash flows from operations and effective cash management. Our ability to maintain positive operating cash flows is dependent on, among other factors, our success in achieving our revenue goals and manufacturing and operating cost targets.

Our management of our assets and liabilities, including both working capital and long-term assets and liabilities, also influences our operating cash flows, and each of these components is discussed below.

Working Capital

Working capital, calculated as total current assets less total current liabilities, fluctuates depending on end-market demand and our effective management of certain items such as receivables, inventory and payables. In times of escalating demand, our working capital requirements may be affected as we purchase additional manufacturing materials and increase production. Our working capital may also be affected by restructuring programs, which may require us to use cash for severance payments, asset transfers and contract termination costs. In addition, our working capital may be affected by acquisitions and transactions involving our convertible notes and other debt instruments. Our working capital, excluding cash and cash equivalents and the current portion of long-term debt, was $767.4 million as of December 31, 2018 and has fluctuated between $743.4 million and $941.0 million at the end of each of our last eight fiscal quarters. Our working capital, including cash and cash equivalents and the current portion of long-term debt, was $1,698.5 million as of December 31, 2018 and has fluctuated between $1,022.0 million and $1,782.3 million at the end of each of our last eight fiscal quarters.

Although investments made to fund working capital will reduce our cash balances, these investments are necessary to support business and operating initiatives. For the year ended December 31, 2018, our working capital was most significantly impacted by our capital expenditures and our repayment of long-term debt, including capital leases. See Note 9: “Long-Term Debt” and Note 10: “Earnings Per Share and Equity” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information.

Long-Term Assets and Liabilities

Our long-term assets consist primarily of property, plant and equipment, intangible assets, deferred taxes and goodwill.

Our manufacturing rationalization plans have included efforts to utilize our existing manufacturing assets and supply arrangements more efficiently. We believe that near-term access to additional manufacturing capacity, should it be required, could be readily obtained on reasonable terms through manufacturing agreements with third parties. We will continue to look for opportunities to make strategic purchases in the future for additional capacity.

Our long-term liabilities, excluding long-term debt and deferred taxes, consist of liabilities under our foreign defined benefit pension plans and contingent tax reserves. In regard to our foreign defined benefit pension plans, our annual funding of these obligations is at a minimum generally equal to the minimum amount legally required in each jurisdiction in which the plans operate. This annual amount is dependent upon numerous actuarial assumptions. For additional information, see Note 12: “Employee Benefit Plans” and Note 16: “Income Taxes” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

Key Financing and Capital Events

Overview

For the past several years, we have undertaken various measures to secure liquidity to pursue acquisitions, repurchase shares of our common stock, reduce interest costs, amend existing key financing arrangements and, in some cases, extend a portion of our debt maturities to continue to provide us additional operating flexibility. Certain of these measures continued in 2018. Set forth below is a summary of certain key financing events affecting our capital structure during the last three years. For further discussion of our debt instruments, see Note 9: “Long-Term Debt” and for further discussion on Share Repurchase Programs, see Note 10: “Earnings Per Share and Equity” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

On April 15, 2016, the Company and certain of its subsidiaries, as guarantors (the “Guarantors”), entered into the Amended Credit Agreement, which provides for the Revolving Credit Facility and the Term Loan “B” Facility. Borrowings under the Amended Credit Agreement may be incurred in U.S. Dollars, Euros, Pounds Sterling, Japanese Yen or any other currency approved by the agent and the lenders under the Revolving Credit Facility, subject to certain qualifications described in the Amended Credit Agreement. Regardless of currency, all borrowings under the Amended Credit Agreement may, at the Company’s option, be incurred as either eurocurrency loans (“Eurocurrency Loans”) or alternate base rate loans (“ABR Loans”).

On April 15, 2016, the Company and the Guarantors entered into a Guarantee and Collateral Agreement (the “Guarantee and Collateral Agreement”), pursuant to which the Amended Credit Agreement was guaranteed by the Guarantors and secured by a pledge of substantially all of the assets of the Company and the Guarantors, including a pledge of the equity interests in certain of the Company’s domestic and first tier foreign subsidiaries, subject to customary exceptions. The obligations under the Amended Credit Agreement are also collateralized by mortgage on certain real property assets of the Company and its domestic subsidiaries.

Recent Events

2018 Financing Events

Amendments to the Amended Credit Agreement

On May 31, 2018, the Company, the Guarantors, the several lenders party thereto and the Agent entered into the Fourth Amendment to the Amended Credit Agreement (the “Fourth Amendment”). Pursuant to the Fourth Amendment, for any interest period ending after the date of the Fourth Amendment, Eurocurrency Loans will accrue interest at (i) a base rate per annum equal to the Adjusted LIBO Rate (as defined in the Amended Credit Agreement) plus (ii) an applicable margin equal to (x) 1.25% with respect to borrowings under the Revolving Credit Facility (with step-downs and step-ups as set forth in the Amended Credit Agreement) or (y) 1.75% with respect to borrowings under the Term Loan “B” Facility.

Pursuant to the Fourth Amendment, ABR Loans will accrue interest at (i) a base rate per annum equal to the highest of (x) the Federal funds rate plus 0.50%, (y) the prime commercial lending rate announced by the Agent from time to time as its prime lending rate and (z) the Adjusted LIBO Rate for a one month interest period (or if such day is not a business day, the immediately preceding business day) (determined after giving effect to any applicable “floor”) plus 1.00%; provided that, the Adjusted LIBO Rate for any day shall be based on the LIBO Rate (as defined in the Amended Credit Agreement), subject to the interest rate floors set forth in the Amended Credit Agreement, plus (ii) an applicable margin equal to (x) 0.25% with respect to borrowings under the Revolving Credit Facility (with step-ups as set forth in the Amended Credit Agreement) or (y) 0.75% with respect to borrowings under the Term Loan “B” Facility.

During the year ended December 31, 2018 we prepaid $70.0 million of borrowings under the Term Loan “B” Facility.

Share Repurchase Programs

We repurchased 16.8 million shares of our common stock for $315.0 million under the 2014 Share Repurchase Program during the year ended December 31, 2018. No shares were repurchased under our 2018 Share Repurchase Program during the year ended December 31, 2018.

We repurchased 4.2 million shares of our common stock for $71.7 million under our 2018 Share Repurchase Program subsequent to December 31, 2018 through February 15, 2019.

2017 Financing Events

Amendments to the Amended Credit Agreement

On April 15, 2016, we and the Guarantors entered into the Amended Credit Agreement. On March 31, 2017, we and the Guarantors entered into the Second Amendment to the Amended Credit Agreement (the “Second Amendment”). The Second Amendment provided for, among other things, modifications to the Amended Credit Agreement to allow the 1.625% Notes to rank pari passu with borrowings under the Amended Credit Agreement and to reduce the interest rates payable under the Term Loan “B” Facility and the Revolving Credit Facility. For any interest period ending after the date of the Second Amendment, the Second Amendment reduced the applicable margins on borrowings under Eurocurrency Loans to 1.75% and 2.25% for borrowings under the Revolving Credit Facility and the Term Loan “B” Facility, respectively, and reduced applicable margins on borrowings under ABR Loans to 0.75% and 1.25% for borrowings under the Revolving Credit Facility and the Term Loan “B” Facility, respectively. For further discussion of the Amended Credit Agreement, see “2016 Financing Events—Amended Credit Agreement.”

During the quarter ended June 30, 2017, we repaid in full the $120.0 million outstanding under the Revolving Credit Facility. During the quarter ended September 29, 2017, we prepaid $200.0 million of borrowings under the Term Loan “B” Facility.

On November 30, 2017, we and the Guarantors entered into the Third Amendment to the Amended Credit Agreement (the “Third Amendment”). The Third Amendment provided for, among other things, modifications to the Amended Credit Agreement to reduce the interest rate payable under the Term Loan “B” Facility and to increase the amount that may be borrowed pursuant to the Revolving Credit Facility to $1.0 billion. For any interest period ending after the date of the Third Amendment, the Third Amendment reduced the applicable margins on Eurocurrency Loans to 2.00% for borrowings under the Term Loan “B” Facility, and reduced applicable margins on ABR Loans to 1.00% for borrowings under the Term Loan “B” Facility. In connection with the Third Amendment, we prepaid $400.0 million of borrowings under the Term Loan “B” Facility, bringing the outstanding borrowings under the Term Loan “B” Facility to approximately $1.2 billion as of the date of the Third Amendment. We had $400.0 million of borrowings outstanding under the Revolving Credit Facility as of the date of the Third Amendment.

Issuance of 1.625% Notes

On March 31, 2017, we completed a private placement of $575.0 million of our 1.625% Notes to qualified institutional buyers pursuant to Rule 144A under the Securities Act. The 1.625% Notes are governed by an indenture (the “1.625% Indenture”) between the Company, the guarantors party thereto, and Wells Fargo Bank, National Association, as trustee. The net proceeds from the offering of the 1.625% Notes were used to repay $562.1 million of borrowings outstanding under the Term Loan “B” Facility. The 1.625% Notes bear interest at the rate of 1.625% per year from the date of issuance, payable semiannually in arrears on April 15 and October 15 of each year, beginning on October 15, 2017. The 1.625% Notes are fully and unconditionally guaranteed, on a joint and several basis, by each of our subsidiaries that is a borrower or guarantor under our Amended Credit Agreement.

Share Repurchase Programs

We repurchased approximately 1.6 million shares of our common stock for an aggregate purchase price of $25.0 million pursuant to the 2014 Share Repurchase Program in connection with the offering of the 1.625% Notes during the year ended December 31, 2017.

2016 Financing Events

Redemption of 2.625% Notes, Series B

On November 17, 2016, we announced that we would be exercising our option to redeem the entire $356.9 million outstanding principal amount of the 2.625% Notes, Series B, on December 20, 2016 pursuant to the terms of the indenture governing the 2.625% Notes, Series B (the “2.625% Notes, Series B Indenture”). The holders of the 2.625% Notes, Series B, had the right to convert their 2.625% Notes, Series B, into shares of common stock of the Company at a conversion rate of 95.2381 shares per $1,000 principal amount until the close of business on December 19, 2016. We satisfied our conversion obligation with respect to the 2.625% Notes, Series B, tendered for conversion with cash. The final conversion was settled on January 26, 2017, resulting in an aggregate payment of approximately $445.0 million for the redemption and conversion of the 2.625% Notes, Series B.

Amended Credit Agreement

On April 15, 2016, we entered into: (1) the Amended Credit Agreement; and (2) the Guarantee and Collateral Agreement. Subject to the terms and conditions of the Amended Credit Agreement, on April 15, 2016, we borrowed an aggregate of $2.2 billion under the Term Loan “B” Facility (the “Gross Proceeds”).

On April 15, 2016, the Gross Proceeds, along with certain other amounts funded by the Company, were deposited into escrow accounts pursuant to the terms of an escrow agreement and, upon release from escrow, in accordance with the terms of the escrow agreement, were available primarily to pay, directly or indirectly, the purchase price of the Fairchild Transaction pursuant to the terms of the Fairchild Agreement and certain other items, subject to the terms and conditions of the Amended Credit Agreement.

On September 19, 2016, the Company completed the acquisition and acquired 100% of Fairchild, whereby Fairchild became a wholly-owned subsidiary of the Company. The Company funded the acquisition with the Term Loan “B” Facility proceeds and Company funded amounts previously deposited into escrow accounts, proceeds from a $200.0 million draw against the Company’s Revolving Credit Facility, and existing cash on hand. Proceeds from the Term Loan “B” Facility were also used to pay for debt issuance costs, transaction fees and expenses.

On September 30, 2016, we and the Guarantors entered into the First Amendment to the Amended Credit Agreement (the “First Amendment”). The First Amendment reduced the applicable margins on Eurocurrency Loans to 2.75% and 3.25% for borrowings under the Revolving Credit Facility and the Term Loan “B” Facility, respectively, and reduced applicable margins on ABR Loans to 1.75% and 2.25% for borrowings under the Revolving Credit Facility and the Term Loan “B” Facility, respectively. Additionally, the First Amendment included the following: (i) the Term Loan “B” Facility was increased to $2.4 billion; (ii) certain restructuring transactions and intercompany IP transfers are permitted in order to achieve efficient integration of the Company, its subsidiaries and acquired entities; and (iii) certain changes were made to the provisions regarding hedge agreements to allow the Company and each of the guarantors to enter into certain hedge arrangements. We used the additional $200.0 million proceeds under the Term Loan “B” Facility to pay off the $200.0 million outstanding balance under the Revolving Credit Facility.

Share Repurchase Programs

We did not repurchase shares pursuant to the 2014 Share Repurchase Program during the year ended December 31, 2016, as we focused on the funding required for the Fairchild Transaction.

Debt Guarantees and Related Covenants

As of December 31, 2018, we were in compliance with the indentures relating to our 1.00% Notes and 1.625% Notes and with covenants relating to our Term Loan “B” Facility, Revolving Credit Facility and our other debt agreements. Our 1.00% Notes are senior to the existing and future subordinated indebtedness of ON Semiconductor and its guarantor subsidiaries. Our 1.625% Notes rank equally in right of payment to all of our existing and future senior debt and as unsecured obligations are subordinated to all of our existing and future secured debt. See Note 9: “Long-Term Debt” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information.

Critical Accounting Policies and Estimates

The accompanying discussion and analysis of our financial condition and results of operations is based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. We believe certain of our accounting policies are critical to understanding our financial position and results of operations. We utilize the following critical accounting policies in the preparation of our financial statements.

Use of Estimates. The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses during the reporting period. We evaluate these estimates and judgments on an ongoing basis and base our estimates on experience, current and expected future conditions, third-party evaluations and various other assumptions that we believe are reasonable under the circumstances. Significant estimates have been used by management in conjunction with the following: (i) estimates of future payouts for customer incentives and estimates of amounts subject to allowances, returns and warranties; (ii) measurement of valuation allowances relating to inventories; (iii) fair values of share-based compensation and of financial instruments (including derivative financial instruments); and (iv) measurement of valuation allowances against deferred tax assets, evaluations of uncertain tax positions, and impact of U.S. tax reform. Additionally, during periods where it becomes applicable, significant estimates will be used by management in determining the future cash flows used to assess and test for impairment of goodwill, indefinite-lived intangible assets and long-lived assets and in assumptions used in connection with business combinations. Actual results may differ from the estimates.

Revenue****. We generate revenue from sales of our semiconductor products to OEMs, electronic manufacturing service providers and distributors. We also generate revenue, to a much lesser extent, from product development agreements and manufacturing services provided to customers. We recognize revenue when we satisfy a performance obligation in an amount reflecting the consideration to which we expect to be entitled. For sales agreements, we have identified the promise to transfer products, each of which is distinct, to be the performance obligation. For product development agreements, we have identified the completion of a service defined in the agreement to be the performance obligation. We apply a five step approach in determining the amount and timing of revenue to be recognized: (1) identifying the contract with a customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligations in the contract; and (5) recognizing revenue when the performance obligation is satisfied. We allocate the transaction price to each distinct product based on its relative stand-alone selling price. In determining the transaction price, we evaluate whether the price is subject to refund or adjustment to determine the net consideration to which we expect to be entitled. Sales to certain distributors, primarily those with ship and credit rights, can be subject to price adjustment on certain products. Substantially all of our revenue is recognized at the time control of the products transfers to the customer.

Prior to the first quarter of 2017, for products sold to distributors who are entitled to ship and credit rights, we recognized the related revenue and cost of revenue when we were informed by the distributor that it had resold the products to the end-user. This was due to our inability to reliably estimate up front the effects of the returns and allowances with these distributors. In anticipation of the adoption of the New Revenue Standard (see Note 3: “Revenue and Segment Information”), we had developed our internal systems, processes and controls for making the required estimates on the sales to these distributors. We develop an estimate of their expected claims under the ship and credit program based primarily on the historical claims submitted by product and customer which requires the use of estimates and assumptions related to the amount of each claim as well as the historical period used to develop the estimate.

Our OEM customers do not have the right to return products, other than pursuant to the provisions of the Company’s standard warranty. Sales to distributors, however, are typically made pursuant to agreements that provide return rights and stock rotation provisions permitting limited levels of product returns. Provisions for discounts and rebates to customers, estimated returns and allowances, ship and credit claims and other adjustments are provided for in the same period the related revenue are recognized, and are netted against revenue. For returns, we recognize a related asset for the right to recover returned products with a corresponding reduction to cost of goods sold. We record a reserve for cash discounts as a reduction to accounts receivable and a reduction to revenue, based on the experience with each customer. Although payment terms vary, most distributor agreements require payment within 30 days. In addition, the Company offers cash discounts to certain customers for payments received within an agreed upon time, generally 10 days after shipment.

We have elected to record freight and handling costs associated with outbound freight after control over a product has transferred to a customer as a fulfillment cost and include it in cost of revenue. Taxes assessed by government authorities on revenue-producing transactions, including value-added and excise taxes, are presented on a net basis (excluded from revenue) in the Consolidated Statements of Operations and Comprehensive Income.

Inventories****. We carry our inventories at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or net realizable value and record provisions for potential excess and obsolete inventories based upon a regular analysis of inventory on hand compared to historical and projected end-user demand. The determination of projected end-user demand requires the use of estimates and assumptions related to projected unit sales for each product. These provisions can influence our results from operations. For example, when demand falls for a given part, all or a portion of the related inventory that is considered to be in excess of anticipated demand is reserved, impacting our cost of revenue and gross profit. If demand recovers and the parts previously reserved are sold, we will generally recognize a higher than normal margin. However, the majority of product inventory that has been previously reserved is ultimately discarded. Although we do sell some products that have previously been written down, such sales have historically been relatively consistent on a quarterly basis and the related impact on our margins has not been material.

Share-Based Compensation. We record compensation expense for all share-based payment awards including RSUs and ESPPs and measure them at the grant date, based on the estimated fair value of the award, recognized as an expense over the employee’s requisite service period. Determining the amount of share-based compensation to be recorded requires us to develop estimates to be used in calculating the grant-date fair value of the award. We calculate the grant-date fair values of the award using valuation models. The use of valuation models requires us to make estimates of key assumptions such as expected option term and stock price volatility to determine the fair value of the award. The estimate of these key assumptions is based on historical information and judgment regarding market factors and trends. For the past several years, we have utilized RSUs as our primary equity incentive compensation for employees. We have outstanding awards with performance, time and service-based vesting provisions.

Income Taxes. Income taxes are accounted for using the asset and liability method. Under this method, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for those deferred tax assets for which we cannot conclude that it is more likely than not that such deferred tax assets will be realized.

In determining the amount of the valuation allowance, estimated future taxable income, as well as feasible tax planning strategies for each taxing jurisdiction, are considered. If we determine it is more likely than not that all or a portion of the remaining deferred tax assets will not be realized, the valuation allowance will be increased with a charge to income tax expense. Conversely, if we determine it is more likely than not to be able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been provided, the related portion of the valuation allowance will be recorded as a reduction to income tax expense.

We recognize and measure benefits for uncertain tax positions using a two-step approach. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that is it more likely than not that the tax positions will be sustained upon audit, including resolution of any related appeals or litigation processes. For tax positions that are more likely than not to be sustained upon audit, the second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement. Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. Significant judgment is required to evaluate uncertain tax positions. Evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law, correspondence with tax authorities during the course of tax audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in income tax expense in the period in which the change is made, which could have a material impact to our effective tax rate. See Note 16: “Income Taxes” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information. See also “Management’s Discussion and Analysis—Results of Operations—Income Tax Provision (Benefit)” for additional information.

Impairment of Goodwill, Indefinite-lived Intangible Assets and Long-Lived Assets. We evaluate our goodwill for potential impairment annually during the fourth quarter and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Our impairment evaluation consists of a qualitative assessment, and if deemed necessary, a quantitative test is performed which compares the fair value of a reporting unit with its carrying amount, including goodwill.

If the fair value of the reporting unit exceeds the carrying value of the net assets associated with that unit, goodwill is not considered impaired. If the carrying value of the net assets associated with the reporting unit exceeds the fair value of the reporting unit, goodwill is considered impaired and will be determined as the amount by which the reporting units carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Determining the fair value of our reporting units is subjective in nature and involves the use of significant estimates and assumptions, including projected net cash flows, discount and long-term growth rates. We determine the fair value of our reporting units based on an income approach, whereby the fair value of the reporting unit is derived from the present value of estimated future cash flows. The assumptions about estimated cash flows include factors such as future revenue, gross profit, operating expenses, and industry trends. We consider historical rates and current market conditions when determining the discount and long-term growth rates to use in its analysis. We consider other valuation methods, such as the cost approach or market approach, if it is determined that these methods provide a more representative approximation of fair value.

We are required to test our IPRD assets for impairment annually using the guidance for indefinite-lived intangible assets. An IPRD asset is considered to be impaired when the asset’s carrying amount is greater than its fair value. Our impairment evaluation consists of first assessing qualitative factors, and if deemed necessary, we calculate the fair value of the IPRD asset and record an impairment charge if the carrying amount exceeds fair value. We determine the fair value based on an income approach, which is calculated as the present value of the estimated future cash flows of the IPRD asset. The assumptions about estimated cash flows include factors such as future revenue, gross profit, operating expenses, and industry trends.

We evaluate the recoverability of the carrying amount of our property, plant and equipment and intangible assets (excluding IPRD), whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be fully recoverable. Impairment is first assessed when the undiscounted expected cash flows derived for an asset group are less than its carrying amount. Impairment losses, if applicable, are measured as the amount by which the carrying value of an asset group exceeds its fair value and are recognized in operating results. We continually apply our best judgment when applying these impairment rules to determine the timing of the impairment test, the undiscounted cash flows used to assess impairments and the fair value of an impaired asset group. The dynamic economic environment in which we operate and the resulting assumptions used to estimate future cash flows impact the outcome of our impairment tests.

Business Combination. We use significant estimates and assumptions in allocating the purchase price of acquired business by utilizing established valuation techniques appropriate for the technology industry. We utilize the income approach, cost approach or market approach, depending upon which approach is the most appropriate based on the nature and reliability of available data. The income approach is predicated upon the value of the future cash flows that an asset is expected to generate over its economic life and involves significant assumptions as to cash flows, associated expenses, long-term growth rates and discount rates. The cost approach takes into account the cost to replace (or reproduce) the asset and involves assumptions relating to the asset’s value of physical, functional and/or economic obsolescence that has occurred with respect to the asset. The market approach is used to estimate value from an analysis of actual transactions or offerings for economically comparable assets available as of the valuation date.

Contingencies****. We are involved in a variety of legal matters that arise in the normal course of business. Based on the available information, we evaluate the relevant range and likelihood of potential outcomes and we record the appropriate liability when the amount is deemed probable and reasonably estimable.

For a further listing and discussion of our accounting policies, see Note 2: “Significant Accounting Policies” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements, see Note 4: “Recent Accounting Pronouncements” in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

Previous: Item 6. Selected Financial Data · Next: Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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