ON SEMICONDUCTOR CORP - Quarter Report: 2018 June (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 29, 2018

Or

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

(Commission File Number) 000-30419

 

 

ON SEMICONDUCTOR CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		36-3840979
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5005 E. McDowell Road

Phoenix, AZ 85008

(602) 244-6600

(Address, zip code and telephone number, including area code, of principal executive offices)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		☒		Accelerated filer		☐
Non-accelerated filer		☐  (Do not check if a smaller reporting company)		Smaller reporting company		☐
				Emerging growth company		☐

If emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

The number of shares outstanding of the issuer’s class of common stock as of the close of business on July 25, 2018:

 

Title of Each Class		Number of Shares
Common Stock, par value $0.01 per share		426,215,520

 

 

 

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

FORM 10-Q

TABLE OF CONTENTS

 

Part I: Financial Information
Item 1. Financial Statements (unaudited)			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			38
Item 3. Quantitative and Qualitative Disclosures About Market Risk			54
Item 4. Controls and Procedures			54
Part II: Other Information
Item 1. Legal Proceedings			56
Item 1A. Risk Factors			56
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			57
Item 3. Defaults Upon Senior Securities			58
Item 4. Mine Safety Disclosures			58
Item 5. Other Information			58
Item 6. Exhibits			59
Signatures			60

(See the glossary of selected terms immediately following this table of contents for definitions of certain abbreviated terms)

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

FORM 10-Q

GLOSSARY OF SELECTED ABBREVIATED TERMS*

 

Abbreviated Term		Defined Term
1.00% Notes		1.00% Convertible Senior Notes due 2020
1.625% Notes		1.625% Convertible Senior Notes due 2023
ADAS		Advanced driver assistance systems
Amended and Restated SIP		ON Semiconductor Corporation Amended and Restated Stock Incentive Plan, as amended
AMIS		AMIS Holdings, Inc.
Aptina		Aptina, Inc.
ASU		Accounting Standards Update
ASC		Accounting Standards Codification
ASIC		Application Specific Integrated Circuit
AXSEM		AXSEM A.G.
DSP		Digital signal processing
ESPP		ON Semiconductor Corporation 2000 Employee Stock Purchase Plan, as amended
Exchange Act		Securities Exchange Act of 1934, as amended
Fairchild		Fairchild Semiconductor International, Inc.
FASB		Financial Accounting Standards Board
Freescale		Freescale Semiconductor, Inc.
IC		Integrated circuit
IoT		Internet-of-Things
IP		Intellectual property
IPRD		In-Process Research and Development
LED		Light-emitting diode
LIBOR		A base rate per annum equal to the London Interbank Offered Rate as administered by ICE Benchmark Administration
LiDAR		Light detection and ranging
MCU		Microcontroller Unit
MOSFET		Metal oxide semiconductor field effect transistor
Motorola		Motorola Inc.
OEM		Original equipment manufacturers
RSU		Restricted Stock Unit
SANYO Electric		SANYO Electric Co., Ltd.
SCI LLC		Semiconductor Components Industries, LLC, a wholly-owned subsidiary of ON Semiconductor Corporation
SEC		Securities and Exchange Commission
SoC		System on chip
Securities Act		Securities Act of 1933, as amended
SMBC		Sumitomo Mitsui Banking Corporation
WSTS		World Semiconductor Trade Statistics

 

*	Terms used, but not defined, within the body of the Form 10-Q are defined in this Glossary.

PART I: FINANCIAL INFORMATION

 

Item 1.

Financial Statements (unaudited)

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in millions, except share and per share data)

(unaudited)

 

		June 29, 2018				December 31, 2017
Assets
Cash and cash equivalents		$	850.2			$	949.2
Receivables, net			698.8				701.5
Inventories			1,204.4				1,089.5
Other current assets			173.6				193.0
Total current assets			2,927.0				2,933.2
Property, plant and equipment, net			2,387.2				2,279.1
Goodwill			928.8				916.9
Intangible assets, net			627.9				628.3
Deferred tax assets			298.9				339.1
Other assets			127.5				98.5
Total assets		$	7,297.3			$	7,195.1
Liabilities, Non-Controlling Interest and Stockholders’ Equity
Accounts payable		$	584.7			$	548.0
Accrued expenses			563.9				612.8
Current portion of long-term debt			746.4				248.1
Total current liabilities			1,895.0				1,408.9
Long-term debt			2,020.4				2,703.7
Deferred tax liabilities			63.6				55.1
Other long-term liabilities			221.5				226.4
Total liabilities			4,200.5				4,394.1
Commitments and contingencies (Note 10)
ON Semiconductor Corporation stockholders’ equity:
Common stock ($0.01 par value, 1,250,000,000 and 1,250,000,000 shares authorized, 555,619,904 and 551,873,115 issued, 426,359,988 and 425,118,194 outstanding, respectively)			5.6				5.5
Additional paid-in capital			3,646.1				3,593.5
Accumulated other comprehensive loss			(34.9	)			(40.6	)
Accumulated earnings			646.9				351.5
Less: Treasury stock, at cost: 129,259,916 and 126,754,921 shares, respectively			(1,191.0	)			(1,131.1	)
Total ON Semiconductor Corporation stockholders’ equity			3,072.7				2,778.8
Non-controlling interest in consolidated subsidiary			24.1				22.2
Total stockholders’ equity			3,096.8				2,801.0
Total liabilities and stockholders’ equity		$	7,297.3			$	7,195.1

See accompanying notes to consolidated financial statements

 

4

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(in millions, except per share data)

(unaudited)

 

		Quarters Ended								Six Months Ended
		June 29, 2018				June 30, 2017				June 29, 2018				June 30, 2017
Revenues		$	1,455.9			$	1,338.0			$	2,833.5			$	2,774.7
Cost of revenues (exclusive of amortization shown below)			900.9				846.0				1,761.1				1,779.6
Gross profit			555.0				492.0				1,072.4				995.1
Operating expenses:
Research and development			167.1				145.6				322.3				285.7
Selling and marketing			81.7				79.5				159.5				157.0
General and administrative			74.6				76.6				145.5				145.0
Amortization of acquisition-related intangible assets			27.9				28.6				55.3				57.7
Restructuring, asset impairments and other, net			3.2				5.9				3.6				6.4
Goodwill and intangible asset impairment			3.3				1.8				3.3				6.2
Total operating expenses			357.8				338.0				689.5				658.0
Operating income			197.2				154.0				382.9				337.1
Other (expense) income, net:
Interest expense			(32.6	)			(34.7	)			(64.1	)			(73.1	)
Interest income			1.1				0.5				2.0				1.1
Loss on debt refinancing and prepayment			(4.0	)			—				(4.0	)			(26.2	)
Gain on divestiture of business			4.6				—				4.6				—
Licensing income			28.1				23.9				31.9				23.9
Other expense			(1.0	)			(0.5	)			(3.0	)			(4.6	)
Other (expense) income, net			(3.8	)			(10.8	)			(32.6	)			(78.9	)
Income before income taxes			193.4				143.2				350.3				258.2
Income tax provision			(37.1	)			(48.8	)			(53.5	)			(85.1	)
Net income			156.3				94.4				296.8				173.1
Less: Net income attributable to non-controlling interest			(1.0	)			(0.5	)			(1.9	)			(1.0	)
Net income attributable to ON Semiconductor Corporation		$	155.3			$	93.9			$	294.9			$	172.1
Comprehensive income, net of tax:
Net income		$	156.3			$	94.4			$	296.8			$	173.1
Foreign currency translation adjustments			(1.5	)			0.8				0.9				7.1
Effects of cash flow hedges			1.0				(1.5	)			4.8				(0.7	)
Other comprehensive income (loss), net of tax			(0.5	)			(0.7	)			5.7				6.4
Comprehensive income			155.8				93.7				302.5				179.5
Comprehensive income attributable to non-controlling interest			(1.0	)			(0.5	)			(1.9	)			(1.0	)
Comprehensive income attributable to ON Semiconductor Corporation		$	154.8			$	93.2			$	300.6			$	178.5
Net income per common share attributable to ON Semiconductor Corporation:
Basic		$	0.36			$	0.22			$	0.69			$	0.41
Diluted		$	0.35			$	0.22			$	0.66			$	0.40
Weighted-average common shares outstanding:
Basic			427.0				420.8				426.5				420.4
Diluted			444.3				425.9				444.4				426.0

See accompanying notes to consolidated financial statements

 

5

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(unaudited)

 

		Six Months Ended
		June 29, 2018				June 30, 2017
Cash flows from operating activities:
Net income		$	296.8			$	173.1
Adjustments to reconcile net income to net cash provided by operating activities and other adjustments:
Depreciation and amortization			245.4				230.8
Loss on sale or disposal of fixed assets			2.4				1.8
Gain on divestiture of business			(4.6	)			—
Loss on debt refinancing and prepayment			4.0				26.2
Amortization of debt discount and issuance costs			6.7				8.4
Payments for term debt modification			(1.1	)			(2.4	)
Write-down of excess inventories			23.8				35.6
Share-based compensation expense			41.5				35.9
Non-cash interest on convertible notes			17.6				13.3
Goodwill and intangible asset impairment charges			3.3				6.2
Change in deferred taxes			43.2				57.2
Other			(1.0	)			2.0
Changes in assets and liabilities (exclusive of the impact of acquisition and divestiture):
Receivables			(28.8	)			(63.5	)
Inventories			(130.1	)			(7.1	)
Other assets			(4.9	)			(41.3	)
Accounts payable			21.3				35.7
Accrued expenses			(29.8	)			139.8
Deferred income on sales to distributors			—				(109.8	)
Other long-term liabilities			(10.7	)			(0.2	)
Net cash provided by operating activities			495.0				541.7
Cash flows from investing activities:
Purchases of property, plant and equipment			(252.4	)			(121.7	)
Proceeds from sales of property, plant and equipment			6.0				1.8
Deposits utilized (made) for purchases of property, plant and equipment			(13.7	)			1.1
Purchase of business, net of cash acquired			(70.7	)			(0.8	)
Proceeds from divestiture of business, net of cash transferred			5.6				—
Proceeds from repayment of note receivable			10.2				—
Equity method investment			(19.8	)			—
Purchase of held-to-maturity securities			—				(1.6	)
Net cash used in investing activities			(334.8	)			(121.2	)
Cash flows from financing activities:
Proceeds from issuance of common stock under the ESPP			6.9				11.3
Proceeds from exercise of stock options			4.3				9.2
Payment of tax withholding for restricted shares			(19.9	)			(13.6	)
Repurchase of common stock			(40.0	)			(25.0	)
Proceeds from debt issuance			7.5				695.9
Repayment of long-term debt			(215.4	)			(1,191.3	)
Purchase of convertible note hedges			—				(144.7	)
Proceeds from issuance of warrants			—				85.2
Payment of capital lease obligations			(3.2	)			(6.5	)
Net cash used in financing activities			(259.8	)			(579.5	)
Effect of exchange rate changes on cash, cash equivalents and restricted cash			0.7				2.2
Net decrease in cash, cash equivalents and restricted cash			(98.9	)			(156.8	)
Cash, cash equivalents and restricted cash, beginning of period (Note 15)			966.6				1,045.8
Cash, cash equivalents and restricted cash, end of period (Note 15)		$	867.7			$	889.0

See accompanying notes to consolidated financial statements

 

6

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1:    Background and Basis of Presentation

ON Semiconductor Corporation, together with its wholly-owned and majority-owned subsidiaries (“ON Semiconductor” or the “Company”), uses a thirteen-week fiscal quarter accounting period for the first three fiscal quarters of each year, with the second quarter of 2018 having ended on June 29, 2018, and each fiscal year ending on December 31. The quarters ended June 29, 2018 and June 30, 2017 each contained 91 days. The six months ended June 29, 2018 and June 30, 2017 contained 180 and 181 days, respectively. During the quarter ended June 29, 2018, the Company changed the name of one of its operating and reporting segments from Image Sensor Group to Intelligent Sensing Group. As of June 29, 2018, the Company was organized into the following three operating and reporting segments: the Power Solutions Group, the Analog Solutions Group and the Intelligent Sensing Group. Additional details on the Company’s operating and reporting segments are included in Note 2: “Revenue and Segment Information.”

The accompanying unaudited financial statements as of and for the quarter and six months ended June 29, 2018 have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for unaudited interim financial information. Accordingly, the unaudited financial statements do not include all of the information and footnotes required by GAAP for audited financial statements. The balance sheet as of December 31, 2017 was derived from the Company’s audited financial statements but does not include all disclosures required by GAAP for audited financial statements. In the opinion of the Company’s management, the interim information includes all adjustments, which includes normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The footnote disclosures related to the interim financial information included herein are also unaudited. Such financial information should be read in conjunction with the consolidated financial statements and related notes thereto for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, which was filed with the SEC on February 21, 2018 (the “2017 Form 10-K”). Financial results for interim periods are not necessarily indicative of the results of operations that may be expected for a full fiscal year.

Adoption of New Revenue Standard

On January 1, 2018, as required, the Company adopted ASU No. 2014-09 - Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), ASU No. 2015-14 - Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date (“ASU 2015-14”), ASU No. 2016-08 - Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (“ASU 2016-08”), ASU No. 2016-10 - Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”), ASU No. 2016-12 - Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”) and ASU No. 2016-20 - Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” (“ASU 2016-20”) (collectively “the New Revenue Standard”). To conform to the New Revenue Standard, the Company modified its revenue recognition policy as described below.

Change in Accounting Policy

On January 1, 2018, the Company adopted the New Revenue Standard using the modified retrospective method, applying the guidance to all open contracts and recognized the cumulative effect adjustment of $2.1 million to retained earnings and accrued expenses as of that date. The comparative financial information has not been restated and continues to be presented under the accounting standards in effect for the respective periods. The Company applied the practical expedient and has not disclosed the revenues allocated to future shipments of partially completed contracts.

Substantially all of the Company’s revenues continue to be recognized following the transfer of control of the products to the customer, which typically occurs upon shipment or delivery depending on the terms of the underlying contracts. Under the New Revenue Standard, revenues from certain product development agreements, which were previously deferred as delivered, are now recognized over time.

 

7

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

During the quarter and six months ended June 29, 2018, revenues increased by $1.0 million and $2.8 million, respectively, due to the impact of the adoption of the New Revenue Standard.

Revenue Recognition Policy

In anticipation of the adoption of the New Revenue Standard, during the quarter ended March 31, 2017, the Company developed its internal systems, processes and controls to enable it to make the estimates required by the New Revenue Standard on sales to its distributors and was able to reliably estimate upfront the effects of returns and allowances and record revenues at the time of shipments to these distributors. Prior to this, the Company recognized revenues from distributors under the sell-through method as it did not have the ability to estimate the effects of returns and allowances. As a result of this change, the Company recognized an additional $155.1 million in revenues during the first quarter of 2017, which resulted in an increase of $59.0 million to income before income taxes.

The Company generates revenue from sales of its semiconductor products to OEMs, electronic manufacturing service providers and distributors. The Company also generates revenue, to a much lesser extent, from product development agreements and manufacturing services provided to customers. The Company recognizes revenue when it satisfies a performance obligation in an amount reflecting the consideration to which it expects to be entitled. For sales agreements, the Company has identified the promise to transfer products, each of which is distinct, to be the performance obligation. For product development agreements, the Company has identified the completion of a service defined in the agreement to be the performance obligation. The Company applies 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. Substantially all of the Company’s revenue is recognized at the time control of the products transfers to the customer.

Sales agreements with customers are renewable periodically and contain terms and conditions with respect to payment, delivery, warranty and supply, but typically do not require minimum purchase commitments. In the absence of a sales agreement, the Company’s standard terms and conditions apply. The Company considers the customer purchase orders, governed by sales agreements or the Company’s standard terms and conditions, to be the contract with the customer. The Company evaluates certain factors including the customer’s ability to pay (or credit risk).

Most of the Company’s OEM customers negotiate pricing terms on an annual basis, while the electronic manufacturer service providers and distributors generally negotiate pricing terms on a quarterly basis. Pricing terms on product development agreements are negotiated at the beginning of a project. The Company allocates the transaction price to each distinct product based on its relative stand-alone selling price.

In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment to determine the net consideration to which the Company expects to be entitled. The Company’s 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 with respect to discontinued or slow-moving products, referred to as stock rotation. Sales to distributors can also be subject to price adjustment on certain products, primarily for distributors with ship and credit rights. 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.

 

8

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

The Company recognizes revenue when it satisfies a performance obligation. The Company recognizes revenue from sales agreements upon transferring control of a product to the customer. This typically occurs when products are shipped or delivered, depending on the delivery terms, or when products that are consigned at customer locations are consumed. The Company recognizes revenue from product development agreements over time based on the cost-to-cost method. Revenues recognized during the quarter and six months ended June 29, 2018, for sales agreements was $1,447.9 million and $2,820.7 million, respectively, and for product development agreements was $8.0 million and $12.8 million, respectively. Sales returns and allowances are estimated based on historical experience. 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 revenues are recognized, and are netted against revenues. For returns, the Company recognizes a related asset for the right to recover returned products with a corresponding reduction to cost of goods sold. The Company reviews warranty and related claims activity and records provisions, as necessary. The Company records a reserve for cash discounts as a reduction to accounts receivable and a reduction to revenues, based on the experience with each customer.

Frequently, the Company receives orders with multiple delivery dates that may extend across reporting periods. Since each delivery constitutes a performance obligation, the Company allocates the transaction price of the contract to each performance obligation based on the stand-alone selling price of the products. The Company invoices the customer for each delivery upon shipment and recognizes revenue in accordance with delivery terms. As scheduled delivery dates are within one year, revenue allocated to future shipments of partially completed contracts are not disclosed.

The Company has 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 revenues. Taxes assessed by government authorities on revenue-producing transactions, including value-added and excise taxes, are presented on a net basis (excluded from revenues) in the Consolidated Statements of Operations and Comprehensive Income.

The Company generally warrants that products sold to its customers will, at the time of shipment, be free from defects in workmanship and materials and conform to specifications. The Company’s standard warranty extends for a period of two years from the date of delivery, except in the case of image sensor products, which are warrantied for one year from the date of delivery. At the time revenue is recognized, the Company establishes an accrual for estimated warranty expenses associated with its sales and records them as a component of the cost of revenues.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management 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 revenues and expenses during the reporting period. Management evaluates these estimates and judgments on an ongoing basis and bases its estimates on experience, current and expected future conditions, third-party evaluations and various other assumptions that management believes 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 and trade receivables; (iii) future cash flows used to assess and test for impairment of goodwill and indefinite-lived intangible assets and long-lived assets, if applicable; (iv) assumptions surrounding future pension obligations; (v) fair values of share-based compensation and of financial instruments (including derivative financial instruments); (vi) measurement of valuation allowances against deferred tax assets, evaluations of uncertain tax positions and the impact of U.S. tax reform; and (vii) estimates and assumptions used in connection with business combinations. Actual results may differ from the estimates and assumptions used in the consolidated financial statements and related notes.

 

9

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Foreign Currencies

Most of the Company’s foreign subsidiaries conduct business primarily in U.S. dollars and, as a result, utilize the dollar as their functional currency. For the remeasurement of financial statements of these subsidiaries, assets and liabilities in foreign currencies that are receivable or payable in cash are remeasured at current exchange rates, while inventories and other non-monetary assets in foreign currencies are remeasured at historical rates. Gains and losses resulting from the remeasurement of such financial statements are included in the operating results, as are gains and losses incurred on foreign currency transactions.

Historically, the majority of the Company’s Japanese subsidiaries utilized Japanese Yen as their functional currency. The assets and liabilities of these subsidiaries are translated at current exchange rates, while revenues and expenses are translated at the average rates in effect for the period. The related translation gains and losses are included in other comprehensive income or loss within the Consolidated Statements of Operations and Comprehensive Income. As a result of an analysis which took into account the economic indicators of these subsidiaries from a long-term perspective, the Company changed the functional currency for some of these subsidiaries from Japanese Yen to U.S. dollars effective as of January 1, 2018.

Note 2:    Revenue and Segment Information

The Company is organized into three operating and reporting segments consisting of the Power Solutions Group, the Analog Solutions Group and the Intelligent Sensing Group. Each of the Company’s major product lines has been examined and assigned to a reporting segment based on the Company’s operating strategy. Because many products are sold into different end-markets, the total revenues reported for a segment is not indicative of actual sales in the end-market associated with that segment, but rather is the sum of the revenues from the product lines assigned to that segment. These segments represent the Company’s view of the business and as such are used to evaluate progress of major initiatives and allocation of resources.

Revenues and gross profit for the Company’s operating and reporting segments were as follows (in millions):

 

		Power Solutions Group				Analog Solutions Group				Intelligent Sensing Group				Total
For the quarter ended June 29, 2018:
Revenues from external customers		$	748.2			$	513.2			$	194.5			$	1,455.9
Gross profit		$	267.1			$	219.3			$	82.6			$	569.0
For the quarter ended June 30, 2017:
Revenues from external customers		$	671.4			$	468.5			$	198.1			$	1,338.0
Gross profit		$	228.5			$	195.8			$	74.9			$	499.2
For the six months ended June 29, 2018:
Revenues from external customers		$	1,440.8			$	1,009.4			$	383.3			$	2,833.5
Gross profit		$	506.3			$	426.1			$	164.3			$	1,096.7
For the six months ended June 30, 2017:
Revenues from external customers		$	1,415.2			$	972.1			$	387.4			$	2,774.7
Gross profit		$	472.5			$	405.1			$	142.3			$	1,019.9

Gross profit shown above and below is exclusive of the amortization of acquisition-related intangible assets. Reconciliations of segment gross profit to consolidated gross profit are as follows (in millions):

 

		Quarters Ended								Six Months Ended
		June 29, 2018				June 30, 2017				June 29, 2018				June 30, 2017
Gross profit for reporting segments		$	569.0			$	499.2			$	1,096.7			$	1,019.9
Less: unallocated manufacturing costs			(14.0	)			(7.2	)			(24.3	)			(24.8	)
Consolidated gross profit		$	555.0			$	492.0			$	1,072.4			$	995.1

 

10

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

The Company operates in various geographic locations. Sales to unaffiliated customers have little correlation with the location of manufacturers. It is, therefore, not meaningful to present operating profit by geographical location. Revenues for the Company’s operating and reporting segments disaggregated into geographic locations and sales channels were as follows (in millions):

 

		Quarter Ended June 29, 2018
		Power Solutions Group				Analog Solutions Group				Intelligent Sensing Group				Total
Geographic Location
United States		$	98.2			$	85.9			$	33.4			$	217.5
United Kingdom			124.5				82.4				35.5				242.4
Hong Kong			229.4				133.1				42.4				404.9
Singapore			244.1				157.8				31.9				433.8
Other			52.0				54.0				51.3				157.3
Total		$	748.2			$	513.2			$	194.5			$	1,455.9
Sales Channel
OEM		$	219.8			$	220.0			$	69.0			$	508.8
Distributors			482.0				257.5				115.3				854.8
Electronic Manufacturing Service Providers			46.4				35.7				10.2				92.3
Total		$	748.2			$	513.2			$	194.5			$	1,455.9

 

		Six Months Ended June 29, 2018
		Power Solutions Group				Analog Solutions Group				Intelligent Sensing Group				Total
Geographic Location
United States		$	192.7			$	164.1			$	59.9			$	416.7
United Kingdom			243.1				161.5				71.4				476.0
Hong Kong			434.6				255.6				75.6				765.8
Singapore			472.5				319.0				75.2				866.7
Other			97.9				109.2				101.2				308.3
Total		$	1,440.8			$	1,009.4			$	383.3			$	2,833.5
Sales Channel
OEM		$	417.9			$	427.6			$	133.5			$	979.0
Distributors			934.6				511.6				230.2				1,676.4
Electronic Manufacturing Service Providers			88.3				70.2				19.6				178.1
Total		$	1,440.8			$	1,009.4			$	383.3			$	2,833.5

The Company’s consolidated assets are not specifically ascribed to its individual reporting segments. Rather, assets used in operations are generally shared across the Company’s operating and reporting segments.

 

11

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Property, plant and equipment, net by geographic location, is summarized as follows (in millions):

 

		As of
		June 29, 2018				December 31, 2017
United States		$	572.9			$	547.9
Korea			396.9				380.5
Malaysia			225.0				230.0
Philippines			464.7				439.5
China			254.9				246.0
Other			472.8				435.2
Total		$	2,387.2			$	2,279.1

For the quarters ended June 29, 2018 and June 30, 2017, no single customer, including any distributor, accounted for 10% or more of the Company’s total consolidated revenues.

 

Note 3:

Recent Accounting Pronouncements

ASUs Adopted:

New Revenue Standard

The Company adopted the New Revenue Standard on a modified retrospective basis on January 1, 2018. The cumulative-effect adjustment related to the timing of revenue recognition on certain product development agreements recorded to beginning retained earnings as of January 1, 2018, was $2.1 million. The Company expects the ongoing impact of the New Revenue Standard to be immaterial to the consolidated financial statements.

ASU No. 2017-09 - Scope of Modification Accounting (“ASU 2017-09”)

In May 2017, the FASB issued ASU No. 2017-09 to reduce diversity in practice and provide clarity regarding existing guidance in ASC 718, “Stock Compensation.” The amendments clarify that an entity should apply modification accounting in response to a change in the terms and conditions of an entity’s share-based payment awards unless three newly specified criteria are met. The amendments are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted ASU 2017-09 during the first quarter of 2018. The adoption of this standard did not have a material impact on the consolidated financial statements.

ASU No 2017-07 - Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (“ASU 2017-07”)

In March 2017, the FASB issued ASU 2017-07 primarily to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. The guidance will require the net benefit cost to be split in the income statement. The service cost component will be included in operating income. The other components, including amortization of past service costs or credits and settlement and curtailments amounts, will be reported separately outside of operating income. The amendment is effective for fiscal years beginning after December 15, 2017. The Company adopted ASU 2017-07 during the first quarter of 2018, applying the standard retrospectively to all periods presented. The adoption of this standard did not have a material impact on the current period or prior period consolidated financial statements. See Note 6: “Balance Sheet Information” for further information on the adoption of ASU 2017-07.

 

12

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

ASU No. 2016-18 - Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force) (“ASU 2016-18”)

In November 2016, the FASB issued ASU 2016-18, which requires entities to include in their cash and cash-equivalent balances in the statement of cash flows those amounts that are deemed to be restricted cash and restricted cash equivalents. The ASU does not define the terms “restricted cash” and “restricted cash equivalents.” The amendments are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted ASU 2016-18 during the first quarter of 2018, applying the standard retrospectively to all periods presented. The adoption of this standard did not have a material impact on the current period or prior period consolidated financial statements. See Note 15: “Supplemental Disclosures” for further information on the adoption of ASU 2016-18.

ASU No. 2016-16 - Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”)

In October 2016, the FASB issued ASU 2016-16, which eliminates the exception for all intra-entity sales of assets other than inventory. As a result, a reporting entity would recognize the tax expense from the sale of the asset in the seller’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. Any deferred tax asset that arises in the buyer’s jurisdiction would also be recognized at the time of the transfer. The new guidance does not apply to intra-entity transfers of inventory. The income tax consequences from the sale of inventory from one member of a consolidated entity to another will continue to be deferred until the inventory is sold to a third party. The amendments are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted ASU 2016-16 during the first quarter of 2018. The adoption of this standard did not have a material impact on the consolidated financial statements.

ASU No. 2016-15 - Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”)

In August 2016, the FASB issued ASU 2016-15, which changes how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted ASU 2016-15 during the first quarter of 2018. The adoption of this standard did not have a material impact on the consolidated financial statements.

ASUs Pending Adoption:

ASU No. 2017-12 - Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”)

In August 2017, the FASB issued ASU No. 2017-12 to better align hedge accounting with risk management strategies, and as a result, more hedging strategies will be eligible for hedge accounting. Public business entities will have until the end of the first quarter in which a hedge is designated to perform an initial assessment of a hedge’s effectiveness. After initial qualification, the new guidance permits a qualitative effectiveness assessment for certain hedges instead of a quantitative test if the company can reasonably support an expectation of high effectiveness throughout the term of the hedge. An initial quantitative test to establish that the hedge relationship is highly effective is still required. The amendments are effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. The Company does not anticipate the adoption of ASU 2017-12 will have a material impact on its consolidated financial statements.

 

13

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

ASU No. 2016-02 - Leases (Topic 842) (“ASU 2016-02”)

In February 2016, the FASB issued ASU 2016-02, which amends the accounting treatment for leases. Lessees (for capital and operating leases) and lessors (for sales-type leases, direct financing leases and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company expects the adoption of this standard will result in a significant component of the Company’s future minimum lease obligations as disclosed in Note 10: “Commitments and Contingencies” to be included on its Consolidated Balance Sheets. The Company is currently reviewing its service agreements and other arrangements to evaluate whether they meet the definition of a lease under ASU 2016-02 and what additional impact that the adoption of ASU 2016-02 may have on its consolidated financial statements.

Note 4:    Acquisitions, Divestitures and Licensing Transactions

Acquisition

On May 8, 2018, the Company acquired 100% of the outstanding shares of SensL Technologies Ltd. (“SensL”), a company specializing in Silicon Photomultipliers, Single Photon Avalanche Diode and LiDAR sensing products for the automotive, medical, industrial and consumer markets, for $71.4 million in cash, subject to certain adjustments. As a result of the acquisition, SensL became a wholly-owned subsidiary of the Company. The purchase price was funded with cash on hand. This acquisition positions the Company to extend its products in automotive sensing applications for ADAS and autonomous driving by adding LiDAR capabilities to the Company’s existing capabilities in imaging and radar.

The following table presents the provisional allocation of the purchase price of SensL for the assets acquired and liabilities assumed based on their fair values (in millions):

 

		Initial Estimate
Current assets (including cash and cash equivalents of $0.7 million)		$	4.2
Property, plant and equipment and other non-current assets			1.8
Goodwill			15.2
Intangible assets (excluding IPRD)			30.4
IPRD			25.0
Total assets acquired			76.6
Current liabilities			0.7
Other non-current liabilities			4.5
Total liabilities assumed			5.2
Net assets acquired/purchase price		$	71.4

Acquired intangible assets of $30.4 million include developed technology of $29.0 million (which are estimated to have a six year weighted-average useful life). The total weighted average amortization period for the acquired intangibles is six years.

IPRD assets are amortized over the estimated useful life of the assets upon successful completion of the related projects. The value assigned to IPRD was determined by estimating the net cash flows from the projects when completed and discounting the net cash flows to their present value using a discount rate of 29.5%. The cash flows from IPRD’s significant products are expected to commence in the second half of 2018.

 

14

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

The acquisition produced $15.2 million of goodwill, which was allocated to the Intelligent Sensing Group. The goodwill is attributable to a combination of SensL’s assembled workforce, expectations regarding a more meaningful engagement by the customers due to the scale of the combined company and other product and operating synergies. Goodwill will not be amortized but instead tested for impairment at least annually (more frequently if certain indicators are present). Goodwill arising from the SensL acquisition is not deductible for tax purposes.

The initial estimated purchase price allocation is subject to change as the Company finalizes its determination relating to the valuation of net assets and finalizes key assumptions, approaches and judgments with respect to intangible assets acquired from SensL. Accordingly, future adjustments may impact the initial estimated amount of goodwill and other allocated amounts represented in the table above.

Divestiture

On June 25, 2018, the Company divested the transient voltage suppressing diodes business it acquired from Fairchild to TSC America, Inc. for $5.6 million in cash and recorded a gain of $4.6 million after writing off the carrying values of the assets and liabilities disposed. This gain has been presented as “Gain on divestiture of business” in the Consolidated Statements of Operations and Comprehensive Income for the quarter and six months ended June 29, 2018.

Licensing Transactions

During 2016 and 2017, the Company entered into an Asset Purchase Agreement with Huaian Imaging Device Manufacturer Corporation (“HIDM”) pursuant to which the Company received $52.5 million in cash in 2017 and provided perpetual, non-exclusive licenses relating to certain technologies to HIDM. Of this amount, $10.0 million was recorded as deferred licensing income to be recognized in the period in which certain qualification requirements of the technologies are achieved (or refunded to HIDM, if such qualification did not occur by June 21, 2018). During the quarter ended June 29, 2018, the Company achieved such qualification requirements for the technologies transferred and recognized $10.0 million as licensing income.

On November 29, 2017, the Company and QST Co. Ltd (“QST”) entered into an IP license and technology transfer agreement (“IP Agreement”) to grant QST patent licenses and IP rights to certain of the Company’s technologies. Pursuant to the IP Agreement, QST receives perpetual, worldwide, nonexclusive and nontransferable patents licenses and IP rights upon the payment of license fees of $13.0 million and other fees of $8.5 million in its entirety. Such amounts were paid by QST between the fourth quarter of 2017 and the first and second quarters of 2018. As a result, the Company has recognized licensing income of $18.0 million during the quarter ended June 29, 2018. The remaining amounts were previously recognized as licensing income during 2017 and the quarter ended March 30, 2018.

 

15

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Note 5:    Goodwill and Intangible Assets

Goodwill

The following table summarizes goodwill by operating and reporting segments (in millions):

 

		As of
		June 29, 2018												December 31, 2017
		Goodwill				Accumulated Impairment Losses				Carrying Value				Goodwill				Accumulated Impairment Losses				Carrying Value
Operating and Reporting Segments:
Power Solutions Group		$	432.2			$	(31.9	)		$	400.3			$	432.2			$	(28.6	)		$	403.6
Analog Solutions Group			836.7				(418.9	)			417.8				836.7				(418.9	)			417.8
Intelligent Sensing Group			110.7				—				110.7				95.5				—				95.5
		$	1,379.6			$	(450.8	)		$	928.8			$	1,364.4			$	(447.5	)		$	916.9

The following table summarizes the change in goodwill from December 31, 2017 to June 29, 2018 (in millions):

 

Net balance as of December 31, 2017		$	916.9
Addition due to business combination			15.2
Goodwill impairment			(3.3	)
Net balance as of June 29, 2018		$	928.8

During the quarter ended June 29, 2018, the Company recorded a goodwill impairment charge of $3.3 million, which represented the entire goodwill assigned to a reporting unit within the Power Solutions Group as a result of the licensing transaction with QST. See Note 4: “Acquisitions, Divestitures and Licensing Transactions” for more information.

Goodwill is tested for impairment annually on the first day of the fourth quarter or more frequently if events or changes in circumstances (each, a “triggering event”) would more likely than not reduce the carrying value of goodwill below its fair value. Management did not identify any triggering events through June 29, 2018 that would require an interim impairment analysis.

Intangible Assets

Intangible assets, net, were as follows (in millions):

 

		As of June 29, 2018
		Original Cost				Accumulated Amortization				Accumulated Impairment Losses				Carrying Value
Customer relationships		$	556.7			$	(343.8	)		$	(20.1	)		$	192.8
Developed technology			686.6				(316.8	)			(2.6	)			367.2
IPRD			79.5				—				(19.0	)			60.5
Other intangibles			79.9				(57.3	)			(15.2	)			7.4
Total intangible assets		$	1,402.7			$	(717.9	)		$	(56.9	)		$	627.9

 

16

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

		As of December 31, 2017
		Original Cost				Accumulated Amortization				Accumulated Impairment Losses				Carrying Value
Customer relationships		$	555.9			$	(328.5	)		$	(20.1	)		$	207.3
Developed technology			657.6				(278.2	)			(2.6	)			376.8
IPRD			54.5				—				(19.0	)			35.5
Other intangibles			79.8				(55.9	)			(15.2	)			8.7
Total intangible assets		$	1,347.8			$	(662.6	)		$	(56.9	)		$	628.3

Amortization expense for acquisition-related intangible assets amounted to $27.9 million and $55.3 million for the quarter and six months ended June 29, 2018, respectively, and $28.6 million and $57.7 million for the quarter and six months ended June 30, 2017, respectively. Amortization expense for intangible assets, with the exception of the $60.5 million of IPRD assets that will be amortized once the corresponding projects have been completed, is expected to be as follows for the remainder of 2018, each of the next four years and thereafter (in millions):

 

Period		Amortization Expense
Remainder of 2018		$	57.1
2019			104.9
2020			89.9
2021			75.1
2022			62.9
Thereafter			177.5
Total amortization expense		$	567.4

 

17

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Note 6:

Balance Sheet Information

Certain significant amounts included in the Company’s Consolidated Balance Sheets consist of the following (in millions):

 

		As of
		June 29, 2018				December 31, 2017
Receivables, net:
Accounts receivable		$	700.6			$	704.2
Less: Allowance for doubtful accounts			(1.8	)			(2.7	)
		$	698.8			$	701.5
Inventories:
Raw materials		$	135.4			$	117.7
Work in process			760.4				660.8
Finished goods			308.6				311.0
		$	1,204.4			$	1,089.5
Property, plant and equipment, net:
Land		$	148.5			$	148.4
Buildings			770.1				744.0
Machinery and equipment			3,687.0				3,454.6
Property, plant and equipment, gross			4,605.6				4,347.0
Less: Accumulated depreciation			(2,218.4	)			(2,067.9	)
		$	2,387.2			$	2,279.1
Accrued expenses:
Accrued payroll and related benefits		$	185.5			$	201.8
Sales related reserves			261.2				280.0
Income taxes payable			20.7				29.9
Other			96.5				101.1
		$	563.9			$	612.8

Assets classified as held-for-sale, consisting of properties, are required to be recorded at the lower of carrying value or fair value less costs to sell. The carrying value of these assets as of June 29, 2018 and December 31, 2017 was $1.4 million and $5.3 million, respectively, and is reported as other current assets on the Company’s Consolidated Balance Sheets. The Company sold the assets held-for-sale at December 31, 2017 in January 2018 for $5.5 million.

Warranty Reserves

The activity related to the Company’s warranty reserves was as follows (in millions):

 

		Six Months Ended
		June 29, 2018				June 30, 2017
Beginning Balance		$	8.0			$	8.8
Provision			(0.3	)			2.2
Usage			(0.8	)			(3.6	)
Ending Balance		$	6.9			$	7.4

 

18

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Defined Benefit Plans

The Company maintains defined benefit plans for certain of its foreign subsidiaries. The Company recognizes the aggregate amount of all overfunded plans as assets and the aggregate amount of all underfunded plans as liabilities in its financial statements. As of June 29, 2018, the total accrued pension liability for underfunded plans was $110.4 million, of which the current portion of $0.3 million was classified as accrued expenses. As of December 31, 2017, the total accrued pension liability for underfunded plans was $109.3 million, of which the current portion of $0.2 million was classified as accrued expenses.

The components of the Company’s net periodic pension expense are as follows (in millions):

 

		Quarters Ended								Six Months Ended
		June 29, 2018				June 30, 2017				June 29, 2018				June 30, 2017
Service cost		$	2.4			$	2.3			$	4.9			$	4.6
Interest cost			1.2				1.1				2.4				2.1
Expected return on plan assets			(1.5	)			(1.3	)			(3.1	)			(2.6	)
Total net periodic pension cost		$	2.1			$	2.1			$	4.2			$	4.1

With the retrospective adoption of ASU 2017-07, the service cost component is included in operating income while the other components, including the interest cost and the expected return on plan assets, are reported separately outside of operating income. The Company utilized the practical expedient to estimate the amounts for the comparative periods using the information previously disclosed in the notes to the consolidated financial statements in the 2017 Form 10-K. The service cost is allocated between the cost of revenues, research and development, selling and marketing and general and administrative line items, while the other components are included in other expense in the Consolidated Statements of Operations and Comprehensive Income.

 

Note 7:

Long-Term Debt

The Company’s long-term debt consists of the following (annualized interest rates, in millions):

 

		As of
		June 29, 2018				December 31, 2017
Amended Credit Agreement:
Revolving Credit Facility due 2021, interest payable monthly at 3.34% and 3.07%, respectively		$	400.0			$	400.0
Term Loan “B” Facility due 2023, interest payable monthly at 3.84% and 3.57%, respectively			1,154.5				1,204.5
1.00% Notes due 2020 (1)			690.0				690.0
1.625% Notes due 2023 (2)			575.0				575.0
Note payable to SMBC due 2016 through 2018, interest payable quarterly at 0% and 3.09%, respectively (3)			—				122.7
Other long-term debt (4)			144.6				182.8
Gross long-term debt, including current maturities			2,964.1				3,175.0
Less: Debt discount (5)			(159.2	)			(178.8	)
Less: Debt issuance costs (6)			(38.1	)			(44.4	)
Net long-term debt, including current maturities			2,766.8				2,951.8
Less: Current maturities			(746.4	)			(248.1	)
Net long-term debt		$	2,020.4			$	2,703.7

 

(1)	Interest is payable on June 1 and December 1 of each year at 1.00% annually.

 

19

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

(2)	Interest is payable on April 15 and October 15 of each year at 1.625% annually.

(3)	This loan represented SCI LLC’s non-collateralized loan with SMBC, which was guaranteed by the Company.

(4)	Consists of U.S. real estate mortgages, term loans, revolving lines of credit and other facilities at certain international locations where interest is payable weekly, monthly or quarterly, interest rates range between 1.00% and 5.00%, with maturity dates between 2018 and 2020.

(5)	Debt discount of $52.0 million and $62.0 million for the 1.00% Notes, $96.7 million and $104.3 million for the 1.625% Notes and $10.5 million and $12.5 million for the Term Loan “B” Facility, in each case as of June 29, 2018 and December 31, 2017, respectively.

(6)	Debt issuance costs of $7.3 million and $8.6 million for the 1.00% Notes, $9.3 million and $10.0 million for the 1.625% Notes and $21.5 million and $25.8 million for the Term Loan “B” Facility, in each case as of June 29, 2018 and December 31, 2017, respectively.

Expected maturities relating to the Company’s long-term debt (including current maturities) as of June 29, 2018 are as follows (in millions):

 

Period		Expected Maturities
Remainder of 2018		$	802.4
2019			31.2
2020			1.0
2021			400.0
2022			—
Thereafter			1,729.5
Total		$	2,964.1

Fourth Amendment to Credit Agreement

On May 31, 2018, the Company and certain of the Company’s subsidiaries, as guarantors (the “Guarantors”), entered into the Fourth Amendment (the “Fourth Amendment”) to the Credit Agreement, dated as of April 15, 2016, as amended by the First Amendment to the Credit Agreement, dated as of September 30, 2016, the Second Amendment to the Credit Agreement, dated as of March 31, 2017, and the Third Amendment to the Credit Agreement, dated as of November 30, 2017 (as amended, the “Credit Agreement”), with the several lenders party thereto and Deutsche Bank AG New York Branch, as the administrative agent (the “Agent”).

Borrowings under the 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 a $1.0 billion revolving credit facility (the “Revolving Credit Facility”), subject to certain qualifications described in the Credit Agreement. Regardless of currency, all borrowings under the Credit Agreement, may, at the Company’s option, be incurred as either eurocurrency loans (“Eurocurrency Loans”) or alternate base rate loans (“ABR Loans”).

Pursuant to the Credit Agreement, 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 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 Credit Agreement) or (y) 1.75% with respect to borrowings under a $2.4 billion term loan “B” facility (the “Term Loan “B” Facility”).

 

20

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Pursuant to the Credit Agreement, 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 Credit Agreement), subject to the interest rate floors set forth in the Credit Agreement, plus (ii) an applicable margin equal to (x) 0.25% with respect to borrowings under the Revolving Credit Facility (with step downs and step-ups as set forth in the Credit Agreement) or (y) 0.75% with respect to borrowings under the Term Loan “B” Facility.

The obligations under the Credit Agreement are guaranteed by the Guarantors and collateralized 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 Credit Agreement are also collateralized by mortgage on certain real property assets of the Company and its domestic subsidiaries.

The Credit Agreement includes financial maintenance covenants, including, among others, a maximum total net leverage ratio and a minimum interest coverage ratio. It also contains other customary affirmative and negative covenants and events of default. The Company was in compliance with its covenants as of June 29, 2018.

Debt Refinancing and Prepayment

The Company incurred third party, legal and other fees of $1.1 million related to the Fourth Amendment. The Company performed an analysis and recorded a debt extinguishment charge of $2.6 million, which included a write-off of $1.5 million of unamortized debt discount and issuance costs and $1.1 million in third party fees, as previously mentioned.

During the quarter ended June 29, 2018, the Company prepaid $50.0 million of borrowings under the Term Loan “B” Facility and expensed $1.4 million of unamortized debt discount and issuance costs attributed to the partial pay-down, as loss on debt refinancing and prepayment.

1.00% Notes due 2020

On June 8, 2015, the Company completed a private placement of $690.0 million of its 1.00% Notes to qualified institutional buyers pursuant to Rule 144A under the Securities Act. The 1.00% Notes are governed by an indenture between the Company, as the issuer, the guarantors named therein and Wells Fargo Bank, National Association, as trustee (the “1.00% Indenture”). The 1.00% Notes are convertible by holders into cash and shares of the Company’s common stock at a conversion rate of 54.0643 shares of common stock per $1,000 principal amount of notes (subject to adjustment in certain events), which is equivalent to an initial conversion price of $18.50 per share of common stock. The Company will settle conversion of all 1.00% Notes validly tendered for conversion in cash, shares of the Company’s common stock or a combination of cash and shares to be determined by the Company. Holders may convert their 1.00% Notes only under the following circumstances: (i) during any calendar quarter commencing after the calendar quarter ending on September 30, 2015, if the last reported sale price of common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (ii) during the five business-day period immediately following any five consecutive trading-day period in which the trading price per $1,000 principal amount of 1.00% Notes for each day of such period was less than 98% of the product of the closing sale price of the Company’s common stock and the conversion rate; (iii) upon occurrence of the specified transactions described in the 1.00% Indenture; or (iv) on and after September 1, 2020 (each considered a “trigger”). Upon conversion of the 1.00% Notes, the Company will deliver cash, shares of its common stock or a combination of cash and shares of its common stock, at the Company’s election.

 

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ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

As previously experienced during the quarter ended March 30, 2018, the last reported sale price of the Company’s common stock for at least 20 trading days during the period of 30 consecutive trading days ending on June 30, 2018 was greater than or equal to $24.05 (130% of the conversion price) on each applicable trading day. As a result, the Company recorded the outstanding balance, net of discount, of $630.7 million of the 1.00% Notes as a current portion of long-term debt as of June 29, 2018, and as required by the 1.00% Indenture, gave notice to the trustee, the conversion agent and each holder on June 29, 2018 that each holder has the right to surrender any portion of its 1.00% Notes (in minimum denominations of $1,000 in principal amount or an integral multiple thereof) for conversion during the calendar quarter ending September 30, 2018 (and only during such calendar quarter unless the trigger remains) pursuant to the terms of the 1.00% Indenture.

Note Payable to SMBC

On January 31, 2013, the Company amended and restated its seven-year, non-collateralized loan obligation with SANYO Electric. In connection with the amendment and restatement of the loan agreement, SANYO Electric assigned all of its rights under the loan agreement to SMBC. The loan had an original principal amount of approximately $377.5 million and had a principal balance of $122.7 million as of December 31, 2017. The entire balance was repaid on the due date of January 2, 2018.

 

Note 8:

Earnings Per Share and Equity

Earnings Per Share

Calculations of net income per common share attributable to ON Semiconductor are as follows (in millions, except per share data):

 

		Quarters Ended								Six Months Ended
		June 29, 2018				June 30, 2017				June 29, 2018				June 30, 2017
Net income attributable to ON Semiconductor Corporation		$	155.3			$	93.9			$	294.9			$	172.1
Basic weighted-average common shares outstanding			427.0				420.8				426.5				420.4
Dilutive effect of share-based awards			4.6				5.1				5.2				5.6
Dilutive effect of convertible notes			12.7				—				12.7				—
Diluted weighted-average common shares outstanding			444.3				425.9				444.4				426.0
Net income per common share attributable to ON Semiconductor Corporation:
Basic		$	0.36			$	0.22			$	0.69			$	0.41
Diluted		$	0.35			$	0.22			$	0.66			$	0.40

Basic income per common share is computed by dividing net income attributable to ON Semiconductor Corporation by the weighted average number of common shares outstanding during the period.

The number of incremental shares from the assumed exercise of stock options and assumed issuance of shares relating to RSUs is calculated by applying the treasury stock method. Share-based awards whose impact is considered to be anti-dilutive under the treasury stock method were excluded from the diluted net income per share calculation. The excluded number of anti-dilutive shares subject to share-based awards was zero for the quarters ended June 29, 2018 and June 30, 2017 and 0.3 million and 0.5 million for the six months ended June 29, 2018 and June 30, 2017, respectively.

The dilutive impact related to the Company’s 1.00% Notes and 1.625% Notes is determined in accordance with the net share settlement requirements prescribed by ASC Topic 260, Earnings Per Share. Under the net share settlement calculation, the Company’s convertible notes are assumed to be convertible into cash up to the par value, with the excess of par value being

 

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ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

convertible into common stock. A dilutive effect occurs when the stock price exceeds the conversion price for each series of the convertible notes. During the quarter ended June 29, 2018, the average share price exceeded the conversion price for both the 1.00% Notes and the 1.625% Notes and the impact of the excess over par value is included in calculating the dilutive effect of the convertible notes. In periods when the share price is lower than the conversion price, the impact is anti-dilutive and therefore has no impact on the Company’s earnings per share calculations. Additionally, if the average price of the Company’s common stock exceeds $25.96 per share, with respect to the 1.00% Notes, or $30.70 per share, with respect to the 1.625% Notes, for a reporting period, the Company will also include the effect of the additional potential shares, using the treasury stock method, that may be issued related to the warrants that were issued concurrently with the issuance of the 1.00% Notes and 1.625% Notes, respectively. Prior to conversion, the convertible note hedges are not considered for purposes of the earnings per share calculations, as their effect would be anti-dilutive. Upon conversion, the convertible note hedges are expected to offset the dilutive effect of the 1.00% Notes and 1.625% Notes, respectively, when the stock price is above $18.50 per share, with respect to the 1.00% Notes, and $20.72 per share, with respect to the 1.625% Notes.

Equity

Share Repurchase Program

During the quarter and six months ended June 29, 2018, the Company repurchased common stock worth approximately $40.0 million under the share repurchase program. There were zero and $25.0 million of repurchases of the Company’s common stock under the share repurchase program during the quarter and six months ended June 30, 2017.

Under the share repurchase program, the Company may repurchase up to $1.0 billion (exclusive of fees, commissions and other expenses) of the Company’s common stock over a period of four years from December 1, 2014, subject to certain contingencies. The Company may repurchase its common stock from time to time in privately negotiated transactions or open market transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and Rule 10b-18 of the Exchange Act, or by any combination of such methods or other methods. The timing of any repurchases and the actual number of shares repurchased will depend on a variety of factors, including the Company’s stock price, corporate and regulatory requirements, restrictions under the Company’s debt obligations and other market and economic conditions. The share repurchase program does not require the Company to purchase any particular amount of common stock and is subject to the board’s discretion. As of June 29, 2018, $563.2 million remained of the total authorized amount to repurchase common stock pursuant to the share repurchase program.

Information relating to the Company’s share repurchase program during the quarter and six months ended June 29, 2018, is as follows (in millions, except per share data):

 

		Quarter Ended				Six Months Ended
		June 29, 2018				June 29, 2018
Number of repurchased shares (1)			1.7				1.7
Aggregate purchase price		$	40.0			$	40.0
Weighted-average purchase price per share (2)		$	23.34			$	23.34
Available for future purchases at June 29, 2018		$	563.2			$	563.2

 

(1)	None of these shares had been reissued or retired as of June 29, 2018, but may be reissued or retired by the Company at a later date.

(2)	Exclusive of fees, commissions and other expenses.

 

23

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Shares for Restricted Stock Units Tax Withholding

Treasury stock is recorded at cost and is presented as a reduction of stockholders’ equity in the accompanying consolidated financial statements. Shares with a fair market value equal to the applicable statutory minimum amount of the employee withholding taxes due are withheld by the Company upon the vesting of RSUs to pay the applicable statutory minimum amount of employee withholding taxes and are considered common stock repurchases. The Company then pays the applicable statutory minimum amount of withholding taxes in cash. The amount remitted for the quarter and six months ended June 29, 2018 was $1.1 million and $19.9 million, respectively, for which the Company withheld approximately 0.1 million and 0.8 million shares of common stock, respectively, that were underlying the RSUs that vested. The amount remitted for the quarter and six months ended June 30, 2017 was $0.6 million and $13.6 million, respectively, for which the Company withheld approximately 0.1 million and 0.9 million shares of common stock, respectively, that were underlying the RSUs that vested. None of these shares had been reissued or retired as of June 29, 2018, but may be reissued or retired by the Company at a later date. These repurchases do not count against the Company’s share repurchase program.

Non-Controlling Interest

The Company’s entity, which operates assembly and test operations in Leshan, China is owned by Leshan-Phoenix Semiconductor Company Limited, a joint venture company in which the Company owns a majority of the outstanding equity interests (“Leshan”). The Company owns 80% of the outstanding equity interests in Leshan and its investment in Leshan has been consolidated in the Company’s financial statements.

At December 31, 2017, the non-controlling interest balance was $22.2 million. This balance increased to $24.1 million as of June 29, 2018, resulting from the non-controlling interest’s $1.9 million share of the earnings for the six months ended June 29, 2018.

Subsequent to the third closing date of Aizu Fujitsu Semiconductor Manufacturing Limited (“AFSM”), the Company will consolidate the results of AFSM and the non-controlling interest held by the minority shareholder will be initially recognized at fair value. See Note 11: “Fair Value Measurements” for further information about the investment in AFSM.

 

Note 9:

Share-Based Compensation

Total share-based compensation expense related to the Company’s stock options, RSUs, stock grant awards and ESPP were recorded within the Consolidated Statements of Operations and Comprehensive Income as follows (in millions):

 

		Quarters Ended								Six Months Ended
		June 29, 2018				June 30, 2017				June 29, 2018				June 30, 2017
Cost of revenues		$	1.8			$	1.5			$	3.4			$	3.0
Research and development			4.0				3.5				7.2				6.4
Selling and marketing			4.0				3.2				7.2				6.0
General and administrative			13.3				12.6				23.7				20.5
Share-based compensation expense before income taxes		$	23.1			$	20.8			$	41.5			$	35.9
Related income tax benefits (1)			4.9				7.3				8.7				12.6
Share-based compensation expense, net of taxes		$	18.2			$	13.5			$	32.8			$	23.3

 

(1)	Tax benefit was calculated using the federal statutory rate of 21% and 35% for the quarters and six months ended June 29, 2018 and June 30, 2017, respectively.

At June 29, 2018, total unrecognized share-based compensation expense, net of estimated forfeitures, related to non-vested RSUs with time-based service conditions and performance-based vesting criteria was $112.0 million, which is expected to be recognized over a weighted-average period of 1.76 years. The total intrinsic value of stock options exercised during the quarter and six months ended June 29, 2018 was $1.1 million and $10.5 million, respectively. The Company received cash of $0.6 million and $4.3 million, respectively, during the quarter and six months ended June 29, 2018 from the exercise of stock options. Upon option exercise, vesting of RSUs, stock grant awards or completion of a purchase under the ESPP, the Company issues new shares of common stock.

 

24

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Share-based compensation expense is based on awards that are ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The annualized pre-vesting forfeiture rate for stock options was estimated to be 11% during the quarters and six months ended June 29, 2018 and June 30, 2017. The annualized pre-vesting forfeiture rate for RSUs was estimated to be 5% during the quarters and six months ended June 29, 2018 and June 30, 2017.

Shares Available

As of June 29, 2018, there was an aggregate of 35.0 million shares of common stock available for grant under the Amended and Restated SIP and 7.6 million shares available for issuance under the ESPP. As of December 31, 2017, there was an aggregate of 39.0 million shares of common stock available for grant under the Company’s Amended and Restated SIP and 8.0 million shares available for issuance under the ESPP.

Stock Options

The number of options outstanding at December 31, 2017 was 1.1 million at a weighted average exercise price of $6.95 per option, of which 0.6 million options were exercised at a weighted average exercise price of $7.01 per option during the six months ended June 29, 2018. The number of options outstanding at June 29, 2018 was 0.5 million at a weighted average exercise price of $6.87 per option. All outstanding options had exercise prices below $22.24 per share, the closing price of the Company’s common stock at June 29, 2018.

Restricted Stock Units

RSUs generally vest over three years with service-based requirements or performance-based requirements or a combination of service-based and performance-based requirements and are payable in shares of the Company’s common stock upon vesting. A summary of the RSU transactions for the six months ended June 29, 2018 is as follows (in millions, except per share data):

 

		Number of Shares				Weighted-Average Grant Date Fair Value Per Share
Non-vested RSUs at December 31, 2017			9.8			$	12.63
Granted			2.8				24.39
Released			(2.7	)			12.22
Forfeited			(0.3	)			14.55
Non-vested RSUs at June 29, 2018			9.6				16.17

 

25

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

Note 10:

Commitments and Contingencies

Leases

The following represents future minimum lease obligations under non-cancelable operating leases as of June 29, 2018 (in millions):

 

Remainder of 2018		$	19.7
2019			35.0
2020			24.5
2021			19.9
2022			15.3
Thereafter			56.5
Total (1)		$	170.9

 

(1)	Excludes $16.5 million of expected sublease income.

Environmental Contingencies

The Company’s headquarters in Phoenix, Arizona are located on property that is a “Superfund” site, which is a property listed on the National Priorities List and subject to clean-up activities under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”). Motorola and Freescale (acquired by NXP Semiconductors N.V.) have been involved in the cleanup of on-site solvent contaminated soil and groundwater and off-site contaminated groundwater pursuant to consent decrees with the State of Arizona. As part of the Company’s separation from Motorola in 1999, Motorola retained responsibility for this contamination, and Motorola and Freescale have agreed to indemnify the Company with respect to remediation costs and other costs or liabilities related to this matter.

The Company’s former front-end manufacturing location in Aizu, Japan is located on property where soil and ground water contamination was detected. The Company believes that the contamination originally occurred during a time when the facility was operated by a prior owner. The Company worked with local authorities to implement a remediation plan and has completed remaining remediation. The majority of the cost of remediation was covered by insurance. Any costs to the Company in connection with this matter have not been, and, based on the information available, are not expected to be, material.

The Company’s manufacturing facility in the Czech Republic has ongoing remediation projects to respond to releases of hazardous substances that occurred during the years that this facility was operated by government-owned entities. The remediation projects consist primarily of monitoring groundwater wells located on-site and off-site with additional action plans developed to respond in the event activity levels are exceeded. The government of the Czech Republic has agreed to indemnify the Company and its respective subsidiaries, subject to specified limitations, for remediation costs associated with this historical contamination. Any costs to the Company in connection with this matter have not been, and, based on the information available, are not expected to be, material.

The Company’s design center in East Greenwich, Rhode Island is located on property that has localized soil contamination. In connection with the purchase of the facility, the Company entered into a Settlement Agreement and Covenant Not to Sue with the State of Rhode Island. This agreement requires that remedial actions be undertaken and a quarterly groundwater monitoring program be initiated by the former owners of the property. Any costs to the Company in connection with this matter have not been, and, based on the information available, are not expected to be, material.

 

26

ON SEMICONDUCTOR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued

(unaudited)

 

As a result of the acquisition of AMIS in 2008, the Company is a “primary responsible party” to an environmental remediation and cleanup at AMIS’s former corporate headquarters in Santa Clara, California. Costs incurred by AMIS include implementation of the clean-up plan, operations and maintenance of remediation systems, and other project management costs. However, AMIS’s former parent company, a subsidiary of Nippon Mining, contractually agreed to indemnify AMIS and the Company for any obligations relating to environmental remediation and cleanup at this location. Any costs to the Company in connection with this matter have not been, and, based on the information available, are not expected to be, material.

Through its acquisition of Fairchild, the Company acquired a facility in South Portland, Maine. This facility has ongoing environmental remediation projects to respond to certain releases of hazardous substances that occurred prior to the leveraged recapitalization of Fairchild from its former parent company, National Semiconductor Corporation, which is now owned by Texas Instruments, Inc. Although the Company may incur certain liabilities with respect to these remediation projects, pursuant to the asset purchase agreement entered into in connection with the Fairchild recapitalization, National Semiconductor Corporation agreed to indemnify Fairchild, without limitation and for an indefinite period of time, for all future costs related to these projects. Under a 1999 asset purchase agreement pursuant to which Fairchild purchased the power device business of Samsung, Samsung agreed to indemnify Fairchild in an amount up to $150.0 million for remediation costs and other liabilities related to historical contamination at Samsung’s Bucheon, South Korea operations. Any costs to the Company in connection with this matter have not been, and, based on the information available, are not expected to be, material.

Under a 2001 asset purchase agreement pursuant to which Fairchild purchased a manufacturing facility in Mountain Top, Pennsylvania, Intersil Corp. (acquired by Renesas Electronics Corporation) agreed to indemnify Fairchild for remediation costs and other liabilities related to historical contamination at the facility. Any costs to the Company incurred to respond to the above conditions and projects have not been, and are not expected to be, material, and any future payments the Company makes in connection with such liabilities are not expected to be material.

The Company was notified by the Environmental Protection Agency (“EPA”) that it has been identified as a “potentially responsible party” (“PRP”) under CERCLA in the Chemetco Superfund matter. Chemetco, a defunct reclamation services supplier that operated in Illinois at what is now a Superfund site, has performed reclamation services for the Company in the past. The EPA is pursuing Chemetco customers for contribution to the site cleanup activities. The Company has joined a PRP group which is cooperating with the EPA in the evaluation and funding of the cleanup. Any costs to the Company in connection with this matter have not been, and, based on the information available, are not expected to be, material.

Financing Contingencies

In the ordinary course of business, the Company provides standby letters of credit or other guarantee instruments to certain parties initiated by either the Company or its subsidiaries, as required for transactions such as, but not limited to, material purchase commitments, agreements to mitigate collection risk, leases, utilities or customs guarantees. As of June 29, 2018, the Revolving Credit Facility included $15.0 million of availability for the issuance of letters of credit. There were $0.1 million of letters of credit outstanding under the Revolving Credit Facility as of June 29, 2018, which reduces the Company’s borrowing capacity. The Company also had outstanding guarantees and letters of credit outside of its Revolving Credit Facility totaling $6.1 million as of June 29, 2018.

As part of obtaining financing in the ordinary course of business, the Company has issued guarantees related to certain of its subsidiaries’ capital lease obligations, equipment financing, lines of credit and real estate mortgages, which totaled $104.4 million as of June 29, 2018.

Based on historical experience and information currently available, the Company believes that it will not be required to make payments under the standby letters of credit or guarantee arrangements for the foreseeable future.

 

27