ON SEMICONDUCTOR CORP (ON) FY 2022 MD&A

Executive Overview

This executive overview presents summarized information regarding our 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.

onsemi Results

Our revenue for the year ended December 31, 2022 was $8,326.2 million, an increase of 23.5% from $6,739.8 million for the year ended December 31, 2021. The increase was attributable to our strategy to focus on a product mix that yields higher margins, and an increase in average selling prices driven by strong market demand. During 2022, we reported net income attributable to onsemi of $1,902.2 million compared to $1,009.6 million in 2021. Our operating income totaled $2,360.0 million during 2022 compared to $1,287.6 million during 2021. The increase in our operating income and net income was due to significantly better gross margins primarily driven by higher revenue in focused end-markets, favorable product mix, increase in average selling prices and savings from restructuring activities. Our gross margin increased by approximately 870 basis points to 49.0% in 2022 from 40.3% in 2021. See discussion under "Results of Operations" for additional discussion on the reasons for the fluctuations year over year.

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Business and Macroeconomic Environment

The semiconductor industry has traditionally been highly cyclical, has often experienced significant downturns in connection with, or in anticipation of, declines in general economic conditions, and may experience uncertainty and volatility in the future.

During the year ended December 31, 2022, our product demand remained strong as we achieved record annual revenues. However, we are aware of and are monitoring the economic environment and related forecasts, which suggest global economic slowdowns could continue and potentially result in certain economies entering a recessionary period, which could include the United States. Given the current conditions, we are actively managing our manufacturing activity and spending to align with our forecasted demand. We believe the current volatility in general economic conditions is not expected to have a significant impact on our long-term strategic and growth initiatives.

During 2022, we achieved revenue growth as well as expanded our gross margin and operating margin. The semiconductor industry conditions have resulted in increased costs throughout our supply chain. In some cases, we have been able to increase our prices and pass these increased costs along to our customers, which also partially contributed to higher revenue for 2022. We expect to continue to evaluate cost-saving initiatives to be able to align our overall cost structure, capital investments and other expenditures with our expected revenue, spending and capacity levels to help offset increased costs. We have taken, and continue to take actions, including but not limited to, exiting product lines, that do not support our gross margin improvements and strategic objectives.

See Note 7: ''Restructuring, Asset Impairments and Other Charges, 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

A discussion of our results of operations for the year ended December 31, 2022 compared to December 31, 2021 is included below. For a discussion and comparison of the results of our operations for the year ended December 31, 2021 with the year ended December 31, 2020, refer to "Management's Discussion and Analysis of Financial Conditions and Results of Operations" in our Form 10-K for the year ended December 31, 2021 filed with the SEC on February 14, 2022.

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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):

Revenue

Revenue was $8,326.2 million and $6,739.8 million for 2022 and 2021, respectively. The increase from 2021 to 2022 of $1,586.4 million, or 23.5%, was attributable to a 22.4%, 18.4% and 41.7% increase in revenue in PSG, ASG and ISG, respectively, which is further explained below.

We had one customer, a distributor, whose revenue accounted for approximately 12% of the total revenue for the year ended December 31, 2022.

Revenue by operating and reportable segments was as follows (dollars in millions):

_______________________

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

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Revenue from PSG

Revenue from PSG increased by $769.1 million, or approximately 22.4%, during 2022 compared to 2021. The revenue from our Advanced Power Division and our Integrated Circuits, Protection and Signal Division increased by $672.7 million and $96.4 million, respectively. These increases primarily were driven by our strategy to focus on SiC, a product mix that yields higher margins and an increase in average selling prices driven by strong market demand.

Revenue from ASG

Revenue from ASG increased by $441.4 million, or approximately 18.4%, during 2022 compared to 2021. The revenue from our Automotive Division, Industrial Solutions Division and Mobile, Computing and Cloud Division increased by $224.2 million, $173.8 million and $77.1 million, respectively. The increases primarily were due to our strategy to focus on a product mix that yields higher margins, and an increase in average selling prices driven by strong market demand.

Revenue from ISG

Revenue from ISG increased by $375.9 million, or approximately 41.7%, during 2022 compared to 2021. The revenue from our Automotive Sensing Division and our Industrial and Consumer Solutions Division increased by $357.3 million and $18.7 million, respectively. The increase in revenue was due to our strategy to focus on a product mix that yields higher margins, and an increase in average selling prices driven by strong market demand.

Revenue by Geographic Location

Revenue by geographic location, based on sales billed from the respective country or regions, are as follows (dollars in millions):

_______________________

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

Gross Profit and Gross Margin

Our gross profit by operating and reportable segment was as follows (dollars in millions):

_______________________

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

Our gross profit increased by $1,362.9 million, or approximately 50%, from $2,714.3 million during 2021 to $4,077.2 million during 2022. Gross margin increased to 49.0% during 2022 compared to 40.3% during 2021.

The significant increases in gross profit and gross margin were primarily driven by higher revenue, particularly in the

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automotive and industrial end-markets, and a favorable product mix, which included price increases to resolve price-to-value discrepancies for our products.

Operating Expenses

Research and Development

Research and development expenses were $600.2 million and $655.0 million, or approximately 7% and 10% of revenue for 2022 and 2021, respectively, representing a decrease of $54.8 million, or approximately 8% year-over-year. The decrease was primarily due to a reduction in payroll and other related expenses associated with the wind down of QCS.

Selling and Marketing

Selling and marketing expenses were $287.9 million and $293.6 million, or approximately 3% and 4% of revenue for 2022 and 2021, respectively, representing a decrease of $5.7 million, or approximately 2% year-over-year. The decrease was primarily due to a reduction in payroll-related expenses due to census declines from hiring delays and attrition.

General and Administrative

General and administrative expenses were $343.2 million and $304.8 million, or approximately 4% and 5% of revenue for 2022 and 2021, respectively, representing an increase of $38.4 million, or approximately 13% year-over-year. The increase was primarily due to higher variable compensation and stock compensation.

Amortization of Acquisition—Related Intangible Assets

Amortization of acquisition-related intangible assets was $81.2 million and $99.0 million for 2022 and 2021, respectively, representing a decrease of $17.8 million, or approximately 18.0%, year-over-year. The decrease was due to the reduction in amortization expense as certain intangible technology-related assets became fully amortized in 2021 and the full write-off of QCS intangibles.

Restructuring, Asset Impairments and Other Charges, net

Restructuring, asset impairments and other charges, net was $17.9 million and $71.4 million for 2022 and 2021, respectively. Charges in 2022 represent severance charges, contract termination costs and litigation expenses and primarily relate to the QCS wind down. Amounts incurred during 2021 primarily related to the involuntary severance plan. For additional information, see Note 7: ''Restructuring, Asset Impairments and Other Charges, 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 impairment was $386.8 million and $2.9 million for 2022 and 2021, respectively. During 2022, we recorded a goodwill impairment charge of $330.0 million and an intangible asset impairment charge of $56.8 million, as a result of a shift in our focus on long-term product mix in our strategic markets and the QCS wind down. See Note 6: ''Goodwill and Intangible Assets'' in the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-K for additional information.

Other Income and Expenses

Interest Expense

Interest expense decreased by $35.5 million, or approximately 27.2%, to $94.9 million during 2022 compared to $130.4 million in 2021. The decrease was primarily due to the lack of amortization of debt discount on our convertible notes due to the adoption of ASU 2020-06, the effect of the issuance of the 0% Notes, as a majority of the proceeds were utilized to repay higher rate debt. Our average gross amount of long-term debt balance (including current maturities) during 2022 and 2021 was $3,243.3 million and $3,423.9 million, respectively. Our weighted average interest rate on our gross amount of long-term debt (including current maturities) was 2.9% and 3.8% per annum in 2022 and 2021, 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

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our refinancing activities.

Gain on Divestiture of Businesses

Gain on divestiture of business was $67.0 million in 2022, compared to $10.2 million in 2021. The gain during 2022 relates to the divestiture of the wafer manufacturing facilities in Niigata, Japan, Pocatello, Idaho, South Portland, Maine and Oudenaarde, Belgium.

Loss on Debt Refinancing and Prepayment

We recorded loss on debt refinancing and prepayment of $7.1 million during 2022. This was primarily related to the partial prepayment of the Term Loan "B" Facility. 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.

Other income, net

Other income, net was $18.0 million in 2021 compared to an income of $21.7 million in 2022, reflecting a change of approximately 20.6%. The increase was primarily due to the fluctuations in foreign currencies resulting in increased transaction gains offset by losses on hedges that were realized.

Income Tax Provision

We recorded an income tax provision of $458.4 million and $146.6 million in 2022 and 2021, respectively, representing effective tax rates of 19.4% and 12.7%. The increase in our effective tax rate was substantially driven by the impact of nondeductible goodwill and foreign operations.

For additional information, see Note 16: ''Income Taxes'' and Note 6: ''Goodwill and Intangible Assets'' in the notes to the audited consolidated financial statements included elsewhere in this Form 10-K.

Liquidity and Capital Resources

Overview

Our principal sources of liquidity are cash on hand, cash generated from operations, funds from external borrowings and debt 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, which has approximately $1.5 billion available for future borrowings. Our balance of cash and cash equivalents was $2,919.0 million as of December 31, 2022.

We require cash to: (i) fund our operating expenses, working capital requirements, outlays for strategic acquisitions and investments; (ii) service our debt, including principal and interest; (iii) conduct research and development; (iv) incur capital expenditures; and (v) repurchase our common stock. As part of our business strategy, we review acquisition and divestiture opportunities on a regular basis.

During the ordinary course of business, we evaluate our cash requirements and, if necessary, adjust our expenditures to reflect the current market conditions and our projected sales and demand. Our capital expenditures are primarily directed towards manufacturing equipment, and can materially influence our available cash for other initiatives. Future capital expenditures may be impacted by events and transactions that are not currently forecasted.

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

•Changes in demand for our products, competitive pricing pressures, supply chain constraints, effective management of our manufacturing capacity, our ability to achieve further reductions in operating expenses, our ability to make progress on the achievement of our business strategy and sustainability goals, 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

•The debt and equity capital markets could impact our ability to obtain needed financing on acceptable terms or to

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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.

Sources and Uses of Cash

As part of our business strategy, we review acquisition and divestiture opportunities on a regular basis. Excluded from the discussion below is the EFK facility, which we acquired on December 31, 2022 for $406.3 million in cash, of which approximately $236.3 million was paid in January 2023. See Note 5: ''Acquisitions and Divestitures'' in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

The following are the significant sources and uses of cash during 2022:

•Our cash flows from operating activities were $2,633.1 million.

•We paid approximately $1,005.0 million for capital expenditures.

•Borrowing of $500.0 million under the Revolving Credit Facility, the net proceeds of which were used to prepay the outstanding balance of $500.0 million under the Term Loan "B" Facility.

•Repurchased approximately 4.0 million shares of common stock for an aggregate purchase price of $259.8 million.

•Divestiture of manufacturing facilities in Oudenaarde, Belgium, South Portland, Maine, Pocatello, Idaho and Niigata, Japan for approximately $275.0 million in the aggregate. See Note 5: ''Acquisitions and Divestitures'' in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

Operating Activities

Our long-term cash generation is dependent on the ability of our operations to generate cash. Our cash flows from operating activities were $2,633.1 million, $1,782.0 million and $884.3 million for the years ended December 31, 2022, 2021 and 2020, respectively. Our operating cash flows for the year ended December 31, 2022 increased by $851.1 million, or 47.8%, compared to the year ended December 31, 2021 and was primarily attributable to a significant increase in net income due to our strategy to focus on a product mix that yields higher margins combined with increased demand and prices for our products.

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. Management of our assets and liabilities, including both working capital and long-term assets and liabilities, also influences our operating cash flows.

Investing Activities

Our cash flows used in investing activities were $705.4 million, $915.1 million and $453.6 million for the years ended December 31, 2022, 2021 and 2020, respectively. The decrease of $209.7 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily attributable to capital expenditures offset by proceeds from the sale of real estate and divestitures. During the year ended December 31, 2022, 2021 and 2020, we paid $1,005.0 million, $444.6 million and $383.6 million, respectively, for capital expenditures. Our capital expenditures as a percent of revenue increased in 2022 to 12%, primarily as a result of the silicon carbide expansion and our facility expansion investments. In 2023, we expect capital expenditures to be approximately 20% of revenue as these investments along with other capital initiatives will increase.

Financing Activities

Our cash flows used in financing activities were $370.0 million, $569.4 million and $244.0 million for the years ended December 31, 2022, 2021 and 2020, respectively. The decrease of $199.4 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily attributable to proceeds and payments related to long-term borrowings and share repurchase activity.

See Part I, Item 1A "Risk Factors" included elsewhere in this Form 10-K for additional information related to liquidity matters.

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Debt

Our ability to service our long-term debt, including our 0% Notes, 3.875% Notes, 1.625% Notes, the Revolving Credit Facility and the 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 financial, competitive, legislative, regulatory and other conditions, some of which may be beyond our control.

As of December 31, 2022, there was $1,086.0 million outstanding under the Term Loan "B" Facility, in addition to $805.0 million aggregate principal amount of the 0% Notes, $700.0 million aggregate principal amount of 3.875% Notes and $137.3 million aggregate principal amount of the 1.625% Notes. The aggregate principal amount of outstanding 1.625% Notes, net of unamortized discount and issuance costs, has been reclassified as a current portion of long-term debt. The associated interest expense related to this indebtedness will continue to have a significant impact on our results of operations.

See Note 5: ''Acquisitions and Divestitures'' and Note 9: ''Long-Term Debt'' in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K for additional information.

Key Financing and Capital Events

Overview

We continually evaluate our debt and capital structure and when appropriate, we have completed various measures to secure liquidity, 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 2022, which included the partial repayment of our Term Loan through borrowings of $500.0 million under our Revolving Credit Facility and the amendment of our credit agreement to eliminate the LIBO Rate as a borrowing alternative. For further discussion of our debt instruments, see Note 9: ''Long-Term Debt'' and for further discussion on the Share Repurchase Program (as defined below), see Note 10: ''Earnings Per Share and Equity'' in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

2022 Financing Events

•In connection with the Company’s $500.0 million draw down on the Revolving Credit Facility, we expensed $7.3 million of unamortized debt discount and issuance costs primarily attributed to a partial pay-down of debt as loss on debt refinancing and prepayment.

•Repurchases under the Share Repurchase Program amounted to $259.8 million during the year ended December 31, 2022.

•On November 9, 2022, we entered into separate privately negotiated transactions with certain holders of the 1.625% Notes to repurchase or exchange, as applicable, $16.0 million in aggregate principal amount of the 1.625% Notes for a total consideration of $16.0 million in cash and 552,000 shares of common stock.

•On November 16, 2022, we entered into the Tenth Amendment to the Amended Credit Agreement to transition the interest rate base from the LIBO Rate to Term SOFR.

2021 Financing Events

•In May 2021, we completed a private offering of $805.0 million aggregate principal amount of 0% Notes. In connection with the issuance of the 0% Notes, we entered into convertible note hedge transactions with the initial purchasers of the 0% Notes or their affiliates ("Counterparties") and paid $160.3 million in cash for the convertible note hedges. We also entered into warrant transactions with the Counterparties and received $93.8 million in cash for the sale of warrants.

•Contemporaneously with the issuance of the 0% Notes, we entered into separate privately negotiated transactions with certain holders of the 1.625% Notes to repurchase or exchange, as applicable, $372.4 million in aggregate principal amount of the 1.625% Notes for a total consideration of $506.5 million in cash and 5.4 million shares of common stock. In December 2021, we repurchased $47.4 million of the 1.625% Notes for $47.4 million in cash and 1.6 million

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shares of common stock.

•During the year ended December 31, 2021, we repaid the outstanding balance of $700.0 million under the Revolving Credit Facility using a portion of the net proceeds from the issuance of the 0% Notes and cash on hand.

2020 Financing Events

•The 1.00% Notes matured on December 1, 2020. The maturity of the notes resulted in us paying $690.0 million in cash, to holders of the 1.00% Notes using our available cash and cash equivalents. The excess over the principal amount was settled by issuing shares of common stock held in treasury. At the time of issuance of the 1.00% Notes, we concurrently entered into hedge transactions with certain of the initial purchasers of the 1.00% Notes, and accordingly, repurchased an equivalent number of shares of our common stock at fair market value, to effectively offset the issuance of shares. Also at the time of issuance of the 1.00% Notes, we sold warrants to certain bank counterparties whereby the holders of the warrants had the option to purchase from us the equivalent number of shares of our common stock at a price of $25.96 per share. All these warrants were exercised by the holders during the first and second quarters of 2021 and were settled by issuing an aggregate of 13.4 million shares of common stock.

•In August 2020, we completed a private offering of $700.0 million aggregate principal amount of the 3.875% Notes due 2028. In connection with the issuance, we incurred original issue discount and debt issuance costs amounting to $9.4 million.

•In March 2020, we borrowed $1,165.0 million under the Revolving Credit Facility as a precautionary measure in order to increase our cash position and provide financial flexibility in light of the uncertainty resulting from the impact of the COVID-19 pandemic. Due to better macroeconomic and business conditions, we used the net proceeds from the issuance of the 3.875% Notes along with cash on hand to repay $1,200.0 million of outstanding borrowings with the remaining $65.0 million balance we repaid $65.0 million on December 31, 2020.

•During 2020, we repurchased 3.6 million shares of our common stock for an aggregate purchase price of $65.3 million pursuant to the Share Repurchase Program.

Debt Guarantees and Related Covenants

As of December 31, 2022, we were in compliance with the indentures relating to our 0% Notes, 3.875% Notes and 1.625% Notes and with covenants relating to our Term Loan "B" Facility and Revolving Credit Facility. Our 0% Notes, 3.875% Notes and 1.625% Notes are senior to the existing and future subordinated indebtedness of onsemi and our guarantor subsidiaries and rank equally in right of payment to all of our existing and future senior debt and as unsecured obligations and are subordinated to all of our existing and future secured debt to the extent of the assets securing such debt. Failure to comply with any of our covenants or any other terms of our Term Loan "B" Facility and Revolving Credit Facility could result in higher interest rates on our borrowings or the acceleration of the maturities of our outstanding 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. In addition to our critical accounting policies below, see Note 2: ''Significant Accounting Policies'' in the notes to our audited consolidated financial statements included elsewhere in this Form 10-K.

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) future payouts for customer incentives and amounts subject to allowances and returns; (ii) valuation and obsolescence relating to inventories; (iii) measurement of valuation allowances against deferred tax assets, and

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evaluations of uncertain tax positions; (iv) assumptions used in business combinations; and (v) testing for impairment of long-lived assets and goodwill. 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 long-lived assets and goodwill. Actual results may differ from the estimates and assumptions used in the consolidated financial statements.

Revenue Recognition. We generate revenue from sales of our semiconductor products to direct customers 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. Substantially all of our revenue is recognized at the time control of the products transfers to the customer.

Sales to certain distributors, primarily those with ship and credit rights, can be subject to price adjustment on certain products. We develop an estimate of their expected claims under the ship and credit program based on the historical claims data submitted by product and customer and expected future claims, 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 direct customers do not have the right to return products, other than pursuant to the provisions of our 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 non-quality related 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.

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. The majority of product inventory that has been previously reserved is ultimately discarded. However, we do sell some products that have previously been written down, such sales have historically been consistently insignificant and the related impact on our margins has also been insignificant.

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, feasible tax planning strategies, future reversals of existing temporary differences and taxable income in prior carryback years, if a carryback is permitted 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

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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. No tax benefit is recognized for tax positions that are not more likely than not to be sustained. 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.

Business Combination. We use estimates and assumptions in allocating the purchase price of acquired business by utilizing established valuation techniques appropriate for the technology industry to record the acquired assets and liabilities at fair value. 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. If the income approach is used, the fair value determination 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. Determining the fair value of acquired technology assets is judgmental in nature and requires the use of significant estimates and assumptions, including the discount rate, revenue growth rates, projected gross margins, and estimated research and development expenses.

Impairment of Goodwill 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.

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 evaluate the recoverability of the carrying amount of our property, plant and equipment and intangible assets, 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. As we continue to implement our business strategy to rationalize products and manufacturing locations to transition to a lighter internal fabrication model, there could be divestiture transactions resulting in a portion of goodwill or other assets being de-recognized, and which may or may not result in accounting charges.

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.

Recent Accounting Pronouncements

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