ON Semiconductor Corporation — Q1 2018 Form 10-Q
Reporting period: Thirteen-week quarter ended March 30, 2018; comparative quarter ended March 31, 2017. Amounts are in U.S. dollars unless stated otherwise. Financial statements are unaudited.
Business context and results
ON Semiconductor designs and manufactures semiconductor products for markets including automotive, industrial, consumer, communications, computing and medical. It reports three segments: Power Solutions Group (PSG), Analog Solutions Group (ASG) and Image Sensor Group (ISG). The company shipped about 17.6 billion units, versus 18.0 billion a year earlier.
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $1,377.6 million | $1,436.7 million | Down $59.1 million (4%) reported |
| Gross profit | $517.4 million | $503.1 million | Up $14.3 million |
| Gross margin | 37.6% | 35.0% | Up 2.6 percentage points |
| Operating income | $185.7 million | $183.1 million | Up $2.6 million |
| Net income attributable to ON Semiconductor | $139.6 million | $78.2 million | Up $61.4 million |
| Diluted EPS | $0.31 | $0.18 | Up $0.13 |
| Operating cash flow | $226.5 million | $208.5 million | Up $18.0 million |
| Capital expenditures | $99.5 million | $52.7 million | Up $46.8 million |
Consolidated gross profit and margin are stated before acquisition-related intangible amortization. Management attributed the margin improvement primarily to higher factory utilization and product mix. Operating expenses were $331.7 million, including R&D of $155.2 million, up $15.1 million year over year, primarily from increased headcount.
Material changes and segment performance
- The reported revenue decline reflects a prior-year accounting-related distributor revenue benefit: Q1 2017 included an additional $155.1 million of revenue and $59.0 million of income before taxes after the company began estimating distributor returns and allowances upfront. Excluding this prior-year revenue item, management said revenue increased $96.0 million, or approximately 7%.
- Reported segment revenue was PSG $692.6 million, ASG $496.2 million and ISG $188.8 million. Excluding the respective prior-year distributor accounting effects, management cited stronger demand in PSG power MOSFET and high-power products and in ASG automotive and digital/DC-DC products. ISG automotive growth was partly offset by lower consumer revenue, primarily following the exit from the Mobile CIS business.
- Net income also benefited from a lower tax provision and the absence of the prior-year $26.2 million debt refinancing and prepayment loss. Q1 2018 included $3.8 million of licensing income. The reported earnings increase therefore was not solely an operating improvement.
- Interest expense declined to $31.5 million from $38.4 million, mainly due to lower debt balances. The company repaid the $122.7 million SMBC note at its January 2, 2018 due date.
Cash, debt and liquidity
- Cash and cash equivalents were $924.9 million at March 30, 2018, down from $949.2 million at year-end; cash, cash equivalents and restricted cash totaled $942.3 million. Management reported approximately $221 million of cash available within the United States.
- Net cash provided by operations was $226.5 million; investing activities used $105.5 million and financing activities used $146.9 million. Higher capital spending and a $73.3 million cash use from inventory growth were notable. Management said cash, operating cash flow and available credit were expected to fund operating and capital needs for at least 12 months.
- Gross debt, including current maturities, was $3.044 billion; net carrying debt was $2.832 billion after discounts and issuance costs. The balance sheet classified $747.2 million as current debt, versus $248.1 million at December 31, 2017. The $625.0 million net carrying amount of the 1.00% Notes was reclassified as current after the stock-price conversion trigger was met; holders had a conversion right during the quarter ending June 30, 2018.
- The company was in compliance with its debt covenants. It had $400 million outstanding under its revolving credit facility and $1.205 billion under its Term Loan B facility. Management cited variable-rate debt exposure: a 50-basis-point rate increase was estimated to raise annual interest expense by about $5 million, including swaps.
- Working capital, excluding cash and cash equivalents, was $97.1 million; including cash it was $1.022 billion. Its quarter-end level was significantly affected by the convertible-note reclassification.
Outlook, risks and unusual items
- No specific revenue or earnings forecast for the next quarter or full year is stated in the provided filing text. Management referenced WSTS estimates of approximately 5% compound annual growth in its serviceable addressable market through 2020, noting these were third-party estimates, not company projections.
- Management estimated a future effective tax rate of 23%–27% before discrete items until U.S. federal net operating losses are fully used. The Q1 effective tax rate was 10.5%, including discrete benefits of $17.1 million related to expected realization of deferred tax assets following a foreign subsidiary liquidation and $6.7 million from equity-award tax benefits. Accounting for the U.S. Tax Act remained provisional in certain respects.
- Tariffs were a newly highlighted risk. Proposed U.S. tariffs included an additional 25% on specified Chinese imports; the filing said covered products included transistors and other items in the company’s supply chain. Final scope and business impact were uncertain.
- The company disclosed eight ongoing patent proceedings with Power Integrations and related patent challenges. It estimated aggregate possible losses across those cases at approximately $4 million–$20 million; outcomes remain uncertain.
- Other matters include operating lease commitments of $176.2 million, environmental remediation matters (generally expected by the company to be immaterial), product liability and indemnification exposure, and routine tax audits in several foreign jurisdictions. The company said it had adequate provisions for probable and estimable legal losses.
- Capital spending commitments were approximately $122.6 million for the remainder of 2018 and $32.8 million for 2019 and thereafter. A subsequent event: on April 1, 2018, the company completed the purchase of an additional 30% of AFSM for about $20 million, bringing ownership to 40%; further increases to 60% and then 100% are contemplated subject to stated conditions and timing.
Important facts for investors to verify
- Compare revenue and profit using a like-for-like basis that accounts for the $155.1 million prior-year distributor revenue timing effect and related $59.0 million profit effect.
- Assess the durability of improved gross margin, factory utilization and demand by segment, including the ISG consumer business exit.
- Review the 1.00% Notes’ conversion status and potential share dilution, along with near-term debt maturities and refinancing or repayment plans.
- Evaluate cash conversion, inventory growth, the materially higher capital expenditure run rate and the company’s liquidity assumptions.
- Monitor tariff developments, the Power Integrations litigation and related possible losses, U.S. tax-accounting finalization, and the staged AFSM acquisition obligations.