ON Semiconductor Corporation — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also reports unaudited fourth-quarter results. ON Semiconductor designs and manufactures power, analog, image-sensor, connectivity and other semiconductor products for automotive, industrial, communications, computing and consumer markets. In September 2016, it acquired Fairchild and realigned reporting into Power Solutions, Analog Solutions and Image Sensor groups.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Revenue | $3,906.9 million | $3,495.8 million |
| Gross profit / margin | $1,296.9 million / 33.2% | $1,193.2 million / 34.1% |
| Operating income | $236.1 million | $261.1 million |
| Net income attributable to ON Semiconductor | $182.1 million | $206.2 million |
| Diluted EPS | $0.43 | $0.48 |
| Operating cash flow | $581.2 million | $470.6 million |
| Capital expenditures | $210.7 million | $270.8 million |
| Cash and cash equivalents at year-end | $1,028.1 million | $617.6 million |
| Gross debt at year-end | $3,806.8 million | $1,515.8 million |
Management-defined free cash flow—operating cash flow less capital expenditures—was approximately $370.5 million in 2016. Net carrying value of long-term debt, including current maturities, was $3,622.3 million. Current assets were $2,869.1 million and current liabilities $1,502.6 million. Management said cash, operating cash flow and credit facilities were expected to fund operating and capital needs for at least 12 months; approximately $399 million of cash was available in the United States.
Fourth quarter
Q4 2016 revenue was $1,261.0 million, versus $840.3 million in Q4 2015. Net income attributable to ON Semiconductor was $110.9 million, versus $54.1 million, and diluted EPS was $0.26, versus $0.13. Quarterly gross profit, excluding acquisition-related intangible amortization, was $384.5 million, versus $279.9 million. The comparison is affected by Fairchild, whose results were included from September 19, 2016.
Material changes and unusual items
- Revenue increased 11.8% year over year, primarily because of Fairchild; the acquired business contributed $411.5 million of revenue from closing through year-end. Image Sensor Group revenue declined 4% for the year, while Power Solutions and Analog Solutions revenue rose 21% and 11%, respectively.
- Gross margin declined 90 basis points to 33.2%, mainly because $67.5 million of Fairchild acquired-inventory fair-value step-up was expensed. Management said margin excluding that charge improved, primarily from higher factory utilization and product mix.
- Operating income fell to $236.1 million, while interest expense increased to $145.3 million from $49.7 million, chiefly reflecting acquisition financing. Restructuring charges rose to $33.2 million, including $25.7 million of post-Fairchild costs.
- The Fairchild acquisition cost approximately $2.532 billion, funded with term-loan and revolver borrowings and cash. The company recorded a $92.2 million gain on the sale of two product lines to Littelfuse for $104 million in cash, partly to satisfy FTC requirements.
- The $3.9 million income tax benefit included significant valuation-allowance releases and a tax expense from reversing the prior indefinite-reinvestment assertion. The filing says these changes did not affect cash taxes; management expects the future tax rate to more closely approximate the 35% U.S. statutory rate.
Outlook, risks and contingencies
For Q1 2017, management forecast revenue of $1.215–$1.265 billion and gross margin of 33.4%–34.8%. Opening backlog represented approximately 80%–85% of anticipated Q1 revenue. Management expected integration-related cost reductions and continued restructuring, while noting that actual results could differ from forecasts.
- Key risks include semiconductor cyclicality, pricing pressure, customer order cancellations and inventory swings, dependence on distributors and major end markets, supply-chain and manufacturing disruptions, and the challenge of integrating Fairchild and realizing expected synergies.
- Debt and financing risk increased materially after the acquisition. The $2.4 billion Term Loan B is due in 2023; the $600 million revolver was undrawn at year-end. Debt agreements include collateral, financial covenants and other restrictions. The company reported covenant compliance at December 31, 2016.
- Variable-rate debt was $2,708.1 million; the filing estimates a 50-basis-point rate increase would raise annual interest expense by approximately $13.5 million. Interest-rate swaps entered into in January 2017 hedge a portion of this exposure.
- Power Integrations litigation remained a significant uncertainty: the company estimated possible losses across the cases at $4–$20 million and was appealing adverse rulings. A separate Acbel complaint seeks at least $30 million; the company says it is defending the case. The filing states that other legal matters were not expected to have a material adverse effect, but outcomes remain uncertain.
- Environmental remediation matters and indemnification obligations were described as not expected to be material based on information available. The company also identified cyber, foreign-exchange, tax, product-liability and environmental risks.
- Management and the auditor reported effective internal control over financial reporting, but Fairchild was excluded from the 2016 assessment and audit. Fairchild represented approximately 25% of consolidated assets and 11% of 2016 revenue; integration of its controls was expected to be completed by Q4 2017.
Important facts for investors to verify
- Whether Fairchild integration delivers the anticipated cost savings and product and customer benefits, and how acquired operations perform after the partial-year contribution.
- Underlying gross-margin performance after the $67.5 million inventory step-up charge and the impact of ongoing restructuring.
- Debt repayment capacity, interest-rate exposure, covenant headroom and the availability and location of cash.
- The basis and sustainability of the unusually low 2016 effective tax rate, including deferred-tax-asset realizability and tax-audit exposures.
- Developments in Power Integrations and Acbel litigation, and the eventual effect of distributor revenue-recognition changes planned for adoption in 2018.