ON Semiconductor Corporation — Q3 2012 Form 10-Q
Business context and reporting period. ON Semiconductor supplies power and signal management, logic, discrete and custom semiconductor products for automotive, industrial, communications, computing, consumer and other markets. This unaudited report covers the 13-week quarter ended September 28, 2012, and the nine months ended that date; comparisons are to the periods ended September 30, 2011, except balance-sheet comparisons, which are to December 31, 2011. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $725.5 | $898.0 | $2,214.7 | $2,674.4 |
| Gross profit / margin | $238.0 / 32.8% | $261.1 / 29.1% | $741.5 / 33.5% | $769.6 / 28.8% |
| Operating income (loss) | $44.6 | $(6.7) | $115.1 | $82.9 |
| Net income (loss) attributable to ON Semiconductor | $12.5 | $(49.4) | $47.6 | $20.4 |
| Diluted earnings (loss) per share | $0.03 | $(0.11) | $0.10 | $0.04 |
| Operating cash flow | Not presented separately | Not presented separately | $139.4 | $380.8 |
- Revenue and margins: Q3 revenue fell 19.2% year over year. Management attributed the decline to weaker demand across segments, lower volume and mix (about 14%), lower average selling prices (about 5%), and the Thailand flood’s impact on SANYO products. Gross margin improved year over year, partly because 2011 included SANYO inventory step-up expense and noncash manufacturing charges that did not recur in 2012.
- Segment trends: Q3 SANYO Semiconductor revenue declined 34.5% year over year, while automotive/industrial/medical/mil-aero revenue fell 18.1%. SANYO’s segment gross margin rose to 19.2% from 9.0%, but its segment operating loss remained $21.4.
- Cash flow and investment: Nine-month operating cash flow decreased to $139.4 from $380.8. Capital expenditures were $198.8, versus $259.3 in the prior-year period. Cash and cash equivalents were $421.4, and short-term investments were $221.6, at September 28.
- Liquidity: Current assets were $1,835.0 and current liabilities $1,053.6; working capital was $781.4, including cash and short-term investments. Management said available cash, investments and operating cash flow were expected to fund operating and capital needs for at least 12 months.
- Debt: Total debt, including current maturities, was $1,063.4, down from $1,207.0 at year-end 2011; $260.9 was current. The company had no revolver borrowings and reported compliance with debt covenants. Cash and short-term investments totaled $643.0. A $311.4 SANYO Electric loan is guaranteed by the company.
Material changes, outlook and commentary
- For the first nine months, revenue decreased 17.2%; management cited industry weakness, reduced demand in Japan, and the lingering impact of the 2011 Thailand flooding. Unit shipments were about 28.4 billion versus 33.6 billion in the comparable period.
- Q3 operating expenses were lower year over year, notably restructuring and other charges ($11.2 versus $65.4) and general and administrative costs ($36.8 versus $51.9). Nine-month restructuring and other charges were $57.3, including $45.7 of SANYO voluntary-retirement severance, partly offset by a $11.7 pension-related benefit. A global workforce reduction affecting 172 employees began in Q3.
- Q4 2012 guidance: revenue of approximately $650–$690; gross margin of 30%–32%; and average selling prices expected to decline about 2% from Q3. Q4 backlog represented approximately 80%–85% of anticipated revenue. Management said normal second-half seasonality was not evident amid uncertain market conditions.
- In September, the company exchanged $99.9 of 2026 convertible notes for an equal principal amount of Series B notes and $2.0 cash, extending the exchanged notes’ first put date from December 2013 to December 2016. It recorded a $7.8 debt-exchange loss. It also repaid $96.2 principal of zero-coupon 2024 notes in April.
- The board authorized a share-repurchase program of up to $300 over three years. Q3 purchases totaled approximately $27.0 for 4.1 million shares; $273.1 remained available at quarter-end.
- Q3 net income was affected by a $7.8 debt-exchange loss. Nine-month 2011 results were retrospectively revised: the SANYO acquisition gain was reduced from $58.0 to $24.3, and reported ON-attributable net income from $54.1 to $20.4.
Risks, contingencies and unusual items
- Management highlighted semiconductor cyclicality, uncertain demand, competitive pricing, customer order changes, manufacturing yields and capacity, supply-chain availability, restructuring execution, foreign-exchange exposure, and substantial leverage. Political and economic tensions between Japan and China and Thailand flood-related disruption were also cited.
- A SANYO customer sought approximately $20.0 for alleged product failures predating the acquisition. The company was investigating, said defenses were available, and did not expect a material effect based on its then-current knowledge.
- Thailand employee claims sought approximately $25.4; all but one plaintiff settled confidentially in September 2012. The company expected the remaining case to have no material effect. Other legal matters were described as not expected to be material, although management cautioned that litigation outcomes are uncertain.
- Defined-benefit pension liabilities for underfunded plans were $85.0; estimated SANYO Electric multiemployer pension obligations were $137.5. The company expected to receive approximately $22.2 in Q4 2012 in connection with pension-plan withdrawals.
- Goodwill was $198.7. Management reported no impairment-triggering event through September 28, but warned that a longer or more severe downturn could reduce asset fair values and lead to impairment charges.
- A 50-basis-point increase in interest rates was estimated to raise annual interest expense by approximately $2.1. A hypothetical 10% currency-rate change was estimated to affect pretax income by approximately $31.9 before offsets from hedges.
- The company expected to use $8.8 of remaining SANYO operational support credits in Q4; the remaining $19.6 was expected to expire at year-end. It also disclosed $123.0 of future minimum operating-lease payments.
Investor verification priorities
- Track whether Q4 revenue and gross-margin guidance was achieved, and whether demand, pricing and backlog trends stabilized.
- Assess the sustainability of improved gross margin, separating underlying performance from nonrecurring 2011 comparison charges and restructuring effects.
- Reconcile the sharp year-over-year decline in operating cash flow with working-capital movements, restructuring payments and capital spending.
- Review debt maturities and put options, covenant compliance, and the company’s ability to service debt while funding capital needs and buybacks.
- Monitor SANYO integration and restructuring costs, Thailand-related demand recovery, pension-plan withdrawals, and the customer product-liability claim.
- Confirm the revised 2011 comparative figures and consider the effects of the SANYO acquisition-gain adjustment when evaluating year-over-year earnings.