ON Semiconductor Corporation — Q2 2011 Form 10-Q
Business context and period. ON Semiconductor designs, manufactures and sells semiconductor components for automotive, industrial, computing, consumer, communications and other markets. This unaudited filing covers the quarter and six months ended July 1, 2011; comparisons are with the periods ended July 2, 2010. Results include SANYO Semiconductor from January 1, 2011, and the acquired Cypress CMOS Image Sensor Business Unit (ISBU) from February 27, 2011, so reported growth is not wholly organic.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $905.8 million | $583.3 million | $1,776.4 million | $1,133.5 million |
| Gross profit / margin | $266.1 million / 29.4% | $243.8 million / 41.6% as reported | $508.5 million / 28.6% | $471.9 million / 41.6% |
| Operating income | $56.9 million | $101.5 million | $89.6 million | $185.7 million |
| Net income attributable to ON Semiconductor | $41.0 million | $78.7 million | $123.6 million | $141.7 million |
| Diluted EPS | $0.09 | $0.18 | $0.27 | $0.32 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $261.6 million | $268.4 million |
- Q2 revenue rose about 55% year over year, principally reflecting acquisitions and 6% growth from volume and mix, partly offset by approximately 1% lower average selling prices. SANYO contributed $274.3 million of Q2 revenue.
- Despite higher gross profit dollars, Q2 gross margin fell sharply. The company cited $22.1 million of acquisition-related inventory fair-value step-up costs and $30.4 million of noncash SANYO manufacturing costs. It estimated Japan earthquake-related production disruption reduced Q2 gross profit and net income by about $10 million.
- Q2 operating expenses rose to $209.2 million from $142.3 million, reflecting acquired operations, increased headcount and higher research and development, selling and marketing, and general and administrative costs. Higher operating expenses and acquisition costs contributed to lower operating income and net income.
- For the first half, reported net income included a $69.1 million bargain-purchase gain on SANYO. Excluding that item, reported net income was lower than in the comparable 2010 period; the filing does not provide a directly stated adjusted net-income measure.
- At July 1, cash and cash equivalents were $756.6 million and short-term investments were $112.2 million, totaling $868.8 million. Current assets were $2,296.9 million and current liabilities $1,294.2 million; working capital was $1,002.7 million.
- Total debt, including current maturities and capital leases, was $1,285.4 million, versus $888.8 million at December 31, 2010. Current maturities were $286.7 million; cash and short-term investments exceeded debt by about $416.6 million. Debt includes $358.6 million owed under the SANYO acquisition note. The company reported compliance with debt covenants.
- First-half investing cash use was $158.2 million, including $173.5 million of capital expenditures, $17.9 million net business-acquisition spending and $112.2 million of investment purchases, partly offset by $142.1 million use of restricted cash. Financing provided $27.9 million; cash increased $133.3 million.
Material changes and significant items
- The January SANYO acquisition expanded the company’s Asian and Japanese presence and product portfolio. The preliminary purchase price was revised to $479.9 million and produced a $69.1 million bargain-purchase gain. The purchase allocation remains subject to adjustment, particularly for pension, retirement-plan, asset-retirement and tax valuations.
- The company acquired the ISBU for approximately $34.1 million in cash. Its initial allocation included $8.0 million of goodwill and $11.2 million of in-process research and development.
- Inventories rose to $749.2 million from $360.8 million and receivables to $575.8 million from $294.6 million, largely due to the SANYO acquisition. Property, plant and equipment increased to $1,150.9 million from $864.3 million.
- Cash capital expenditures were $173.5 million in the first half, compared with $93.5 million in the first half of 2010. The company also recorded $17.5 million of first-half restructuring, asset impairment and other charges, including SANYO integration costs, Phoenix facility closure charges and earthquake-related damaged inventory and assets.
- The company reported $76.9 million of underfunded pension liabilities at July 1, including $51.2 million assumed with SANYO, and estimated a further $136.3 million obligation associated with SANYO Electric multiemployer plans it intends to exit. The timing of these estimated obligations is not included in its contractual-obligations schedule.
Outlook, commentary and risks
- Management said end-market conditions deteriorated during July and cited a challenging global economic climate. Q3 2011 revenue guidance was $895 million to $925 million, with approximately 90% of anticipated revenue represented by backlog.
- Q3 gross margin guidance was 33% to 35%, including an expected $10 million negative effect from acquisition inventory fair-value step-up charges. Operating expenses were projected at $200 million to $205 million, including about $15 million of amortization, restructuring, impairment and other charges.
- Other Q3 estimates: net interest expense and other of about $21 million, including $9 million of noncash convertible-note interest; income-tax provision of $8 million to $10 million and cash tax payments of $5 million to $7 million; cash capital expenditures of about $85 million; and share-based compensation expense of about $12 million.
- Management cited commodity-price increases and a weak U.S. dollar as cost pressures. Japan factories returned to full capacity in May, but future SANYO gross-profit improvement depends substantially on manufacturing consolidation. The company intended to consolidate Japanese manufacturing sites and was evaluating possible further consolidation costs.
- The filing describes approximately $1.9 billion of contractual obligations, including debt payments and interest, leases and purchase commitments. The company said existing cash and operating cash flow should fund operating and capital needs and support covenant compliance for at least 12 months, while cautioning that performance differing from plans could harm liquidity. A 50-basis-point increase in rates was estimated to raise annual interest expense by about $2.7 million.
- Material risks include semiconductor cyclicality, weaker demand and pricing, customer and distributor inventory changes, supply-chain and manufacturing disruption, foreign-exchange and commodity exposure, acquisition integration and pension liabilities, leverage and debt maturities, and natural disasters. Management reported no material change to previously disclosed risk factors.
- The company described ongoing legal matters. It said insurers were expected to pay its allocated share of the IPO class-action settlement, subject to a remaining appeal-related issue; management did not expect a material financial effect based on information then available. A separate stockholder lawsuit concerning the stock incentive plan was being defended.
Key facts for investors to verify
- How much of revenue growth and the Q3 outlook reflects acquired businesses versus underlying volume, mix and end-market demand.
- Whether gross margins recover as acquisition inventory step-up and SANYO manufacturing charges run off, and whether planned factory consolidation delivers savings on schedule and within expected costs.
- The final SANYO purchase-price allocation, including pension and other assumed liabilities, and the sustainability of the $69.1 million bargain-purchase gain as a one-time item.
- Inventory and receivables quality, working-capital needs, and the conversion of operating cash flow to free cash flow given elevated capital spending.
- Debt maturity and refinancing exposure, including convertible-note holder put rights beginning in 2012 and the sizable scheduled debt obligations in 2012–2013.
- The extent and timing of pension funding or withdrawal liabilities, and the ability to use the SANYO operational-support credits, which could total up to approximately $205 million but are not guaranteed to be fully utilized.
- Management’s Q3 guidance assumptions, particularly the July deterioration in end markets, backlog coverage, pricing, foreign exchange and commodity costs.