ON Semiconductor Corporation — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017, including fourth-quarter results. ON Semiconductor designs and manufactures power, analog, image-sensor and other semiconductor products. Its three reporting segments are Power Solutions, Analog Solutions and Image Sensor.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $5,543.1 million | $3,906.9 million |
| Gross profit / margin | $2,033.8 million / 36.7% | $1,296.9 million / 33.2% |
| Operating income | $680.9 million | $236.1 million |
| Net income attributable to ON Semiconductor | $810.7 million | $182.1 million |
| Diluted EPS | $1.89 | $0.43 |
| Operating cash flow | $1,094.2 million | $581.2 million |
| Capital expenditures | $387.5 million | $210.7 million |
| Cash and cash equivalents at year-end | $949.2 million | $1,028.1 million |
| Gross debt at year-end | $3,175.0 million | $3,806.8 million |
- Fourth-quarter revenue was $1,377.5 million; net income attributable to ON Semiconductor was $529.9 million and diluted EPS was $1.22.
- FY2017 free cash flow, calculated as operating cash flow less capital expenditures, was approximately $706.7 million. Cash flow from investing activities was negative $364.5 million; financing activities used $810.9 million.
- Net long-term debt, including current maturities and after discounts and issuance costs, was $2,951.8 million. Management said cash, operating cash flow and available credit should fund operating and capital needs for at least 12 months. About $422.4 million of cash was available in the United States.
- Working capital was $1,524.3 million including cash and short-term investments, or $575.1 million excluding them.
Changes versus prior year
- Revenue increased 41.9%, primarily because FY2017 included a full year of Fairchild results, compared with only part of 2016. The filing also attributes $155.1 million of 2017 revenue to a change in distributor revenue-recognition practices.
- Gross margin rose 350 basis points, attributed mainly to higher factory utilization, product mix and Fairchild contributions. Excluding Fairchild inventory step-up charges, gross margin was 36.9% in 2017 versus 34.9% in 2016.
- Operating cash flow increased $513.0 million, mainly reflecting improved operating results. Capital spending increased to $387.5 million.
- Gross debt declined from $3,806.8 million to $3,175.0 million. The company issued $575 million of 1.625% convertible notes and used proceeds principally to repay term-loan debt, prepaid additional term-loan borrowings, and amended its credit agreement to lower rates and expand revolving-facility capacity.
- FY2017 net income includes a provisional $449.9 million tax benefit from the Tax Cuts and Jobs Act. The fourth-quarter earnings increase should therefore not be viewed as solely operating-driven.
Segments, outlook and management commentary
- FY2017 revenue by segment: Power Solutions $2,819.3 million (50.9% of revenue); Analog Solutions $1,950.9 million (35.2%); Image Sensor $772.9 million (13.9%). Automotive represented approximately 31% of revenue, industrial 25%, communications 20%, consumer 14% and computing 10%.
- Management’s first-quarter 2018 outlook was revenue of $1.340–$1.390 billion, gross margin of 36.4%–38.4%, operating expenses of $318–$336 million, net other expense including interest of $33–$36 million, and diluted share count of 445–447 million.
- Management cited Fairchild integration and synergy-related cost reductions as ongoing priorities. The company shipped approximately 72.8 billion units in 2017, versus 59.4 billion in 2016.
- The company expects its future effective tax rate to more closely approximate the new 21% U.S. federal statutory rate, but said the Tax Act accounting remained provisional. It estimated $28.3 million of cash repatriation tax payable over eight years, with $2.3 million due in 2018, after expected tax-credit offsets.
Risks, contingencies and unusual items
- Key risks include semiconductor cyclicality, pricing pressure and rapid product obsolescence; customer order changes and inventory exposure; reliance on distributors and external manufacturers; raw-material and supply-chain interruptions; and manufacturing-site disruption.
- Substantial leverage, variable-rate debt, restrictive covenants and convertible-note cash settlement or dilution are material financial risks. The company reported compliance with debt covenants at year-end. A 50-basis-point rate increase was estimated to raise annual interest expense by about $5 million before offsets.
- Eight civil proceedings and more than two dozen patent administrative proceedings involve Power Integrations. The company estimated aggregate possible losses of approximately $4–$20 million for the PI cases; outcomes remain uncertain.
- Other items include $47.2 million of debt-refinancing and prepayment losses, $13.1 million of intangible-asset impairment charges, $20.8 million of restructuring and related net charges, and $47.6 million of licensing income. The company also recorded a $12.5 million gain on the Xsens divestiture.
- Environmental remediation matters are described at several current or former sites, with indemnities covering some exposures; the company said known expected costs were not expected to be material. Product liability, warranty, cyber-security, foreign-exchange, tax-audit and regulatory risks also remain.
- The independent auditor gave unqualified opinions on the financial statements and internal controls. Management concluded internal control over financial reporting was effective at December 31, 2017; Fairchild’s systems and control environment were integrated by October 30, 2017.
Important facts for investors to verify
- How much of revenue and margin growth reflects Fairchild, underlying demand and mix, versus the distributor revenue-recognition change and acquisition accounting.
- The final Tax Act measurement and the sustainability of earnings excluding the provisional tax benefit.
- Debt repayment, refinancing and cash-conversion progress, including the location and availability of cash and convertible-note settlement exposure.
- Execution of the Q1 2018 outlook and continued gross-margin improvement, especially if industry demand or utilization changes.
- Developments in the Power Integrations litigation and administrative proceedings, and any changes to the estimated loss range.
- Distributor returns and allowances, inventory levels, customer backlog quality and concentration risks; backlog is substantially revisable or cancelable.