ON Semiconductor Corporation — Q2 2018 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the 13 weeks ended June 29, 2018, with comparisons to the quarter ended June 30, 2017; six-month comparisons are also presented. ON Semiconductor makes semiconductor components and related products for automotive, industrial, communications, consumer and other markets. Its reporting segments are Power Solutions, Analog Solutions and Intelligent Sensing.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1,455.9 million | $1,338.0 million | $2,833.5 million | $2,774.7 million |
| Gross profit | $555.0 million | $492.0 million | $1,072.4 million | $995.1 million |
| Gross margin | 38.1% | 36.8% | 37.8% | 35.9% |
| Operating income | $197.2 million | $154.0 million | $382.9 million | $337.1 million |
| Net income attributable to ON Semiconductor | $155.3 million | $93.9 million | $294.9 million | $172.1 million |
| Diluted EPS | $0.35 | $0.22 | $0.66 | $0.40 |
| Operating cash flow | — | $495.0 million | $541.7 million | |
| Capital expenditures | — | $252.4 million | $121.7 million |
Cash and cash equivalents were $850.2 million at June 29, 2018, down from $949.2 million at December 31, 2017. Total debt, including current maturities and before debt discounts and issuance costs, was $2,964.1 million; net carrying debt was $2,766.8 million. The company reported $746.4 million of current debt, including $630.7 million of the 1.00% convertible notes reclassified as current after their conversion trigger was met. It had $400 million outstanding under its $1.0 billion revolving facility and reported compliance with debt covenants.
Material changes and performance drivers
- Q2 revenue rose 9% year over year. Power Solutions revenue increased 11% and Analog Solutions increased 10%; Intelligent Sensing revenue declined, primarily reflecting the exit from the Mobile CIS business.
- Management attributed higher gross margin mainly to increased factory utilization and favorable product mix. Research and development expense rose 15% in Q2, primarily due to higher payroll, headcount and materials costs.
- Six-month reported revenue grew 2.1%; excluding the $155.1 million 2017 revenue-recognition benefit from distributor sales, management said revenue grew approximately 8%. The comparison is therefore affected by a prior-period accounting change.
- Six-month operating cash flow decreased $46.7 million year over year, with working-capital changes a principal factor. Inventory increased to $1,204.4 million from $1,089.5 million at year-end; cash flow included a $130.1 million inventory use.
- Capital spending more than doubled year over year to $252.4 million for the first half. Cash flow after capital expenditures was approximately $242.6 million for the period.
Outlook, management commentary, risks and unusual items
- Management said cash, operating cash flow and available credit should fund operating and capital needs for at least the next 12 months. It expects capital expenditures of approximately 8%–9% of annual revenue for the remainder of 2018 and 2019, compared with a historical 6%–7% range. Minimum contractual capital expenditure commitments were approximately $105.7 million for the rest of 2018 and $37.8 million for 2019 and thereafter.
- The company expects a future effective tax rate of 23%–27%, before discrete items, until U.S. federal net operating losses are fully used. Q2 and first-half 2018 tax rates benefited from discrete releases and other tax items. No specific revenue or earnings guidance is provided in the supplied filing text.
- Trade policy is a stated risk: a 25% U.S. tariff on Chinese-origin transistors took effect July 6, 2018; further tariffs on diodes and integrated circuits were proposed. The company warned that tariffs could raise costs or make products less competitive if costs cannot be passed on.
- Q2 included $28.1 million of licensing income, including recognition of $10.0 million after technology qualification and $18.0 million under a separate IP agreement; the company said recognition under existing agreements was complete at quarter-end. It also recorded a $4.6 million divestiture gain, a $4.0 million debt refinancing and prepayment loss, and a $3.3 million goodwill impairment.
- ON Semiconductor acquired SensL Technologies for $71.4 million in cash, adding sensing and LiDAR capabilities. It also divested a transient voltage suppressing diodes business for $5.6 million in cash. The SensL purchase-price allocation was provisional.
- The company estimated possible aggregate losses of $4 million–$20 million in its Power Integrations patent matters; outcomes and the ultimate financial impact remain uncertain. Other disclosed risks include semiconductor cyclicality, demand and pricing pressure, supply constraints, currency exposure, leverage and product liability.
Most important facts for investors to verify
- Whether revenue growth and margin improvement continue after accounting for the unusual 2017 distributor-revenue comparison and 2018 licensing income.
- Whether inventory growth and higher planned capital spending convert into sustained demand, operating cash flow and acceptable returns.
- The timing and potential dilution or cash impact of conversion of the 1.00% Notes classified as current, and the company’s debt maturity and refinancing plans.
- The actual cost and customer impact of U.S.–China tariffs, including any further tariffs on semiconductor products.
- Final SensL purchase accounting, progress toward expected product cash flows, and developments in Power Integrations litigation.