ON Semiconductor Corporation — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended July 2, 2010; unaudited. Comparisons are with the quarter and six months ended July 3, 2009 unless noted. ON Semiconductor supplies power, signal-management, logic, discrete and custom semiconductor products across automotive, computing, consumer, industrial, communications, medical and other markets.
Financial performance and liquidity
- Q2 revenue: $583.3 million, up 39% year over year and approximately 6% from Q1 2010. Growth primarily reflected higher volume and mix; acquisitions contributed $15.3 million, while average selling prices declined approximately 5% year over year.
- Q2 profitability: Gross profit was $243.8 million and gross margin 41.8%, versus $138.2 million and 32.9%. Operating income was $101.5 million (17.4% margin), versus $13.7 million. Net income attributable to ON Semiconductor was $78.7 million, or $0.18 diluted EPS, versus a $3.0 million loss, or $0.01 loss per share.
- First-half results: Revenue was $1,133.5 million, up 42%; gross profit was $471.9 million and gross margin 41.6%, versus $250.3 million and 31.3%. Operating income was $185.7 million, versus $9.1 million. Net income attributable to ON Semiconductor was $141.7 million, or $0.32 diluted EPS, versus a $36.9 million loss, or $0.09 loss per share.
- Drivers and segment mix: Management attributed margin improvement principally to higher volume and factory utilization, cost-savings programs, and lower acquired-inventory fair-value step-up expense. All four reporting segments increased Q2 revenue year over year: Automotive & Power 50%, Computing & Consumer 42%, Digital & Mixed-Signal 16%, and Standard Products 46%.
- Cash flow: First-half operating cash flow was $268.4 million, versus $87.0 million. Capital expenditures were $93.5 million, versus $37.0 million; operating cash flow less capital expenditures was $174.9 million before acquisitions and other investing items. Investing used $139.1 million, including $90.2 million for acquisitions; financing used $188.0 million, including $199.5 million of debt repayments. Cash declined $58.6 million to $467.1 million.
- Balance sheet and debt: At July 2, cash was $467.1 million, current assets $1,171.3 million and current liabilities $647.9 million; working capital was $523.4 million. Total debt, including current maturities and capital leases, was $753.4 million, down from $933.5 million at December 31, 2009; cash less reported debt was approximately negative $286.3 million. The company prepaid $169.8 million of senior bank facilities. It reported compliance with debt covenants at quarter-end.
- Receivables rose to $317.2 million and inventory to $321.5 million from year-end levels of $260.9 million and $269.9 million. Deferred income on distributor sales increased to $127.8 million from $98.8 million.
Acquisitions, outlook and management commentary
- ON Semiconductor completed its $113.2 million acquisition of California Micro Devices in January and acquired Sound Design Technologies in June for approximately $22 million in cash, plus an earnout liability. Integration and restructuring costs were recorded; acquired businesses’ systems and controls were still being integrated.
- On July 14, after quarter-end, the company announced a definitive agreement to acquire SANYO Semiconductor and related assets for approximately ¥33.0 billion (then about $366 million). The proposed consideration included cash and ON Semiconductor shares; up to approximately 35.3 million shares could be issued, subject to the company’s option to substitute cash. The transaction was expected to close in Q4 2010, subject to approvals and other conditions. The company cited customer, product and geographic complementarities.
- Q3 2010 guidance: Revenue of $585–$610 million; gross margin of approximately 42.2%–42.7%; operating expenses of $141–$145 million, including $10 million of amortization, restructuring and other charges; net interest and other expenses of approximately $18 million; and income-tax provision of approximately $4 million. Management expected average selling prices to be approximately flat sequentially, cash capital expenditures of approximately $50 million, and share-based compensation of $13–$14 million. Beginning backlog represented over 90% of anticipated Q3 revenue.
- Management said cash on hand and operating cash flow should fund operations and capital needs for at least 12 months. It cited semiconductor cyclicality, economic volatility, demand, pricing, manufacturing efficiency and access to financing as factors that could affect results and liquidity. The company estimated a 50-basis-point increase in rates would add approximately $0.6 million to annual interest expense on variable-rate debt.
Risks, contingencies and unusual items
- The pending SANYO deal carried completion, regulatory, financing, integration, management-distraction, liquidity and potential dilution risks. ON Semiconductor also noted that transaction or integration costs could exceed expectations and anticipated benefits might not be realized.
- Restructuring and other charges were $2.3 million in Q2 and $6.1 million in the first half. These included SDT and CMD integration-related employee costs and a $0.8 million settlement payment concerning former minority-interest shareholders of a Czech subsidiary.
- Longstanding IPO-related securities litigation remained subject to appeals; the company said its allocated settlement share would be paid by insurers. The CMD acquisition lawsuits were settled, with the court requesting further information concerning plaintiffs’ fees. In the Ricoh patent case, the court entered judgment for Synopsys on non-infringement; Ricoh appealed.
- The company reported effective disclosure controls at period-end. CMD and SDT continued to operate under separate systems and much of their own control environments during integration. Environmental remediation, indemnification, product liability and other legal exposures were also disclosed; management did not expect the described matters to have a material effect based on information then available.
Important facts for investors to verify
- Whether the revenue and margin recovery persisted, including the effects of selling prices, volume, factory utilization and acquired-inventory step-up costs.
- Whether receivables, inventory and distributor deferred income converted to cash as expected, and whether operating cash flow remained strong after capital spending and acquisitions.
- Final SANYO transaction terms, funding mix, regulatory conditions, assumed debt and pension obligations, share issuance or cash substitution, and integration costs and benefits.
- Debt maturities and holder put dates, covenant compliance, variable-rate exposure, and liquidity after planned investment and acquisitions.
- Progress integrating CMD and SDT into financial reporting controls, and developments in the pending litigation appeals and other contingencies.