ON SEMICONDUCTOR CORP annual report, FY2019

Business context and reporting period

ON Semiconductor Corporation filed this Form 10-K for the fiscal year ended December 31, 2019. The company designs and manufactures semiconductors for automotive, industrial, communications, consumer and computing markets, and reports three segments: Power Solutions Group (PSG), Advanced Solutions Group (ASG) and Intelligent Sensing Group (ISG). The 2019 results include Quantenna from its June 19 acquisition date.

Financial performance

Revenue fell 6.1%; management attributed the decline to lower demand across all three segments. Gross margin contracted 230 basis points amid competitive pricing, weaker demand, mix shift toward lower-margin products and higher manufacturing costs. Operating cash flow declined 45.5%, principally due to lower earnings, prior-year variable compensation payments and the litigation settlement.

Year-end total current assets were $3,020.0 million and current liabilities were $1,818.4 million. Gross debt was $3,749.2 million; net carrying debt, including current maturities, was $3,612.5 million. The current portion of long-term debt was $736.0 million. Management said cash, operating cash flow and available revolving credit should cover operating and capital needs for at least the next 12 months. The company reported compliance with debt covenants at year-end.

Segment revenue was PSG $2,788.3 million (down 8.2%), ASG $1,972.3 million (down 4.8%) and ISG $757.3 million (down 1.5%). Automotive represented approximately 33% of revenue, industrial 26%, communications 19%, consumer 11% and computing 11%.

Material changes and unusual items

• Acquired Quantenna for $1,039.3 million, funded partly by a $900.0 million revolver draw. Quantenna contributed $84.8 million of post-acquisition revenue and a $39.3 million net loss through year-end.
• Recorded a $169.5 million litigation settlement expense after paying Power Integrations $175.0 million to resolve outstanding disputes. The settlement contributed to a third-quarter net loss attributable to the company of $60.7 million; fourth-quarter attributable net income was $56.5 million.
• Fourth-quarter revenue was $1,401.8 million, versus $1,503.1 million in fourth-quarter 2018; diluted EPS was $0.14, versus $0.39.
• Interest expense rose to $148.3 million from $128.2 million, primarily reflecting higher debt associated with the Quantenna acquisition. The company amended credit facilities, extended Term Loan B maturity to 2026 and had $800.0 million outstanding on its revolver and $1,630.9 million on Term Loan B at year-end.
• Repurchased 7.8 million shares for $138.9 million under its share repurchase program. No cash dividends have been declared or paid.
• Operating cash flow less capital expenditures was approximately $160.1 million. Capital spending was about 10% of revenue in 2019.

Outlook, risks and contingencies

Management expected near-term product demand could remain adversely affected by geopolitical and macroeconomic factors, while citing automotive, industrial and cloud-power trends as longer-term growth drivers. It expected 2020 capital expenditures of approximately 8% of revenue and an effective tax rate of 22%–26% before discrete items and the potential impact of a planned intellectual-property rights repatriation; management anticipated U.S. federal net operating losses and credits would be substantially utilized by 2021. The filing does not provide a specific revenue or earnings forecast.

Key risks include semiconductor cyclicality and price pressure; customer order cancellations and inventory adjustments; concentration (the ten largest end-customers accounted for approximately 27% of revenue); trade restrictions and export controls, including restrictions involving Huawei; dependence on suppliers and concentrated manufacturing locations; and substantial debt, variable interest rates and convertible-note obligations. The filing also identifies the early-2020 coronavirus outbreak as a potential source of production and supply-chain disruption.

Other items to monitor include the AcBel litigation, remanded for additional discovery and a new trial scheduled for July 2020; the planned $400.0 million acquisition of a GLOBALFOUNDRIES facility expected to close around December 2022, subject to conditions; and the proposed repatriation of economic rights to intellectual property, which could materially affect the 2020 effective tax rate. Management and the auditor reported effective internal control over financial reporting; Quantenna was excluded from the control assessment and audit.

Investor verification priorities

1. Confirm the pace of revenue and margin recovery against the 2019 demand-driven declines, and assess whether pricing, product mix and capacity utilization improve.
2. Review cash conversion, capital spending and liquidity, including the 2020 maturity of the $690 million 1.00% convertible notes and remaining credit availability.
3. Track debt-service costs, covenant headroom, refinancing needs and potential dilution or cash demands from convertible notes.
4. Assess whether Quantenna integration and expected connectivity synergies offset acquisition costs, debt and acquired goodwill.
5. Monitor the AcBel case, GLOBALFOUNDRIES transaction obligations, tax uncertainties and the operational effects of trade restrictions or supply-chain disruption.