ON Semiconductor Corporation — Q3 2018 Form 10-Q
Business context and period. This unaudited quarterly report covers the 13 weeks ended September 28, 2018, with nine-month comparisons to the period ended September 29, 2017. ON Semiconductor supplies power, analog, sensing and related semiconductor products through its Power Solutions, Analog Solutions and Intelligent Sensing groups.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $1,541.7 million | $1,390.9 million | $4,375.2 million | $4,165.6 million |
| Gross profit | $596.6 million | $524.0 million | $1,669.0 million | $1,519.1 million |
| Gross margin | 38.7% | 37.7% | 38.1% | 36.5% |
| Operating income | $241.6 million | $177.0 million | $624.5 million | $514.1 million |
| Net income attributable to ON Semiconductor | $166.9 million | $108.7 million | $461.8 million | $280.8 million |
| Diluted earnings per share | $0.38 | $0.25 | $1.05 | $0.66 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $853.2 million | $869.9 million |
Q3 revenue rose approximately 11% year over year; operating income and attributable net income also increased. Nine-month reported revenue increased approximately 5%; excluding the $155.1 million 2017 benefit from a distributor revenue-recognition change, management said revenue growth was approximately 9%. Nine-month 2018 operating margin was approximately 14.3% and net margin approximately 10.6%, calculated from reported figures.
Cash, debt and liquidity
- At September 28, cash and cash equivalents were $951.0 million; current assets were $3,097.0 million and current liabilities $1,314.7 million. Working capital was $1,782.3 million including cash, or $831.3 million excluding cash.
- Gross debt, including current maturities, was $2,900.1 million; net carrying value was $2,714.9 million. The company reported $2,615.7 million of long-term debt excluding current maturities. It was in compliance with debt covenants.
- Nine-month capital expenditures were $382.8 million, versus $211.8 million in 2017. Operating cash flow less property and equipment purchases was approximately $470.4 million, compared with $658.1 million in 2017; this simple calculation excludes other investing cash flows.
- Cash and cash equivalents were nearly unchanged from year-end 2017. Management said cash, operating cash flows and credit facilities should cover operating and capital needs for at least 12 months.
Material changes, outlook and commentary
- Revenue increased in all three groups in Q3. Power Solutions revenue rose 15%, Analog Solutions 8%, and Intelligent Sensing 4%. Management attributed growth mainly to demand and new markets; Intelligent Sensing growth was partly offset by the exit from the Mobile CIS business.
- Management attributed higher gross margin primarily to product mix. Research and development spending increased with headcount and materials costs.
- Management expected capital expenditures of approximately 8%–9% of annual revenue for the remainder of 2018 and 2019, above its historical 6%–7% range, to support growth and manufacturing cost improvements. Minimum contractual capital commitments were $76.8 million for the remainder of 2018 and $59.4 million for 2019 and thereafter.
- Management expected a future effective tax rate of 23%–27% before discrete items until U.S. federal net operating losses are used. Potential U.S. tax-method changes could materially affect tax expense in the year adopted, though management did not expect a material cash-tax effect.
- The company acquired SensL for $71.6 million in cash in May, adding sensing and LiDAR capabilities. On October 1, 2018, after quarter-end, it acquired a majority stake in AFSM for $12.3 million, bringing ownership to 60%; future periods will consolidate AFSM.
- Tariffs are a material uncertainty: U.S. tariffs on specified Chinese transistors, diodes and integrated circuits were imposed in 2018, and China imposed retaliatory tariffs. The company warned that costs could rise and harm profitability if it cannot exclude products or pass costs to customers.
- One distributor accounted for 12% of Q3 revenue. The company highlighted customer concentration and the risk of reduced orders or lost customers.
- Eight outstanding patent proceedings with Power Integrations were disclosed; the company estimated aggregate possible losses of approximately $4 million to $20 million. Outcomes remain uncertain. Other legal and environmental matters were also described, with management generally not expecting material costs except as disclosed.
- The company repurchased $115.0 million of shares in the first nine months, including $75.0 million in Q3; $488.2 million remained authorized under the program, which was scheduled to expire November 30, 2018.
Important facts for investors to verify
- Whether revenue growth, gross-margin improvement and demand trends continued after Q3, particularly in Power and automotive-related products.
- How tariffs and any subsequent trade measures affected costs, pricing and customer demand.
- Whether inventory growth and higher capital spending converted into sales and cash generation; inventory stood at $1,200.6 million, up from $1,089.5 million at year-end.
- Debt maturities and refinancing or conversion exposure: $690.9 million of scheduled maturities fell in 2020, including convertible notes.
- Developments in the Power Integrations litigation and any changes to the disclosed possible-loss range.
- The financial effects of AFSM consolidation and SensL purchase-accounting adjustments, which were not yet final at filing.