ON Semiconductor Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter ended July 1, 2016; comparative quarter ended July 3, 2015. Six-month results compare the periods ended July 1, 2016 and July 3, 2015. Amounts are in U.S. dollars; financial statements are unaudited.
Business context
ON Semiconductor supplies analog, digital and mixed-signal integrated circuits, standard products, image sensors and custom devices to markets including automotive, industrial, communications and consumer electronics. It reported four segments: Application Products, Image Sensor, Standard Products and System Solutions.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $877.8M | $880.5M | $1,695.0M | $1,751.3M |
| Gross profit | $307.9M | $304.4M | $583.4M | $604.8M |
| Gross margin | 35.1% | 34.6% | 34.4% | 34.5% |
| Operating income | $75.3M | $67.8M | $133.7M | $136.2M |
| Net income attributable to ON Semiconductor | $25.1M | $50.7M | $61.1M | $105.8M |
| Diluted EPS | $0.06 | $0.12 | $0.15 | $0.24 |
- Q2 revenue was essentially flat year over year. Application Products and Standard Products grew modestly, while System Solutions revenue fell 10% to $122.6M; Image Sensor revenue was nearly unchanged.
- Management attributed the Q2 gross-margin improvement to product-line volume and mix. For the first half, revenue declined 3.2%, primarily from an approximately 8% decrease in average selling prices, partly offset by higher unit volume.
- First-half operating cash flow was $219.1M, up from $185.1M. Capital expenditures were $124.9M, compared with $140.3M; cash and cash equivalents declined to $588.1M from $617.6M at year-end 2015.
- At July 1, current assets were $1.922B and current liabilities $1.261B. The balance sheet also included $2.236B of restricted cash, principally acquisition-financing proceeds held in escrow.
- Gross debt, including current maturities, was $3.652B; reported net debt including current maturities was $3.472B. Long-term debt excluding current maturities was $2.935B. The $2.2B Term Loan B bears interest at 5.25%; total interest expense was $42.1M in Q2 and $57.7M for the first half.
Material changes and unusual items
- Q2 net income attributable to the company fell by $25.6M year over year despite higher operating income. The principal driver was a $31.4M increase in quarterly interest expense, mainly from the Term Loan B borrowed for the pending Fairchild acquisition.
- First-half operating income was down $2.5M, while net income attributable to the company declined $44.7M, reflecting higher interest expense and weaker other income, as well as lower revenue and gross profit.
- First-half inventory write-downs were $35.7M, versus $28.2M a year earlier. Restructuring expense was $6.9M and intangible-asset impairment was $2.2M for the first half.
- Restricted cash and debt rose substantially in connection with the planned approximately $2.4B Fairchild acquisition. ON Semiconductor expected the transaction to close in Q3 2016, subject to conditions including regulatory approvals. The company had borrowed $2.2B under Term Loan B and deposited the proceeds, together with company funds, into escrow.
Outlook, risks and contingencies
- For Q3 2016, management forecast revenue of $885M–$925M and gross margin of 34.6%–36.6%. Backlog represented approximately 80%–85% of anticipated quarterly revenue. The outlook excluded Fairchild.
- Management said cash flows from operations and existing cash were expected to cover operating and capital needs for at least 12 months, excluding Fairchild-related capital requirements. It noted that only $117.3M of cash and cash equivalents was available in the United States at quarter-end and that some foreign-held cash was not readily available for U.S. needs.
- Variable-rate debt was $2.544B; management estimated a 50-basis-point rate increase would add approximately $12.7M to annual interest expense. The company cited substantial leverage, debt covenants and pledged collateral as risks associated with the acquisition financing.
- Other disclosed risks include semiconductor cyclicality, pricing pressure, changing customer demand and inventory, foreign-exchange exposure, manufacturing and supply-chain challenges, and acquisition integration and execution. A Delaware shareholder lawsuit challenged the Fairchild transaction; management said it believed the claim against the company was without merit but could not guarantee the outcome.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the Fairchild transaction closed as expected, and its final purchase price, financing, integration costs and expected synergies.
- Post-acquisition debt, interest expense, covenant headroom, collateral and the availability of cash held outside the United States.
- Whether Q3 revenue and margin guidance was achieved, particularly given the stated backlog coverage and the company’s exposure to pricing and demand changes.
- Trends in average selling prices, segment revenue and margins, inventory write-downs, and operating cash flow relative to capital expenditures.
- Developments in the Fairchild-related litigation, regulatory approvals and any resulting transaction delays or costs.