ON Semiconductor Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter ended June 27, 2014; the quarter comprised 13 weeks. Comparisons are with the quarter ended June 28, 2013. The filing was signed July 31, 2014. Amounts below are in U.S. dollars; financial statement figures are in millions except per-share data.
Business context and results
ON Semiconductor supplies power and signal management, logic, discrete, custom and imaging semiconductors across automotive, industrial, communications, computing, consumer and other markets. It reported three segments: Application Products, Standard Products and System Solutions. Management described semiconductor-market conditions as uncertain and volatile, while citing improved demand in some product groups.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $757.6 | $688.3 | $1,464.1 | $1,349.3 |
| Gross profit | $273.0 | $231.8 | $523.8 | $436.3 |
| Gross margin | 36.0% | 33.7% | 35.8% | 32.3% |
| Operating income | $81.7 | $50.9 | $155.0 | $88.6 |
| Net income attributable to ON Semiconductor | $88.0 | $47.7 | $146.4 | $70.3 |
| Diluted EPS | $0.20 | $0.11 | $0.33 | $0.16 |
- Q2 revenue rose about 10% year over year; management attributed growth to improved demand and volume/mix, partly offset by approximately 4% lower average selling prices (ASPs). First-half revenue rose about 9%, despite approximately 5% lower ASPs.
- Q2 gross margin improved 2.3 percentage points. Management cited higher utilization, cost savings from prior restructuring, favorable product mix and greater revenue contribution from the higher-margin Application and Standard Products groups. First-half margin also benefited from lower inventory write-downs and the weaker yen’s effect on costs.
- Q2 operating expenses were $191.3, up $10.4 year over year; increases in selling and marketing, general and administrative, and acquisition-related amortization more than offset lower restructuring charges. First-half R&D declined $9.2, while selling and marketing and general and administrative expenses each increased about $9 million.
- Six-month operating cash flow was $226.5, compared with $140.4 in 2013. Investing cash outflow was $72.0, including $96.5 of capital expenditures and $90.9 net cash paid for businesses, partly offset by $116.2 proceeds from maturing investments. Financing cash outflow was $66.2. Cash and cash equivalents increased $89.4 to $598.9; cash, cash equivalents and short-term investments totaled $601.2 at quarter-end.
- Working capital, including cash and short-term investments, was $892.3. Current assets were $1,761.6 and current liabilities $869.3.
- Total debt, including current maturities and capital leases, was $904.9 ($169.4 current and $735.5 long-term), down from $942.2 at year-end 2013. Interest expense was $7.9 in Q2 and $16.0 for the first half. The company reported compliance with its debt covenants.
- Capital expenditures were $96.5 for the first half. Management projected $120–$130 of additional capital expenditures for the remainder of 2014.
Material changes and notable items
- Application Products revenue increased 20% in Q2 and Standard Products revenue rose 10%; System Solutions revenue fell 5%, reflecting softer consumer markets. For the first half, those groups changed by approximately +17%, +10% and −8%, respectively. System Solutions remained loss-making at the segment operating-income level: a $0.1 loss in Q2 and $8.8 loss for the first half, improved from the prior-year losses.
- ON Semiconductor completed its April 30 acquisition of Truesense Imaging for approximately $95.1 cash. The acquired image-sensor business contributed about $13.3 of Q2 revenue. Purchase accounting included $27.0 goodwill, $33.1 of acquired intangible assets and $7.5 of in-process R&D; the allocation remained subject to adjustment.
- Aptina acquisition was pending at quarter-end: the June 9 merger agreement contemplated approximately $400.0 cash consideration, subject to closing conditions and regulatory approvals. The company said it might use its revolving credit facility in part to fund the transaction.
- Q2 income-tax benefit was $16.2, including a $21.5 reversal of a U.S. deferred-tax-asset valuation allowance related to the Truesense acquisition and reversals of certain foreign tax reserves. The benefit increased reported net income; management said a further substantial valuation-allowance reversal within one year was reasonably possible, with no material cash-tax effect expected.
- First-half restructuring, impairment and other charges were $9.9, mainly related to Japanese voluntary retirement programs and the KSS facility closure. Management expected additional KSS severance and exit costs through year-end and cited first-year savings of $36–$45 million for the earlier retirement program. An additional 60–70 positions were expected to be eliminated in Q3 2014.
Outlook, risks and contingencies
- For Q3 2014, management forecast revenue of approximately $765–$795 million and gross margin of 35.6%–37.6%. Backlog represented approximately 80%–85% of anticipated Q3 revenue. ASPs were expected to decline approximately 1%–2% sequentially.
- Management said operating cash flow, available cash and investments, and credit facilities should fund operating and capital needs for at least 12 months. Approximately $312.7 of cash and investments was available in the United States; some foreign cash was intended to remain indefinitely reinvested and was not readily available for domestic needs.
- Risks highlighted include semiconductor cyclicality, demand and customer-inventory changes, pricing and margin pressure, foreign-exchange movements, supply and manufacturing constraints, acquisition integration and execution, substantial leverage and restrictive covenants, and possible litigation or product-liability exposure. Management said no material changes had occurred to the risk factors in its 2013 Form 10-K.
- The company reported ordinary-course legal matters and environmental remediation matters; management did not expect them to have a material effect based on currently available information, but noted litigation outcomes are inherently uncertain. Operating lease commitments totaled $88.0. The company also disclosed guarantees, including its guarantee of a $254.8 SCI LLC loan.
- Management reported disclosure controls were effective. Truesense was operating with separate systems and much of its prior control environment, with integration expected by December 31, 2014.
Most important facts for investors to verify
- Whether Q3 revenue and margin guidance was achieved, and whether ASP declines and market demand changed as expected.
- Whether the Aptina transaction closed, its final purchase price and financing, and the resulting debt and integration effects.
- Whether gross-margin improvement and restructuring savings persisted, particularly as System Solutions remained loss-making.
- How much reported earnings growth came from operating performance versus the non-cash tax valuation-allowance reversal and other unusual items.
- Whether cash generation covered the planned capital expenditures, acquisition funding, debt maturities and share repurchases without increasing leverage or relying on restricted foreign cash.