ON Semiconductor Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended April 1, 2011. ON Semiconductor designs, manufactures and sells semiconductor products for automotive, industrial, computing, consumer, communications and other markets. Results include SANYO Semiconductor from its January 1 acquisition and the Cypress CMOS Image Sensor Business Unit (ISBU) from February 27.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 | Change / context |
|---|---|---|---|
| Revenue | $870.6 million | $550.2 million | Up 58%; acquisitions contributed $299.9 million, with volume and mix also higher and average selling prices down about 1%. |
| Gross profit / margin | $242.4 million / 27.8% | $228.1 million / 41.5% | Profit rose modestly, but margin fell sharply. |
| Operating income / margin | $32.7 million / 3.8% | $84.2 million / 15.3% | Operating expenses rose to $209.7 million from $143.9 million. |
| Net income attributable to ON Semiconductor | $74.8 million; diluted EPS $0.16 | $63.0 million; diluted EPS $0.14 | Includes a $61.3 million SANYO bargain-purchase gain in 2011. |
| Operating cash flow | $125.6 million | $109.5 million | Capital expenditures were $88.7 million versus $41.0 million. |
| Cash and cash equivalents | $766.0 million at April 1 | $623.3 million at December 31, 2010 | Quarter-end cash increased $142.7 million. |
| Total debt, including current maturities and capital leases | $1,272.0 million | $888.8 million at December 31, 2010 | Increase largely reflects acquisition-related borrowing. |
Quarter-end total current assets were $2,247.9 million and current liabilities were $1,146.1 million, a current ratio of approximately 2.0. Working capital was $1,101.8 million. Management said cash on hand and operating cash flow should fund operating and capital needs and support debt-covenant compliance for at least the next 12 months. Free cash flow, calculated as operating cash flow less capital expenditures, was approximately $36.9 million.
Material changes and operating drivers
- Reported revenue growth was primarily acquisition-driven. Historical ON Semiconductor revenue was approximately $592.5 million; SANYO contributed $278.1 million.
- Gross margin fell to 27.8%, reflecting acquired SANYO costs, including $50.0 million of non-cash manufacturing expense associated with the acquisition and acquired-inventory fair-value step-up expense. The prior-year quarter also included acquisition-related inventory step-up expense, of approximately $20.3 million.
- Operating expenses increased across research and development, selling and marketing, and general and administrative costs, principally due to SANYO and higher headcount. Restructuring and other charges were $12.4 million, including $8.4 million for 280 SANYO-related employee terminations, $1.5 million of exit costs and $2.5 million of Japan earthquake-related damaged inventory and assets.
- SANYO’s segment reported $4.4 million gross profit and a $42.8 million operating loss. Management said SANYO should be accretive to Q2 earnings, but future gross-margin improvement depends in part on integration and manufacturing consolidation.
- Operating cash flow increased year over year, while capital spending more than doubled. Cash-flow comparisons and balance-sheet movements were materially affected by the SANYO acquisition.
Outlook, risks and unusual items
- Q2 2011 guidance: Revenue of $860–900 million; gross margin of 31–33%; operating expenses of $198–208 million; net interest expense and other of approximately $21 million; and income-tax provision of $8–10 million. Guidance includes SANYO.
- Management estimated the Japan earthquake and tsunami could reduce Q2 sales by approximately $50 million and earnings by more than $30 million; these effects were included in guidance. It anticipated possible revenue and profit impacts through Q3. Five of six Japanese factories were near full production, with the sixth ramping.
- Q2 gross-margin guidance includes approximately $15 million of acquired-inventory fair-value step-up expense and $30 million of non-cash acquisition-related manufacturing expense. Management stated the latter would not affect results after Q2.
- Management forecast Q2 cash capital expenditures of approximately $80 million and 2011 capital expenditures of $310–340 million. It expected SANYO gross margins to reach the low-to-mid 30% range after supply-chain recovery and stabilization.
- The SANYO purchase-price allocation remained preliminary, including valuations of certain intangibles, tax accounts and Japanese retirement-plan liabilities. The filing records estimated liabilities of $134.8 million for the intended withdrawal from SANYO-related multiemployer pension plans; timing and final amounts remain uncertain.
- Debt rose to $1.272 billion. Variable-rate debt was $534.8 million; a 50-basis-point rate increase was estimated to raise annual interest expense by approximately $2.7 million. Convertible notes have holder put dates beginning in 2012.
- Risks include semiconductor cyclicality, pricing and demand changes, customer and distributor inventory, supply-chain and production disruptions, acquisition integration and cost-savings execution, leverage and covenant compliance, foreign-exchange exposure, and litigation. Management said it did not expect the disclosed legal matters to materially affect results, but noted litigation outcomes are uncertain.
- The company reported effective disclosure controls and procedures. Acquired businesses were still operating with separate systems and control environments pending integration.
Important facts for investors to verify
- How much of reported growth and earnings is sustainable apart from acquisitions and the $61.3 million SANYO bargain-purchase gain?
- Whether Q2 revenue, margin and earnings guidance is achieved, including the estimated Japan disruption and acquisition-related costs.
- Progress on SANYO factory consolidation, supply-chain recovery, integration savings and the path toward targeted gross margins.
- Cash conversion and working-capital quality, particularly the large increases in receivables and inventory associated with SANYO.
- Final purchase accounting and the amount, timing and funding of assumed pension and multiemployer withdrawal obligations.
- Debt repayment capacity, upcoming convertible-note put dates, variable-rate exposure and continued covenant compliance.