ON Semiconductor Corporation — Q1 2017 Form 10-Q
Reporting period: 13-week quarter ended March 31, 2017; the comparable quarter ended April 1, 2016 included 92 days. Unaudited consolidated results. The company reports Power Solutions, Analog Solutions and Image Sensor segments.
Financial results
| Metric | Q1 2017 | Prior-year quarter |
|---|---|---|
| Revenue | $1,436.7 million | $817.2 million |
| Gross profit / margin | $503.3 million / 35.0% | $275.5 million / 33.7% |
| Operating income | $183.4 million | $58.4 million |
| Net income attributable to ON Semiconductor | $78.2 million | $36.0 million |
| Diluted EPS | $0.18 | $0.09 |
| Cash from operating activities | $208.5 million | $114.9 million |
| Capital expenditures | $52.7 million | $72.9 million |
| Cash and cash equivalents at period end | $728.9 million | $619.5 million at prior-year quarter end |
Revenue increased 76%, principally reflecting Fairchild, acquired in September 2016, and a distributor revenue-recognition change. Q1 2017 operating cash flow less capital expenditures was $155.8 million, compared with $42.0 million in the prior-year quarter. This is a simple calculation from reported figures.
At March 31, 2017, current assets were $2,609.1 million and current liabilities were $1,212.0 million. Gross debt, including current maturities, was $3,538.4 million; net carrying debt was $3,259.6 million. The company reported $1,728.1 million of variable-rate debt and $1,810.3 million of fixed-rate debt. Cash declined by $299.2 million during the quarter, including substantial debt repayments and financing transactions.
Segments and changes versus the comparable period
- Power Solutions revenue was $743.8 million versus $326.9 million; segment gross profit was $244.1 million versus $103.2 million.
- Analog Solutions revenue was $503.6 million versus $311.3 million; segment gross profit was $209.4 million versus $117.3 million.
- Image Sensor revenue was $189.3 million versus $179.0 million; segment gross profit was $67.4 million versus $62.2 million.
- Management attributed much of the Power and Analog growth to Fairchild. The periods are not directly comparable because Fairchild was not included in Q1 2016.
Reported Q1 revenue included $155.1 million recognized on distributor shipments under a newly supportable estimate of returns and allowances. The change increased pretax income by $59.0 million, or $0.09 per basic and diluted share; the company also accrued $8.1 million for estimated returns, reducing revenue by that amount. Excluding the gross-profit effect of this recognition change, management reported a 34.7% gross margin, versus 35.0% reported.
Gross margin improved year over year, which management attributed to Fairchild, higher factory utilization and product mix. The increase was partly offset by $9.8 million of Fairchild inventory step-up expense. Operating expenses rose with the acquisition. Interest expense increased to $38.4 million from $15.6 million, and the company recorded $26.2 million of debt refinancing and prepayment losses. Q1 net income also reflected a $4.4 million intangible-asset impairment charge.
Liquidity, financing and capital allocation
- On March 31, the company issued $575 million of 1.625% convertible notes due 2023 and used $562.1 million of proceeds to repay Term Loan B borrowings. It also amended its credit agreement to reduce facility interest rates.
- The company redeemed the 2.625% notes in January 2017, paying approximately $445 million for redemption and conversions. Term Loan B debt was $1,804.5 million and revolving-credit borrowings were $120.0 million at quarter end.
- The credit agreement is secured by substantially all company and guarantor assets, includes financial and other covenants, and the company reported compliance at March 31.
- Management said cash, operating cash flow and available credit were expected to fund operating and capital needs for at least 12 months. Of reported cash, approximately $181.6 million was available in the United States.
- The company repurchased 1.6 million shares for $25.0 million in connection with the convertible-note transactions. Approximately $603.2 million remained under its share-repurchase authorization.
Outlook, commentary and risks
For Q2 2017, management forecast revenue of approximately $1,285 million to $1,335 million and gross margin of 34.5% to 36.4%. Backlog represented approximately 80% to 85% of anticipated Q2 revenue. The filing provides no full-year financial guidance.
Management described the semiconductor market as cyclical and identified demand, pricing, manufacturing capacity, customer and distributor inventories, costs, integration of Fairchild, and realization of acquisition synergies as important factors. It expected Fairchild integration to be completed by Q4 2017 and said interest expense would remain material. A 50-basis-point rise in rates was estimated to increase annual interest expense by approximately $8.6 million before potential offsets; interest-rate swaps hedge part of the exposure.
Material disclosed litigation includes multiple Power Integrations patent cases. The company estimated possible losses across those cases at approximately $4 million to $20 million, while vigorously contesting the claims. In one case, a $139.8 million jury damages award plus approximately $7 million of prejudgment interest remained subject to appeal. Acbel sought at least $30 million in a separate case, with trial scheduled for June 2017. Management stated that it believed adequate provision had been made for probable and estimable losses, but cautioned that litigation outcomes could adversely affect results or liquidity.
Other risks include substantial leverage, variable-rate exposure, debt covenants and refinancing needs; conditional conversion, cash repurchase and potential dilution associated with convertible notes; acquisition-integration and synergy risks; foreign-exchange exposure; and ordinary-course product, intellectual-property and environmental contingencies. Disclosure controls were considered effective. Revenue controls were enhanced during the quarter, and integration of Fairchild into company systems and controls remained underway.
Important facts for investors to verify
- How much of reported growth and earnings reflects Fairchild versus underlying organic demand, and how distributor revenue estimates affect future periods.
- Whether Q2 revenue and margin guidance is achieved, including the comparatively high share of forecast revenue represented by backlog.
- Debt service, covenant headroom, refinancing needs and the cash available to the U.S. parent, especially after the quarter’s financing and repayment activity.
- Developments in the Power Integrations and Acbel litigation, including appeals, judgments, reserves and potential cash exposure.
- Progress on Fairchild integration, cost synergies, manufacturing efficiency and completion of the planned controls integration.