ON Semiconductor Corporation — Q2 2015 Form 10-Q
Reporting period: The quarter ended July 3, 2015; the six-month period ended the same date. The quarter and comparable 2014 quarter each had 91 days, while the six-month periods had 184 and 178 days, respectively. Amounts below are in millions of dollars except per-share data.
Business context
ON Semiconductor designs and manufactures semiconductor products serving automotive, communications, computing, consumer, industrial, medical and other markets. Its four reporting segments are Application Products, Image Sensor, Standard Products and System Solutions. Aptina and Truesense acquisition contributions are included in 2015 results; the Image Sensor Group was established in 2014 following those acquisitions.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $880.5 | $757.6 | $1,751.3 | $1,464.1 |
| Gross profit | $304.4 | $278.1 | $604.8 | $526.3 |
| Gross margin | 34.6% | 36.7% | 34.5% | 35.9% |
| Operating income | $67.8 | $86.8 | $136.2 | $157.5 |
| Net income | $51.4 | $95.1 | $107.2 | $151.0 |
| Net income attributable to ON Semiconductor | $50.7 | $94.1 | $105.8 | $149.8 |
| Diluted EPS | $0.12 | $0.21 | $0.24 | $0.34 |
| Operating cash flow | Not provided separately | Not provided separately | $185.1 | $226.5 |
Revenue increased 16% year over year in Q2 and 20% for the six-month period, primarily reflecting Aptina and Truesense sales. Management also cited improved demand and favorable volume and mix, partly offset by average selling price declines of approximately 1% in Q2 and 8% for the six months. The acquired Image Sensor business added about $149.3 million of Q2 revenue and $308.1 million for the six months.
Gross profit rose, but margins declined as Image Sensor represented a larger share of revenue and had lower margins than certain other segments. Operating income and earnings fell as operating expenses rose, particularly acquisition-related intangible amortization, R&D and other acquired-business costs. Q2 income also compared with a prior-year tax benefit; the 2014 comparison included a $21.5 million reversal of a U.S. deferred-tax valuation allowance. The 2015 Q2 tax provision was $7.7 million; the six-month provision was $15.1 million.
At July 3, cash and cash equivalents were $576.6 million and short-term investments were $1.3 million. Working capital was $611.8 million. Total debt, including current maturities, was $1,378.2 million, versus $1,192.6 million at year-end 2014; current maturities were $555.9 million. The company reported $1.0 billion of capacity under its amended revolving credit facility. Management said available cash, operating cash flow and credit facilities should fund operating and capital needs for at least 12 months, while noting that some foreign-held cash is not readily available for U.S. needs.
Six-month capital expenditures were $140.3 million, compared with $96.5 million in the prior comparable period. Inventory was $743.0 million at period-end, up from $729.9 million at year-end; cash flow included a $28.2 million write-down of excess inventory. Operating cash flow declined $41.4 million year over year, which management attributed primarily to working-capital changes.
Material changes and capital transactions
- On June 8, the company issued $690.0 million of 1.00% convertible senior notes due 2020. Proceeds were used in part to repay $350.0 million of revolving-credit borrowings, fund note hedge transactions and repurchase $70.0 million of stock; remaining proceeds were intended for general corporate purposes, including potential repurchases and acquisitions.
- The company amended its revolving facility, increasing capacity from $800 million to $1.0 billion and resetting its five-year maturity. It reported a $0.4 million loss on debt extinguishment related to the amendment.
- In Q2, ON Semiconductor repurchased 10.4 million shares for an aggregate purchase price of $131.1 million, at a weighted-average $12.59 per share. The six-month cash-flow statement reports $225.1 million of repurchases, reflecting timing of payments and the broader period. The program had $748.2 million remaining at quarter-end.
- Debt maturities include substantial near-term amounts: $160.1 million for the remainder of 2015 and $426.9 million in 2016. The maturity schedule assumes the 2.625% Notes, Series B mature at their earliest conversion date.
Outlook, risks and unusual items
For Q3 2015, management estimated revenue of $890–$930 million and gross margin of 34%–36%. Backlog covered approximately 80%–85% of anticipated Q3 revenue. The filing cites WSTS estimates of approximately 4% annual compound growth in the company’s serviceable addressable market for 2015–2017, while emphasizing these are third-party estimates, not company forecasts.
- Management identified semiconductor cyclicality, changing demand and customer inventories, pricing pressure, competition, manufacturing yields and cost control as risks. It also cited foreign-exchange exposure, supply-chain risks, acquisition integration, litigation and the company’s substantial leverage.
- The new convertible notes create potential cash-settlement, refinancing, dilution and liquidity risks, including repurchase obligations after specified fundamental changes. The related warrants may dilute shareholders if the stock price exceeds $25.96 per share; the note hedges are subject to counterparty risk.
- The company recorded a $3.7 million impairment after canceling certain in-process research and development projects. Q2 restructuring expense was $3.5 million, mainly related to relocating its European marketing organization and acquisition-related severance.
- Aptina-related $40.0 million consideration remained in escrow through November 2015. A patent lawsuit filed by Collabo Innovations alleges infringement involving CMOS image sensor products; the company disputes the claims and said it could not estimate a possible loss or range of loss.
- Previously issued 2014 quarterly financial statements were revised for errors involving deferred taxes, foreign-currency translation and a manufacturing-variance accounting convention. Management determined the errors were not material to prior periods; the 2014 comparisons in this filing reflect revisions.
- After quarter-end, the company borrowed $50.0 million under Philippine term loans. The company reported compliance with its debt covenants at July 3, 2015.
Important facts for investors to verify
- Whether acquisition-driven revenue growth can persist and whether Image Sensor margins improve; that segment’s Q2 gross margin was 29.8%, versus 48.1% in the prior-year comparison.
- Whether the Q3 revenue and margin outlook is achieved, and how bookings, backlog and average selling prices develop.
- Working-capital trends, inventory quality and cash conversion, given lower operating cash flow and the inventory write-down.
- Debt maturities, available liquidity and the cash impact of convertible-note conversions, fundamental-change repurchases and planned capital spending.
- Progress on the Collabo patent litigation, the Aptina escrow release and any subsequent impairment or contingency developments.