ON SEMICONDUCTOR CORP quarterly report, Q1 FY2013

Business context and reporting period

ON Semiconductor Corporation designs, manufactures and markets semiconductor components for automotive, communications, computing, consumer, industrial and other markets. This unaudited Form 10-Q covers the quarter ended March 29, 2013; the comparable quarter ended March 30, 2012. The quarters contained 88 and 90 days, respectively.

Financial performance and liquidity

Revenue declined 11.2% year over year. Gross margin fell 2.0 percentage points; operating income and attributable net income also declined. Operating cash flow increased by $16.8 million. Cash and cash equivalents were $537.0 million at quarter-end, with $77.3 million of short-term investments, or $614.3 million combined. Management reported working capital of $743.5 million and believes cash, investments and operating cash flow will fund operating and capital needs for at least 12 months.

Total debt, including current maturities, was $949.6 million, versus $1,011.9 million at year-end 2012. Current maturities were $242.8 million and long-term debt was $706.8 million. The company had no balance outstanding on its $325 million senior revolving credit facility.

Material changes and drivers

• Revenue fell across all segments: Application Products Group to $245.0 million (down 6%), Standard Products Group to $265.2 million (down 5%), and SANYO Semiconductor Products Group to $150.8 million (down 27%). SANYO segment operating loss widened to $45.7 million from $20.4 million.
• Management attributed lower sales to weaker demand and global economic conditions, especially continued Thailand flood effects, a soft Japanese consumer market, a weaker yen, and, to a lesser extent, Japan-China political tensions. Management cited an approximately 3% revenue decrease from volume and mix and an approximately 8% decrease from average selling prices versus the prior-year quarter.
• Operating expenses declined to $166.8 million from $201.6 million, including lower R&D, selling and marketing, and general and administrative costs. Restructuring, asset impairments and other was a net $6.0 million benefit, compared with $11.5 million of expense a year earlier.
• Q1 cash and debt actions included paying approximately $77.5 million to settle conversion of $73.4 million principal of the 1.875% Notes, and exchanging $60.0 million principal of 2.625% Notes for $58.5 million principal of Series B notes. The exchange extended the earliest put date on the exchanged amount from December 2013 to December 2016 and generated a $3.1 million loss.

Outlook, commentary, risks and unusual items

For Q2 2013, management forecast revenue of $675 million to $715 million, gross margin of 32.5% to 34.5%, and average selling prices down approximately 1% to 2% from Q1. Q2 backlog represented approximately 80% to 85% of forecast revenue. WSTS estimates cited by the company projected approximately 4% compound annual growth in its serviceable addressable market for 2013–2015; management cautioned these were third-party estimates, not company projections.

• Unusual Q1 items included a $21.0 million foreign currency translation gain reclassified into earnings on closure and liquidation of the Aizu facility; a $9.0 million pension curtailment gain related to SANYO voluntary retirements; and approximately $5.0 million of business-interruption insurance income associated with the 2011 Thailand flood, recorded in cost of revenues. The voluntary retirement program had approximately 500 participants; further severance and pension-related costs were expected during 2013.
• Management expected approximately $130 million of capital expenditures for the remainder of 2013, and approximately $27.4 million of scheduled pension contributions plus $21.7 million of payments related to the voluntary retirement program.
• Key risks include semiconductor cyclicality, uncertain demand, pricing pressure, customer and distributor inventory changes, supply and manufacturing disruptions, foreign exchange exposure, restructuring execution, substantial leverage and debt covenants, and litigation or regulatory matters. The company said there were no material changes to risk factors from its 2012 Form 10-K. Management did not expect pending legal matters to have a material effect based on available information, but noted an unfavorable outcome could be adverse.
• A 50-basis-point rise in rates was estimated to increase annual interest expense by approximately $2.1 million; a hypothetical 10% currency-rate change was estimated to affect pretax income by approximately $4.5 million, assuming no hedge offsets. Management reported disclosure controls were effective and no material change in internal control over financial reporting.

Most important facts for investors to verify

• Whether Q2 revenue and margin guidance is achieved, and whether demand and pricing recover after the year-over-year declines.
• Whether SANYO segment losses improve as Thailand-related capacity effects, Japan market weakness and restructuring progress evolve.
• Cash generation, capital spending and liquidity availability, including the location of cash held abroad and expected pension and retirement-program payments.
• Debt maturities and refinancing or repayment requirements, including convertible-note put dates and compliance with debt covenants.
• The sustainability of reported earnings after the Aizu currency-translation benefit, pension curtailment gain and Thailand insurance proceeds.