ON Semiconductor Corporation — Q2 2019 Form 10-Q
Reporting period: Quarter ended June 28, 2019; comparative quarter ended June 29, 2018. The six-month period ended June 28, 2019 is also reported. Amounts are in U.S. dollars.
Business context
ON Semiconductor supplies power, analog, sensing, connectivity and other semiconductor products through its Power Solutions Group (PSG), Analog Solutions Group (ASG) and Intelligent Sensing Group (ISG). Management cited adverse geopolitical and macroeconomic effects on semiconductor demand and expected possible short-term demand weakness, while identifying automotive, industrial and cloud-power markets as longer-term growth drivers.
On June 19, 2019, the company completed its $1.039 billion acquisition of Quantenna Communications, adding Wi-Fi connectivity capabilities. Quantenna contributed approximately $2.2 million of revenue and a $17.2 million net loss between acquisition and quarter-end.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Revenue | $1,347.7 million | $1,455.9 million | Down $108.2 million, or 7% |
| Gross profit / margin | $499.0 million / 37.0% | $555.0 million / 38.1% | Margin down 1.1 percentage points |
| Operating income | $158.3 million | $197.2 million | Down $38.9 million |
| Net income attributable to ON Semiconductor | $101.8 million | $155.3 million | Down $53.5 million |
| Diluted EPS | $0.24 | $0.35 | Down $0.11 |
For the six months, revenue was $2,734.3 million, down 3.5%; gross margin was 37.0%, versus 37.8%; operating income was $337.7 million, versus $382.9 million; and net income attributable to the company was $215.9 million, versus $294.9 million. Diluted EPS was $0.52, versus $0.66. Lower sales volume and product mix were the primary factors cited for the gross-margin decline.
Q2 revenue by segment was PSG $700.9 million, ASG $462.0 million and ISG $184.8 million; each was lower year over year. Six-month operating cash flow was $360.8 million, down from $495.0 million. Capital expenditures were $310.5 million, compared with $252.4 million, and investing cash flow included $867.0 million for business acquisitions and $100.0 million for a manufacturing-site deposit and technology license. Cash, cash equivalents and restricted cash were $899.1 million at period-end; balance-sheet cash and cash equivalents were $885.2 million.
At June 28, 2019, gross long-term debt including current maturities was $3,805.8 million, versus $2,939.0 million at year-end 2018. The company had $1.3 billion drawn on its $1.9 billion revolving facility and $1,134.5 million outstanding under its Term Loan B facility. It reported covenant compliance. Current assets were $3,064.2 million and current liabilities $1,266.8 million. Management said cash, operating cash flow and available credit were expected to fund operating and capital needs for at least 12 months.
Material changes, outlook and risks
- Revenue weakness affected all three segments; management attributed declines to softer demand in certain end markets. Six-month unit shipments fell to 31.9 billion from 36.7 billion.
- Q2 restructuring, asset impairment and other charges rose to $18.1 million from $3.2 million, including $13.8 million of Quantenna-related restructuring. A broader workforce program had notified approximately 139 employees of termination; 104 had exited by quarter-end.
- Prior-year results included $28.1 million of Q2 licensing income and a $4.6 million divestiture gain, neither of which recurred in Q2 2019. These items contributed to the year-over-year decline in pretax income.
- The Quantenna acquisition was funded in part with a $900 million revolver draw. The company also agreed to acquire GLOBALFOUNDRIES’ East Fishkill site for $400 million, with closing expected around December 31, 2022; a $70 million deposit and $30 million technology license fee had been paid.
- Management expected capital expenditures of approximately 10%–11% of annual revenue for the remainder of 2019 and 2020. It expected an effective tax rate, before discrete items, of 22%–26% until U.S. federal NOLs and credits are used, anticipated by 2021. No specific revenue or gross-margin forecast for the next quarter is provided in the supplied filing text.
- Interest-rate sensitivity: a 50-basis-point increase, including swaps, was estimated to raise expected annual interest expense by approximately $7.6 million. Management also cited foreign-exchange exposure, semiconductor cyclicality, demand and pricing pressure, customer inventory changes, supply and manufacturing risks, acquisition integration, leverage and litigation.
- Power Integrations litigation remained material and contested. The company disclosed an estimated aggregate possible loss range of $4 million–$20 million across the cases, while also reporting a post-trial judgment of approximately $32 million in one Fairchild case, including prejudgment interest; the company planned to appeal. Acbel litigation was remanded for additional discovery and a new trial.
- Quantenna continued to operate with separate systems and much of its existing control environment; integration into ON Semiconductor’s systems was expected by Q4 2019. Management reported disclosure controls effective and no material change in internal control other than this acquisition-related arrangement. The filing reported no material changes to the risk factors from the 2018 Form 10-K.
Important facts for investors to verify
- Whether demand and product mix stabilize, and how subsequent-quarter revenue and gross margins compare with management’s short-term caution.
- Quantenna integration progress, realized synergies, acquired-business profitability and final purchase-price allocation.
- Debt and liquidity after the acquisition financing, ongoing capital expenditures, share repurchases and the future $400 million facility purchase obligation.
- The status, reserve treatment and potential exposure from Power Integrations and Acbel proceedings, particularly the disclosed possible-loss range versus the approximately $32 million judgment.
- Whether restructuring delivers expected savings without further material charges, and whether Quantenna control integration is completed on schedule.