Business Context and Reporting Period
ON Semiconductor Corporation filed this unaudited Form 10-Q for its fiscal first quarter ended April 1, 2016, a 13-week period of 92 days. The company supplies semiconductor products to automotive, industrial, communications, computing, consumer, medical, and other markets through four reporting segments: Application Products, Image Sensor, Standard Products, and System Solutions.
Financial Performance and Liquidity
All amounts are in millions of dollars, except per-share data and percentages.
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $817.2 | $870.8 | Down $53.6, or about 6% |
| Gross profit | $275.5 | $300.4 | Down $24.9 |
| Gross margin | 33.7% | 34.5% | Down 0.8 percentage points |
| Operating income | $58.4 | $68.4 | Down $10.0 |
| Net income attributable to ON Semiconductor | $36.0 | $55.1 | Down $19.1 |
| Diluted earnings per share | $0.09 | $0.13 | Down $0.04 |
| Operating cash flow | $114.9 | $83.5 | Up $31.4 |
| Capital expenditures | $72.9 | $64.8 | Up $8.1 |
Cash and cash equivalents were $619.5 at April 1, 2016, versus $617.6 at December 31, 2015; approximately $153.4 was available within the United States. Management said existing cash and operating cash flow should cover operating and capital needs for at least 12 months, excluding the Fairchild acquisition. The filing reports working capital of $712.3 including cash and short-term investments, and $92.8 excluding cash and cash equivalents.
Net long-term debt, including current maturities and after discounts and issuance costs, was $1,360.5, compared with $1,393.9 at year-end. Current maturities were $525.4, and gross debt including current maturities was $1,475.2. Cash flow from operations less capital expenditures was approximately $42.0, calculated from the reported figures. The company repaid $38.4 of long-term debt and paid $6.6 of capital lease obligations. Inventory was $759.7, up from $750.4 at year-end.
Material Changes Versus the Prior Comparable Period
- Revenue fell about 6%, which management attributed primarily to weaker demand and an approximately 7% decline in average selling prices. Revenue declined in Application Products, Standard Products, and System Solutions; Image Sensor revenue was nearly flat.
- System Solutions revenue fell about 14% to $113.6; Standard Products fell about 6% to $284.9; Application Products fell about 5% to $250.5; and Image Sensor fell about 1% to $168.2.
- Gross margin declined to 33.7% from 34.5%, reflecting volume and product-mix changes. Image Sensor segment gross profit increased, while gross profit declined in the other three segments.
- Operating expenses decreased to $217.1 from $232.0, including lower acquisition-related intangible amortization. However, interest expense rose to $15.6 from $9.2, reflecting higher average debt and interest rates; other expense also worsened year over year.
- Operating cash flow increased, primarily because of working-capital changes. Capital spending also increased. The company made no share repurchases in the quarter, citing the need to build cash reserves ahead of the Fairchild transaction.
Outlook, Management Commentary, Risks, and Unusual Items
For Q2 2016, management forecast revenue of $835–$875 and gross margin of 33.3%–35.3%, based on bookings, backlog, and estimated turns. Backlog represented approximately 80%–85% of anticipated Q2 revenue. The outlook excludes Fairchild.
The proposed Fairchild acquisition was valued at approximately $2.4 billion, with closing then expected late in Q2 2016, subject to conditions including regulatory approvals. On April 15, after quarter-end, ON Semiconductor borrowed $2.2 billion under a term loan facility and placed the proceeds in escrow; it also established a $600 million revolving facility. The financing is intended principally to fund the acquisition and related refinancing and costs. The new facilities carry floating rates, are secured by substantial assets, and include leverage and interest-coverage covenants. Commitment fees were expected to materially affect interest expense before closing. If the acquisition and refinancing conditions are not met by November 18, 2016, escrowed funds are to be returned to repay the term loan and related amounts.
- Management cited semiconductor cyclicality, demand uncertainty, pricing pressure, manufacturing and supply risks, foreign-exchange exposure, and the challenge of aligning costs and capacity with sales as ongoing risks.
- The company’s $2.2 billion Fairchild-related borrowing and new secured debt may constrain financial flexibility and increase leverage; acquisition completion, integration, synergies, and litigation outcomes remain uncertain.
- A Delaware shareholder lawsuit challenges aspects of the Fairchild transaction and seeks, among other relief, an injunction. The company said it believes the claim against it is without merit and intends to defend it, but cannot guarantee the outcome.
- New workforce and manufacturing actions generated $1.7 of restructuring expense in Q1. The voluntary program in System Solutions was expected to cost about $4.4; a manufacturing relocation affecting approximately 160 employees was expected to cost about $5.7.
- The company reported a $92.3 pension liability for underfunded foreign defined-benefit plans. It also disclosed various environmental, product liability, indemnification, and intellectual-property risks; management did not expect the cited environmental and ordinary-course legal matters to have a material effect based on information then available.
- The effective tax rate was 12.7%. The company maintained a full valuation allowance on domestic and substantially all Japan-related deferred tax assets and said a substantial portion of the domestic allowance might reverse within a year, with no expected material cash-tax effect. Fairchild could prompt a reassessment of tax judgments.
Important Facts for Investors to Verify
- Whether revenue and margins stabilize, particularly in the weaker Standard Products and System Solutions segments, and whether the Q2 outlook is achieved.
- Fairchild closing conditions, timing, litigation and regulatory status, final financing and refinancing needs, and the transaction’s effect on leverage, interest expense, and covenant headroom.
- Cash availability by location and the company’s ability to meet the $510.5 of scheduled debt maturities shown for the remainder of 2016.
- Inventory levels, excess-inventory write-downs ($17.9 in Q1), capital spending, and the conversion of operating cash flow into cash after investment.
- Potential effects of tax-valuation-allowance changes, restructuring execution and costs, and foreign-exchange movements.