ON Semiconductor Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter ended September 30, 2016; nine-month results are compared with the period ended October 2, 2015. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise. The quarter includes Fairchild results only from its September 19 acquisition.
Business context
ON Semiconductor supplies semiconductor products to automotive, industrial, communications, computing, consumer and other markets. In Q3, it acquired Fairchild Semiconductor for $2.532 billion, aiming to broaden its power and analog offerings and pursue integration benefits. The company reorganized reporting into Power Solutions, Analog Solutions and Image Sensor groups.
Financial performance
| Metric | Q3 2016 | Prior-year quarter | Nine months 2016 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $950.9 | $904.2 | $2,645.9 | $2,655.5 |
| Gross profit / margin | $329.0 / 34.6% | $308.5 / 34.1% | $912.4 / 34.5% | $913.3 / 34.4% |
| Operating income | $46.7 | $69.4 | $180.4 | $205.6 |
| Net income attributable to ON Semiconductor | $10.1 | $46.3 | $71.2 | $152.1 |
| Diluted EPS | $0.02 | $0.11 | $0.17 | $0.35 |
- Q3 revenue rose 5%, including $53.1 million from Fairchild; Image Sensor revenue fell 9.4%, primarily due to weaker CMOS image-sensor demand. Power Solutions revenue increased 13.6%, including Fairchild and growth in IPM products.
- Nine-month revenue declined 0.4%. Management attributed pressure primarily to an approximately 11% decline in average selling prices, partly offset by increased volume and Fairchild revenue.
- Q3 operating income fell despite higher sales: operating expenses increased to $282.3 million from $239.1 million, including acquisition-related spending and $21.8 million of restructuring and other charges.
- Q3 interest expense was $46.7 million, up from $14.9 million, reflecting acquisition financing. The $92.2 million divestiture gain helped lift pretax income to $87.3 million.
- Q3 income-tax provision was $76.7 million; the effective tax rate was 87.9%. The nine-month effective rate was 55.2%. Both were affected by discrete tax accounting items related to reversing the prior indefinite-reinvestment assertion and releasing a U.S. federal valuation allowance; management said these changes did not affect cash taxes.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $351.8 million, versus $313.4 million a year earlier. Capital expenditures were $160.8 million, versus $204.8 million.
- Cash and cash equivalents were $880.5 million at September 30, 2016, including approximately $326.6 million available in the United States. Current assets were $2.802 billion and current liabilities $1.498 billion.
- Gross debt, including current maturities, was $3.831 billion; net carrying debt including current maturities was $3.636 billion. Long-term debt excluding current maturities was $3.096 billion. The $2.4 billion Term Loan B bears variable interest; no balance was outstanding on the $600 million revolver at quarter-end.
- Debt is secured by substantially all of the company’s and certain subsidiaries’ assets, subject to exceptions. The company reported compliance with debt covenants at quarter-end and said cash, operating cash flow and available facilities should fund operating and capital needs for at least 12 months.
- A 50-basis-point increase in interest rates was estimated to raise annual interest expense by approximately $13.6 million, before any offset from higher returns on cash.
Material transactions, outlook and risks
- Fairchild contributed $53.1 million of revenue and $17.0 million of net loss from acquisition through quarter-end. Purchase-price allocation was provisional and included $733.6 million of goodwill. Integration and synergy realization remain important execution risks.
- To satisfy FTC requirements, ON sold its ignition IGBT business and certain diode and thyristor product lines to Littelfuse for $104.0 million cash, recognizing a $92.2 million gain.
- Management forecast Q4 2016 revenue of $1.19–$1.24 billion and gross margin of 27.4%–29.5%; backlog represented approximately 80%–85% of anticipated Q4 revenue. Management cited semiconductor cyclicality, pricing pressure, demand and inventory changes, and execution of cost reductions as important business factors.
- Notable legal exposure includes multiple patent disputes with Power Integrations involving Fairchild and ON products. A Fairchild-related jury award of $139.8 million was being challenged, and other cases remained pending or at early stages. Acbel Polytech sought damages of at least $30 million in a separate case; the company said it was vigorously defending the claims.
- The company identified substantial leverage, variable-rate debt, restrictive covenants, acquisition integration, litigation, foreign-currency exposure and possible taxes on repatriated foreign earnings as risks. It expected Fairchild’s systems and controls integration to be completed by Q4 2017; disclosure controls were deemed effective, while Fairchild’s controls remained separately maintained during integration.
Important facts for investors to verify
- Whether Fairchild integration delivers the expected product, cost and profitability benefits, and how its results affect margins after the limited post-acquisition contribution in this quarter.
- Whether Q4 revenue, margin and backlog expectations were achieved, particularly given the forecast margin below Q3’s 34.6%.
- Debt service, variable-rate exposure, covenant headroom and the effect of acquisition financing on future interest expense and liquidity.
- Resolution and potential financial impact of Power Integrations and other litigation, including the challenged $139.8 million award.
- Future tax provision and cash-tax effects, and final purchase-accounting values for Fairchild; the filing states that the acquisition allocation remained provisional.