ON Semiconductor (ONNN) Misses Q3 Earnings; Beats Revenues - Analyst Blog

ON Semiconductor (ONNN) reported third-quarter 2014 earnings of 21 cents, missing the Zacks Consensus Estimate by a penny. The third-quarter results were impacted by a slowdown in orders in the second half of September.

Revenues

ON Semiconductor reported revenues of $833.5 million, up 10% sequentially and 16.5% year over year. Reported revenues also beat the company's expected range of $765.0–$795.0 million and the Zacks Consensus Estimate of $811.0 million.

Revenues by End Market

Automotive brought in 29% of the total revenue. Segment revenues were up 7% on a sequential basis. The growth was driven by solid contribution from the Aptina acquisition and design win across all product lines, especially body electronics, lighting, active safety and powertrain applications, which are at the core of automotive customer alignment strategy. Others include SmartFET, LED driver, MOSFET, intelligent power modules, igniter and protection solutions.

ON Semiconductor's design wins for integrated power modules in front-lighting and oil pump applications are expected to contribute significantly as electronic content in new vehicles continues to increase. The company has secured many auto design wins in Korea in the reported quarter which is expected to contribute to revenues in the near future.

Management expects this segment to increase sequentially in the fourth quarter.

Consumer generated 16% of the total revenue, up 5% sequentially. Results in the quarter were driven by contribution from Aptina and strong demand for its products, particularly home electronics, gaming and set-top box applications. Additionally, the company saw strong demand for imaging devices, manufacturing action sports cameras, gaming consoles and various video applications.

However, the company saw declines in the consumer white goods market due to normal seasonality. On the other hand, design wins in this market should drive strong growth in the near term. Management expects this segment to remain flat sequentially.

Computing generated 14% of the total revenue, up 7% sequentially, driven by stabilization in the PC market and market share gains as the Haswell and Broadwell platforms continue to gain traction. Additionally, ramping up sales of VCore controllers commencing for channel motherboards led to the improvement. Management expects revenues in this segment to be down sequentially due to seasonality.

Industrial/Military/Aerospace/Medical generated another 22% of total revenue, up 13% from the prior quarter. The increase was driven by strong demand for industrial circuit breakers, medical imaging, security cameras and magnetic card swipe readers for mobile point-of-sales applications. Also, the Truesense and Aptina acquisitions aided revenue growth.

Design wins in ASICs for both medical and military/aerospace applications, onshore military programs in the United States and hearing health and audiology products are gaining momentum.

Industrial segment revenues are expected to be up sequentially in the upcoming quarter.

Communications accounted for 19% of revenues and were up 20% on a sequential basis, driven by ramp up of new programs and contribution from Aptina, partially offset by softness in the Asia-based smartphone market.

ON Semiconductor continues to gain market share in the smartphone market with various products such as battery protection, battery chargers, protection devices, filtering and power management ICs. Also, the demand for lithium-ion battery MOSFETs is expected to accelerate driven by its increased adoption across various smartphone OEMs. Numerous design wins in the smartphone market for display power, LED drivers, camera modules and battery solutions will boost revenues in the upcoming quarter.

Management expects this segment to decrease sequentially in the fourth quarter.

Margins

The GAAP gross margin for the quarter was 34.1%, down 190 basis points (bps) sequentially and 70 bps from the year-ago quarter. The decrease was due to unfavorable mix, resulting from strong growth in lower-margin businesses.

ON Semiconductor reported GAAP operating expenses of $226.5 million, up 24.5% from $181.9 million incurred in the year-ago quarter. As a percentage of sales, research & development and selling & marketing expenses decreased from the year-ago quarter, while general & administrative expenses increased. The net result was a GAAP operating margin of 6.9% versus 9.4% in the year-ago quarter.

Net Profit

On a pro-forma basis, ON Semiconductor reported net income of $93.2 million or 21 cents per share compared with $89.7 million or 20 cents in the previous quarter and $75.4 million or 17 cents in the year-ago quarter. Our pro-forma estimate for the reported quarter excludes restructuring, intangibles amortization and other charges on a tax-adjusted basis but includes stock-based compensation. Our calculations may differ from the company's presentation due to the inclusion/exclusion of some items that were not considered by management.

On a GAAP basis, the company recorded a net profit of $41.6 million or 9 cents per share compared with $88.0 million or 20 cents in the previous quarter and $51.8 million or 11 cents in the year-ago quarter

Balance Sheet

The cash and short-term investments balance was $494.9 million at quarter-end versus $601.2 million in the prior quarter. Trade receivables were $488.7 million, up from $437.3 million in the prior quarter. Inventories were $724.3 million, up 14.5% sequentially.

At quarter-end, ON Semiconductor had $1183.6 million of total debt (long-term plus short-term) on its balance sheet, with debt equity ratio being 41.4%. During the quarter, the company borrowed approximately $230 million from revolving line of credit to finance the Aptina acquisition. Cash flow from operations was $92.3 million and $67 million of cash spent on capex.

During the quarter, management used approximately $33 million to repay long-term debt and capital leases. The company repurchased 2.6 million shares worth $23.0 million in the quarter at an average price of $9.23 per share.

Guidance

ON Semiconductor expects fourth-quarter revenues in the range of $835.0–$875.0 million, the mid-point of $855.0 million being above the Zacks Consensus Estimate of $822.0 million. Gross margins are expected in the 31.8–33.6% range on a GAAP basis and within the 33.4–35.4% range on a non-GAAP basis. Operating expenses, on a GAAP basis, are expected within $237.0–$249.0 million, and within $205.0–$215.0 million on a non-GAAP basis. The company also expects other income/expense within $7.0–$9.0 million, both on a GAAP and a non-GAAP basis.

Taxes are expected to be within $7–$10 million on a GAAP basis and $5–$7 million on a non-GAAP basis, with share count of 442.0 million.

Conclusion

ON Semiconductor has a well-diversified business and an end-market focus that would typically generate relatively steady revenues throughout the year. The company's bottom-line figures missed our expectations but the top line exceeded the same.

The third quarter was impacted by a slowdown in orders in the second half of September, but management expects to see a recovery in orders to be shipped in the first half of 2015, indicating that the company's fundamentals remain intact.

Also, restructuring measures related to System Solutions Group (SSG) have been completed effectively and should positively contribute to margin expansion in the near term. Also, the recent closure of the back-end facility in Japan should generate savings, beginning first-quarter 2015. The recent acquisitions of Aptina and Truesense will further increase the company's presence in automotive and industrial end markets, expanding the top-line figures.

Though the end-market demand trends indicate strengthening industrial and automotive markets in the near term, computing and communications end markets are expected to remain weak in the near term. Also, the significant debt position, ever-increasing competition and integration risks related to Aptina and Truesense remain major concerns.

ON Semiconductor has a Zacks Rank #4 (Sell). Other stocks that have been performing well and are worth a look include NeoPhotonics Corporation (NPTN), Texas Instruments (TXN) and Inphi Corporation (IPHI). All the stocks carry a Zacks Rank #2 (Buy).