ON Semiconductor (NasdaqGS:ONNN - News) reported second quarter earnings that missed the Zacks Consensus Estimate by 3 cents. Despite higher revenue, ON Semi saw lower margins and a higher tax rate that impacted results.
Management stated that the impact of the Japan tsunami had a worse-than-expected impact on the gross margin and that utilization post the disaster dropped 30% in Japan.
ON Semi reported revenue of $905.8 million, of which $271.7 million came from the newly acquired SANYO Semiconductor. Core ON Semi revenue of $634.1 million was up 7.0% sequentially and 8.7% year over year.
Revenue exceeded management’s expectations of $860-900 million, or down 1.2% to up 3.4% sequentially. Combined revenue grew 4.0% sequentially and 55.3% from last year. The comparison with the year-ago quarter benefited from the impact of SANYO, which was combined in the results from the first quarter of 2011.
ON saw revenue growth in both Europe and Asia, but saw declines in the Americas. Asia (including Japan) remained the largest contributor, accounting for 73% of total revenue and growing 5.6% sequentially. The Americas was next with a revenue share of 14%, having declined 4.9% from the March 2011 quarter. Europe followed close on its heels, generating 13% of revenue and posting the highest growth of 6.2%.
Revenue by End Market
On Semi’s second quarter performance by end market is a little hard to determine, given the addition of SANYO’s business and the clubbing of medical with Industrial/Military/Aerospace, which started in the fiscal first quarter. However, management commentary was positive.
Following the acquisition, the consumer market emerged as the largest contributor of quarterly revenue, with a 27% revenue share. Revenues were up 4.0% sequentially and 146.6% from last year.
On Semi previously stated that roughly half of the business acquired from SANYO catered to the consumer market, so this was the main reason for the significant increase from the year-ago quarter. However, the margin profile being softer, there is a negative impact on profits that may be expected to continue, especially in the first half.
Automotive brought in 20% of revenue, down 5.4% sequentially and up 55.3% year over year. ON attributed the sequential decline to weaker sales at SANYO and automotive supply chain disruptions in Japan. The increase from last year was largely on account of SANYO. The core business grew slightly, driven by MOSFET sales into anti-lock break systems and IGBT sales into powertrain systems, as well as direct gas injection applications for North American, European and Korean customers.
External lighting solutions also did well in Europe. The increasing number of cars, the increasing use of electronics in the automotive sector, as well as increased adoption of ON Semi products, such as its parking assistance and position sensors remain longer-term drivers.
China is developing into an important market, and On Semi’s decision to open an engineering center in the country is wise, considering the fact that a significant percentage of automotive manufacturing has shifted to the region.
Computing also generated 20% of revenue, flat sequentially, but growing 19.5% from a year ago. Strength in emerging markets and corporate IT spending drive ON Semi’s performance in the last quarter.
Power management, protection, audio and system interface design wins into more than 10 tablet platforms started paying off. Management has stated earlier that ON Semi had aound $3.50 of addressable content for tablets, $8 or notebooks and $11 for desktops.
Industrial/Military/Aerospace/Medical generated another 20% of revenue. On Semi saw great momentum in these markets, which resulted in sequential and year-over-year increases of 22.4% and 63.5%, respectively. Management attributed the increase to the successful sales at the CMOS image sensor business unit that was recently purchased from Cypress Semiconductor.
Factory automation and heavy industrial applications, such as motor protection and circuit-breaking drove the quarter’s results, according to ON Semi. Longer-term, the convergence of connected building automation systems with energy efficient initiatives will work in ON Semi’s favor, increasing demand for wired communications over IP, embedded control, motor control, sensors, and lighting and imaging equipment.
The remaining 13% of revenue was derived from the Communications market. This represented a sequential increase of 4.0% and a year-over-year increase of 34.6%.
On Semi continues to drive penetration in the smartphone market, seeking to gain from the grown in the area. On Semi can support a dollar content of $3.50 per smartphone. The company continues to introduce new products, which will augment the strength from increased penetration of its custom ASICs, precision clock and timing products, as well as infrastructure buildouts in China and India.
Revenue by Product Segment
The largest segment is currently the SANYO Semiconductor Products Group (30% of revenue in the last quarter, down 2.3% sequentially). Standard Products, which generated 20% of revenue, was the second-largest segment. Segment revenue was up 4.6% sequentially and down 6.6% from the year-ago quarter.
Automotive & Power generated 17%, up 4.8% sequentially and 10.6% year over year. Digital & Mixed Signal products accounted for 17% of total revenue, up 10.8% from the previous quarter and 32.6% from last year. Computing & Consumer brought in another 16%, up 8.7% sequentially, while increasing 8.1% from last year.
Gross margin for the quarter was 35.2%, down 76 basis points (bps) from the previous quarter’s 36.0%. Management stated that the tsunami impact on ON Semi was slightly worse than expected. Moreover, commodity prices (particularly, copper and oil, which impacts freight) increased due to unfavorable currency impact, which increased overall manufacturing expenses and lowered the gross margin by 200 bps.
The Digital & Mixed Signal business generated a gross margin of 55.3% (down 100 bps sequentially and 841 bps year over year); Computing & Consumer generated 40.2% (down 65 bps sequentially, down 578 bps year over year); Standard Products 35.8% (down 280 bps sequentially, up 80 bps year over year); and Automotive & Power 35.5% (down 216 bps sequentially and 176 bps year over year).
The total operating expenses of $192.7 million were up significantly both sequentially and from last quarter, although the increase from the year-ago quarter was more significant because of the addition of SANYO’s business. The operating margin dropped 132 bps sequentially and 590 bps year over year to 14.0% of revenue.
As a percentage of sales, all except cost of sales declined from the year-ago quarter and all except sales and marketing grew sequentially. Cost of sales increased both sequentially and year over year, while S&M was flattish sequentially.
On a pro forma basis, ON Semi reported a net income of $106.3 million, or a 11.7% net income margin on a consolidated basis compared to $113.2 million, or 13.0% in the previous quarter and $93.2 million or 16.0% in the second quarter of last year.
Our pro forma estimate for the last quarter excludes inventory and other adjustments related to the SANYO acquisition, restructuring charges and intangibles amortization charges on a tax adjusted basis but includes stock based compensation.
On a fully diluted GAAP basis, the company recorded a net income of $41.0 million ($0.09 per share) compared to $74.8 million ($0.16 per share) in the previous quarter and $78.7 million ($0.18 per share) in the prior-year quarter.
Inventories were down 2.4% and inventory turns went up from 2.9X to 3.1X. Days sales outstanding (DSOs) were around 58, down from around 60 in the previous quarter.
The cash and short term investments balance was $868.8 million at quarter-end (up $102.8 million during the quarter), with ON Semi generating $136.0 million from operations and spending around $85 million on capex.
At quarter-end, ON Semi had $998.7 million of long-term debt on its balance sheet. Including both short and long-term debt, the net debt position at quarter-end was $416.6 million, down from a net debt position of $506.0 million at the beginning of the quarter.
ON Semi expects revenue of $895-925 million, or down 1.2% to up 2.1% sequentially. The GAAP gross margin is expected to be 33-35%. Excluding special items of $10 million, the non GAAP gross margin is expected to be 34-36%.
Operating expenses on a GAAP basis are expected to be $200-205 million, while on a non GAAP basis, they are expected to be $185-190 million. ON Semi also expects other income/expense of around -$12 million.
Taxes are expected to be $8-10 million on a GAAP basis and $5-7 million on a non-GAAP basis, with the fully diluted share count remaining at 460 million. This should result in an EPS of around 25 cents, much lower than the Zacks Consensus Estimate of 29 cents when On Semi reported.
ON Semi now expects the 2011 capex to come in at $340 million, at the high end of the previously guided range of around $310-340 million.
ON Semi shares have seen some pressure in the recent past due to concerns related to Japan, particularly since its SANYO purchase increased its exposure to Japan. It now appears that the impact of Japan was somewhat worse than management’s prior expectations, resulting in weaker revenue from the automotive end market and pulling down gross margins, and thereby, results in the last quarter.
However, we believe the margin impact is temporary and we remain positive about the pace of turnaround in Japan. We think the complementary capacity and product lines are very likely to help ON Semi take share in the Japanese automotive market. We believe it will also help strengthen its position in the European auto market. Our long term rating therefore remains Neutral.
We also have a Zacks #3 Rank of #3 on ON Semi shares, which translates to a Hold recommendation over the next 1-3 months. Peers National Semiconductor (:NSM) and Monolithic Power (NasdaqGS:MPWR - News) were also similarly ranked, as macro weakness continues to impact the sector.
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