ON Semiconductor (ONNN) reported third quarter earnings that missed the Zacks Consensus Estimate by 3 cents, or 12.0%. Revenues were more or less in line, exceeding the Zacks Consensus by a mere 0.1%. As a result, shares slumped 2.67% in after-market trading. We had expected ON Semi to report mediocre results this quarter, given its high exposure to the computing market, which remains soft.
Revenue
ON Semi reported revenue of $600.7 million, which was up 3.0% sequentially and 27.0% year over year. This was in the middle of management’s revenue expectations of $585–$610 million, or an increase of 0%–5% sequentially. Guidance was below seasonality, in our opinion and we are relieved that ON Semi did not miss it.
The Americas region was the strongest for ON Semi in the last quarter, growing 14.5% sequentially. It was followed by the Asia/Pacific region, which was flattish (up 0.4%), and Europe, which declined 3.0%. The revenue split among the three was 23%, 62% and 15%, respectively. China and Singapore are the largest markets for ON Semi.
Revenue by End-Market
Revenue from all end-markets increased double-digits from the year-ago quarter. The biggest disappointment was computing, which declined sequentially, instead of seeing seasonal strength. Industrial and automotive declined slightly on a sequential basis, which was not really unexpected, considering the slowing down of these two markets in the last few months.
Computing was still the largest end-market, with a 25% revenue share. Segment revenue was down 1.0% sequentially and up 17.6% year over year. The power management business within computing remained strong however, driven by increasing penetration into notebooks. ON Semi made some progress at a tablet manufacturer and mentioned other opportunities in this emerging market.
Automotive was the second largest end-market in the last quarter with a 19% contribution, although declining 2.2% on a sequential basis. Segment revenue was up 34.1% from the recession-dampened third quarter of 2009. ON Semi attributed the sequential decline to normal seasonality. Design win momentum continued at both European and Asian manufacturers.
Industrial brought in 18% of revenue, down 2.4% sequentially and up 34.5% from the year-ago quarter. ON Semi did not shed much light on its performance in the market, but stated that revenues were likely to hold up, rather than decline. 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.
Consumer was 18% of total revenue (up 9.0% sequentially and 34.5% year over year). Gaming consoles drove the strength in the last quarter, partially offset by LCD TVs. Going forward, the segment is expected to soften, most likely until the inventory correction in the LCD TV market has run its course.
Communications generated 17% of revenue, up 16.7% sequentially and 27.0% year over year. Smartphones drove ON Semi’s strength in the wireless segment, while the networking portion benefited from increased penetration of its custom ASICs, precision clock and timing products, as well as infrastructure build-outs in China and India.
Medical, representing 3% of revenue, grew 3.0% seqentially and dropped 4.7% year over year.
Revenue by Segment
The largest segment is Standard Products, which generated 24% of revenue in the last quarter. Segment revenue was up 5.3% sequentially and 33.3% from the year-ago quarter. Automotive & Power generated 24%, up 3.6% sequentially and 33.1% year over year. Computing & Consumer brought in another 23%, increasing 3.0% sequentially and and 20.8% from the year-ago quarter. Digital & Mixed Signal was the only segment that declined. The segment accounted for 19% of total revenue, which was down 1.7% from the previous quarter, while increasing17.7% from last year.
Gross margin for the quarter was 41.3%, down 116 basis points (bps) from the previous quarter’s 42.5%. Currency (80%) and rising commodity prices (20%) lowered gross profit by $7-8 million. Specifically, copper and gold prices moved up during the quarter, nagatively impacting ON Semi’s gross margin.
The operating expenses of $130.3 million were down 1.2% sequentially. The operating margin dropped 24 bps sequentially, but expanded 589 bps year over year to 19.6% of revenue. While all expenses as a percentage of sales declined from the year-ago quarter, the weaker gross margin and slightly higher R&D impacted the sequential comparison.
Profit
On a pro forma basis, ON Semi reported a net income of $97.8 million, or a 16.3% net income margin compared to $93.2 million, or 16.0% in the previous quarter and $45.8 million or 9.7% in the third quarter of last year.
Our pro forma estimate for the last quarter excludes inventory adjustments, restructuring charges and amortization of intangibles on a tax-adjusted basis but includes stock-based compensation.
On a fully diluted GAAP basis, the company recorded a net income of $87.5 million (20 cents per share) compared to $78.7 million (18 cents per share) in the previous quarter and $29.9 million (7 cents per share) in the prior-year quarter.
Balance Sheet
Inventories were up 9.1% sequentially and inventory turns continued to edge downward from around 4.2x to around 4.0x. Days sales outstanding (DSOs) were around 48, down from around 50 in the previous quarter.
The cash and short term investments balance was $562.9 million at quarter-end (up $95.8 million during the quarter), with ON Semi generating $123.6 million from operations and spending around $52 million on capex.
At quarter-end, ON Semi had $650.2 million of long-term debt on its balance sheet. Including both short and long-term debt, the net debt position at quarter-end was $223.1 million, down from a net debt position of $286.3 million at the end of the June 2010 quarter.
Guidance
On Semi provided muted guidance for the fourth quarter. Revenue expectations of $565–$585 million, representing a sequential decline of 3-6% is again below normal seasonality and likely driven by slowdown in consumer, computing and industrial end markets.
The GAAP gross margin is expected to be 40%–41%. Excluding special items of approximately $1 million, the non GAAP gross margin is expected to remain in the 40%–41% range. GAAP operating expenses are expected to be $137–$141 million. Excluding special items of approximately $10 million, the non GAAP operating expenses are expected to range between $127–$131 million.
Interest and other expenses are expected to be $9 million and non-cash interest expense also approximately $9 million. GAAP and non-GAAP taxes are expected to total $4 million and $3 million, respectively. The diluted share count is expected to be 445 million.
ON Semi also expects to spend around $200 million on equipment purchases in 2010, of which $35 million will be spent on buildings to consolidate offices in the Bay area, as well as the consolidation of assembly and test operations in the Philippines.
Our Recommendation
We have lowered our outlook on ON Semi shares, given the softening of its end-markets and another disappointing guidance. We believe investors will discount the company’s solid technology, design wins and good execution. ON Semi shares now have a Zacks #5 Rank, implying a “Strong Sell” recommendation in the 1–3 month timeframe.
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