ON Semiconductor (ONNN) reported fourth quarter earnings that were a penny short of the Zacks Consensus Estimate. Revenues were more or less in line, exceeding the Zacks Consensus by 0.4%. As a result, shares dropped 0.04% in after-market trading after sliding 2.91% during the day. We had expected weak results at ON Semi given its high exposure to the computing market, which remained soft in the fourth quarter.
Revenue
ON Semi reported revenue of $579.2 million, which was down 3.6% sequentially and up 16.5% year over year.Revenue’s came in within management’s revenue expectations of $565-585 million, or a sequential decline of 3-6%. Guidance was again below seasonality, in our opinion, likely driven by slowdown in consumer, computing and industrial end markets. So it’s a good thing that ON Semi did not miss it.
Europe rebounded in the last quarter, growing 9.3% sequentially. It was in fact the only region that grew. On Semi’s Americas business was the weakest, declining12.0%. This was followed by Asia (down 3.6%). The revenue split among the three was 17%, 21% and 62%, respectively. China and Singapore are the largest markets for ON Semi.
Revenue by End Market
As expected, On Semi saw significant weakness in the consumer and computing end markets and slower growth in the industrial market. Communications was also weak, particularly the wireless side of the business, although On Semi expressed optimism about future growth here.
Computing remained the biggest segment for On Semi with a 23% revenue share, despite two straight quarters of decline. Segment revenue was down 11.3% sequentially although up 3.1% year over year. The weakness was on account of the inventory correction and largely over and done with in the last quarter, according to On Semi.
Automotive was the second largest end market with a 22% contribution, representing sequential and year-over-year increases of 11.6% and 34.9%, respectively. The sequential increase was on account of seasonality, 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. Design win momentum continued at both European and Asian manufacturers. China is developing into an important market and On Semi’s decision to open an engineering center in the country was good, given that a significant percentage of automotive manufacturing has shifted to the region (a trrend that may be expected to continue).
Industrial/Military/Aerospace brought in 19% of revenue, up 1.8% sequentially and 23.0% 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 steady. We note that the SANYO Semiconductor and CypressSemiconductor’s (CY) image sensor businesses will add to revenues in the industrial market. 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.
Consumerwas 16% of total revenue (down 14.3% sequentially and up 3.6% year over year). The softness was as expected, given the inventory correction in the LCD TV market. On Semi stated that roughly half of the business acquired from SANYO catered to the consumer market, so there will be a positive impact on revenues. The margin profile appears softer, so that could have a negative impact, especially in the first half.
Communications generated 16% of revenue, down 9.3% sequentially and up 24.3% year over year. Seasonality played a role in the sequential comparison, as smart phone builds in the preceding quarter made for tough comps. Both the wireless and networking sides of the business were strong compared to the year-ago quarter due to the increased adoption of On Semi products. Management stated that On Semi can now 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.
Medical, representing 4% of revenue, grew 28.6% seqentially and 16.5% year over year.
Revenue by Product Segment
The largest segment is Standard Products, which generated 34% of revenue in the last quarter. Segment revenue was down 3.6% sequentially and up 20.0% from the year-ago quarter. Automotive & Power generated 23%, down 7.6% sequentially and up 16.5% year over year. Computing & Consumer brought in another 23%, declining 3.6% sequentially, while increasing 16.5% from last year. Digital & Mixed Signal products accounted for 20% of total revenue, up 1.5% from the previous quarter and 11.0% from last year.
Margins
Gross margin for the quarter was 41.2%, down 7 basis points (bps) from the previous quarter’s 42.3%. The flattish margins are encouraging, given the sequential revenue decline. We think this was possible because of favorable mix in the last quarter, as the highest-margin digital and mixed signal family grew slightly, while all other product lines declined. On Semi stated that mix-adjusted average selling prices were down on a sequnetial basis. Management also did not mention the impact of commodity costs on quarterly results, although we note that these have been on the rise.
The operating expenses of $129.3 million were flattish sequentially (down 0.8%). The operating margin dropped 71 bps sequentially and 4 bps year over year to 18.9% of revenue. While G&A and R&D expenses as a percentage of sales grew from the year-ago quarter, all except R&D expenses negatively impacted the sequential comparison.
Net Profit
On a pro forma basis, ON Semi reported a net income of $88.3 million, or a 15.2% net income margin compared to $97.8 million, or 16.3% in the previous quarter and $84.5 million or 17.0% in the fourth quarter of last year.
Our pro forma estimate for the last quarter excludes inventory adjustments, restructuring charges, goodwill an intangibles impairment 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 $61.0 million ($0.14 per share) compared to $87.5 million ($0.20 per share) in the previous quarter and $76.3 million ($0.17 per share) in the prior-year quarter.
Balance Sheet
Inventories were up 2.9% sequentially and inventory turns went down again from 4.0X to 3.8X. Days sales outstanding (DSOs) were around 46, down from around 48 in the previous quarter.
The cash and short term investments balance was $623.3 million at quarter-end (up $60.4 million during the quarter), with ON Semi generating $159.8 million from operations and spending around $43 million on capex.
At quarter-end, ON Semi had $752.8 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, similar to the position at the end of the September 2010 quarter.
Guidance
On Semi expects revenue of $570-590 million, or down 2% to up 2% sequentially. The recently closed SANYO acquisition will add another $260-285 million to first quarter revenue. Management felt that automotive was likely to be the biggest driver of the company’s business, not just in the next quarter, but right through the year. The computing business, which weakened considerably in the second half of 2010, is likely to see better than seasonal growth in the first quarter of 2011 and improving through each quarter as we move through the year. The industrial business is expected to be sluggish and the wireless business growing, driven by smartphones.
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 $10 million and non-cash interest expense 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 460 million.
ON Semi also expects to spend around $250 million on equipment purchases in 2011.
Our Recommendation
ON Semi remains in favor with us, since we believe that its poor performance over the last two quarters was a temporary matter, something that is unlikely to impact its business in 2011. On the other hand, we like the way it has acquired complementary capacity and product lines, as well as the design win momentum it is seeing. As a result we have allotted a Zacks Rank of #2 to the shares, which implies a short-term (1-3 months) Buy recommendation.
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