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ON SEMICONDUCTOR CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[May 02, 2014]

ON SEMICONDUCTOR CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion in conjunction with our audited historical consolidated financial statements, which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 ("2013 Form 10-K"), filed with the Securities and Exchange Commission (the "Commission") on February 21, 2014, and our unaudited consolidated financial statements for the fiscal quarter ended March 28, 2014, included elsewhere in this Form 10-Q.

Management's Discussion and Analysis of Financial Condition and Results of Operations contains statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risk, uncertainties, and other factors. Actual results could differ materially because of the factors discussed below or elsewhere in this Form 10-Q. See Part II, Item 1A. "Risk Factors" of this Form 10-Q and Part I, Item 1A. "Risk Factors" of our 2013 Form 10-K.

Company Highlights for the Quarter Ended March 28, 2014 • Total revenues of approximately $706.5 million • Gross margin of approximately 35.5% • Net income of $0.13 per diluted share • Cash, cash equivalents and short-term investments of approximately $617.0 million • Completed the repurchase of approximately 2.2 million shares of common stock pursuant to our previously announced share repurchase program Executive Overview This Executive Overview presents summary information regarding our industry, markets, business and operating trends only. For further information regarding the events summarized herein, see Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in its entirety.


Industry Overview We participate in unit and revenue surveys and use data summarized by the WSTS group to evaluate overall semiconductor market trends and to track our progress against the market in the areas we provide semiconductor components. The most recently published estimates from WSTS project a compound annual growth rate in our serviceable addressable market of approximately 4% during 2014 through 2016.

These are not our projections and may not be indicative of actual results. We, like many of our competitors, view this information as helpful third party projections and estimates.

Business Overview ON Semiconductor Corporation and its subsidiaries ("we," "us," "our," "ON Semiconductor," or the "Company") is driving innovation in energy efficient electronics. Our extensive portfolio of power and signal management, logic, discrete and custom devices helps customers efficiently solve their design challenges in advanced electronic systems and products. Our power management and motor driver semiconductor components control, convert, protect and monitor the supply of power to the different elements within a wide variety of electronic devices. Our custom ASICs use analog, DSP, mixed-signal and advanced logic capabilities to act as the brain behind many of our automotive, medical, military/aerospace, consumer and industrial customers' products. Our data management semiconductor components provide high-performance clock management and data flow management for precision computing, communications and industrial systems. Our image sensors, optical image stabilization and auto focus devices provide advanced imaging solutions for optical systems. Our standard semiconductor components serve as "building blocks" within virtually all types of electronic devices. These various products fall into the logic, analog, discrete, image sensors and memory categories used by the WSTS group.

Subsequent to March 28, 2014, we completed the purchase of Truesense Imaging, Inc. ("Truesense"), whereby Truesense became our wholly-owned subsidiary. The aggregate purchase price of this transaction was approximately $95.0 million after closing adjustments for cash and working capital amounts. See Note 16: "Subsequent Events" of the notes to our unaudited consolidated financial statement located elsewhere in this Form 10-Q for additional information.

We serve a broad base of end-user markets, including automotive, communications, computing, consumer electronics, medical, industrial, smart grid and military/aerospace. Our devices are found in a wide variety of end-products including automotive electronics, smartphones, media tablets, wearable electronics, computers, servers, industrial building and home automation systems, consumer white goods, LED lighting, power supplies, networking and telecom equipment, medical diagnostics, imaging and hearing health, and sensor networks.

33 -------------------------------------------------------------------------------- Table of Contents Our portfolio of devices enables us to offer advanced ICs and the "building block" components that deliver system level functionality and design solutions.

Our extensive product portfolio consisted of approximately 46,000 products as of March 28, 2014 and we shipped approximately 10.9 billion units in the first three months of 2014, as compared to 9.9 billion units in the first three months of 2013. We offer micro packages, which provide increased performance characteristics while reducing the critical board space inside today's ever shrinking electronic devices and power modules, delivering improved energy efficiency and reliability for a wide variety of high power applications. We believe that our ability to offer a broad range of products, combined with our global manufacturing and logistics network, provides our customers with single source purchasing on a cost-effective and timely basis.

Segments As of March 28, 2014, we were organized into three operating segments, which also represented our three reporting segments: Application Products Group, Standard Products Group, and System Solutions Group. Each of our major product lines has been assigned to a segment based on our operating strategy. Because many products are sold into different end-markets, the total revenue reported for a segment is not indicative of actual sales in the end-market associated with that segment, but rather is the sum of the revenues from the product lines assigned to that segment. From time to time we reassess the alignment of our product families and devices associated with our operating segments, and may move product families or individual devices from one operating segment to another.

Business and Macroeconomic Environment We have recognized efficiencies from implemented restructuring activities and programs and continue to implement profitability enhancement programs to improve our cost structure. However, the semiconductor industry has traditionally been highly cyclical and has often experienced significant downturns in connection with, or in anticipation of, declines in general economic conditions. While there have been recent indications of improving conditions, our business environment continues to experience significant uncertainty and volatility. We have historically reviewed, and will continue to review, our cost structure, capital investments and other expenditures to align our spending and capacity with our current sales and manufacturing projections.

Outlook ON Semiconductor Second Quarter 2014 Outlook Based upon product booking trends, backlog levels, and estimated turns levels, we estimate that our revenues will be approximately $738 million to $768 million in the second quarter of 2014. Backlog levels for the second quarter of 2014 represent approximately 80% to 85% of our anticipated second quarter 2014 revenues. We estimate average selling prices for the second quarter of 2014 will be down approximately 1% when compared to the first quarter of 2014. For the second quarter of 2014, we estimate that gross margin as a percentage of revenues will be approximately 34.7% to 36.6%. Our guidance for the second quarter of 2014 includes the contribution from our acquisition of Truesense, which closed on April 30, 2014. See Note 16: "Subsequent Events" of the notes to our unaudited consolidated financial statements located elsewhere in this Form 10-Q for additional information.

34-------------------------------------------------------------------------------- Table of Contents Results of Operations Quarter Ended March 28, 2014 Compared to the Quarter Ended March 29, 2013 The following table summarizes certain information relating to our operating results that has been derived from our unaudited consolidated financial statements for the quarters ended March 28, 2014 and March 29, 2013 (in millions): Quarter Ended March 28, 2014 March 29, 2013 Dollar Change Revenues $ 706.5 $ 661.0 $ 45.5 Cost of revenues 455.7 456.5 (0.8 ) Gross profit 250.8 204.5 46.3 Operating expenses: Research and development 78.1 88.4 (10.3 ) Selling and marketing 44.4 39.8 4.6 General and administrative 41.0 36.2 4.8 Amortization of acquisition-related intangible assets 8.2 8.4 (0.2 ) Restructuring, asset impairments and other, net 5.8 (6.0 ) 11.8 Total operating expenses 177.5 166.8 10.7 Operating income 73.3 37.7 35.6 Other income (expense), net: Interest expense (8.1 ) (10.1 ) 2.0 Interest income 0.2 0.3 (0.1 ) Other (0.6 ) 0.9 (1.5 ) Loss on debt exchange - (3.1 ) 3.1 Other income (expense), net (8.5 ) (12.0 ) 3.5 Income before income taxes 64.8 25.7 39.1 Income tax provision (6.2 ) (2.4 ) (3.8 ) Net income 58.6 23.3 35.3 Less: Net income attributable to non-controlling interest (0.2 ) (0.7 ) 0.5 Net income attributable to ON Semiconductor Corporation $ 58.4 $ 22.6 $ 35.8 Revenues Revenues were $706.5 million and $661.0 million for the quarters ended March 28, 2014 and March 29, 2013, respectively. The increase in revenues for the quarter ended March 28, 2014 compared to the quarter ended March 29, 2013 was attributed to our Application Products Group and Standard Products Group, both of which experienced increases in revenue as a result of an improved demand environment, partially offset by decreased revenue from our System Solutions Group due to a weakened Yen and the continued impact of a softening of the consumer end-markets.

As compared to the quarter ended March 29, 2013, we experienced a decline in average selling prices of approximately 5%, offset by favorable changes in volume and mix, which resulted in a net increase in revenue of approximately 7% for the quarter ended March 28, 2014.

Our revenues by reportable segment for the quarters ended March 28, 2014 and March 29, 2013 were as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of March 28, 2014 Total Revenue (1) March 29, 2013 Total Revenue (1) Application Products Group $ 279.5 39.6 % $ 245.0 37.1 % Standard Products Group 292.9 41.5 % 265.2 40.1 % System Solutions Group 134.1 19.0 % 150.8 22.8 % Total revenues $ 706.5 $ 661.0 (1) Certain amounts may not total due to rounding of individual amounts.

35 -------------------------------------------------------------------------------- Table of Contents Revenues from the Application Products Group increased by $34.5 million, or approximately 14%, from the first quarter of 2013 to the first quarter of 2014.

This increase is primarily attributable to a $18.0 million, or approximately 14%, increase in revenues from our ASIC products, combined with an increase in revenues from our analog products of $13.2 million, or approximately 15%, as a result of an improved demand environment.

Revenues from the Standard Products Group increased by $27.7 million, or approximately 10%, from the first quarter of 2013 to the first quarter of 2014.

This increase is primarily attributable to a $18.9 million, or approximately 18%, increase in revenue from our discrete products, combined with an increase in revenues from our analog products of $4.5 million, or approximately 6%, as a result of an improved demand environment.

Revenues from the System Solutions Group decreased by $16.7 million, or approximately 11%, from the first quarter of 2013 to the first quarter of 2014.

This decrease is primarily attributable to a $15.7 million, or approximately 15% decrease in revenue from our LSI products along with decreases from a softening of the consumer end-markets and the impact of a weakening Yen.

Revenues by geographic location for the quarters ended March 28, 2014 and March 29, 2013 were as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of March 28, 2014 Total Revenue (1) March 29, 2013 Total Revenue (1) United States $ 112.0 15.9 % $ 98.9 15.0 % Japan 65.3 9.2 % 71.7 10.8 % China 202.7 28.7 % 199.4 30.2 % Singapore 180.4 25.5 % 166.4 25.2 % United Kingdom 117.2 16.6 % 97.7 14.8 % Other 28.9 4.1 % 26.9 4.1 % Total $ 706.5 $ 661.0 (1) Certain amounts may not total due to rounding of individual amounts.

A majority of our end customers, served directly or through distribution channels, are manufacturers of electronic devices. For the quarters ended March 28, 2014 and March 29, 2013, we had no single customer that accounted for 10% or more of our total revenues.

Gross Profit Our gross profit by reportable segment for the quarters ended March 28, 2014 and March 29, 2013 was as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of March 28, 2014 Segment Revenue (1) March 29, 2013 Segment Revenue (1) Application Products Group $ 126.1 45.1 % $ 106.9 43.6 % Standard Products Group 106.2 36.3 % 94.5 35.6 % System Solutions Group 25.0 18.6 % 8.6 5.7 % Gross profit by segment $ 257.3 $ 210.0 Unallocated manufacturing costs (2) (6.5 ) (0.9 )% (5.5 ) (0.8 )% Total gross profit $ 250.8 35.5 % $ 204.5 30.9 % (1) Certain amounts may not total due to rounding of individual amounts.

(2) Unallocated manufacturing costs are shown as a percentage of total revenue.

Our gross profit was $250.8 million in the first quarter of 2014 compared to $204.5 million in the first quarter of 2013. The gross profit increase of $46.3 million, or approximately 23%, during the first quarter of 2014 is primarily due to increased capacity utilization, the impact of a weakened Yen on our cost of revenues, costs savings realized from previous restructuring activities and a lower inventory write down, partially offset by decreased average selling prices. Additionally, gross profit during the first quarter of 2013 was impacted by approximately $6.7 million of actuarial losses related to the Company's pension plans. No such losses were incurred during the first quarter of 2014.

36 -------------------------------------------------------------------------------- Table of Contents Gross profit as a percentage of revenues increased from approximately 30.9% in the first quarter of 2013 to approximately 35.5% in the first quarter of 2014.

This increase was primarily driven by favorable changes in volume and mix across certain product lines as well as a larger proportion of revenues generated from our Applications Products Group and Standard Products Group which experience higher gross margin levels than our System Solutions Group.

Operating Expenses Research and development expenses were $78.1 million for the first quarter of 2014 compared to $88.4 million for the first quarter of 2013, representing a decrease of $10.3 million, or approximately 12%. This decrease in research and development expenses is primarily associated with our System Solutions Group and is attributable to decreased payroll related expenses resulting from our 2013 restructuring and cost saving activities, along with the impact of a weakened Yen and a first quarter 2013 expense of approximately $6.0 million from actuarial losses related to the Company's pension plans, of which no such losses were incurred during the first quarter of 2014. These decreases were partially offset by increased personnel costs in our Application Products Group and Standard Products Group.

Selling and marketing expenses were $44.4 million for the first quarter of 2014 compared to $39.8 million for the first quarter of 2013, representing an increase of $4.6 million, or approximately 12%. This increase is primaily associated with increased sales commissions and increased payroll related expenses associated with the increase in revenue for the first quarter of 2014 compared to the first quarter of 2013.

General and administrative expenses were $41.0 million in the first quarter of 2014 compared to 36.2 million in the first quarter of 2013, representing an increase of $4.8 million, or approximately 13%. This increase in general and administrative expenses is primarily associated with increased payroll related expenses associated with performance-based compensation as a result of improved performance results for the first quarter of 2014 compared to the first quarter of 2013.

Other Operating Expenses Amortization of Acquisition-Related Intangible Assets Amortization of acquisition-related intangible assets was $8.2 million and $8.4 million for the quarters ended March 28, 2014 and March 29, 2013, respectively.

Restructuring, Asset Impairments and Other, Net Restructuring, asset impairments and other, net was an expense of $5.8 million for the quarter ended March 28, 2014 compared to a net benefit of $6.0 million for the quarter ended March 29, 2013. The information below summarizes certain activities for each respective quarter. See Note 4: "Restructuring, Asset Impairments and Other, Net" of the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q for additional information.

Quarter Ended March 28, 2014 During the fourth quarter of 2013, we initiated a voluntary retirement program for certain employees of our System Solutions Group subsidiaries in Japan (the "Q4 2013 Voluntary Retirement Program"). Approximately 350 employees opted to retire pursuant to the Q4 2013 Voluntary Retirement Program, of which 290 employees had retired by March 28, 2014. The remaining employees who accepted retirement packages are expected to retire by the end of 2014. As part of these restructuring activities, approximately 70 contractor positions were also identified for elimination, of which, the remaining 15 contractors are expected to be terminated by the end of 2014. We also identified approximately 40 additional positions within the Company that are expected to be eliminated as an extension of the Q4 2013 Voluntary Retirement Program, representing approximately $2.7 million in future restructuring charges. We anticipate total cost savings for the Q4 2013 Voluntary Retirement Program, which includes the above referenced headcounts, to be within the range of our previously disclosed expectations of $36 million to $45 million during the first year following the completion of the anticipated headcount reductions.

During the quarter ended March 28, 2014, we recorded net charges of approximately $2.2 million in connection with the Q4 2013 Voluntary Retirement Program, which consisted of employee severance charges of $5.0 million, partially offset by pension and related retirement liability adjustments associated with the affected employees, which resulted in a pension curtailment benefit of $2.8 million.

Additionally, during the quarter ended March 28, 2014, we recorded approximately $3.6 million of restructuring charges during the quarter ended March 28, 2014, related to our previously announced plan to close our KSS facility.

37-------------------------------------------------------------------------------- Table of Contents Quarter Ended March 29, 2013 During the quarter ended March 29, 2013, we initiated a voluntary retirement program for employees of certain of our System Solutions Group subsidiaries in Japan. We recorded net charges of approximately $16.6 million in connection with this program, which consisted of employee severance charges of $25.6 million, partially offset by pension and related retirement liability adjustments associated with the affected employees, which resulted in a pension curtailment benefit of $9.0 million.

Additionally, during the quarter ended March 29, 2013, we recorded $2.2 million of restructuring charges related to the announced closure of our Aizu facility for cost savings purposes. We also released approximately $21.0 million of associated cumulative foreign currency translation gains related to our subsidiary that owns the Aizu facility, which utilizes the Japanese Yen as its functional currency. The related amount was recorded as a benefit to restructuring, asset impairments and other, net on the Company's Consolidated Statements of Operations and Comprehensive Income.

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