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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, 2012 ("2012 Form 10-K"), filed with the Securities and Exchange Commission (the "Commission") on February 26, 2013, and our unaudited consolidated financial statements for the fiscal quarter ended September 27, 2013, 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 2012 Form 10-K. Company Highlights for the Quarter Ended September 27, 2013 • Total revenues of $715.4 million • Gross margin of 34.8 percent • Net income per fully diluted share of $0.11 • Completed the repurchase of approximately 4.1 million shares of common stock for an aggregate purchase price of approximately $30.2 million 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, you should read "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 5% during 2013 through 2015. 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, together with its wholly and majority-owned subsidiaries, ("we," "us," "our," "ON Semiconductor," or the "Company") is driving innovation in energy efficient electronics. Our broad portfolio of power and signal management, logic, discrete and custom devices helps customers efficiently solve their design challenges in automotive, communications, computing, consumer, industrial, LED lighting, medical, military/aerospace, smart grid and power applications. We design, manufacture and market an extensive portfolio of semiconductor components that address the design needs of sophisticated electronic systems and products. Our power management 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' unique products. Our data management semiconductor components provide high-performance clock management and data flow management for precision computing and communications systems. Our standard semiconductor components serve as "building block" components 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. We serve a broad base of end-user markets, including automotive, communications, computing, consumer, medical, industrial, smart grid and military/aerospace. Applications for our products in these markets include portable electronics, computers, game consoles, servers, automotive and industrial control systems, LED lighting, power supplies, networking and telecom gear and automated test equipment. Our extensive portfolio of devices enables us to offer advanced ICs and the "building block" components that deliver system level functionality and design solutions. Our product portfolio was comprised of approximately 46,000 products as of September 27, 2013 and we shipped approximately 31.2 billion units in the first nine months of 2013, as compared to 28.4 billion units in the first nine months of 2012. We specialize in micro packages, which offer increased performance characteristics while reducing the critical board space inside today's ever shrinking electronic devices. We believe that our ability to offer a broad range of products, global manufacturing network and logistics provides our customers with single source purchasing on a cost-effective and timely basis. 41 -------------------------------------------------------------------------------- Table of Contents Segments As of September 27, 2013, we were organized into three operating segments, which also represented our three reporting segments: Application Products Group, Standard Products Group, and SANYO Semiconductor Products 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. To further improve our cost structure within our SANYO Semiconductor Products Group, on October 6, 2013 we announced a plan to close KSS by the end of the second quarter of 2014 (the "KSS Plan"). In addition, on October 7, 2013 we also announced an additional voluntary retirement program for employees of our certain SANYO Semiconductor Products Group subsidiaries in order to further improve the cost structure within our SANYO Semiconductor Products Group. See Note 16: "Subsequent Events" of the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q for further details relating to our most recent cost saving actions. Outlook ON Semiconductor Fourth Quarter 2013 Outlook Based upon product booking trends, backlog levels, and estimated turns levels, we estimate that our revenues will be approximately $675 million to $705 million in the fourth quarter of 2013. Backlog levels for the fourth quarter of 2013 represent approximately 80% to 85% of our anticipated fourth quarter 2013 revenues. We estimate average selling prices for the fourth quarter of 2013 will be down approximately one percent when compared to the third quarter of 2013. For the fourth quarter of 2013, we estimate that gross margin as a percentage of revenues will be approximately 33.8% to 34.8%. 42-------------------------------------------------------------------------------- Table of Contents Results of Operations Quarter Ended September 27, 2013 Compared to Quarter Ended September 28, 2012 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 September 27, 2013 and September 28, 2012 (in millions): Quarter Ended September 27, 2013 September 28, 2012 Dollar Change Revenues $ 715.4 $ 725.5 $ (10.1 ) Cost of revenues 466.2 487.5 (21.3 ) Gross profit 249.2 238.0 11.2 Operating expenses: Research and development 84.0 90.1 (6.1 ) Selling and marketing 44.2 44.2 - General and administrative 34.5 36.8 (2.3 ) Amortization of acquisition-related intangible assets 8.2 11.1 (2.9 ) Restructuring, asset impairments and other, net 11.0 11.2 (0.2 ) Total operating expenses 181.9 193.4 (11.5 ) Operating income 67.3 44.6 22.7 Other income (expenses), net: Interest expense (9.2 ) (13.6 ) 4.4 Interest income 0.3 0.3 - Other (1.4 ) (3.6 ) 2.2 Loss on debt exchange - (7.8 ) 7.8 Other income (expenses), net (10.3 ) (24.7 ) 14.4 Income before income taxes 57.0 19.9 37.1 Income tax provision (4.2 ) (6.5 ) 2.3 Net income 52.8 13.4 39.4 Less: Net income attributable to non-controlling interest (1.0 ) (0.9 ) (0.1 ) Net income attributable to ON Semiconductor Corporation $ 51.8 $ 12.5 $ 39.3 Revenues Revenues were $715.4 million and $725.5 million for the quarters ended September 27, 2013 and September 28, 2012, respectively. The decrease in revenues for the quarter ended September 27, 2013 compared to the quarter ended September 28, 2012 was isolated to our SANYO Semiconductor Products Group with our other operating segments experiencing increases in revenue as a result of an improved demand environment. Our SANYO Semiconductor Products Group was impacted by a softening of the Japanese consumer market and a weakened Yen. As compared to the quarter ended September 28, 2012, we experienced a decline in average selling prices of approximately 7%, partially offset by favorable changes in volume and mix, which resulted in a net decrease in revenue of approximately 1% for the quarter ended September 27, 2013. Our revenues by reportable segment for the quarters ended September 27, 2013 and September 28, 2012 were as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of September 27, 2013 Total Revenue (1) September 28, 2012 Total Revenue (1)Application Products Group $ 269.0 37.6 % $ 252.7 34.8 % Standard Products Group 289.6 40.5 % 279.8 38.6 % SANYO Semiconductor Products Group 156.8 21.9 % 193.0 26.6 % Total revenues $ 715.4 $ 725.5 (1) Certain amounts may not total due to rounding of individual amounts. 43 -------------------------------------------------------------------------------- Table of Contents Revenues from the Application Products Group increased by $16.3 million, or approximately 6%, from the third quarter of 2012 to the third quarter of 2013. This increase is primarily attributable to a $13.2 million, or approximately 14%, increase in revenues for our analog products combined with increases in revenues from our ASIC, TMOS and foundry products. Revenues from the Standard Products Group increased by $9.8 million, or approximately 4%, from the third quarter of 2012 to the third quarter of 2013. This increase is primarily attributable to an $11.8 million, or approximately 11%, increase in revenue from our discrete products, offset by a decrease of $3.2 million, or approximately 5%, in revenue from our TMOS products. Revenues from the SANYO Semiconductor Products Group decreased by $36.2 million, or approximately 19%, from the third quarter of 2012 to the third quarter of 2013, due to a softening of the Japanese consumer market and the impact of a weakening Yen. Revenues by geographic location for the quarters ended September 27, 2013 and September 28, 2012 were as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of September 27, 2013 Total Revenue (1) September 28, 2012 Total Revenue (1)United States $ 109.0 15.2 % $ 106.7 14.7 % Japan 70.3 9.8 % 93.9 12.9 % China 230.1 32.2 % 228.5 31.5 % Singapore 178.3 24.9 % 157.3 21.7 % United Kingdom 101.9 14.2 % 94.0 13.0 % Other 25.8 3.6 % 45.1 6.2 % Total $ 715.4 $ 725.5 (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 September 27, 2013 and September 28, 2012, we had no single customer that accounted for 10% of our total revenues. Gross Profit Our gross profit by reportable segment for the quarters ended September 27, 2013 and September 28, 2012 was as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of September 27, 2013 Segment Revenue (1) September 28, 2012 Segment Revenue (1) Application Products Group $ 119.0 44.2 % $ 113.5 44.9 % Standard Products Group 95.6 33.0 % 100.1 35.7 % SANYO Semiconductor Products Group 34.3 21.9 % 37.0 19.2 % Gross profit by segment $ 248.9 $ 250.6 Unallocated manufacturing costs (2) 0.3 - % (12.6 ) (1.7 )% Total gross profit $ 249.2 34.8 % $ 238.0 32.8 % (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 $249.2 million in the third quarter of 2013 compared to $238.0 million in the third quarter of 2012. The gross profit increase of $11.2 million, or approximately 5%, during the third quarter of 2013 is primarily due to increased capacity utilization, the impact of a weakened Yen on our cost of revenues and costs savings realized from previous restructuring activities, partially offset by decreased average selling prices. 44-------------------------------------------------------------------------------- Table of Contents Gross profit as a percentage of revenues increased from approximately 33% in the third quarter of 2012 to approximately 35% in the third quarter of 2013. This increase was primarily driven by changes in volume and mix across certain product lines. Operating Expenses Research and development expenses were $84.0 million for the third quarter of 2013 compared to $90.1 million for the third quarter of 2012, representing a decrease of $6.1 million or approximately 7%. This decrease in research and development expenses is primarily associated with decreased payroll related expenses resulting from our previously enacted restructuring and cost saving activities along with the impact of a weakened Yen. Selling and marketing expenses were $44.2 million for the third quarter of 2013 compared to $44.2 million for the third quarter of 2012. General and administrative expenses were $34.5 million in the third quarter of 2013 compared to $36.8 million in the third quarter of 2012, representing a decrease of $2.3 million or approximately 6%. This decrease in general and administrative expenses is primarily associated with decreased payroll related expenses resulting from our previously enacted restructuring and cost saving activities along with the impact of a weakened Yen. Other Operating Expenses Amortization of Acquisition-Related Intangible Assets Amortization of acquisition-related intangible assets was $8.2 million and $11.1 million for the quarters ended September 27, 2013 and September 28, 2012, respectively. The decrease of $2.9 million, or approximately 26%, is the result of the impairment of certain of SANYO Semiconductor Products Group's intangible assets recorded during the fourth quarter of 2012. See Note 3: "Goodwill and Intangible Assets" of the notes to our audited consolidated financial statements included in Part IV, Item 15 of our 2012 Form 10-K for information on intangible asset impairments during 2012. Restructuring, Asset Impairments and Other, Net Restructuring, asset impairments and other, net was $11.0 million for the quarter ended September 27, 2013 compared to $11.2 million for the quarter ended September 28, 2012. 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 with respect to restructuring activities. Quarter Ended September 27, 2013 During the quarter ended September 27, 2013, we recorded net charges of approximately $2.4 million in connection with the previously announced voluntary retirement program for certain employees of our SANYO Semiconductor Products Group, which consisted of employee severance charges of $2.6 million, partially offset by pension and related retirement liability adjustments associated with the affected employees, which resulted in a pension curtailment benefit of $0.2 million. On October 6, 2013, we announced a plan to close our SANYO Semiconductor Products Group KSS back-end manufacturing facility by the end of the second quarter of 2014. Pursuant to the KSS Plan, a majority of the production from KSS will be transferred to other Company-owned back-end manufacturing facilities. We recorded approximately $6.8 million of net restructuring charges related to the KSS Plan during the quarter ended September 27, 2013, which consisted of multi-employer pension plan withdrawal charges of $3.9 million and $2.9 million of asset impairment charges associated with the KSS Plan. Quarter Ended September 28, 2012 During the third quarter of 2012, we initiated a global workforce reduction program. Restructuring charges for the quarter ended September 28, 2012 consisted primarily of $7.8 million associated with employee severance charges related to this global workforce reduction program. 45-------------------------------------------------------------------------------- Table of Contents Operating Income Information about operating income (loss) from our reportable segments for the quarters ended September 27, 2013 and September 28, 2012 is as follows (in millions): SANYO Standard Semiconductor Application Products Products Products Group Group Group Total For quarter ended September 27, 2013: Segment operating income (loss) $ 30.4 $ 54.9 $ (3.0 ) $ 82.3 For quarter ended September 28, 2012: Segment operating income (loss) $ 28.8 $ 60.9 $ (21.4 ) $ 68.3 Reconciliations of segment information to the financial statements is as follows (in millions): Quarter Ended September 27, 2013 September 28, 2012 Operating income for reportable segments $ 82.3 $ 68.3 Unallocated amounts: Restructuring, asset impairments and other charges, net (11.0 ) (11.2 ) Other unallocated manufacturing costs 0.3 (12.6 ) Other unallocated operating expenses (4.3 ) 0.1 Operating income $ 67.3 $ 44.6 Other unallocated operating expenses consist of expenses associated with certain corporate decisions and initiatives which are not directly attributable to our reporting segments. Interest Expense Interest expense decreased by $4.4 million to $9.2 million during the quarter ended September 27, 2013 compared to $13.6 million during the quarter ended September 28, 2012. We recorded amortization of debt discount to interest expense of $2.7 million and $5.5 million for the quarters ended September 27, 2013 and September 28, 2012, respectively. Our average long-term debt balance (including current maturities and net of debt discount) during the quarter ended September 27, 2013 was $913.0 million at a weighted average interest rate of approximately 4.0%, compared to $1,066.9 million at a weighted average interest rate of approximately 5.1% during the quarter ended September 28, 2012. Other Other expense decreased by $2.2 million from a loss of $3.6 million for the quarter ended September 28, 2012 to a loss of $1.4 million for the quarter ended September 27, 2013. The decrease is primarily attributable to the impact of our hedging activities during the quarter ended September 27, 2013. Provision for Income Taxes We recorded an income tax provision of $4.2 million and a provision for income taxes of $6.5 million during the quarters ended September 27, 2013 and September 28, 2012, respectively. The income tax provision for the quarter ended September 27, 2013 was $4.2 million, which consisted of $6.4 million for income and withholding taxes of certain of our foreign operations and $0.3 million of interest on existing reserves for potential liabilities in foreign jurisdictions, partially offset by the reversal of $2.5 million for reserves and interest for potential liabilities in foreign taxing jurisdictions which were effectively settled or for which the statute lapsed during the quarter ended September 27, 2013. The income tax provision for the quarter ended September 28, 2012 was $6.5 million, which consisted of $6.6 million for income and withholding taxes of certain of our foreign operations and $0.2 million of interest on existing reserves for potential liabilities in foreign taxing jurisdictions, partially offset by the reversal of $0.3 million for reserves and interest for potential liabilities in foreign taxing jurisdictions which were effectively settled or for which the statute lapsed during the third quarter of 2012. 46-------------------------------------------------------------------------------- Table of Contents Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated in countries that have lower tax rates and earnings being higher than anticipated in countries that have higher tax rates. Our effective tax rate for the quarter ended September 27, 2013 was 7.4%, which differs from the U.S. statutory federal income tax rate of 35% due to our domestic tax losses and tax rate differential in our foreign subsidiaries, as well as the reversal of certain reserves and interest for potential liabilities in foreign taxing jurisdictions which were effectively settled or for which the statute lapsed during the quarter ended September 27, 2013. We continue to maintain a full valuation allowance on all of our domestic and substantially all of our Japan related deferred tax assets. Nine Months Ended September 27, 2013 Compared to Nine Months Ended September 28, 2012 The following table summarizes certain information relating to our operating results that has been derived from our unaudited consolidated financial statements for the nine months ended September 27, 2013 and September 28, 2012 (in millions): Nine Months Ended September 27, 2013 September 28, 2012 Dollar Change Revenues $ 2,064.7 $ 2,214.7 $ (150.0 ) Cost of revenues 1,379.2 1,473.2 (94.0 ) Gross profit 685.5 741.5 (56.0 ) Operating expenses: Research and development 255.5 279.3 (23.8 ) Selling and marketing 127.3 136.8 (9.5 ) General and administrative 110.9 119.7 (8.8 ) Amortization of acquisition-related intangible assets 24.8 33.3 (8.5 ) Restructuring, asset impairments and other, net 11.1 57.3 (46.2 ) Total operating expenses 529.6 626.4 (96.8 ) Operating income 155.9 115.1 40.8 Other income (expenses), net: Interest expense (28.6 ) (43.4 ) 14.8 Interest income 1.0 1.1 (0.1 ) Other 3.6 3.4 0.2 Loss on debt exchange (3.1 ) (7.8 ) 4.7 Other income (expenses), net (27.1 ) (46.7 ) 19.6 Income before income taxes 128.8 68.4 60.4 Income tax provision (4.0 ) (17.8 ) 13.8 Net income 124.8 50.6 74.2 Less: Net income attributable to non-controlling interest (2.7 ) (3.0 ) 0.3 Net income attributable to ON Semiconductor Corporation $ 122.1 $ 47.6 $ 74.5 Revenues Revenues were $2,064.7 million and $2,214.7 million for the nine months ended September 27, 2013 and September 28, 2012, respectively. The decrease in revenues for the nine months ended September 27, 2013 compared to the nine months ended September 28, 2012 was most pronounced in our SANYO Semiconductor Products Group, while all operating segments experienced revenue declines as a result of a weakened demand environment associated with less favorable global economic conditions. Our SANYO Semiconductor Products Group was impacted by a softening of the Japanese consumer market, a weakened Yen, and, to a lesser extent, political tensions between Japan and China which began to impact revenue levels during the second half of 2012. For the nine months ended September 27, 2013, we experienced a decline in average selling prices of approximately 7% as compared to the nine months ended September 28, 2012. 47 -------------------------------------------------------------------------------- Table of Contents Our revenues by reportable segment for the nine months ended September 27, 2013 and September 28, 2012 were as follows (dollars in millions): Nine Months Ended As a % of Nine Months Ended As a % of September 27, 2013 Total Revenue (1) September 28, 2012 Total Revenue (1)Application Products Group $ 765.5 37.1 % $ 772.8 34.9 % Standard Products Group 831.2 40.3 % 837.6 37.8 % SANYO Semiconductor Products Group 468.0 22.7 % 604.3 27.3 % Total revenues $ 2,064.7 $ 2,214.7 (1) Certain amounts may not total due to rounding of individual amounts. Revenues from the Application Products Group decreased by $7.3 million, or approximately 1%, from the nine months ended September 28, 2012 to the nine months ended September 27, 2013. This decrease is primarily attributable to a $17.3 million, or approximately 4%, decrease in revenues from our ASIC products combined with a decrease of $5.6 million, or approximately 16%, in revenues from our ECL products, partially offset by a $14.4 million, or approximately 5%, increase in revenues from our analog products. Revenues from the Standard Products Group decreased by $6.4 million, or approximately 1%, from the nine months ended September 28, 2012 to the nine months ended September 27, 2013. This decrease is primarily attributable to an $11.6 million, or approximately 6%, decrease in revenue from our TMOS products and decrease in revenue of $4.5 million, or approximately 10%, from our memory products, partially offset by an increase of $10.6 million, or approximately 3%, from our discrete products. Revenues from the SANYO Semiconductor Products Group decreased by $136.3 million, or approximately 23%, from the nine months ended September 28, 2012 to the nine months ended September 27, 2013, due to a softening of the Japanese consumer market, a weakening Yen, and, to a lesser extent, political tensions between Japan and China, which began to impact revenue levels during the second half of 2012. Revenues by geographic location for the nine months ended September 27, 2013 and September 28, 2012 were as follows (dollars in millions): Nine Months Ended As a % of Nine Months Ended As a % of September 27, 2013 Total Revenue (1) September 28, 2012 Total Revenue (1)United States $ 306.4 14.8 % $ 338.3 15.3 % Japan 217.6 10.5 % 314.2 14.2 % China 628.0 30.4 % 664.4 30.0 % Singapore 525.6 25.5 % 464.3 21.0 % United Kingdom 302.2 14.6 % 299.8 13.5 % Other 84.9 4.1 % 133.7 6.0 % Total $ 2,064.7 $ 2,214.7 (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 nine months ended September 27, 2013 and September 28, 2012, we had no single customer that accounted for 10% of our total revenues. 48-------------------------------------------------------------------------------- Table of Contents Gross Profit Our gross profit by reportable segment for the nine months ended September 27, 2013 and September 28, 2012, respectively, was as follows (in millions): Nine Months Ended As a % of Nine Months Ended As a % of September 27, 2013 Segment Revenue September 28, 2012 Segment RevenueApplication Products Group $ 336.3 43.9 % $ 352.6 45.6 % Standard Products Group 296.1 35.6 % 312.5 37.3 % SANYO Semiconductor Products Group 63.4 13.5 % 110.8 18.3 % Gross profit by segment $ 695.8 $ 775.9 Unallocated manufacturing (1) (10.3 ) (0.5 )% (34.4 ) (1.6 )% Total gross profit $ 685.5 33.2 % $ 741.5 33.5 % (1) Unallocated manufacturing costs are being shown as a percentage of total revenue. Our gross profit was $685.5 million for the nine months ended September 27, 2013 compared to $741.5 million for the nine months ended September 28, 2012. The gross profit decrease of $56.0 million for the nine months ended September 27, 2013 is primarily attributable to a decrease in gross profit for our SANYO Semiconductor Products Group and a result of lower revenues for the nine months ended September 27, 2013 compared to the nine months ended September 28, 2012. Gross profit as a percentage of revenues decreased from approximately 34% for the nine months ended September 28, 2012 to 33% for the nine months ended September 27, 2013, primarily due to the decreased gross margin in our SANYO Semiconductor Products Group, which experienced an increase in inventory reserves and, to a lesser extent, the expiration of certain operational support credits at the end of 2012. Operating Expenses Research and development expenses were $255.5 million for the nine months ended September 27, 2013 compared to $279.3 million for the nine months ended September 28, 2012, representing a decrease of $23.8 million or approximately 9%. This decrease in research and development expenses is primarily associated with decreased payroll related expenses resulting from our previously enacted restructuring and cost saving activities along with the impact of a weakening Yen. Selling and marketing expenses were $127.3 million for the nine months ended September 27, 2013 compared to $136.8 million for the nine months ended September 28, 2012, representing a decrease of $9.5 million or approximately 7%. This decrease in selling and marketing expenses is primarily associated with decreased payroll related expenses resulting from our previously enacted restructuring and cost saving activities along with the impact of a weakening Yen. General and administrative expenses were $110.9 million for the nine months ended September 27, 2013 compared to $119.7 million for the nine months ended September 28, 2012, representing a decrease of $8.8 million or 7%. This decrease in general and administrative expenses is primarily associated with decreased payroll and outside service related expenses resulting from our previously enacted restructuring and cost saving activities along with impact of a weakening Yen. Other Operating Expenses Amortization of Acquisition-Related Intangible Assets Amortization of acquisition-related intangible assets was $24.8 million and $33.3 million for the nine months ended September 27, 2013 and September 28, 2012, respectively. The decrease of $8.5 million, or approximately 26%, is the result of the impairment of certain of SANYO Semiconductor Products Group's intangible assets recorded during the fourth quarter of 2012. See Note 3: "Goodwill and Intangible Assets" of the notes to our audited consolidated financial statements included in Part IV, Item 15 of our 2012 Form 10-K for information on intangible asset impairments during 2012. Restructuring, Asset Impairments and Other, Net Restructuring, asset impairments and other, net was $11.1 million for the nine months ended September 27, 2013 compared to $57.3 million for the nine months ended September 28, 2012. The information below summarizes certain of the activities for each respective period. 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 with respect to restructuring activities. 49-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 27, 2013 During the nine months ended September 27, 2013, we initiated a voluntary retirement program for certain employees of our SANYO Semiconductor Products Group. We recorded net charges of approximately $22.9 million in connection with this program, which consisted of employee severance charges of $35.0 million, partially offset by pension and related retirement liability adjustments associated with the affected employees, which resulted in a pension curtailment benefit of $12.1 million. Additionally, during the nine months ended September 27, 2013, we recorded $3.1 million of restructuring charges related to the announced closure of our Aizu facility. We also released approximately $21.0 million of associated cumulative foreign currency translation gains related to our subsidiary that owned the Aizu facility, which utilized 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. See Note 12: "Changes in Accumulated Other Comprehensive Loss" of the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q for additional information on amounts reclassified from accumulated other comprehensive loss. On October 6, 2013 we announced a plan to close our SANYO Semiconductor Products Group KSS back-end manufacturing facility by the end of the second quarter of 2014. Pursuant to the KSS Plan, a majority of the production from KSS will be transferred to other Company-owned back-end manufacturing facilities. We recorded approximately $6.8 million of net restructuring charges related to the KSS Plan during the nine months ended September 27, 2013, consisting of multi-employer pension plan withdrawal charges of $3.9 million and $2.9 million of asset impairment charges associated with the KSS Plan. Nine Months Ended September 28, 2012 During the nine months ended September 28, 2012, we initiated a voluntary retirement program for certain employees of our SANYO Semiconductor Products Group and recorded charges of $34.0 million associated with this activity, which was comprised of employee severance charges of $45.7 million, partially offset by pension and related retirement liability adjustments associated with the affected employees, which resulted in a pension curtailment benefit of $11.7 million. Additionally, during the nine months ended September 28, 2012, we initiated a global workforce reduction program. Restructuring charges for the nine months ended September 28, 2012 related to this program consisted primarily of $7.8 million associated with employee severance charges. Operating Income Information about operating income (loss) from our reportable segments for the nine months ended September 27, 2013 and September 28, 2012 is as follows (in millions): SANYO Standard Semiconductor Applications Products Products Products Group Group Group Total For the nine months ended September 27, 2013: Segment operating income (loss) $ 80.1 $ 177.8 $ (71.7 ) $ 186.2 For the nine months ended September 28, 2012: Segment operating income (loss) $ 90.8 $ 190.1 $ (73.2 ) $ 207.7 Reconciliations of segment information to the financial statements is as follows (in millions): Nine Months Ended September 27, 2013 September 28, 2012 Operating income for reportable segments $ 186.2 $ 207.7 Unallocated amounts: Restructuring, asset impairments and other charges, net (11.1 ) (57.3 ) Other unallocated manufacturing costs (10.3 ) (34.4 ) Other unallocated operating expenses (8.9 ) (0.9 ) Operating income $ 155.9 $ 115.1 50 -------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense decreased by $14.8 million to $28.6 million for the nine months ended September 27, 2013 compared to $43.4 million in the first nine months of 2012. We recorded amortization of debt discount to interest expense of $8.5 million and $18.7 million for the nine months ended September 27, 2013 and September 28, 2012, respectively. Our average long-term debt balance (including current maturities and net of debt discount) for the nine months ended September 27, 2013 was $960.2 million at a weighted average interest rate of 4.0%, compared to $1,135.2 million at a weighted average interest rate of 5.1% for the nine months ended September 28, 2012. Other Other income increased $0.2 million from a gain of $3.4 million for the nine months ended September 28, 2012 to a gain of $3.6 million for the nine months ended September 27, 2013. Loss on Debt Exchange During the nine months ended September 27, 2013, we exchanged $60.0 million in principal value ($57.4 million of carrying value) of our 2.625% Notes for $58.5 million in principal value of our 2.625% Notes, Series B, plus accrued and unpaid interest on the 2.625% Notes, resulting in a loss on debt repurchase of $3.1 million. Subject to certain other terms and conditions, this transaction extended the earliest put date for the exchanged amount from December 2013 to December 2016. See Note 6: "Long-Term Debt" of the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q for information on this exchange. Provision for Income Taxes We recorded an income tax provision of $4.0 million and $17.8 million during the nine months ended September 27, 2013 and September 28, 2012, respectively. The income tax provision for the nine months ended September 27, 2013 was $4.0 million, which consisted of $11.8 million for income and withholding taxes of certain of our foreign operations and $0.8 million of interest on existing reserves for potential liabilities in foreign taxing jurisdictions, partially offset by the reversal of $6.0 million of valuation allowances against deferred tax assets of certain foreign subsidiaries and the reversal of $2.6 million for reserves and interest for potential liabilities in foreign taxing jurisdictions that were effectively settled or for which the statute lapsed during the nine months ended September 27, 2013. The income tax provision for the nine months ended September 28, 2012 was $17.8 million, which consisted of $17.9 million for income and withholding taxes of certain of our foreign operations and $0.7 million of interest on existing reserves for potential liabilities in foreign taxing jurisdictions, partially offset by the reversal of $0.8 million for reserves and interest for potential liabilities in foreign taxing jurisdictions which were effectively settled or for which the statute lapsed during the nine months ended September 28, 2012. Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated in countries that have lower tax rates and earnings being higher than anticipated in countries that have higher tax rates. Our effective tax rate for the nine months ended September 27, 2013 was 3.1%, which differs from the U.S. statutory federal income tax rate of 35% due to our domestic tax losses and tax rate differential in our foreign subsidiaries, as well as the reversal of certain valuation allowances and the reversal of reserves and interest for potential liabilities in certain foreign taxing jurisdictions which were effectively settled or for which the statute lapsed during the nine months ended September 27, 2013. We continue to maintain a full valuation allowance on all of our domestic and substantially all of our Japan related deferred tax assets. Liquidity and Capital Resources This section includes a discussion and analysis of our cash requirements, off-balance sheet arrangements, contingencies, sources and uses of cash, operations, working capital, and long-term assets and liabilities. Contractual Obligations During the nine months ended September 27, 2013, there have not been any material changes outside of the ordinary course of business to the contractual obligations table, including notes thereto, contained in our 2012 Form 10-K. For information on long-term debt see Note 6: "Long-Term Debt," for operating leases see Note 9: "Commitments and Contingencies" and for pension plans see Note 5: "Balance Sheet Information" of the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q. 51-------------------------------------------------------------------------------- Table of Contents Our balance of cash, cash equivalents and short-term investments was $553.6 million as of September 27, 2013. We believe that our cash flows from operations, coupled with our existing cash and cash equivalents and short-term investments, will be adequate to fund our operating and capital needs for at least the next 12 months. Total cash and cash equivalents and short-term investments at September 27, 2013 include approximately $341.6 million available in the United States. In addition to cash and cash equivalents and short-term investments already on hand in the United States, we have the ability to obtain cash in the United States by settling loans with our foreign subsidiaries in order to cover our domestic needs, by utilizing existing credit facilities, or through new bank loans or debt obligations. We hold a significant amount of cash, cash equivalents and short-term investments outside the United States in various foreign subsidiaries. As we intend to reinvest certain of our foreign earnings indefinitely, this cash held outside the United States in various foreign subsidiaries is not readily available to meet certain of our cash requirements in the United States. We require a substantial amount of cash in the United States for operating requirements, debt repurchases, payments and acquisitions. If we are unable to address our U.S. cash requirements through operations, borrowings under our current debt agreements or other sources of cash obtained at an acceptable cost, it may be necessary for us to consider repatriation of earnings that are permanently reinvested, and we may be required to pay additional taxes under current tax laws, which could have a material effect on our results of operations and financial condition. Off-Balance Sheet Arrangements In the normal course of business, we enter into various operating leases for buildings and equipment including our mainframe computer system, desktop computers, communications, foundry equipment and service agreements relating to this equipment. In the normal course of business, we provide standby letters of credit or other guarantee instruments to certain parties initiated by either our subsidiaries or us, as required for transactions such as, but not limited to, material purchase commitments, agreements to mitigate collection risk, leases, utilities or customs guarantees. As of September 27, 2013, our senior revolving credit facility included a $40.0 million availability for the issuance of letters of credit. A $0.2 million letter of credit was outstanding under our senior revolving credit facility as of September 27, 2013. We also had outstanding guarantees and letters of credit outside of our senior revolving credit facility of $4.7 million as of September 27, 2013. As part of securing financing in the normal course of business, we issued guarantees related to our receivable financing, capital lease obligations and real estate mortgages which totaled approximately $83.9 million as of September 27, 2013. We are also a guarantor of SCI LLC's unsecured loan with SMBC, which had a balance of $283.1 million as of September 27, 2013. See Note 6: "Long-Term Debt" and Note 9: "Commitments and Contingencies" of the notes to our unaudited consolidated financial statements found elsewhere in this Form 10-Q for additional information. Based on historical experience and information currently available, we believe that in the foreseeable future we will not be required to make payments under the standby letters of credit or guarantee arrangements. For our operating leases, we expect to make cash payments and similarly incur expenses totaling $112.1 million as payments come due. We have not recorded any liability in connection with these operating leases, letters of credit and guarantee arrangements. See Note 9: "Commitments and Contingencies" of the notes to our unaudited consolidated financial statements found elsewhere in this Form 10-Q for additional information. Contingencies We are a party to a variety of agreements entered into in the ordinary course of business pursuant to which we may be obligated to indemnify other parties for certain liabilities that arise out of or relate to the subject matter of the agreements. Some of the agreements entered into by us require us to indemnify the other party against losses due to IP infringement, property damage including environmental contamination, personal injury, failure to comply with applicable laws, our negligence or willful misconduct, or breach of representations and warranties and covenants related to such matters as title to sold assets. We face risk of exposure to warranty and product liability claims in the event that our products fail to perform as expected or such failure of our products results, or is alleged to result, in bodily injury or property damage (or both). In addition, if any of our designed products are alleged to be defective, we may be required to participate in their recall. Depending on the significance of any particular customer and other relevant factors, we may agree to provide more favorable indemnity rights to such customer for valid warranty claims. We and our subsidiaries provide for indemnification of directors, officers and other persons in accordance with limited liability agreements, certificates of incorporation, by-laws, articles of association or similar organizational documents, as the case may be. We maintain directors' and officers' insurance, which should enable us to recover a portion of any future amounts paid. 52-------------------------------------------------------------------------------- Table of Contents In addition to the above, from time to time, we provide standard representations and warranties to counterparties in contracts in connection with sales of our securities and the engagement of financial advisers and also provide indemnities that protect the counterparties to these contracts in the event they suffer damages as a result of a breach of such representations and warranties or in certain other circumstances relating to the sale of securities or their engagement by us. While our future obligations under certain agreements may contain limitations on liability for indemnification, other agreements do not contain such limitations and under such agreements it is not possible to predict the maximum potential amount of future payments due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under any of these indemnities have not had a material effect on our business, financial condition, results of operations or cash flows, and we do not believe that any amounts that we may be required to pay under these indemnities in the future will be material to our business, financial condition, results of operations or cash flows. See Note 9: "Commitment and Contingencies" of the notes to our unaudited consolidated financial statements under the heading "Legal Matters" in this Form 10-Q for possible contingencies related to legal matters. See also Part I, Item 1 "Business-Government Regulation" of our 2012 Form 10-K for information on certain environmental matters. Sources and Uses of Cash We require cash to fund our operating expenses and working capital requirements, including outlays for research and development, to make capital expenditures, for strategic acquisitions and investments, to repurchase our stock and other Company securities, and to pay debt service, including principal and interest and capital lease payments. Our principal sources of liquidity are cash on hand, cash generated from operations and funds from external borrowings and equity issuances. In the near term, we expect to fund our primary cash requirements through cash generated from operations and cash and cash equivalents on hand and short-term investments. Additionally, as part of our business strategy, we review acquisition and divestiture opportunities and proposals on a regular basis. We believe that the key factors that could affect our internal and external sources of cash include: • Factors that affect our results of operations and cash flows, including the impact on our business and operations as a result of changes in demand for our products, competitive pricing pressures, effective management of our manufacturing capacity, our ability to achieve further reductions in operating expenses, the impact of our restructuring programs on our production and cost efficiency and our ability to make the research and development expenditures required to remain competitive in our business; and • Factors that affect our access to bank financing and the debt and equity capital markets that could impair our ability to obtain needed financing on acceptable terms or to respond to business opportunities and developments as they arise, including interest rate fluctuations, macroeconomic conditions, sudden reductions in the general availability of lending from banks or the related increase in cost to obtain bank financing and our ability to maintain compliance with covenants under our debt agreements in effect from time to time. Our ability to service our long-term debt including our senior subordinated notes, to remain in compliance with the various covenants contained in our debt agreements and to fund working capital, capital expenditures and business development efforts will depend on our ability to generate cash from operating activities, which is subject to, among other things, our future operating performance, as well as to general economic, financial, competitive, legislative, regulatory and other conditions, some of which may be beyond our control. If we fail to generate sufficient cash from operations, we may need to raise additional equity or borrow additional funds to achieve our longer term objectives. There can be no assurance that such equity or borrowings will be available or, if available, will be at rates or prices acceptable to us. We believe that cash flow from operating activities coupled with existing cash and cash equivalents and short-term investments will be adequate to fund our operating and capital needs as well as enable us to maintain compliance with our various debt agreements through at least the next twelve months. To the extent that results or events differ from our financial projections or business plans, our liquidity may be adversely impacted. During the ordinary course of business, we evaluate our cash requirements and, if necessary, adjust our expenditures for inventory, operating expenditures and capital expenditures to reflect the current market conditions and our projected sales and demand. For example, during the nine months ended September 27, 2013, we paid $135.1 million for capital expenditures, while during the nine months ended September 28, 2012, we paid approximately $198.8 million for capital expenditures. Our current projection for capital expenditures for the remainder of 2013 is approximately $35 million, of which our current minimum contractual commitment is approximately $6.1 million. The capital expenditure levels can materially influence our available cash for other initiatives. 53-------------------------------------------------------------------------------- Table of Contents |