CY Cypress Semiconductor Corporation

ON Semiconductor (ONNN) reported first quarter earnings that exceeded the Zacks Consensus Estimate by 5 cents. Revenues were also strong, exceeding the Zacks Consensus by 4.4%.

ON Semi estimates that disruptions related to the Japan natural disaster lowered revenue by $50 million, gross profit by more than $30 million and net income by $10 million, or a couple of cents per share.

Revenue

ON Semi reported revenue of $870.6 million, of which $278.1 million came from the newly acquired SANYO Semiconductor. Core ON Semi revenue of $592.5 million was up 2.3% sequentially and 7.7% year over year.

Revenue was just over management’s expectations of $570-590 million, or down 2% to up 2% sequentially. Combined revenue grew 50.3% sequentially and 58.2% from last year.

Revenue growth was across all geographies, although the Asia/Pacific saw the strongest growth at 74.4%, followed by Europe, which was up 12.6% and then the Americas, which was up 9.7%. The revenue split among the three was 72%, 13% and 15%, respectively. China and Singapore are the largest markets for ON Semi.

Revenue by End Market

On Semi’s first 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 last quarter. Howver, management commentary was positive.

Following the acquisition, the consumer market emerged as the largest contributor of quarterly revenue, with a 27% revenue share. 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 revenue increase. However, the margin profile being softer, there is a negative impact on profits that may be expected to continue, especially in the first half.

The second largest segment was Automotive,with a 22% contribution. The last quarter’s results were driven by China, the U.S. and 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 continued to dirve results.

Design win momentum continued, with On Semi seeing success at a Korean and leading Japanese automotive manufacturer during the quarter.  China is developing into an important market and On Semi’s decision to open an engineering center in the country has started paying dividends, since a significant percentage of automotive manufacturing has shifted to the region.

Computing was the third largest segment for On Semi with a 21% revenue share. ON Semi was optimistic about the addition of SANYO’s business here, stating that SANYO power management products were being well received by its  tablet customers.

Additionally, management stated that ON Semi products, including protection, power management,  audio and system management products have been designed into 10 tablet platforms. Management stated that ON Semi had aound $3.50 of addressable content for tablets, $8 or notebooks and $11 for desktops.

Industrial/Military/Aerospace/Medical brought in 17% of revenue. Increased production at heavy industrial applications drove the quarter’s results, according to ON Semi. Increased investment in factory automation, oil drilling and refining, pushed up demand for On Semi’s flow, level and pressure sensing products and factory communication products.

The lighting market was also strong, with demand for its high brightness LED and standard components for general lighting applications remaining robust. 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.

ON Semi stated that revenue from the Communications market was soft. Seasonality impacted quarterly revenue, although the company remains well positioned to benefit from smart phone demand. 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 Standard Products, which generated 34% of revenue in the last quarter. Segment revenue was down 12.0% sequentially and 2.8% from the year-ago quarter. Automotive & Power generated 23%, up 10.3% sequentially and 16.8% year over year.

Computing & Consumer brought in another 23%, flat sequentially, while increasing 7.3% from last year. Digital & Mixed Signal products accounted for 20% of total revenue, up 20.0% from the previous quarter and 13.9% from last year.

Margins

Gross margin for the quarter was 36.0%, down 524 basis points (bps) from the previous quarter’s 41.2%. The gross margin decline is partially on account of the SANYO acquisition, which brought in a large chunk of lower-margin consumer business.

The Japan crisis also impacted the gross margin in the last quarter (practically all of SANYO’s operations are in Japan, although management stated that the facilities were not unduly damaged). Gross margins for the core business were 40.4%, down slightly compared to both the previous and year-ago quarters.

Pricing started to stabilize in the last quarter, although there wasn’t really an upward movement according to ON Semi. Management did not mention the impact of commodity costs on quarterly results, although we note that these have been on the rise.

The Digital & Mixed Signal business generated an operating margin of 56.3% (down 522 bps sequentially and 777 bps year over year); Computing & Consumer generated 40.8% (up 20 bps sequentially, down 178 bps year over year); Standard Products 38.6% (down 63 bps sequentially, up 162 bps year over year); and Automotive & Power 37.7% (down 60 bps sequentially and up 210 bps year over year).

The operating expenses of $180.3 million were up significantly from last quarter because of the addition of SANYO’s business. The operating margin dropped 363 bps sequentially and 281 bps year over year to 15.3% of revenue. All expenses declined as a percentage of sales both sequentially and from the year-ago quarter, but were offset by the very substantial increase in cost of sales.

Net Profit

On a pro forma basis, ON Semi reported a net income of $113.2 million, or a 13.0% net income margin on a consolidated basis compared to $88.3 million, or 15.2% in the previous quarter and $77.3 million or 14.0% in the first quarter of last year.

Our pro forma estimate for the last quarter excludes inventory and other adjustments related to the SANYO acquisition, restructuring charges, intangibles amortization charges and a $61.3 million gain on the SANYO purchase on a tax adjusted basis but includes stock based compensation.

On a fully diluted GAAP basis, the company recorded a net income of $74.8 million ($0.16 per share) compared to $61.0 million ($0.14 per share) in the previous quarter and $63.0 million ($0.14 per share) in the prior-year quarter.

Balance Sheet

Inventories increased substantially, mostly on accont of the addition of SANYO’s inventory and inventory turns went down again from 3.8X to 2.9X. Days sales outstanding (DSOs) were around 60, up from around 46 in the previous quarter.

The cash and short-term investments balance was $766.0 million at quarter-end (up $142.7 million during the quarter), with ON Semi generating $125.6 million from operations and spending around $89 million on capex.

At quarter-end, ON Semi had $1.095 billion of long-term debt on its balance sheet. Including both short and long-term debt, the net debt position at quarter-end was $506, up from a net debt position of $265.5 million at the beginning of the quarter.

Guidance

ON Semi expects revenue of $860-900 million, or down 1.2% to up 3.4% sequentially. The GAAP gross margin is expected to be 31-33%. Excluding special items of $45 million, the non GAAP gross margin is expected to be 36-38%. Operating expenses on a GAAP basis are expected to be $198-208 million, while on a non GAAP basis, they are expected to be $178-188 million.

ON Semi also expects other income/expense of around $12 million, taxes of around $8-10 million and $7-9 million on a GAAP and non GAAP basis, respectively. The fully diluted share count is expected to be 460 million.  This should result in an EPS of 30 to 33 cents, much better than the Zacks Consensus Estimate of 23 cents when On Semi reported.

ON Semi also expects to spend around $310-340 million on equipment purchases in 2011, significantly better than the $250 million it expected to spend at the end of the previous quarter.

Our Recommendation

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. However, news regarding its limited impact and the minimal impact on the company’s own facilities have increased investor confidence.

The strong results and guidance have also increased optimism regarding the shares. We also like the way it has acquired complementary capacity and product lines, as well as the design win momentum it is seeing.

The Zacks Consensus Estimate for the next two quarters and two fiscal years have moved up by 2, 2, 6 and 5 cents, respectively, as 11, 14, 9 and 9 analysts raised estimates for the respective periods.

However, considering the fact that management was unable to quantify the amount of damage or the losses that could ultimately accrue from the disaster, we think that a certain amount of caution is in order.

As a result we have allotted a Zacks #3 Rank to the shares, which implies a short-term (1-3 months) Hold recommendation.  At this point, we are more positive about peer companies Monolithic Power (MPWR), Microchip Technologies (MCHP) and Microsemi Corp (MSCC), all of which have a Zacks #2 Rank.

 
CYPRESS SEMICON (CY): Free Stock Analysis Report
 
MICROCHIP TECH (MCHP): Free Stock Analysis Report
 
MONOLITHIC PWR (MPWR): Free Stock Analysis Report
 
MICROSEMI CORP (MSCC): Free Stock Analysis Report
 
ON SEMICON CORP (ONNN): Free Stock Analysis Report
 
Zacks Investment Research