ON Semiconductor Corporation (ONNN), based in Phoenix, AZ, is an original equipment manufacturer (OEM) of a broad-based semiconductor analog component product portfolio. The company was spun off from Motorola in August 1999, and went public through an IPO in May 2000. Currently, the company markets over 17,000 individual devices. The company sold approximately 28.4 billion units in 2004.
Semiconductor devices are broadly divided into three categories: analog, digital and radio frequency (RF). Analog semiconductors condition and regulate real world information such as light, temperature, speed, pressure, power and electrical currents. Digital logic semiconductors process information in only two states. Mixed-signal semiconductors combine both analog and digital technology into a single device. Typically, an analog sensor samples real world information, and then converts the input into an electronic analog signal, which is converted into a digital format for further digital processing. The analog and mixed-signal markets tend to be more varied and specialized, with customized products that have longer life cycles than those in the digital industry segment. There is an ongoing drive to decrease the number of discrete devices, lessen power requirements and shrink the size of the existing devices, which correspondingly increase performance and reliability. Consequently, a greater amount of functionality is being consolidated into increasingly smaller devices. The Gartner Group estimated that the total worldwide semiconductor market was a $219.9 billion market in 2004. The analog market component grew 29% in 2004, to a $36.4 billion market, according to In-Stat, an industry trade group. ON Semiconductor products qualify as analog components with a special emphasis in power and power management components.
ONNN reports financial results along four main product lines that include power management and standard analog, metal oxide semiconductor (MOS) power devices, clock and digital data management devices, and standard components. The power management and standard analog product line, along with the MOS power product line, primarily sell into the portable wireless devices and computing end markets. Additionally, the power management and standard analog segment sells products into the consumer electronics and automotive end markets. The high frequency clock and digital data management segment primarily caters to the industrial end markets. Products in the standard components business are mainly used in the wireless and handheld applications and industrial end markets. Revenue by end market for 2004 was computing 24%, consumer 18%, automotive 20%, industrial 15%, wireless 16% and networking 7%. ONNN's products are used in a variety of electronic goods, including network routers, mobile phones, household appliances and automotive braking systems.
The firm's customers are divided between OEMs, electronic service contract manufacturers and distributors. In 2004, the company had roughly $1.27 billion in revenue, of which standard semiconductor components comprised 44%, power management and standard analog 30%, MOS power devices 19% and high-frequency clock and data management 7%. Geographically, approximately 28% of sales were generated in the Americas, the Asia Pacific region generated 55% and Europe the remaining 17%. ON Semiconductor's five largest customers in the last quarter were Delphi, Flextronics, Motorola, Siemens and Visteon. Motorola accounted for 9% of second quarter sales, while distributor customers Avnet and Arrow accounted for 13% and 9%, respectively.
ON Semiconductor has a broad range of products and a diverse clientele, with 200 direct customers and 320 indirect OEM customers. The semiconductor sector trough was reached in the early part of 2005 and a new up cycle has begun. The quarter was characterized by a rebound of 5 of the companies 6 end markets. ONNN also recorded design wins for its filter products at four of the top five cell phone manufacturers. This strength is expected to continue into the fourth. The computing and consumer markets are likely to experience some seasonal growth, as customers build stock in preparation for the holiday season. The company also has some new consumer products in the pipeline (for gaming machines), which are scheduled for launch in the second half of the year. Management expects these products to experience strong growth. Therefore, we believe the second half of the year is likely to pick up. Although the automotive and industrial markets were weak, ONNN recorded some important design wins at North American automobile manufacturers. The company expects to make significant gains with its power supply solutions (incorporating linear rectifiers and small signal products) for digital satellite radio systems.
Products such as EMI filter arrays, lead-free micro bump analog switches, audio amplifiers, DC-to-DC regulators and white LED drivers are driving growth in wireless handset applications. Management is in the process of opening an engineering design center in Seoul. The center will support the wireless handset and portable hand-held products being developed by Korean manufacturers. In the automotive segment, ONNN has launched a line of interconnect network and controller area network transceivers, as well as expanding the line of voltage regulation ICs. Most of the capital investment resources will be allocated to new technologies, and specifically, into new chip packaging, as assembly test capacity increases. These factors should help drive further sales and margin expansion in the second half of 2006.
Management continues to drive down operating expenses through a series of restructurings, which should have a positive effect on margins. One action was the closing of the Rhode Island front-end wafer fabrication plant (or fab). Last quarter it was announced that the Malaysian wafer fab was being moved to Phoenix. Management has also been actively recapitalizing the highly leveraged firm in an effort to reduce interest expense. Over the past year, $760 million in high yield bonds and high interest debt was refinanced, reducing quarterly interest payments from $34 million to $10 million.
On November 14, 2005 ONNN announced that it has repaid $66.4 million of its 10 percent Junior Subordinated Note due 2011 previously issued by the company's subsidiary, Semiconductor Components Industries, LLC. The repayment of a portion of the note was financed with cash on hand and reduces the outstanding principal amount of the 10 percent Junior Subordinated Note to approximately $91.0 million. This transaction is expected to enable the company to reduce its fourth quarter 2005 net interest expense by approximately $0.6 million and its 2006 net interest expense by approximately $5.1 million.
ON Semiconductor has hired substantially all of the LSI manufacturing employees currently working at the Gresham facility. The purchase of the Gresham wafer facility significantly enhances ON Semiconductor's internal manufacturing capabilities. With the completion of this transaction, the Company has gained the skilled process development engineers, operational expertise and process development know-how to help enable it to develop a larger mix of high volume, low cost, high-performance submicron analog and digital power products down to the 0.18 micron level, with toolset capabilities down to the 0.13 micron level in the future.
Growth in the second half of the year will be driven by the computing and wireless segments, with contract wins in the gaming industry possibly contributing to Q1 and thereafter. ONNN potentially can grow quicker than the market due to its innovation and development of computing and gaming technology.
The long-term strategic goal is to raise the gross margin to the 40% level. Although the company continues to devote capex to grow capacity for new higher-margin products, the standard components business continues to generate substantial revenue (45% in the last quarter). The standard components business features highly commoditized products that will continue to limit any effort to expand margins. The revenue contribution has to be lowered, thus changing the product mixture to increase margins.
Raw material pricing has been their biggest concern because of its effect on their ability to bring manufacturing costs down, especially in regards to metal prices being dramatically up over the last six months.
The company remains highly leveraged, even with the refinancing. Heavy refinancing costs negatively impacted the cash position. The company still has a high net debt position, having trimmed debt by $93 million over the past year. Shareholders equity still has a negative balance of $225 million. Further, the company is required to comply with several restrictive covenants, such as maintenance of a minimum EBITDA (earnings before interest, taxes, depreciation and amortization) level of $140 million, holding a minimum cash balance of $50 million, and limiting capital expenditures to no more than $100 million a year, all of which reduce its financial flexibility.
The major share holder Texas Pacific (TPG) group has been selling its 52% position in the stock bringing ownership levels to 36%. (selling nearly 50 million shares) The company has been selling shares via open market selling and private placements. Further selling could pressure the shares and keep the stock price in a trading range.