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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, 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 and nine months ended September 26, 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 September 26, 2014 • Total revenues of approximately $833.5 million • Gross margin of approximately 34.1% • Net income of $0.09 per diluted share • Ended the quarter with cash, cash equivalents and short-term investments of approximately $494.9 million • Completed the acquisition of Aptina, Inc. ("Aptina") for approximately $402.5 million in cash 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 5% 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, image sensors 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 automotive, wireless, industrial and consumer applications. 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. We serve a broad base of end-user markets, including automotive, communications, computing, consumer electronics, medical, industrial and military/aerospace. Our devices are found in a wide variety of end-products including automotive electronics, smartphones, media tablets, wearable electronics, personal computers, servers, industrial building and home automation systems, consumer white goods, advanced imaging systems, LED lighting, power supplies, networking and telecom equipment, medical diagnostics, imaging and hearing health, and sensor networks. 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 48,000 products as of September 26, 2014 and we shipped approximately 36.0 billion units in the first nine months of 2014, as compared to 31.2 billion units in the first nine 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. 40-------------------------------------------------------------------------------- Table of Contents Acquisitions Acquisition of Aptina On August 15, 2014, we completed the purchase of Aptina, whereby Aptina became our wholly-owned subsidiary. The aggregate purchase price of this transaction was approximately $402.5 million in cash, subject to customary closing adjustments. We believe the acquisition of Aptina expands our image-sensor business and establishes ON Semiconductor as a leader in the fast growing segment of image sensors in the automotive and industrial end-markets. Acquisition of Truesense Imaging Inc. ("Truesense") On April 30, 2014, we completed the purchase of Truesense, whereby Truesense became our wholly-owned subsidiary. The aggregate purchase price of this transaction was approximately $95.7 million, subject to customary closing adjustments, of which approximately $0.6 million remained unpaid as of September 26, 2014. We believe that the acquisition of Truesense strengthens our product portfolio targeting industrial end-markets such as machine vision, surveillance, and intelligent transportation systems by complementing our existing high-speed, high-resolution, power-efficient image sensing solutions with Truesense's high-performance image sensors for low-light, low-noise. See Note 3: "Acquisitions" of the notes to our unaudited consolidated financial statements located elsewhere in this Form 10-Q for additional information. Segments Effective for the third quarter of 2014, the we announced a change in the way we report our segment information. Previously reported information has been recast to reflect the current reportable segments. We are currently organized into four reporting segments, consisting of our three existing reporting segments, Application Products Group, Standard Products Group and System Solutions Group, as well as a fourth reporting segment, Image Sensor Group. Our Image Sensor Group was established during the third quarter of 2014 as a reporting segment, which includes our recent image sensor business acquisition of Aptina, along with our existing image sensor business units (including Truesense), which were previously reported as part of our Application Products Group. The Image Senor Group is currently undergoing operational integration to combine Aptina with our previously existing image sensor business units. See Note 3: "Acquisitions" of the notes to our unaudited consolidated financial statements located elsewhere in this Form 10-Q for additional information. 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 Fourth Quarter 2014 Outlook Our third quarter 2014 results and outlook for the fourth quarter of 2014 were impacted by a slowdown in orders from certain geographies and end-markets. However, during the first few weeks of the fourth quarter of 2014, we have noticed a recovery in orders for shipments in the first half of 2015. Despite the recent slowdown, our design win momentum in automotive, industrial, and smartphone end-markets remains strong, and we believe that we remain well positioned to benefit from long term secular trends in these markets. Based upon product booking trends, backlog levels, and estimated turns levels, we estimate that our revenues will be approximately $835 million to $875 million in the fourth quarter of 2014. Backlog levels for the fourth quarter of 2014 represent approximately 80% to 85% of our anticipated fourth quarter 2014 revenues. We estimate average selling prices for the fourth quarter of 2014 will be down approximately one to two percent when compared to the third quarter of 2014. For the fourth quarter of 2014, we estimate that gross margin as a percentage of revenues will be approximately 31.8% to 33.6%. 41-------------------------------------------------------------------------------- Table of Contents Results of Operations Quarter Ended September 26, 2014 Compared to the Quarter Ended September 27, 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 September 26, 2014 and September 27, 2013 (in millions): Quarter Ended September 26, September 27, 2014 2013 Dollar Change Revenues $ 833.5 $ 715.4 $ 118.1 Cost of revenues 549.4 466.2 83.2 Gross profit 284.1 249.2 34.9 Operating expenses: Research and development 93.4 84.0 9.4 Selling and marketing 51.1 44.2 6.9 General and administrative 48.5 34.5 14.0 Amortization of acquisition-related intangible assets 23.4 8.2 15.2 Restructuring, asset impairments and other, net 10.1 11.0 (0.9 ) Total operating expenses 226.5 181.9 44.6 Operating income 57.6 67.3 (9.7 ) Other income (expense), net: Interest expense (8.6 ) (9.2 ) 0.6 Interest income 0.2 0.3 (0.1 ) Other (0.9 ) (1.4 ) 0.5 Other income (expense), net (9.3 ) (10.3 ) 1.0 Income before income taxes 48.3 57.0 (8.7 ) Income tax (provision) benefit (6.3 ) (4.2 ) (2.1 ) Net income 42.0 52.8 (10.8 ) Less: Net income attributable to non-controlling interest (0.4 ) (1.0 ) 0.6 Net income attributable to ON Semiconductor Corporation $ 41.6 $ 51.8 $ (10.2 ) Revenues Revenues were $833.5 million and $715.4 million for the quarters ended September 26, 2014 and September 27, 2013, respectively. The increase in revenues for the quarter ended September 26, 2014 compared to the quarter ended September 27, 2013 was primarily attributed to approximately $21.6 million of additional revenue provided by the acquisition of Truesense and $71.6 million provided by the acquisition of Aptina in our Image Sensor Group, along with increase in our Application Products Group and Standard Products Group, both of which experienced increases in revenue as a result of an improved demand environment. The increase in revenue was partially offset by decreased revenue from our System Solutions Group due to the continued impact of a softening of the consumer end-markets. As compared to the quarter ended September 27, 2013, we experienced a decline in average selling prices of approximately 4.7%, offset by favorable changes in volume and mix, along with contributions from our recent acquisitions of Truesense and Aptina, which resulted in a net increase in revenue of approximately 17% for the quarter ended September 26, 2014. 42-------------------------------------------------------------------------------- Table of Contents Our revenues by reportable segment for the quarters ended September 26, 2014 and September 27, 2013 were as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of September 26, 2014 Total Revenue (1) September 27, 2013 Total Revenue (1)Application Products Group $ 265.8 31.9 % $ 260.5 36.4 % Image Sensor Group 103.6 12.4 % 8.5 1.2 % Standard Products Group 317.3 38.1 % 289.6 40.5 % System Solutions Group 146.8 17.6 % 156.8 21.9 % Total revenues $ 833.5 $ 715.4 (1) Certain amounts may not total due to rounding of individual amounts. Revenues from the Application Products Group increased by $5.3 million, or approximately 2%, from the third quarter of 2013 to the third quarter of 2014. This increase is primarily attributable to a $5.6 million, or approximately 4%, increase in revenues from our ASIC products. Revenues from the Image Sensor Group increased by $95.1 million from the third quarter of 2013 to the third quarter of 2014. This increase is attributable to revenue provided by the 2014 acquisitions of Aptina and Truesense, which generated approximately $71.6 million and $21.6 million, respectively, of revenue during the third quarter of 2014. Revenues from our existing image sensor business units, to a lesser extent, also increased from the third quarter of 2013 to the third quarter of 2014. Revenues from the Standard Products Group increased by $27.7 million, or approximately 10%, from the third quarter of 2013 to the third quarter of 2014. This increase is primarily attributable to a $10.3 million, or approximately 9%, increase in revenue from our discrete products, combined with an increase in revenues from our analog products of $10.3 million, or approximately 14%, as a result of an improved demand environment. Revenues from the System Solutions Group decreased by $10.0 million, or approximately 6%, from the third quarter of 2013 to the third quarter of 2014. This decrease is primarily attributable to a $16.5 million, or approximately 16%, decrease in revenue from our LSI products, along with decreases from a softening of the consumer end-markets, partially offset by a $9.6 million increase in revenues from our discrete products. Revenues by geographic location for the quarters ended September 26, 2014 and September 27, 2013 were as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of September 26, 2014 Total Revenue (1) September 27, 2013 Total Revenue (1)United States $ 125.5 15.1 % $ 109.0 15.2 % Japan 77.4 9.3 % 70.3 9.8 % Hong Kong 263.9 31.7 % 230.1 32.2 % Singapore 210.4 25.2 % 178.3 24.9 % United Kingdom 126.3 15.2 % 101.9 14.2 % Other 30.0 3.6 % 25.8 3.6 % Total $ 833.5 $ 715.4 (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 26, 2014 and September 27, 2013, we had no single customer that accounted for 10% or more of our total revenues. 43-------------------------------------------------------------------------------- Table of Contents Gross Profit Our gross profit by reportable segment for the quarters ended September 26, 2014 and September 27, 2013 was as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of September 26, 2014 Segment Revenue (1) September 27, 2013 Segment Revenue (1)Application Products Group $ 119.1 44.8 % $ 114.4 43.9 % Image Sensor Group 23.8 23.0 % 4.6 54.1 % Standard Products Group 115.8 36.5 % 95.6 33.0 % System Solutions Group 31.9 21.7 % 34.3 21.9 % Gross profit by segment $ 290.6 $ 248.9 Unallocated manufacturing costs (2) (6.5 ) (0.8 )% 0.3 - % Total gross profit $ 284.1 34.1 % $ 249.2 34.8 % (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 $284.1 million in the third quarter of 2014 compared to $249.2 million in the third quarter of 2013. The gross profit increase of $34.9 million, or approximately 14%, during the third quarter of 2014 is primarily due to increased capacity utilization, the impact of our recent acquisitions and cost savings realized from previous restructuring activities, partially offset by decreased average selling prices and the expensing of the fair market value of inventory step-up from our recent acquisitions. Gross profit as a percentage of revenues decreased from approximately 34.8% in the third quarter of 2013 to approximately 34.1% in the third quarter of 2014. This decrease was primarily driven by the margin from our new Image Sensor Group, that was lower than our Applications Products Group and Standard products Group, which experienced favorable changes in volume and mix across certain product lines driving higher gross margins in those segments. Operating Expenses Research and development expenses were $93.4 million for the third quarter of 2014 compared to $84.0 million for the third quarter of 2013, representing an increase of $9.4 million, or approximately 11%. This increase in research and development expenses is primarily associated with increased expenses from the acquisitions of Aptina and Truesense, along with increased personnel costs and increased performance-based compensation as a result of improved performance results for the third quarter of 2014 compared to the third quarter of 2013, partially offset by decreased research and development expenses in our System Solutions Group attributable to decreased payroll related expenses resulting from our 2013 and 2014 restructuring and cost saving activities. Selling and marketing expenses were $51.1 million for the third quarter of 2014 compared to $44.2 million for the third quarter of 2013, representing an increase of $6.9 million, or approximately 16%. This increase is primarily associated with increased expenses from the acquisitions of Aptina and Truesense along with increased sales commissions and increased payroll related expenses associated with performance-based compensation as a result of improved performance results for the third quarter of 2014 compared to the third quarter of 2013. General and administrative expenses were $48.5 million in the third quarter of 2014 compared to $34.5 million in the third quarter of 2013, representing an increase of $14.0 million, or approximately 41%. This increase in general and administrative expenses is primarily associated with increased expenses from the acquisitions of Aptina and Truesense along with increased payroll related expenses associated with performance-based compensation as a result of improved performance results for the third quarter of 2014 compared to the third quarter of 2013, in addition to approximately $4.0 million in third-party acquisition related expenses. Other Operating Expenses Amortization of Acquisition-Related Intangible Assets Amortization of acquisition-related intangible assets was $23.4 million and $8.2 million for the quarters ended September 26, 2014 and September 27, 2013, respectively. The increase in amortization of acquisition-related intangible assets is attributable to the amortization of intangible assets assumed as a result of our acquisitions of Aptina and Truesense. Restructuring, Asset Impairments and Other, Net Restructuring, asset impairments and other, net was $10.1 million for the quarter ended September 26, 2014 compared to $11.0 million for the quarter ended September 27, 2013. The information below summarizes certain activities for each respective quarter. See Note 5: "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. 44-------------------------------------------------------------------------------- Table of Contents Quarter Ended September 26, 2014 During the fourth quarter of 2013, we initiated a voluntary retirement program for employees of certain 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 all employees had exited by September 26, 2014. The remaining employees who accepted retirement packages are expected to retire by the end of 2014. During the quarter ended September 26, 2014, we recorded net charges of approximately $2.9 million in connection with the Q4 2013 Voluntary Retirement Program, which consisted of employee severance charges of $2.9 million. Additionally, during the quarter ended September 26, 2014, we recorded approximately $1.9 million of net charges related to our previously announced plan to close our KSS facility. Certain Aptina executives that did not have a continuing role subsequent to the acquisition date were terminated upon closing of the August 15, 2014 acquisition of Aptina. During the quarter ended September 26, 2014, we recorded approximately $4.8 million of related employee separation charges. 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 System Solutions 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 KSS facility. We recorded approximately $6.8 million of net restructuring charges related to the KSS facility closure 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 facility closure. Operating Income Information about operating income (loss) from our reportable segments for the quarters ended September 26, 2014 and September 27, 2013 is as follows (in millions): Application Standard System Products Image Sensor Products Solutions Group Group Group Group Total For quarter ended September 26, 2014: Segment operating income (loss) $ 30.5 $ (17.8 ) $ 65.0 $ 3.4 $ 81.1 For quarter ended September 27, 2013: Segment operating income (loss) $ 31.9 $ (1.5 ) $ 54.9 $ (3.0 ) $ 82.3 Reconciliations of segment information to the financial statements is as follows (in millions): Quarter Ended September 26, 2014 September 27, 2013 Operating income for reportable segments $ 81.1 $ 82.3 Unallocated amounts: Restructuring, asset impairments and other charges, net (10.1 ) (11.0 ) Other unallocated manufacturing costs (6.5 ) 0.3 Other unallocated operating expenses (1) (6.9 ) (4.3 ) Operating income $ 57.6 $ 67.3 (1) Other unallocated operating expenses consist of expenses associated with certain corporate decisions and initiatives which do not impact expenses that are directly attributable to our reporting segments. 45 -------------------------------------------------------------------------------- Table of Contents Interest Expense Interest expense decreased by $0.6 million to $8.6 million during the quarter ended September 26, 2014 compared to $9.2 million during the quarter ended September 27, 2013. Our average long-term debt balance (including current maturities and net of debt discount) during the quarter ended September 26, 2014 was $1,044.3 million at a weighted average interest rate of approximately 3.3%, compared to $913.0 million at a weighted average interest rate of approximately 4.0% during the quarter ended September 27, 2013. Other Other expense decreased by $0.5 million from $1.4 million for the quarter ended September 27, 2013 to $0.9 million for the quarter ended September 26, 2014. Provision for Income Taxes We recorded an income tax provision of $6.3 million and of $4.2 million during the quarters ended September 26, 2014 and September 27, 2013, respectively. The income tax provision for the quarter ended September 26, 2014, consisted of $7.1 million for income and withholding taxes of certain of our foreign and domestic operations and $0.2 million of new reserves and interest on existing reserves for uncertain tax positions in foreign taxing jurisdictions, partially offset by the reversal of $0.2 million of our previously established valuation allowance against our U.S. deferred tax assets as a result of a net deferred tax liability recorded as part of the Truesense acquisition and a $0.8 million accrual for return adjustments. The income tax provision for the quarter ended September 27, 2013 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. 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 26, 2014 was 13.0%, which differs from the U.S. statutory federal income tax rate of 35%. We continue to maintain a full valuation allowance on all of our domestic and substantially all of our Japan related deferred tax assets; however, it is reasonably possible that a substantial portion of the valuation allowance will be reversed within one year of September 26, 2014, which is not expected to have a material effect on our cash taxes. As of December 31, 2013, the valuation allowance on our domestic deferred tax assets was approximately $524 million. 46 -------------------------------------------------------------------------------- Table of Contents Results of Operations Nine Months Ended September 26, 2014 Compared to the Nine Months Ended September 27, 2013 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 26, 2014 and September 27, 2013 (in millions): Nine Months Ended September 26, September 27, 2014 2013 Dollar Change Revenues $ 2,297.6 $ 2,064.7 $ 232.9 Cost of revenues 1,489.7 1,379.2 110.5 Gross profit 807.9 685.5 122.4 Operating expenses: Research and development 255.7 255.5 0.2 Selling and marketing 143.4 127.3 16.1 General and administrative 134.2 110.9 23.3 Amortization of acquisition-related intangible assets 42.0 24.8 17.2 Restructuring, asset impairments and other, net 20.0 11.1 8.9 Total operating expenses 595.3 529.6 65.7 Operating income 212.6 155.9 56.7 Other income (expense), net: Interest expense (24.6 ) (28.6 ) 4.0 Interest income 0.6 1.0 (0.4 ) Other (2.7 ) 3.6 (6.3 ) Loss on debt exchange - (3.1 ) 3.1 Other income (expense), net (26.7 ) (27.1 ) 0.4 Income before income taxes 185.9 128.8 57.1 Income tax benefit (provision) 3.7 (4.0 ) 7.7 Net income 189.6 124.8 64.8 Less: Net income attributable to non-controlling interest (1.6 ) (2.7 ) 1.1 Net income attributable to ON Semiconductor Corporation $ 188.0 $ 122.1 $ 65.9 Revenues Revenues were $2,297.6 million and $2,064.7 million for the nine months ended September 26, 2014 and September 27, 2013, respectively. The increase in revenues for the nine months ended September 26, 2014 compared to the nine months ended September 27, 2013 was primarily attributed to approximately $71.6 million and $34.9 million of additional revenue in the Image Sensor Group provided by the acquisitions of Aptina and Truesense, along with our Application Products Group and Standard Products Group, which experienced increases in revenue as a result of an improved demand environment. The increase in revenue was partially offset by decreased revenue from our System Solutions Group due to a devaluation of the Yen and the continued impact of a softening of the consumer end-markets. As compared to the nine months ended September 27, 2013, we experienced a decline in average selling prices of approximately 4.6%, offset by favorable changes in volume and mix, along with contributions from our recent acquisitions of Truesense and Aptina, which resulted in a net increase in revenue of approximately 11% for the nine months ended September 26, 2014. Our revenues by reportable segment for the nine months ended September 26, 2014 and September 27, 2013 were as follows (dollars in millions): Nine Months Ended As a % of Nine Months Ended As a % of September 26, 2014 Total Revenue (1) September 27, 2013 Total Revenue (1)Application Products Group $ 810.2 35.3 % $ 737.2 35.7 % Image Sensor Group 139.9 6.1 % 28.3 1.4 % Standard Products Group 913.9 39.8 % 831.2 40.3 % System Solutions Group 433.6 18.9 % 468.0 22.7 % Total revenues $ 2,297.6 $ 2,064.7 (1) Certain amounts may not total due to rounding of individual amounts. 47 -------------------------------------------------------------------------------- Table of Contents Revenues from the Application Products Group increased by $73.0 million, or approximately 10%, from the nine months ended September 27, 2013 to the nine months ended September 26, 2014. This increase is primarily attributable to a $36.8 million, or approximately 10%, increase in revenues from our ASIC products, combined with an increase in revenues from our analog products of $23.9 million, or approximately 8%, along with increases in revenue from our TMOS and foundry products. These increases are the result of an improved demand environment. Revenues from the Image Sensor Group increased by $111.6 million from the nine months ended September 27, 2013 to the nine months ended September 26, 2014. This increase is primarily attributable to revenue provided by the 2014 acquisitions of Aptina and a Truesense which generated approximately $71.6 million and $34.9 million, respectively, of revenue during the nine months ended September 26, 2014. Revenues from our existing image sensor business units, to a lesser extent, also increased from the nine months ended September 27, 2013 to the nine months ended September 26, 2014. Revenues from the Standard Products Group increased by $82.7 million, or approximately 10%, from the nine months ended September 27, 2013 to the nine months ended September 26, 2014. This increase is primarily attributable to a $47.6 million, or approximately 14%, increase in revenue from our discrete products, combined with an increase in revenues from our analog products of $24.4 million, or approximately 11%, and increases in revenues from our memory products of $8.5 million, or 21%, as a result of an improved demand environment. Revenues from the System Solutions Group decreased by $34.4 million, or approximately 7%, from the nine months ended September 27, 2013 to the nine months ended September 26, 2014. This decrease is primarily attributable to a $38.3 million, or approximately 12%, decrease in revenue from our LSI products from a softening of the consumer end-markets, partially offset by a $7.9 million increase in revenues from our discrete products. Revenues by geographic location for the nine months ended September 26, 2014 and September 27, 2013 were as follows (dollars in millions): Nine Months Ended As a % of Nine Months Ended As a % of September 26, 2014 Total Revenue (1) September 27, 2013 Total Revenue (1)United States $ 352.6 15.3 % $ 306.4 14.8 % Japan 210.0 9.1 % 217.6 10.5 % Hong Kong 692.8 30.2 % 628.0 30.4 % Singapore 580.5 25.3 % 525.6 25.5 % United Kingdom 367.0 16.0 % 302.2 14.6 % Other 94.7 4.1 % 84.9 4.1 % Total $ 2,297.6 $ 2,064.7 (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 26, 2014 and September 27, 2013, we had no single customer that accounted for 10% or more of our total revenues. 48-------------------------------------------------------------------------------- Table of Contents Gross Profit Our gross profit by reportable segment for the nine months ended September 26, 2014 and September 27, 2013 was as follows (dollars in millions): Nine Months Ended As a % of Nine Months Ended As a % of September 26, 2014 Segment Revenue (1) September 27, 2013 Segment Revenue (1)Application Products Group $ 362.2 44.7 % $ 318.4 43.2 % Image Sensor Group 43.7 31.2 % 17.9 63.3 % Standard Products Group 332.2 36.3 % 296.1 35.6 % System Solutions Group 87.9 20.3 % 63.4 13.5 % Gross profit by segment $ 826.0 $ 695.8 Unallocated manufacturing costs (2) (18.1 ) (0.8 )% (10.3 ) (0.5 )% Total gross profit $ 807.9 35.2 % $ 685.5 33.2 % (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 $807.9 million during the nine months ended September 26, 2014 compared to $685.5 million during the nine months ended September 27, 2013. The gross profit increase of $122.4 million, or approximately 18%, during the nine months ended September 26, 2014 is primarily due to increased capacity utilization, costs savings realized from previous restructuring activities, partially offset by decreased average selling prices and the fair market value of inventory step-up from our recent acquisitions. Gross profit as a percentage of revenues increased from approximately 33.2% during the nine months ended September 27, 2013 to approximately 35.2% during the nine months ended September 26, 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, Image Sensor Group and Standard Products Group which experienced higher gross margin levels than our System Solutions Group. Operating Expenses Research and development expenses were $255.7 million for the nine months ended September 26, 2014 compared to $255.5 million for the nine months ended September 27, 2013, representing in increase of $0.2 million, or approximately 0%. This increase in research and development expenses is primarily associated with increased expenses from the acquisitions of Aptina and Truesense offset by decreases in our System Solutions Group and is attributable to decreased payroll related expenses resulting from our restructuring and cost saving activities, along with the impact of a devalued Yen. These were further offset by increased personnel costs in our Application Products Group and Standard Products Group along with increased performance-based compensation as a result of improved performance results for the nine months ended September 26, 2014 compared to the nine months ended September 27, 2013. Selling and marketing expenses were $143.4 million for the nine months ended September 26, 2014 compared to $127.3 million for the nine months ended September 27, 2013, representing an increase of $16.1 million, or approximately 13%. This increase is primarily associated with increased expenses from the acquisitions of Aptina and Truesense along with increased sales commissions and increased payroll related expenses associated with performance-based compensation as a result of improved performance results for the nine months ended September 26, 2014 compared to the nine months ended September 27, 2013. General and administrative expenses were $134.2 million for the nine months ended September 26, 2014 compared to $110.9 million for the nine months ended September 27, 2013, representing an increase of $23.3 million, or approximately 21%. This increase in general and administrative expenses is primarily associated with increased expenses from the acquisitions of Aptina and Truesense along with increased payroll related expenses associated with performance-based compensation as a result of improved performance results for the nine months ended September 26, 2014 compared to the nine months ended September 27, 2013, in addition to approximately $8.0 million in third-party acquisition-related expenses. Other Operating Expenses Amortization of Acquisition-Related Intangible Assets Amortization of acquisition-related intangible assets was $42.0 million and $24.8 million for the nine months ended September 26, 2014 and September 27, 2013, respectively. The increase in amortization of acquisition-related intangible assets is attributable to the amortization of intangible assets assumed as a result of our acquisitions of Aptina and Truesense. 49-------------------------------------------------------------------------------- Table of Contents Restructuring, Asset Impairments and Other, Net Restructuring, asset impairments and other, net was $20.0 million for the nine months ended September 26, 2014 compared to $11.1 million for the nine months ended September 27, 2013. The information below summarizes certain activities for each respective period. See Note 5: "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. Nine Months Ended September 26, 2014 During the fourth quarter of 2013, we initiated the Q4 2013 Voluntary Retirement Program. Approximately 350 employees opted to retire pursuant to the Q4 2013 Voluntary Retirement Program, of which all employees had exited by September 26, 2014. As part of these restructuring activities, approximately 70 contractor positions were also identified for elimination, all of which were terminated during the nine months ended September 26, 2014. As an extension of this program, we also identified approximately 40 additional positions for elimination, substantially all of which had exited during the nine months ended September 26, 2014. 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 nine months ended September 26, 2014, we initiated further voluntary retirement activities for employees of certain of our System Solutions Group subsidiaries in Japan, applicable to an additional 60 to 70 positions, consisting of employees and contractors, which have been effectively eliminated as of September 26, 2014. During the nine months ended September 26, 2014, we recorded net charges of approximately $5.7 million in connection with the Q4 2013 Voluntary Retirement Program, which consisted of employee severance charges of $10.2 million, partially offset by pension and related retirement liability adjustments associated with the affected employees, which resulted in a pension curtailment benefit of $4.5 million. Additionally, during the nine months ended September 26, 2014, we recorded approximately $7.2 million of net charges related to our previously announced plan to close our KSS facility. Certain Aptina executives that did not have a continuing role subsequent to the acquisition date were terminated upon closing of the August 15, 2014 acquisition of Aptina. During the nine months ended September 26, 2014, we recorded approximately $4.8 million of related employee separation charges. 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 System Solutions 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. On October 6, 2013, we announced a plan to close our KSS facility. We recorded approximately $6.8 million of net restructuring charges related to the KSS facility closure 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 facility closure. 50-------------------------------------------------------------------------------- Table of Contents Operating Income Information about operating income (loss) from our reportable segments for the nine months ended September 26, 2014 and September 27, 2013 is as follows (in millions): Standard Application Image Sensor Products System Solutions Products Group Group Group Group Total Nine months ended September 26, 2014: Segment operating income (loss) $ 102.1 $ (15.1 ) $ 185.9 $ (5.4 ) $ 267.5 Nine months ended September 27, 2013: Segment operating income (loss) $ 80.2 $ (0.1 ) $ 177.8 $ (71.7 ) $ 186.2 Reconciliations of segment information to the financial statements is as follows (in millions): Nine Months Ended September 26, 2014 September 27, 2013 Operating income for reportable segments $ 267.5 $ 186.2 Unallocated amounts: Restructuring, asset impairments and other charges, net (20.0 ) (11.1 ) Other unallocated manufacturing costs (18.1 ) (10.3 ) Other unallocated operating expenses (1) (16.8 ) (8.9 ) Operating income $ 212.6 $ 155.9 (1) Other unallocated operating expenses consist of expenses associated with certain corporate decisions and initiatives which do not impact expenses that are directly attributable to our reporting segments. Interest Expense Interest expense decreased by $4.0 million to $24.6 million during the nine months ended September 26, 2014 compared to $28.6 million during the nine months ended September 27, 2013. Our average long-term debt balance (including current maturities and net of debt discount) during the nine months ended September 26, 2014 was $1,062.9 million at a weighted average interest rate of approximately 3.1%, compared to $960.2 million at a weighted average interest rate of approximately 4.0% during the nine months ended September 27, 2013. Other Other expense increased by $6.3 million from income of $3.6 million for the nine months ended September 27, 2013 to expenses of $2.7 million for the nine months ended September 26, 2014. The increase is primarily attributable to certain foreign currency exchange movements that are not offset by our hedging activity. Provision for Income Taxes We recorded an income tax benefit of $3.7 million and provision of $4.0 million during the nine months ended September 26, 2014 and September 27, 2013, respectively. The income tax benefit for the nine months ended September 26, 2014 consisted of the reversal of $21.7 million of our previously established valuation allowance against our U.S. deferred tax assets as a result of a net deferred tax liability recorded as part of the Truesense acquisition and the reversal of $3.6 for reserves and interest for uncertain tax positions in foreign taxing jurisdictions that were effectively settled or for which the statute lapsed during the nine months ended September 26, 2014, partially offset by $19.2 million for income and withholding taxes of certain of our foreign and domestic operations and $2.4 million of new reserves and interest on existing reserves for uncertain tax positions in foreign taxing jurisdictions. The income tax provision for the nine months ended September 27, 2013 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. 51 -------------------------------------------------------------------------------- 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 nine months ended September 26, 2014 was a benefit of 2.0%, 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 valuation allowances and certain 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 26, 2014. We continue to maintain a full valuation allowance on all of our domestic and substantially all of our Japan related deferred tax assets; however, it is reasonably possible that a substantial portion of the valuation allowance on our domestic deferred tax assets will be reversed within one year of September 26, 2014, which is not expected to have a material effect on the Company's cash taxes. As of December 31, 2013, the valuation allowance on our domestic deferred tax assets was approximately $524 million. 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 As of September 26, 2014, there were no material changes outside of the ordinary course of business and our acquisition activity, to the contractual obligations table, including notes thereto, contained in our 2013 Form 10-K. For information on long-term debt, see Note 7: "Long-Term Debt," for operating leases and financing activities (including amounts drawn on our revolving credit facility) see, Note 10: "Commitments and Contingencies" and for pension plans see Note 6: "Balance Sheet Information" of the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q. Our balance of cash, cash equivalents and short-term investments was $494.9 million as of September 26, 2014. 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 26, 2014 include approximately $194.9 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 repayments and acquisitions. If we are unable to address our United States 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. See Note 7: "Long-Term Debt," of the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q for a discussion of our long-term debt. 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 including, but not limited to: material purchase commitments, agreements to mitigate collection risk, leases, utilities or customs guarantees. As of September 26, 2014, 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 26, 2014. We also had outstanding guarantees and letters of credit outside of our senior revolving credit facility of $5.6 million as of September 26, 2014. As part of securing financing in the normal course of business, we issued guarantees related to our capital lease obligations, equipment financing, lines of credit and real estate mortgages, which totaled approximately $114.6 million as of September 26, 2014. We are also a guarantor of SCI LLC's unsecured loan with SMBC, which had a balance of $245.4 million as of September 26, 2014. See Note 7: "Long-Term Debt" and Note 10: "Commitments and Contingencies" of the notes to our unaudited consolidated financial statements found elsewhere in this Form 10-Q for additional information. 52-------------------------------------------------------------------------------- Table of Contents 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 $105.3 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 10: "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 economic damage, bodily injury or property damage. 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 rights to such customer for valid defective product 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. 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 10: "Commitments 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 2013 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, capital expenditures, strategic acquisitions and investments, the repurchase of our stock and other Company securities, 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. As part of our business strategy, we review acquisition and divestiture opportunities and proposals on a regular basis. On August 15, 2014, we completed the purchase of Aptina, for a total purchase price of approximately $402.5 million in cash, subject to customary closing adjustments. On April 30, 2014, we completed the purchase of Truesense, for a total purchase price of approximately $95.7 million in cash, subject to customary closing adjustments, of which approximately $0.6 million remained unpaid as of September 26, 2014. See Note 3: "Acquisitions" of the notes to our unaudited consolidated financial statements located elsewhere in this Form 10-Q for additional information. 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 53 -------------------------------------------------------------------------------- Table of Contents • 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 2.625% Notes, Series B, 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, short-term investments and existing credit facilities 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 26, 2014, we paid approximately $163.0 million for capital expenditures, while during the nine months ended September 27, 2013, we paid approximately $135.1 million for capital expenditures. Our current projection for capital expenditures for the remainder of 2014 is approximately $60 million to $70 million, of which our current minimum contractual commitment for the remainder of 2014 is approximately $52.0 million. Our current minimum contractual capital expenditure commitment for 2015 and thereafter is approximately $54.6 million. The capital expenditure levels can materially influence our available cash for other initiatives. 54 -------------------------------------------------------------------------------- Table of Contents |