You should read the following discussion in conjunction with our audited historical consolidated financial statements, which are included in the 2019 Form 10-K and our unaudited consolidated financial statements for the fiscal quarter endedJuly 3, 2020 included elsewhere in this Form 10-Q. This 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 risks, 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 the 2019 Form 10-K. Executive Overview ON Semiconductor Overview ON Semiconductor is driving innovation in energy-efficient electronics. We believe that our extensive portfolio of sensors, power management, connectivity, custom and SoC, analog, logic, timing and discrete 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 and SoC devices use analog, MCU, DSP, mixed-signal and advanced logic capabilities to enable the application and uses of many of our automotive, medical, aerospace/defense, consumer and industrial customers' products. Our signal management semiconductor components provide high-performance clock management and data flow management for precision computing, communications and industrial systems. Our portfolio of sensors, including image sensors, radar and LiDAR, provide advanced solutions for automotive, industrial and IoT 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, IoT, Wi-Fi and memory categories used by the WSTS group. We serve a broad base of end-user markets, including automotive, communications, computing, consumer, medical, industrial, networking, telecom and aerospace/defense. Our devices are found in a wide variety of end products, including life-saving medical devices, automobiles, smartphones, data center and enterprise servers, wearable medical devices, personal computers, industrial building and home automation systems, factory automation, consumer white goods, security and surveillance systems, machine vision and robotics, LED lighting, power supplies, networking and telecom equipment, medical diagnostics and imaging and hearing health. Our portfolio of devices enables us to offer advanced ICs and the "building block" components that deliver system level functionality and design solutions. We shipped approximately 30.0 billion units during the six months endedJuly 3, 2020 , as compared to 31.9 billion units during the six months endedJune 28, 2019 , resulting in a period-over-period decrease of approximately 6%. 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 medium and high power applications. We believe that our ability to offer a broad range of products, combined with our applications and global manufacturing and logistics network, provides our customers with single source purchasing on a cost-effective and timely basis. As many of our 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 revenue from the product lines assigned to that segment. From time to time, we reassess the alignment of our product families and devices to our operating segments and may move product families or individual devices from one operating segment to another. As ofJuly 3, 2020 , we were organized into the following three operating and reportable segments: PSG, ASG and ISG.
Business and Macroeconomic Environment
During the quarter endedJuly 3, 2020 , the impact of the COVID-19 pandemic and the resulting geopolitical and macroeconomic factors continued to manifest in the form of decreased demand for products in the semiconductor industry. The severity and duration of these economic repercussions remain largely unknown and ultimately will depend on many factors, including the speed and effectiveness of the COVID-19 pandemic containment efforts throughout the world. Our operations might be negatively impacted by, among other things, the decrease in production levels and increased costs resulting from our efforts to mitigate the impact of the COVID-19 pandemic through social-distancing measures we have enacted at certain of our locations around the world. We also believe, however, that secular trends in the automotive, industrial, and cloud-power end-markets will continue to drive long-term growth in the semiconductor industry. 27 -------------------------------------------------------------------------------- Table of Contents During portions of the first and second quarters of 2020, in an effort to contain and slow the spread of the COVID-19 pandemic, governments around the world enacted various measures, including orders to close all businesses not deemed "essential," quarantine residents in their homes or places of residence, and practice social distancing when engaging in essential activities. While many of these measures have been relaxed in certain jurisdictions, the extent to which COVID-19 will impact demand for our products depends on future developments, which are highly uncertain and difficult to predict, including new information that may emerge concerning the severity of the COVID-19 pandemic and actions to contain and treat its impacts, as well as the potential impact of a second wave of infection. In response to market and industry trends, we have pursued, and expect to continue to pursue, cost-saving initiatives to align our overall cost structure, capital investments and other expenditures with our expected revenue, spending and capacity levels based on our current sales and manufacturing projections. We have historically taken and continue to take significant cost containment efforts, including, but not limited to, workforce reductions, reducing discretionary spending, furloughs, and mandatory vacations. While all our global manufacturing sites are currently operational, our facilities could be required to temporarily curtail production levels or temporarily cease operations based on government mandates. There can be no assurances that we will adequately forecast the impact of adverse economic conditions on our business or that we will effectively align our cost structure, capital investments and other expenditures with our revenue, spending and capacity levels in the future. With the expected completion of the 300mm fab acquisition inEast Fishkill, New York towards the end of 2022, we began to consolidate and make structural changes to our manufacturing footprint. DuringFebruary 2020 , we announced that we were exploring the sale of our six-inch fab inBelgium . Also, inAugust 2020 , we announced the plan to explore the sale of our six-inch fab in Niigata,Japan . Production from theBelgium and Niigata fabs will be transitioned to other fabs in our manufacturing network. The active marketing and the eventual disposition of these facilities may result in accounting charges in the future.
The Impact of the COVID-19 Pandemic to our Industry
While the full extent of the COVID-19 pandemic's impact on global supply chains and global growth remains to be seen, events surrounding the pandemic have reduced economic activity across the globe. While there has been some increased demand in the areas of business that support the stay-at-home economy, such as products used in data center infrastructure, notebook computers, and similar applications, demand in other categories such as automotive, smartphones and consumer electronics has decreased. While the majority of companies have sought to manage the disruptions caused by the COVID-19 pandemic by implementing contingency plans in the near-term, in the long-term, we believe that, companies are likely to re-assess and consider modifying their supply chain strategies and operating models to mitigate single points of failure.
The Impact of the COVID-19 Pandemic on our Business
The COVID-19 pandemic continues to impact our business and the uncertainty
regarding the duration, severity, and possible resurgence of the pandemic in
future periods is still unclear. In addition to the impact of lower demand, we
continue to experience some supply chain and logistical constraints on
procurement of certain materials. We expect these conditions to continue in
varying duration and severity until such time as the COVID-19 pandemic is
effectively contained globally. While we believe that our business has
stabilized from the impact of the pandemic, the possible resurgence could alter
the business landscape again. While we anticipate an increase in economic
activity depending on the rate, pace, and effectiveness of the containment
efforts deployed by various national, state, and local governments, we are
unable to predict the nature, timing and sustainability of an economic recovery.
Our long-term fundamentals remain strong as we continue to believe we are
well-positioned for growth as business conditions meaningfully improve.
In an effort to protect the health and safety of our employees, we took and
continue to take proactive, aggressive actions to adopt social distancing
policies at our locations around the world, including reducing the number of
people in our sites at any one time, instructing or encouraging our employees to
work from home where possible, limiting the number of employees attending
meetings and suspending employee travel. In our role as responsible corporate
citizens, we have taken actions to support our global communities by providing
essential medical supplies and by donating N95 masks, ActiveAir masks, surgical
masks, smocks, hand sanitizers, hairnets, nitrile gloves and medical protection
suits to hospitals and health workers. We will continue to actively monitor
implications of the COVID-19 pandemic on our and our customers' businesses and
may take further actions to alter our business operations if we determine that
such alterations are in the best interests of our employees, customers,
partners, suppliers, and stakeholders, or as required by federal, state, or
local authorities. It is not clear what the potential effects of such
alterations or modifications may have on our business for the remainder of 2020
or thereafter, including the effects on our customers, employees, and prospects,
or on our financial results.
28
-------------------------------------------------------------------------------- Table of Contents Results of Operations The COVID-19 pandemic continued to impact our business operations during the quarter and six months endedJuly 3, 2020 . Among others, we experienced the impact in the form of decreased demand for some of our products, supply chain constraints in shipment and procurement of materials and lower factory utilization due to governmental regulations implemented to slow and contain the spread of the COVID-19 pandemic during portions of the first and second quarters. While we have taken numerous steps to navigate through the challenges faced and mitigate its impact, we are currently unable to estimate the ultimate potential effects on our business, customers, employees, or our future financial results.
Quarter Ended
The following table summarizes certain information relating to our operating
results that has been derived from our unaudited consolidated financial
statements (in millions):
Quarters Ended
July
3, 2020
Revenue
$
1,213.5
Cost of revenue (exclusive of amortization shown below)
839.2 848.7 (9.5) Gross profit 374.3 499.0 (124.7) Operating expenses: Research and development 156.1 147.0 9.1 Selling and marketing 65.6 73.6 (8.0) General and administrative 62.9 74.1 (11.2) Amortization of acquisition-related intangible assets 29.1 27.5 1.6 Restructuring, asset impairments and other charges, net 16.2 18.1 (1.9) Intangible asset impairment 1.3 0.4 0.9 Total operating expenses 331.2 340.7 (9.5) Operating income 43.1 158.3 (115.2) Other income (expense), net: Interest expense (41.9) (33.7) (8.2) Interest income 1.5 3.0 (1.5) Loss on debt refinancing and prepayment - (0.4) 0.4 Other expense (2.8) (1.0) (1.8) Other income (expense), net (43.2) (32.1) (11.1) Income (loss) before income taxes (0.1) 126.2 (126.3) Income tax provision (0.8) (23.3) 22.5 Net income (loss) (0.9) 102.9 (103.8) Less: Net income attributable to non-controlling interest (0.5) (1.1) 0.6
Net income (loss) attributable to
(1.4)$ 101.8 $ (103.2) Revenue Revenue was$1,213.5 million and$1,347.7 million for the quarters endedJuly 3, 2020 andJune 28, 2019 , respectively, representing a decrease of$134.2 million , or approximately 10%. We had one customer, a distributor, whose revenue accounted for approximately 11% of the total revenue for the quarter endedJuly 3, 2020 . 29 -------------------------------------------------------------------------------- Table of Contents Revenue by operating and reportable segments was as follows (dollars in millions): Quarter Ended As a % of Quarter Ended As a % of July 3, 2020 Total Revenue (1) June 28, 2019 Total Revenue (1) PSG$ 618.4 51.0 %$ 700.9 52.0 % ASG 426.7 35.2 % 462.0 34.3 % ISG 168.4 13.9 % 184.8 13.7 % Total revenue$ 1,213.5 $ 1,347.7
(1) Certain amounts may not total due to rounding of individual amounts.
Revenue from PSG decreased by$82.5 million , or approximately 12%, for the quarter endedJuly 3, 2020 compared to the quarter endedJune 28, 2019 . The revenue from our Advanced Power Division and Protection and Signal Division decreased by$42.8 million and$19.1 million , respectively. The decreases were due to a combination of a general decline in demand for these products due to prevailing economic conditions caused by the COVID-19 pandemic and the impact of delays in fulfilling certain customer orders due to our factories inthe Philippines andMalaysia operating at significantly reduced capacity levels during the first half of the second quarter of 2020 as a result of the COVID-19 pandemic. Revenue from ASG decreased by$35.3 million , or approximately 8%, for the quarter endedJuly 3, 2020 compared to the quarter endedJune 28, 2019 . The revenue from our Automotive Division and Mobile, Computing and Cloud Division decreased by$40.4 million and$7.1 million , respectively. These decreases were partially offset by an increase in revenue of$16.3 million in our Wireless Connectivity Solutions Division, which included the acquiredQuantenna business. The decrease in demand for the Automotive division products was due to the significant issues faced by Automotive component manufacturers and the overall Automotive industry as a result of the COVID-19 pandemic. This was exacerbated by delays in fulfilling certain customer orders due to our factories inthe Philippines andMalaysia operating at significantly reduced capacity levels during the first half of the second quarter of 2020 as a result of the COVID-19 pandemic. Revenue from ISG decreased by$16.4 million , or approximately 9%, for the quarter endedJuly 3, 2020 compared to the quarter endedJune 28, 2019 . The revenue from our Automotive Solutions Division and Consumer Solutions Division decreased by$10.4 million and$10.3 million , respectively. These decreases in revenue were due to decreased demand and delays in fulfilling certain customer orders due to supply chain constraints as a result of the COVID-19 pandemic, partially offset by an increase in revenue in other divisions.
Revenue by geographic locations, based on sales billed from the respective
country or regions, was as follows (dollars in millions):
Quarter Ended As a % of Quarter Ended As a % of
July 3, 2020 Total Revenue (1) June 28, 2019 Total Revenue (1)
Singapore $ 439.4 36.2 % $ 379.9 28.2 %
Hong Kong 323.3 26.6 % 348.4 25.9 %
United Kingdom 140.9 11.6 % 229.4 17.0 %
United States 151.8 12.5 % 223.5 16.6 %
Other 158.1 13.0 % 166.5 12.4 %
Total $ 1,213.5 $ 1,347.7
(1) Certain amounts may not total due to rounding of individual amounts.
30
--------------------------------------------------------------------------------
Table of Contents
Gross Profit and Gross Margin (exclusive of amortization of acquisition-related
intangible assets)
Our gross profit by operating and reportable segments was as follows (dollars in
millions):
Quarter Ended July As a % of Quarter Ended June As a % of
3, 2020 Segment Revenue (1) 28, 2019 Segment Revenue (1)
PSG $ 184.2 29.8 % $ 255.7 36.5 %
ASG 156.1 36.6 % 184.7 40.0 %
ISG 50.3 29.9 % 65.9 35.7 %
Gross profit for all segments $ 390.6 $ 506.3
Unallocated manufacturing costs (16.3) (1.3) % (7.3) (0.5) %
Total gross profit $ 374.3 30.8 % $ 499.0 37.0 %
(1) Certain amounts may not total due to rounding of individual amounts.
Our gross profit decreased by$124.7 million , or approximately 25%, from$499.0 million for the quarter endedJune 28, 2019 to$374.3 million for the quarter endedJuly 3, 2020 . Gross profit as a percentage of revenue decreased to approximately 31% for the quarter endedJuly 3, 2020 from approximately 37% for the quarter endedJune 28, 2019 . The decrease in gross profit and gross margin were attributable to multiple factors, including a significant decline in sales volume, a decline in average selling prices and under-absorbed fixed overhead in some of our manufacturing locations due to abnormally low utilization at the beginning of the second quarter of 2020. Certain of our factories inMalaysia andthe Philippines had to temporarily shut down or operate at a significantly reduced capacity due to the COVID-19 pandemic during the first half of the second quarter of 2020. As a result, during the quarter endedJuly 3, 2020 , we recorded approximately$13 million of fixed overhead charges directly to cost of revenues, representing under-absorbed inventory costs due to the COVID-19 pandemic.
Operating Expenses
The general cost-saving measures initiated by the Company in response to the COVID-19 pandemic had a meaningful impact on selling and marketing expenses and general and administrative expenses for the quarter endedJuly 3, 2020 compared to the quarter endedJune 28, 2019 . Research and development expenses were$156.1 million for the quarter endedJuly 3, 2020 , as compared to$147.0 million for the quarter endedJune 28, 2019 , representing an increase of$9.1 million , or approximately 6%. This increase was primarily due to the inclusion of theQuantenna employees in the headcount for the entire quarter endedJuly 3, 2020 , resulting in higher payroll costs. This increase in payroll was partially offset by a decrease in expenses in other categories due to the cost-saving measures initiated by the Company. Selling and marketing expenses were$65.6 million for the quarter endedJuly 3, 2020 , as compared to$73.6 million for the quarter endedJune 28, 2019 , representing a decrease of$8.0 million , or approximately 11%. The decrease was in the areas of payroll and travel-related expenses due to the cost-saving measures initiated by the Company and travel restrictions implemented in response to the COVID-19 pandemic. General and administrative expenses were$62.9 million for the quarter endedJuly 3, 2020 , as compared to$74.1 million for the quarter endedJune 28, 2019 , representing a decrease of$11.2 million , or approximately 15%. This decrease was primarily attributable to a decrease in stock compensation expense and in certain other categories due to the cost-saving measures initiated by the Company.
Other Operating Expenses
Amortization of Acquisition-Related Intangible Assets
Amortization of acquisition-related intangible assets was$29.1 million for the quarter endedJuly 3, 2020 , as compared to$27.5 million for the quarter endedJune 28, 2019 . The increase of$1.6 million , or approximately 6%, was primarily due to the amortization of our intangible assets acquired fromQuantenna . 31 -------------------------------------------------------------------------------- Table of Contents Restructuring, Asset Impairments and Other, Net Restructuring, asset impairments and other, net was$16.2 million for the quarter endedJuly 3, 2020 , as compared to$18.1 million for the quarter endedJune 28, 2019 , representing costs related to the restructuring programs in effect during the respective quarters. For additional information, see Note 5: ''Restructuring, Asset Impairments and Other, Net'' in the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q.
Interest Expense
Interest expense increased by$8.2 million to$41.9 million during the quarter endedJuly 3, 2020 , as compared to$33.7 million during the quarter endedJune 28, 2019 . The increase was due to the interest for the additional debt incurred for the acquisition ofQuantenna and the Credit Facility Draw. Our average gross long-term debt balance (including current maturities) for the quarter endedJuly 3, 2020 was$4,855.4 million at a weighted-average interest rate of 3.5%, as compared to$3,368.5 million at a weighted-average interest rate of 4.0% for the quarter endedJune 28, 2019 .
Income Taxes Provision and Benefit
We recorded an income tax provision of
quarters ended
The income tax provision for the quarter endedJuly 3, 2020 consisted of$0.9 million for income and withholding taxes of certain of our foreign and domestic operations offset by$0.1 million of discrete benefits. The income tax provision for the quarter endedJune 28, 2019 consisted of$25.6 million for income and withholding taxes of certain of our foreign and domestic operations and$1.4 million of new reserves and interest on existing reserves for uncertain tax positions in foreign jurisdictions. These amounts were offset by discrete benefits of$3.4 million relating to the release of reserves and interest for uncertain tax positions in foreign jurisdictions related to prior years and$0.3 million relating to equity award excess tax benefits.
For additional information, see Note 13: ”Income Taxes” and Note 15:
”Subsequent Event” in the notes to the unaudited consolidated financial
statements included elsewhere in this Form 10-Q.
32 -------------------------------------------------------------------------------- Table of Contents Results of Operations
Six Months Ended
The following table summarizes certain information relating to our operating
results that has been derived from our unaudited consolidated financial
statements (in millions):
Six Months Ended
July
3, 2020
Revenue
$
2,491.4
Cost of revenue (exclusive of amortization shown below)
1,714.4 1,721.6 (7.2) Gross profit 777.0 1,012.7 (235.7) Operating expenses: Research and development 327.1 298.8 28.3 Selling and marketing 142.4 150.7 (8.3) General and administrative 134.1 147.0 (12.9) Amortization of acquisition-related intangible assets 61.4 53.2 8.2 Restructuring, asset impairments and other charges, net 49.0 23.7 25.3 Intangible asset impairment 1.3 1.6 (0.3) Total operating expenses 715.3 675.0 40.3 Operating income 61.7 337.7 (276.0) Other income (expense), net: Interest expense (84.4) (65.4) (19.0) Interest income 3.4 5.5 (2.1) Loss on debt refinancing and prepayment - (0.4) 0.4 Other income (expense) (2.7) 1.1 (3.8) Other income (expense), net (83.7) (59.2) (24.5) Income (loss) before income taxes (22.0) 278.5 (300.5) Income tax benefit (provision) 7.4 (61.5) 68.9 Net income (loss) (14.6) 217.0 (231.6) Less: Net income attributable to non-controlling interest (0.8) (1.1) 0.3
Net income (loss) attributable to
(15.4)$ 215.9 $ (231.3) Revenue Revenue was$2,491.4 million and$2,734.3 million for the six months endedJuly 3, 2020 andJune 28, 2019 , respectively, representing a decrease of$242.9 million , or 8.9%. We had one customer, a distributor, whose revenue accounted for approximately 10% of the total revenue for the six months endedJuly 3, 2020 . Revenue by operating and reportable segments was as follows (dollars in millions): Six Months Ended As a % of Six Months Ended As a % of July 3, 2020 Total Revenue (1) June 28, 2019 Total Revenue (1) PSG$ 1,242.3 49.9 %$ 1,405.1 51.4 % ASG 893.8 35.9 % 956.1 35.0 % ISG 355.3 14.3 % 373.1 13.6 % Total revenue$ 2,491.4 $ 2,734.3
(1) Certain amounts may not total due to rounding of individual amounts.
Revenue from PSG decreased by$162.8 million , or approximately 12%, for the six months endedJuly 3, 2020 compared to the six months endedJune 28, 2019 . The revenue from our Advanced Power Division and Protection and Signal Division decreased by$90.6 million and$40.7 million , respectively. The decreases were due to a combination of a general decline in demand for 33 -------------------------------------------------------------------------------- Table of Contents these products due to prevailing economic conditions caused by the COVID-19 pandemic and the impact of delays in fulfilling certain customer orders due to our factories inChina ,the Philippines andMalaysia operating at significantly reduced capacity levels during portions of the first and second quarters of 2020 as a result of the COVID-19 pandemic. Revenue from ASG decreased by$62.3 million , or approximately 7%, for the six months endedJuly 3, 2020 compared to the six months endedJune 28, 2019 . The revenue from our Automotive Division, Industrial and Offline Power Division and our Mobile, Computing and Cloud Division decreased by$47.4 million ,$25.4 million and$42.3 million , respectively. These decreases were partially offset by an increase in revenue of$53.3 million in our Wireless Connectivity Solutions Division, which included the acquiredQuantenna business. The decrease in demand for the products in the Automotive division was primarily due to the significant issues faced by Automotive manufacturers as a result of the COVID-19 pandemic. This was exacerbated by delays in fulfilling certain customer orders due to our factories inChina ,the Philippines andMalaysia operating at a significantly reduced capacity levels as a result of the COVID-19 pandemic. Revenue from ISG decreased by$17.8 million , or approximately 5%, for the six months endedJuly 3, 2020 compared to the six months endedJune 28, 2019 . The revenue from our Automotive Solutions Division and Consumer Solutions Division decreased by$17.0 million and$9.6 million , respectively. These decreases in revenue were due to decreased demand and delays in fulfilling certain customer orders due to supply chain constraints as a result of the COVID-19 pandemic, and was partially offset by an increase in revenue in other divisions.
Revenue by geographic location, including local sales made by operations within
each area, based on sales billed from the respective region, was as follows
(dollars in millions):
Six Months Ended As a % of Six Months Ended As a % of
July 3, 2020 Total Revenue (1) June 28, 2019 Total Revenue (1)
Singapore $ 847.7 34.0 % $ 805.1 29.4 %
Hong Kong 639.5 25.7 % 686.4 25.1 %
United Kingdom 367.9 14.8 % 476.3 17.4 %
United States 336.3 13.5 % 437.1 16.0 %
Other 300.0 12.0 % 329.4 12.0 %
Total $ 2,491.4 $ 2,734.3
(1) Certain amounts may not total due to rounding of individual amounts.
Gross Profit and Gross Margin (exclusive of amortization of acquisition-related
intangible assets described below)
Our gross profit by operating and reportable segments was as follows (dollars in
millions):
Six Months Ended As a % of Six Months Ended As a % of
July 3, 2020 Segment Revenue (1) June 28, 2019 Segment Revenue (1)
PSG $ 362.8 29.2 % $ 504.7 35.9 %
ASG 330.9 37.0 % 384.8 40.2 %
ISG 113.1 31.8 % 140.8 37.7 %
Gross profit $ 806.8 $ 1,030.3
Unallocated manufacturing costs (29.8) (1.2) % (17.6) (0.6) %
Consolidated gross profit $ 777.0 31.2 % $ 1,012.7 37.0 %
(1) Certain amounts may not total due to rounding of individual amounts.
Our gross profit was
compared to
profit decreased by
percentage of revenue decreased to approximately 31% for the six months ended
The decrease in gross profit and gross margin were attributable to multiple factors, including a significant decline in sales volume, a decline in average selling prices and under absorbed fixed overhead in some of our manufacturing locations due to abnormally low utilization during the first and second quarters of 2020. Certain of our factories inChina ,Malaysia andthe Philippines had to temporarily shut down or operate at a significantly reduced capacity due to the COVID-19 pandemic during 34 --------------------------------------------------------------------------------
Table of Contents
portions of the first and second quarters of 2020. As a result, we recorded
approximately
revenues, representing under absorbed inventory costs due to the COVID-19
pandemic, during the six months ended
Operating Expenses
The general cost-saving measures initiated by the Company in response to the COVID-19 pandemic had a meaningful impact on selling and marketing expenses and general and administrative expenses for the six months endedJuly 3, 2020 compared to the six months endedJune 28, 2019 . Research and development expenses were$327.1 million for the six months endedJuly 3, 2020 , as compared to$298.8 million for the six months endedJune 28, 2019 , representing an increase of$28.3 million , or approximately 9%. This increase was primarily due to the addition ofQuantenna employees in the headcount for the entire six months endedJuly 3, 2020 , resulting in higher payroll costs. Selling and marketing expenses were$142.4 million for the six months endedJuly 3, 2020 , as compared to$150.7 million for the six months endedJune 28, 2019 , representing a decrease of$8.3 million , or approximately 6%. The decrease was primarily in travel-related expenses due to the cost-saving measures initiated by the Company and travel restrictions implemented in response to the COVID-19 pandemic. General and administrative expenses were$134.1 million for the six months endedJuly 3, 2020 , as compared to$147.0 million in the six months endedJune 28, 2019 , representing a decrease of$12.9 million , or approximately 9%. This decrease was primarily attributable to a decrease in stock compensation expense and in certain other categories due to the cost-saving measures initiated by the Company. Other Operating Expenses
Amortization of Acquisition-Related Intangible Assets
Amortization of acquisition-related intangible assets was$61.4 million and$53.2 million for the six months endedJuly 3, 2020 andJune 28, 2019 , respectively, representing a period-over-period increase of$8.2 million , or approximately 15%. The increase was primarily due to the amortization of our intangible assets acquired fromQuantenna .
Restructuring, Asset Impairments and Other, Net
Restructuring, asset impairments and other, net was$49.0 million for the six months endedJuly 3, 2020 , as compared to$23.7 million for the six months endedJune 28, 2019 , representing an increase of$25.3 million . The increase was primarily due to the restructuring costs relating to the VSP and ISP. For additional information, see Note 5: ''Restructuring, Asset Impairments and Other, Net'' in the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q.
Intangible asset impairment was
2020
Interest Expense
Interest expense increased by$19.0 million to$84.4 million during the six months endedJuly 3, 2020 , as compared to$65.4 million during the six months endedJune 28, 2019 . The increase was due to the additional debt incurred for the acquisition ofQuantenna and the Credit Facility Draw. Our average gross long-term debt balance (including current maturities) for the six months endedJuly 3, 2020 was$4,301.2 million at a weighted-average interest rate of 3.9%, as compared to$3,372.4 million at a weighted-average interest rate of 3.9% for the six months endedJune 28, 2019 .
Loss on Debt Refinancing and Prepayment
Loss on debt refinancing was zero for the six months ended
compared to
35 -------------------------------------------------------------------------------- Table of Contents Other Income (Expense) Other income (expense) decreased by$3.8 million to expense of$2.7 million for the six months endedJuly 3, 2020 , compared to income of$1.1 million for the six months endedJune 28, 2019 .
Income Tax Provision and Benefit
We recorded an income tax benefit of
million
respectively.
The income tax benefit for the six months ended
benefit of
foreign and domestic operations partially offset by
expenses.
The income tax provision for the six months endedJune 28, 2019 consisted of$61.6 million for income and withholding taxes of certain of our foreign and domestic operations,$6.0 million relating to the resolution of a foreign tax dispute,$2.3 million of new reserves and interest on existing reserves for uncertain tax positions in foreign jurisdictions, and$0.4 million of prior year adjustments. These amounts were offset by discrete benefits of$3.4 million relating to the release of reserves and interest for uncertain tax positions in foreign jurisdictions related to prior years and$5.4 million relating to equity award excess tax benefits.
For additional information, see Note 13: ”Income Taxes” and Note 15:
“Subsequent Event” in the notes to the unaudited consolidated financial
statements included elsewhere in this Form 10-Q.
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 ofJuly 3, 2020 , there were no material changes outside the ordinary course of business to the contractual obligations table, including the notes thereto, contained in the 2019 Form 10-K. Off-Balance Sheet Arrangements In the ordinary course of business, we provide standby letters of credit or other guarantee instruments to certain parties in connection with certain transactions, including, but not limited to, material purchase commitments, agreements to mitigate collection risk, leases, utilities or customs guarantees. As ofJuly 3, 2020 , the Company's Revolving Credit Facility included$15.0 million of commitment subject to the available balance of the Revolving Credit Facility for the issuance of letters of credit, which, as of the date of this Form 10-Q was$4.0 million . There were$1.0 million letters of credit outstanding under the Revolving Credit Facility as ofJuly 3, 2020 , which reduced the Company's borrowing capacity. As ofJuly 3, 2020 , we also had outstanding guarantees and letters of credit outside of our Revolving Credit Facility in the amount of$6.8 million . As part of securing financing in the ordinary course of business, we have issued guarantees related to certain of our subsidiaries' term loan financing and surety bond, which totaled$1.4 million as ofJuly 3, 2020 . Based on historical experience and information currently available, we believe that we will not be required to make payments under the standby letters of credit or guarantee arrangements for the foreseeable future. We have not recorded any liability in connection with these letters of credit and guarantee arrangements. See Note 7: ''Long-Term Debt'' and Note 10: ''Commitments and Contingencies'' in the notes to our unaudited consolidated financial statements included 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, environmental
contamination and other property damage, personal injury, our failure to comply
with applicable laws, our negligence or willful misconduct or our breach of
representations, warranties or covenants related to such matters as title to
sold assets.
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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 maintain directors’ and officers’ insurance policies that indemnify our
directors and officers against various liabilities, including certain
liabilities under the Exchange Act, that might be incurred by any director or
officer in his or her capacity as such.
The Fairchild Agreement provides for indemnification and insurance rights in favor of Fairchild's then current and former directors, officers and employees. Specifically, we have agreed that, for no fewer than six years following the Fairchild acquisition, we will: (a) indemnify and hold harmless each such indemnitee against losses and expenses (including advancement of attorneys' fees and expenses) in connection with any proceeding asserted against the indemnified party in connection with such person's servings as a director, officer, employee or other fiduciary of Fairchild or its subsidiaries prior to the effective time of the acquisition; (b) maintain in effect all provisions of the certificate of incorporation or bylaws of Fairchild or any of its subsidiaries or any other agreements of Fairchild or any of its subsidiaries with any indemnified party regarding elimination of liability, indemnification of officers, directors and employees and advancement of expenses in existence on the date of the Fairchild Agreement for acts or omissions occurring prior to the effective time of the acquisition and; (c) subject to certain qualifications, provide to Fairchild's then current directors and officers an insurance and indemnification policy that provides coverage for events occurring prior to the effective time of the acquisition that is no less favorable than Fairchild's then-existing policy, or, if insurance coverage that is no less favorable is unavailable, the best available coverage. Similarly, the Quantenna Agreement provides for indemnification and insurance rights in favor ofQuantenna's then current and former directors, officers, employees and agents. Specifically, the Company has agreed that, for no fewer than six years following theQuantenna acquisition, the Company will: (a) indemnify and hold harmless each such indemnified party to the fullest extent permitted byDelaware law in the event of any threatened or actual claim suit, action, proceeding or investigation against the indemnified party based in whole or in part on, or pertaining to, such person's serving as a director, officer, employee or agent ofQuantenna or its subsidiaries or predecessors prior to the effective time of the acquisition or in connection with the Quantenna Agreement; (b) maintain in effect provisions of the certificate of incorporation and bylaws ofQuantenna and each of its subsidiaries regarding the elimination of liability of directors and indemnification of officers, directors and employees that are no less advantageous to the intended beneficiaries than the corresponding provisions in the certificate of incorporation and bylaws ofQuantenna and each of its subsidiaries in existence on the date of theQuantenna Agreement; and (c) obtain and fully pay the premium for a non-cancelable extension of directors' and officers' liability coverage ofQuantenna's directors' and officers' policies andQuantenna's fiduciary liability insurance policies in effect as of the date of the Quantenna Agreement. 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'' in the notes to our unaudited consolidated financial statements under the heading "Legal Matters" included elsewhere in this Form 10-Q for possible contingencies related to legal matters. See also Part I, Item 1 "Business - Government Regulation" of the 2019 Form 10-K for information on certain environmental matters.
Sources and Uses of Cash
Our balance of cash and cash equivalents was$2,060.4 million as ofJuly 3, 2020 . OnMarch 24, 2020 , we borrowed$1,165.0 million under the Revolving Credit Facility as a precautionary measure in order to increase our cash position and provide financial flexibility in light of the uncertainty from the impact of the COVID-19 pandemic ("Credit Facility Draw"). We believe that our existing cash and cash equivalents, coupled with our cash flows from operations will be adequate to fund our operations, debt repayment and capital needs, as well as to enable us to maintain compliance with our various debt agreements, through at least the next 12 months. To the extent that results or events differ from our financial projections or business plans, our liquidity may be adversely impacted. Total cash and cash equivalents as ofJuly 3, 2020 include approximately$1.4 billion 37 --------------------------------------------------------------------------------
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available within
additional cash in
distributions from our foreign subsidiaries, new bank loans or debt obligations.
We require cash to fund our operating expenses, working capital requirements, outlays for strategic acquisitions and investments, for debt service including principal and interest, for research and development, to make capital expenditures, and to repurchase our common stock. As a result of the Credit Facility Draw, as ofMarch 24, 2020 , we had borrowed substantially all amounts available under the Revolving Credit Facility. As of the date of this Form 10-Q, we have$4.0 million available under the Revolving Credit Facility, subject to certain conditions. The proceeds from the Credit Facility Draw could be used to repay portions of debt maturing in 2020, and for working capital, general corporate or other purposes. We expect interest expense to remain significant in future periods as we continue to service our debt. Our principal sources of liquidity are the cash and cash equivalents 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 with cash and cash equivalents on hand.
We believe that the key factors that could affect our internal and external
sources of cash include:
•Geopolitical and macroeconomic factors caused by the COVID-19 pandemic which has had, and is expected to continue to have, negative impacts on the economies of the majority of countries and industries. The potential effect of this pandemic and the responses of various governmental entities and industries thereto, the duration and severity of the pandemic, the possibility of the re-emergence of the pandemic in future months and the anticipated recovery period is uncertain. •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, including as a result of the COVID-19 pandemic, 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, including as a result of the COVID-19 pandemic, 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. The holders of our 1.00% Notes may submit them for conversion on or afterSeptember 1, 2020 . The 1.00% Notes will mature onDecember 1, 2020 . Our ability to service our long-term debt, including our 1.625% Notes, 1.00% Notes, Revolving Credit Facility and Term Loan "B" Facility, 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, timing of the full economic recovery from the COVID-19 pandemic, as well as to financial, competitive, legislative, regulatory and other conditions, some or all 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. While we have observed some recent stabilization in the capital markets impacted by the COVID-19 pandemic, there can be no assurance that equity or borrowings will be available when we access the capital markets or, if available, will be at rates or prices acceptable to us. 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. Our capital expenditures are primarily directed towards manufacturing equipment and capacity expansion. Our capital expenditure levels can materially influence our available cash for other initiatives. For example, during the six months endedJuly 3, 2020 , we paid$205.6 million for capital expenditures, while during the six months endedJune 28, 2019 , we paid$310.5 million for capital expenditures. Our current minimum contractual capital expenditure commitment for the remainder of 2020 and 2021 and thereafter is approximately$33.1 million and$26.5 million , respectively. We revised our forecast to reflect the current developments due to the COVID-19 pandemic, and currently expect to incur capital expenditures of approximately 7% to 8% of revenue for the remainder of 2020. Future capital expenditures may be impacted by events and transactions that are not currently forecasted. 38 --------------------------------------------------------------------------------
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Primary Cash Flow Sources
Our long-term cash generation is dependent on the ability of our operations to generate cash. Our cash flows from operating activities were$320.5 million and$360.8 million for the six months endedJuly 3, 2020 andJune 28, 2019 , respectively. The decrease of$40.3 million was primarily attributable to a significant reduction in net income due to decreased demand for our products, offset by effective working capital management and the non-payment of variable compensation during 2020 compared to 2019. Our ability to maintain positive operating cash flows is dependent on, among other factors, our success in achieving our revenue goals and manufacturing and operating cost targets. Our management of our assets and liabilities, including both working capital and long-term assets and liabilities, also influences our operating cash flows, and each of these components is discussed below.
Working Capital
Working capital, calculated as total current assets less total current liabilities, fluctuates depending on end-market demand and our effective management of certain items such as receivables, inventory and payables. Our working capital, excluding cash and cash equivalents and the current portion of long-term debt, was$1,015.0 million atJuly 3, 2020 and has fluctuated between$1,043.4 million and$767.4 million at the end of each of our last eight fiscal quarters. Our working capital, including cash and cash equivalents and the current portion of long-term debt, was$2,379.8 million atJuly 3, 2020 and has fluctuated between$2,379.8 million and$1,071.4 million at the end of each of our last eight fiscal quarters. During the six months endedJuly 3, 2020 , our working capital was most significantly impacted by Credit Facility Draw and reduced capital expenditures. Although investments made to fund working capital will reduce our cash balances, these investments are necessary to support business and operating initiatives.
Long-Term Assets and Liabilities
Our long-term assets consist primarily of property, plant and equipment, intangible assets, deferred taxes and goodwill. Our manufacturing rationalization plans have included efforts to utilize our existing manufacturing assets and supply arrangements more efficiently. We believe that near-term access to additional manufacturing capacity, should it be required, could be readily obtained on reasonable terms through manufacturing agreements with third parties. Our long-term liabilities, excluding long-term debt and deferred taxes, consist of liabilities under our foreign defined benefit pension plans and contingent tax reserves. In regard to our foreign defined benefit pension plans, our annual funding of these obligations is equal to the minimum amount legally required in each jurisdiction in which the plans operate. This annual amount is dependent upon numerous actuarial assumptions.
Key Financing and Capital Events
Overview
For the past several years, we have undertaken various measures to secure liquidity to pursue acquisitions, repurchase shares of our common stock, reduce interest costs, amend existing key financing arrangements and, in some cases, extend a portion of our debt maturities to continue to provide us additional operating flexibility. Cash Management Our ability to manage cash is limited, as our primary cash inflows and outflows are dictated by the terms of our sales and supply agreements, contractual obligations, debt instruments and legal and regulatory requirements. While we have some flexibility with respect to the timing of capital equipment purchases, we must invest in capital equipment on a timely basis to allow us to maintain our manufacturing efficiency and support our platforms for new products. We continue to hold all amounts borrowed under the Credit Facility Draw, which could be used to repay a portion of debt maturing in 2020, and for working capital, general corporate or other purposes.
Debt Guarantees and Related Covenants
As ofJuly 3, 2020 , we were in compliance with the indentures relating to our 1.00% Notes and 1.625% Notes and with covenants in the Amended Credit Agreement, including those relating to our Term Loan "B" Facility and Revolving Credit Facility, and covenants in our other debt agreements. Our 1.00% Notes and our 1.625% Notes are senior to the existing and future subordinated indebtedness of ON Semiconductor and its guarantor subsidiaries and rank equally in right of payment to 39 -------------------------------------------------------------------------------- Table of Contents all of our existing and future senior debt and as unsecured obligations are subordinated to all of our existing and future secured debt to the extent of the assets securing such debt.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, see our 2019 Form 10-K and
Note 3: “Recent Accounting Pronouncements” in the notes to our unaudited
consolidated financial statements included elsewhere in this Form 10-Q.
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