3 Highlights From ON Semiconductors Q3 2017

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ON Semiconductor (NASDAQ: ON) reported results for its third quarter of 2017 early this week, continuing a streak of rising sales and profits for the small chip maker. Here are the three things you need to know.

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1. New business is delivering more sales

Revenue in the third quarter came in at the top of management expectations at $1.39 billion, a 46% year-over-year increase that came mostly from the acquisition of Fairchild Semiconductor last fall. Revenue notched a 4% increase over the second quarter of this year.

ON has repositioned itself the past few years from a commoditized chipset maker to a specialized designer of devices for a wide variety of connected things. Speaking to that transformation, CFO Bernard Gutmann had this to say on the earnings call:

Our past investments in automotive, industrial, and communications end markets are yielding strong results, and we are very well positioned to benefit from sustainable secular drivers in the fastest growing segments of the semiconductor market. At the same time, our highly diversified customer base, with no end customer contributing more than 5% of our revenue, insulates us from volatility that occurs time to time in various end markets and geographies. 

2. Profit margin on the rise

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The rationale behind the aforementioned purchase of Fairchild Semiconductor a year ago was to realize cost savings and cross-sell existing clients with an expanded portfolio of product. Benefits of that combination are being realized, as evidenced by ON's expanding profit margin.

Gross selling margin for the third quarter was 37.7%, compared with 36.8% in the second quarter and 34.6% a year ago. Management said the company remains on track to hit 40% by 2020.

Operating margin, which is profit left over after all operations are paid for, was at 12.7% during the last quarter. That compares with 11.5% in the second quarter and a mere 4.9% a year ago. The big increase is proving the wisdom of integrating Fairchild to get better utilization of existing operations. If revenue continues to rise, those margins should continue to expand at an even faster rate.

As testament, earnings per share in the quarter were $0.25, a 1,100% increase over last year's $0.02 a share. In spite of the improvement, though, the stock was down because earnings weren't as good as the $0.40-per-share analyst consensus.

3. A long runway for stock growth

This could be a buy-the-dip opportunity for investors. Management is optimistic about future business, reporting continued strong demand from its customers in the short to mid-term. Revenue is expected to be $1.325 billion to $1.375 billion in the fourth quarter, down slightly from the third quarter but 5% higher than a year ago at the low end of guidance. The fourth quarter of 2016 was the first full quarter that included the Fairchild acquisition.

Free cash flow -- money left over after all basic expenses are paid for -- also continues to rise from its bottom in early 2016. Management upped its guidance for that metric to approximately $700 million for 2017, higher than the previous expectation of $600 million to $650 million. About $200 million of that figure was used in the third quarter to reduce debt.

Because of rising profits and debt reduction following the Fairchild purchase, management said it feels comfortable considering a return-of-capital program for shareholders. We'll have to wait and see what that looks like, but paired with the other rosy metrics for the business, ON Semiconductor's stock looks like it has more room to run.

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Nicholas Rossolillo owns shares of ON Semiconductor. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.