Diodes Incorporated — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparisons are with Q1 2015 unless stated otherwise. Diodes makes standard semiconductor products for consumer electronics, computing, communications, industrial, and automotive markets. Q1 2016 was the first quarter to include a full quarter of Pericom, acquired in Q4 2015. Financial amounts below are in millions unless noted.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change / context |
|---|---|---|---|
| Net sales | $222.7 | $206.2 | Up 8.0%; includes approximately $31.8 from Pericom. Sales excluding Pericom declined. |
| Gross profit / margin | $64.2 / 28.8% | $63.9 / 31.0% | Profit nearly flat; margin fell 2.2 percentage points. |
| Operating expenses | $62.8 | $47.0 | Up 33.5%, including about $15.0 of Pericom expenses. |
| Operating income / margin | $1.5 / 0.7% | $16.9 / 8.2% | Substantial decline. |
| Net income (loss) attributable to common stockholders | $(1.7); $(0.04) per diluted share | $11.1; $0.23 per diluted share | Turned to a loss. |
| Cash from operations | $25.5 | $38.6 | Down $13.1. |
| Cash and cash equivalents | $237.0 | $218.4 at Dec. 31, 2015 | Quarter-end balance; short-term investments were $43.1. |
| Total debt | About $450.2 on balance sheet | $464.0 at Dec. 31, 2015 | Company reported $450.5 drawn under its U.S. credit facility; also had about $1.9 of foreign long-term debt and $1.1 used for foreign import/export guarantees. |
Operating cash flow reflected a net loss, offset principally by $25.2 of depreciation and amortization and $4.5 of share-based compensation. Investing activities provided $8.7, mainly from maturities of short-term investments, while financing activities used $17.3, mainly for debt repayments. Cash increased $18.6 during the quarter. Working capital was $571.4, versus $570.9 at year-end. Cash, cash equivalents, and short-term investments totaled approximately $280.1; management said available resources and credit were expected to cover working-capital and capital-expenditure needs for at least 12 months.
Material changes and management commentary
- Sales growth reflected the Pericom acquisition; management cited weaker computing and communications demand and weak domestic demand in China. Customer pressure to lower selling prices continued.
- Gross margin declined due to lower capacity utilization and pricing pressure. Cost of goods sold included a $3.1 Pericom inventory valuation adjustment; excluding Pericom, average unit cost increased 9.7% year over year.
- Higher SG&A, R&D, and acquired-intangible amortization also weighed on operating results. Interest expense rose to $2.5 from $1.1, reflecting acquisition-related borrowing. Other expense included approximately $1.3 of foreign-currency losses.
- Management said future net-income improvement was expected to depend primarily on higher sales volume, better product mix, and manufacturing cost reductions to offset average selling-price declines. It cited new consumer products and early growth in virtual reality. No quantified earnings or revenue guidance was provided.
- Capital expenditures were $12.9 for the quarter, or 5.8% of sales; management’s stated target range was 5%–9% of sales. Non-cancelable capital-expenditure purchase commitments were approximately $18.5.
Other material matters, risks, and contingencies
- Pericom purchase-price allocation remained preliminary. Q1 measurement-period adjustments increased goodwill by $2.0 and did not affect Q1 earnings; the filing cautions that final allocation changes, including amortization periods, could be material.
- Approximately $268.5 of cash, cash equivalents, and investments were held by foreign subsidiaries; about $175.9 could be subject to tax if repatriated. The company intends to permanently reinvest eligible foreign earnings overseas.
- The U.K. defined-benefit plan was underfunded by $27.6 at March 31, 2016. The company had agreed to contribute approximately GBP 2 million annually through 2030.
- Gross unrecognized tax benefits were approximately $27.2; the company said the amount could change significantly within 12 months but could not estimate a range.
- Potential technical credit-agreement breaches related to subsidiary restructuring and a swing-line borrowing were cured or waived; the swing-line borrowing was repaid. A May 2, 2016 waiver and consent was filed.
- The securities class action dismissal was affirmed and the case concluded after the appeal deadline passed without a certiorari petition. A related derivative action remained stayed, and the company intended to defend it.
- Management had previously concluded internal control over financial reporting was ineffective as of December 31, 2015 due to errors in accounting for Pericom-related equity awards and change-in-control agreements. Remediation steps were underway. Management considered disclosure controls effective at March 31, 2016.
- Key risks include semiconductor cyclicality, customer pricing and order reductions, China and other international exposure, foreign currency, acquisition integration and controls, debt and credit-facility restrictions, supplier dependence, and pension assumptions. The filing reported no material changes to risk factors or market-risk disclosures from the prior 10-K.
Most important facts for investors to verify
- How much of reported sales growth and future performance is attributable to Pericom versus the legacy business, and whether demand weakness persists in computing, communications, and China.
- Whether gross margins recover through better utilization, product mix, pricing, and cost reductions, given the sharp increase in operating expenses and acquisition-related amortization.
- Debt, borrowing capacity, covenant compliance, interest costs, and the availability of overseas cash, including potential repatriation taxes.
- Final Pericom purchase-price allocation and its effects on goodwill, amortization, and reported earnings.
- Progress on remediating the identified internal-control weakness and the status of the stayed derivative litigation and uncertain tax positions.