Diodes Incorporated — Q3 2010 Form 10-Q Summary
Business context and reporting period
Diodes designs, manufactures and supplies discrete, logic and analog semiconductor products for consumer electronics, computing, communications, industrial and automotive markets. This unaudited filing covers the three and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods unless noted. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $163.1 million | $122.1 million | $449.1 million | $304.1 million |
| Gross profit / margin | $61.0 million / 37.4% | $37.6 million / 30.8% | $162.2 million / 36.1% | $79.4 million / 26.1% |
| Operating income / margin | $29.8 million / 18.3% | $11.2 million / 9.2% | $72.7 million / 16.2% | $9.1 million / 3.0% |
| Net income attributable to common stockholders | $21.2 million; diluted EPS $0.46 | $7.0 million; diluted EPS $0.16 | $52.8 million; diluted EPS $1.16 | Loss of $6.7 million; diluted loss per share $0.16 |
| Operating cash flow | Not separately presented | Not separately presented | $90.0 million | $44.0 million |
Q3 sales rose 33.6% year over year and 9.4% sequentially; nine-month sales rose 47.7%. Management attributed Q3 sales growth to approximately 22.9% higher unit volume and 8.7% higher average selling prices. Nine-month growth reflected approximately 38.5% higher unit volume and 6.6% higher average selling prices. Improved product mix and higher utilization of manufacturing and wafer fabrication capacity lifted gross margin.
At September 30, cash and cash equivalents were $263.8 million, with no short-term investments, versus $242.0 million of cash and $296.6 million of short-term investments at year-end 2009. Current assets were $519.8 million and current liabilities $125.7 million; working capital was $394.1 million. The company reported no outstanding borrowings on its U.S. or foreign credit facilities, although $3.6 million of foreign facilities supported import/export guarantees. Convertible notes had a $126.3 million carrying value and $134.3 million principal; other debt and capital-lease balances were comparatively small.
Nine-month investing cash flow was $232.0 million, principally reflecting $296.6 million of proceeds from liquidating auction-rate securities, partly offset by capital investment. Financing cash use was $298.6 million, chiefly repayment of $303.2 million on lines of credit. Capital expenditures were approximately $72.2 million, primarily for manufacturing expansion in China. Receivables and inventory increased during the period, using operating cash.
Material changes versus the prior comparable period
- Profitability improved substantially: nine-month common-stockholder earnings moved from a $6.7 million loss to $52.8 million of income, while gross margin expanded 10.0 percentage points.
- Sales gains were broad-based, with particular strength in North America and Europe. Asia subsidiaries generated 72.7% of nine-month net sales, down from 75.4% in 2009.
- Q3 SG&A increased 19.7% and nine-month SG&A increased 30.4%, mainly from sales commissions, employee-related costs and general expenses; both periods’ SG&A as a share of sales declined.
- Research and development spending rose to $20.4 million for nine months from $16.9 million, while falling as a percentage of sales to 4.5% from 5.6%.
- The June 30 UBS settlement enabled the company to put its auction-rate securities back at par, liquidate them for cash and repay the related “no net cost” loan. This explains much of the shift in balance-sheet investments, debt and financing cash flows.
Outlook, commentary, risks and unusual items
- Management expected Q4 2010 sales and gross profit to be roughly in line with Q3 as supply shortages eased and demand leveled off. It expected 2010 capital expenditures to exceed the historical 10%–12% of sales range; nine-month capex was about 16.1% of sales.
- Management cited pricing pressure and said future earnings improvement would depend mainly on sales volume, product mix and manufacturing cost reductions. It expected Q4 gross margin to be roughly level with Q3.
- The 2.25% convertible notes due 2026 become puttable by holders on October 1, 2011. The company said it would reclassify them as current liabilities in Q4 2010 and could need available funds or alternative financing if holders exercise the put.
- The company did not renew approximately $20 million of foreign revolving credit facilities during Q3 and was renegotiating them. Management nevertheless expected cash, operating cash flow and available facilities to cover working-capital and capital needs for at least 12 months.
- The U.K./Germany defined-benefit plan was underfunded by $33.8 million. The filing describes sensitivity to actuarial assumptions and potential for higher contributions.
- Tax items include a 17.5% effective rate for the first nine months, influenced by earnings in lower-tax jurisdictions and reversals of valuation allowances. Tax holidays reduced nine-month tax expense by approximately $5.6 million. Gross unrecognized tax benefits were approximately $8.7 million; the company could not estimate the range of possible changes over the next 12 months.
- Nine-month other income included a $1.7 million gain on sale of non-core intellectual property. Foreign-exchange transaction losses were approximately $0.7 million for the nine-month period. Foreign-currency exposure, semiconductor cyclicality, customer order cancellations, pricing pressure, supply/manufacturing disruptions, China labor-cost increases and related-party dependence are cited risks.
- Lite-On Semiconductor Corporation (LSC), the largest stockholder and a related party, was also the company’s largest external supplier: purchases from LSC represented 7.1% of net sales for the nine months. The filing reports no pending litigation and no material change in internal control over financial reporting; disclosure controls were considered effective at a reasonable-assurance level.
Important facts for investors to verify
- Whether Q4 demand and gross margin tracked management’s expectation of being roughly level with Q3, given easing supply shortages and cyclical demand.
- The status and terms of renegotiated foreign credit facilities and the funding plan for the October 2011 convertible-note holder put right.
- Whether inventory, receivables and elevated China-focused capital spending convert into sales and cash flow at expected levels.
- Developments in the $33.8 million pension underfunding, tax positions and valuation allowances, including any tax audit settlements.
- Changes in related-party purchases and arrangements, particularly LSC supplier concentration and Keylink manufacturing, leasing and service relationships.
- Foreign-exchange exposure and China labor, supplier, regulatory and operational risks, as well as the effect of customer pricing pressure on margins.