Diodes Incorporated — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. Diodes designs, manufactures, and supplies standard discrete, logic, and analog semiconductors to consumer electronics, computing, communications, industrial, and automotive markets. Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $169.8 | $149.2 | $331.4 | $286.0 |
| Gross profit | $55.6 | $53.5 | $113.0 | $101.3 |
| Gross margin | 32.8% | 35.8% | 34.1% | 35.4% |
| Operating income | $25.4 | $24.0 | $53.7 | $42.9 |
| Net income attributable to common stockholders | $18.0 | $16.6 | $37.7 | $31.6 |
| Diluted EPS | $0.38 | $0.37 | $0.80 | $0.70 |
- Q2 sales increased 14% year over year and 5% sequentially. Six-month sales rose 16%; management attributed growth mainly to demand in Europe and Asia. Six-month growth reflected approximately 2% higher average selling prices and 13% more units sold.
- Q2 gross profit rose 4%, but margin declined 3 percentage points year over year and sequentially. Management cited a shift toward lower-margin products, weaker demand, and reduced manufacturing productivity associated with China labor shortages.
- Six-month operating cash flow was $48.1 million, versus $46.9 million a year earlier. Investing used $44.9 million, including $45.0 million of purchases of property, plant, and equipment; financing provided $13.3 million. Cash increased $19.5 million to $290.4 million.
- At June 30, current assets were $588.8 million, current liabilities $273.3 million, and working capital $315.6 million. Total assets were $923.1 million and equity $613.4 million.
- Debt and lease obligations included $132.3 million carrying value of convertible notes, $10.0 million drawn on lines of credit, $3.2 million long-term debt, and $1.2 million long-term capital leases. The notes’ principal amount was $134.3 million.
- Capital expenditures were approximately $54 million for the first half, including $5 million related to the Chengdu investment agreement. The filing reports $22 million in non-cancelable capital-expenditure purchase commitments and an expected approximately $48 million Chengdu investment over the first three years; approximately $5 million had been invested by June 30.
Material changes and management commentary
- Higher sales did not translate into comparable margin growth: cost of goods sold increased 19% in Q2 against 14% sales growth. Q2 average unit cost increased 9%, which management attributed to product mix.
- Management reported weakening demand beginning in May, particularly in consumer and computing markets, with softness in consumer and LED TV markets continuing into July. Channel inventory was at the high end of the company’s preferred range at quarter-end; the outlook for the balance of Q3 was uncertain.
- China labor shortages reduced equipment utilization and slowed productivity as replacement operators were trained. Management expected the productivity issue to be resolved by the end of Q3 and said it had delayed capital investments and frozen manufacturing hiring pending improved demand.
- Six-month effective tax rate was approximately 20%, compared with 16% in 2010, primarily reflecting income earned in lower-tax jurisdictions; the prior-year rate also benefited from a deferred-tax valuation allowance reversal. Tax holidays reduced first-half 2011 tax expense by approximately $2 million.
Outlook, risks, and contingencies
- Q3 2011 guidance: Revenue of $160–$170 million, flat to down 6% sequentially; gross margin of 32%, plus or minus 1.5%; operating expenses expected to be comparable to Q2 in dollars; tax rate of 17%–23%; and approximately 48 million shares for EPS calculations.
- Holders of the 2.25% convertible senior notes may require repurchase at par on October 1, 2011. If holders do not put the notes, the company intends to call them. Either outcome may require available cash or alternative financing. The filing says cash, operating funds, and available credit are expected to cover working capital and capital expenditures for at least 12 months, but the note event is a significant near-term liquidity consideration.
- Other commitments include a planned purchase of up to approximately $14 million of Eris Technology Corporation common stock in the second half of 2011 and the Chengdu joint-venture investment. The defined-benefit plan was underfunded by $18.9 million at June 30; annual payments of approximately £1.0 million were scheduled through 2012.
- Risks highlighted include semiconductor cyclicality and demand volatility, pricing pressure, manufacturing and labor disruptions, foreign-currency exposure, dependence on third-party suppliers, and reliance on Lite-On Semiconductor as the largest external supplier. The company reported approximately $10 million of gross unrecognized tax benefits; possible changes within 12 months could not be estimated. No material litigation was reported.
Most important facts for investors to verify
- Whether noteholders exercised the October 1, 2011 repurchase right, whether the company called the notes, and the resulting cash or refinancing impact.
- Whether Q3 revenue and gross-margin guidance was achieved, given the reported market softness and channel inventories.
- Whether China labor-related productivity constraints improved as expected and how that affected margins and capacity.
- Actual capital spending, Chengdu joint-venture funding, and the proposed Eris investment relative to liquidity and demand.
- Changes in related-party sourcing and supplier exposure, including purchases from Lite-On Semiconductor.