Diodes Incorporated — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; balance-sheet comparisons are with December 31, 2012. Financial amounts below are in millions of U.S. dollars unless noted.
Business context
Diodes manufactures standard discrete, logic and analog semiconductors for consumer electronics, computing, communications, industrial and automotive markets. It completed its acquisition of BCD Semiconductor in March 2013; BCD’s results are included from March 1. The acquisition expanded the analog and power-management portfolio and added significant China operations.
Financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $224.5 | $166.6 | $615.9 | $470.5 |
| Gross profit / margin | $69.6 / 31% | $43.6 / 26% | $177.0 / 29% | $118.3 / 25% |
| Operating income | $20.3 | $7.5 | $34.3 | $21.3 |
| Net income attributable to common stockholders | $13.6 | $8.6 | $20.3 | $20.1 |
| Diluted EPS | $0.28 | $0.18 | $0.43 | $0.43 |
| Operating cash flow | Not separately provided | Not separately provided | $77.8 | $47.9 |
Q3 sales rose 35% year over year and 5% sequentially. Management attributed the annual increase primarily to BCD and higher unit volumes; ASP was relatively flat for the quarter. Nine-month sales increased 31%, reflecting seven months of BCD revenue, 28% higher unit volume and approximately 2% higher ASP. Gross margin improved with product mix, lower gold prices, stable pricing, copper-wire conversion and cost reductions. Q3 operating margin was approximately 9%, versus 5% a year earlier; nine-month operating margin was approximately 6%, versus 5%.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $204.2, with short-term investments of $21.7, at September 30, 2013; cash was $157.1 at year-end 2012.
- Working capital was $489, up from $378 at December 31, 2012, primarily reflecting BCD’s acquired net assets. Management said existing cash, operating cash flow and available credit were expected to cover working-capital and capital-expenditure needs for at least 12 months.
- Long-term debt was $202.1 and current lines of credit were $5.5. The company reported approximately $198 outstanding on its $300 revolving facility, maturing January 2018, and $5 outstanding on foreign facilities. Debt increased principally to fund BCD.
- Operating cash flow of $77.8 was more than offset by $169.4 of investing outflows, including $124.9 net cash used for BCD and $21.7 invested in short-term securities. Financing provided $136.7, mainly from credit-facility borrowings. Cash increased by $47.1.
- Inventory was $194.3, compared with $153.3 at year-end 2012; accounts receivable was $191.8, compared with $152.1.
Material changes and unusual items
- BCD contributed approximately $110 of revenue and $3 of earnings through September, including purchase-accounting adjustments. Acquisition consideration was approximately $155, excluding transaction costs; a separate $5 employee retention plan was established.
- The nine-month tax provision increased to $11.7 from $2.0. It included a $5 China tax-audit charge relating to 2011. The company estimated a 2013 annual tax rate of approximately 20% excluding discrete items; the reported nine-month effective rate was 36%.
- Q3 other expense was $2.8, compared with $1.9 of other income a year earlier. Q3 2013 included approximately $2 of foreign-exchange loss and $2 of interest expense; nine-month interest expense was approximately $4.
- Acquired-inventory purchase accounting added approximately $5 to cost of goods sold in the first half of 2013 as acquired work-in-process and finished goods were sold.
- The U.K. defined-benefit pension plan was underfunded by $20.1 at September 30, 2013. A contribution arrangement calls for approximately £2 million annually through 2019.
Outlook, risks and contingencies
For Q4 2013, management forecast revenue of $205–$220, down 2%–9% sequentially, gross margin of 28%, plus or minus 2 percentage points, operating expenses of approximately 22.7% of sales, plus or minus 1 point, and a tax rate of 18%–24%. Management expected Q4 to be weaker than normal seasonality, citing broad market weakness, particularly in PCs. It anticipated longer-term benefit from operational improvements, BCD integration and transferring BCD products into Diodes’ packaging facilities.
- The company was obligated to contribute approximately $48 to the Chengdu joint venture by December 31, 2013 to qualify for incentives; approximately $25 had been contributed by September 30. Management expected to contribute the full amount by year-end. Failure or delays could result in penalties or additional contributions.
- Two securities-related cases were pending: a derivative action involving historical CEO stock-option grants, with a plaintiff fee motion outstanding, and a putative securities class action concerning statements about China labor conditions. The company intended to defend the matters; outcomes and potential exposure were uncertain.
- Gross unrecognized tax benefits were approximately $28, and the company said a significant increase or decrease within 12 months was reasonably possible, but could not estimate the range. The IRS examination of the 2010 U.S. return was ongoing.
- Key risks include semiconductor cyclicality and weak end-market demand, pricing pressure, customer order cancellations, manufacturing and supply disruption, foreign-exchange and interest-rate exposure, China concentration and incentives, acquisition integration, tax challenges, litigation and the company’s increased debt.
Important facts for investors to verify
- How much of reported growth and margin improvement reflects BCD, and how the business performs on a comparable, organic basis.
- Whether Q4 results meet the stated revenue, margin, expense and tax outlook, given the forecast market weakness.
- BCD integration progress, expected cost savings and the effect of purchase-accounting adjustments on future earnings.
- Debt repayment capacity, covenant headroom and liquidity after the acquisition and planned Chengdu contribution.
- Resolution and potential financial consequences of the China tax audit, other tax positions and the pending legal cases.
- Whether rising receivables and inventory convert to cash without weakening operating cash flow.