Item 3. Legal Proceedings
Item 3. Legal Proceedings.
From time to time, we are involved in various legal proceedings that arise in the normal course of business. While we intend to defend any lawsuit vigorously, we presently believe that the ultimate outcome of any current pending legal proceeding will not have any material adverse effect on our financial position, cash flows or operating results. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. An unfavorable ruling could include monetary damages, which could impact our business and operating results for the period in which the ruling occurs or future periods. In addition, our foreign operations expose us to unique intellectual property technology risks compared to a company with fewer or no international operations. Such risks could lead to litigation or other disputes that would not be applicable to a company with limited or no international operations and could have a material and adverse effect on our financial condition and results of operations. See “Risk Factors – Risks Related to Our International Operations” in Part I, Item 1A of this Annual Report for a more detailed summary of the intellectual property technology risks associated with our international business operations.
Item 4. Mine Safety Disclosures.
Not Applicable.
33 -
PART II
Ite m 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our Common Stock is traded on the Nasdaq Global Select Market (“NasdaqGS”) under the symbol “DIOD.”
Holders
As of February 16, 2021, the approximate number of common stockholders was 226.
Dividends
We have never declared or paid dividends on our Common Stock, and currently do not intend to pay dividends in the foreseeable future as we intend to retain any earnings for future use in our business. Our U.S. banking facility permits us to pay dividends up to $25.0 million per fiscal year to our stockholders so long as we have not defaulted at the time of such dividend and no default would result from declaring and paying such dividend. The payment of dividends is within the discretion of our Board of Directors, and will depend upon, among other things, our earnings, financial condition, capital requirements, and general business conditions.
Securities Authorized for Issuance Under Equity Compensation Plans
The information regarding our equity compensation plans required to be disclosed by Item 201(d) of Regulation S-K is incorporated by reference from our 2021 definitive proxy statement, which we expect to file with the SEC in April 2021, in Item 12 of Part III of this Annual Report.
Performance Graph
The following graph compares the yearly percentage change in the cumulative total stockholder return of our Common Stock against the cumulative total return of the Nasdaq Composite and the Nasdaq Industrial Index for the five calendar years ending December 31, 2020. The graph is not necessarily indicative of future price performance.
The graph shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts.
Source: Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2019.
The graph assumes $100 invested on December 31, 2014 in our Common Stock, the stock of the companies in the Nasdaq Composite Index and the stock of companies in the Nasdaq Industrial Index, and that all dividends received within a quarter, if any, were reinvested in that quarter.
34 -
December 2020
2015
2016
2017
2018
2019
2020
Diodes Incorporated
Return %
11.71
11.69
12.52
74.74
25.07
Cum $
100
111.71
124.76
140.38
245.30
306.79
NASDAQ Industrial Index
Return %
9.47
25.21
(1.13
)
27.17
52.72
Cum $
100
109.47
137.07
135.52
172.34
263.20
NASDAQ Composite-Total Returns
Return %
8.87
29.64
(2.84
)
36.69
44.92
Cum $
100
108.87
141.13
137.12
187.44
271.64
Issuer Purchases of Equity Securities
During the fourth quarter of 2020, as part of the Lite-On Semiconductor acquisition, the Company reacquired 7,765,778 shares of its Common Stock.
35 -
Item 6. Selected Financial Data.
The following selected consolidated financial data for the fiscal years ended December 31, 2016 through 2020, is qualified in its entirety by, and should be read in conjunction with, the other information and consolidated financial statements, including the notes thereto, appearing elsewhere herein. Certain immaterial amounts as presented in the accompanying consolidated financial statements have been reclassified to conform to 2020 financial statement presentation.
(In thousands, except per share data)
Twelve Months Ended December 31,
Statement of Income Data
2020
2019
2018
2017
2016
Net sales
$
1,229,215
$
1,249,130
$
1,213,989
$
1,054,204
$
942,162
Income from operations
134,332
200,608
154,482
79,409
37,991
Net income (loss) attributable to common stockholders
98,088
153,250
104,021
(1,805
)
15,935
Earnings (loss) per share attributable to common stockholders
Basic
$
1.92
$
3.02
$
2.09
$
(0.04
)
$
0.33
Diluted
$
1.88
$
2.96
$
2.04
$
(0.04
)
$
0.32
Number of shares used in computation:
Basic
51,004
50,787
49,841
48,824
48,597
Diluted
52,133
51,860
50,935
48,824
49,789
As of December 31,
Balance Sheet Data
2020
2019
2018
2017
2016
Total assets
$
1,979,457
$
1,639,384
$
1,526,371
$
1,488,673
$
1,528,552
Working capital
514,225
524,637
480,814
415,162
547,409
Long-term debt, net of current portion
288,179
64,401
186,143
247,492
413,126
Total Diodes Incorporated stockholders' equity
963,820
1,106,424
931,463
831,504
776,019
Twelve Months Ended December 31,
Cash Flow Data
2020
2019
2018
2017
2016
Net cash and cash equivalents provided by operating activities
$
187,220
$
229,772
$
185,566
$
181,123
$
124,742
Capital expenditures
$
75,813
98,505
87,507
111,161
58,549
In addition, during the periods presented we made the following acquisitions considered significant to our operations (a) in 2020 we acquired LSC and (b) in 2019 we acquired GFAB.
36 -
Ite m 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following section discusses management’s view of the financial condition, results of operations and cash flows of Diodes Incorporated and its subsidiaries (collectively, “the Company,” “our Company,” “we,” “our,” “ours,” or “us”) and should be read together with the consolidated financial statements and the notes to consolidated financial statements included elsewhere in this Form 10-K.
The following discussion contains forward-looking statements and information relating to our Company. We generally identify forward-looking statements by the use of terminology such as “may,” “will,” “could,” “should,” “potential,” “continue,” “expect,” “intend,” “plan,” “estimate,” “anticipate,” “believe,” “project,” or similar phrases or the negatives of such terms. We base these statements on our beliefs as well as assumptions we made using information currently available to us. Such statements are subject to risks, uncertainties and assumptions, including those identified in Part I, Item 1A.“Risk Factors,” as well as other matters not yet known to us or not currently considered material by us. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. Given these risks and uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements. Forward-looking statements do not guarantee future performance and should not be considered as statements of fact.
You should not unduly rely on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise. The Private Securities Litigation Reform Act of 1995 (the “Act”) provides certain “safe harbor” provisions for forward-looking statements. All forward-looking statements made in this Annual Report on Form 10-K are made pursuant to the Act.
This discussion and analysis does not address certain items in respect of fiscal 2018 in reliance on amendments to disclosure requirements adopted by the SEC in 2019. A discussion and analysis of fiscal 2018 may be found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 12, 2020 , and such discussion and analysis is hereby incorporated into this Form 10-K by this reference .
Summary for the Twelve Months Ended December 31, 2020
•
Revenue was $1.23 billion, a decrease of 1.6% over the $1.25 billion in 2019;
•
Gross profit was $431.1 million, a 7.4% decrease, compared to the $465.8 million in 2019;
•
Gross margin was 35.1% , a decrease of 220 basis points, compared to 37.3% in 2019;
•
Operating income decreased 33.0% to $134.3 million, or 10.9% of revenue, compared to $200.6 million, or 16.1%, of revenue in 2019;
•
Net income was a $98.1 million, or $1.88 per diluted share, compared to $153.3 million, or $2.96 per share, in 2019; and
•
Achieved $187.2 million cash flow from operations. We had $75.8 million of capital expenditures, or 6.2% of revenue. Net cash flow was a positive $61.0 million.
Summary of the Twelve Months Ended December 31, 2019
•
Revenue grew to a record $1.25 billion, an increase of 2.9% over the $1.21 billion in 2018;
•
Gross profit was a record $465.8 million, a 7.0% increase, compared to the $435.3 million in 2018;
•
Gross margin improved 140 basis points to a record 37.3% from 35.9% in 2018;
•
Operating income increased 29.9% to a record $200.6 million, or 16.1% of revenue, compared to $154.5 million, or 12.7%, of revenue in 2018;
•
Net income was a record $153.3 million, or $2.96 per diluted share, compared to $104.0 million, or $2.04 per share, in 2018; and
•
Achieved $229.8 million cash flow from operations. We had $98.5 million of capital expenditures, or 7.9% of revenue. Net cash flow was a positive $17.7 million, which includes the net pay down of $117.3 million of long-term debt.
37 -
Business Outlook and Factors Relevant to Our Results of Operations
In spite of the negative impact COVID-19 had on our fiscal year 2020 results, we continue to pursue our previously announced goals of achieving revenue of $2.5 billion and gross margin of 40%, representing gross profit of $1.0 billion, all by 2025. Acquisitions will continue to be a key part of our growth strategy to reach our 2025 revenue goal. We have a solid pipeline of designs and expanded customer relationships across all regions and product lines. The success of our business depends on, among other factors, the strength of the global economy and the stability of the financial markets, our customers’ demand for our products, the ability of our customers to meet their payment obligations, the likelihood of customers not canceling or deferring existing orders, and the strength of consumers’ demand for items containing our products in the end-markets we serve. We believe the long-term outlook for our business remains generally favorable despite the uncertainties in the global economy as we continue to execute on the strategy that has proven successful for us over the years. In November 2020, the Company completed the acquisition of LSC and in April 2019, we completed the acquisition of GFAB . See “Risk Factors – The success of our business depends on the strength of the global economy and the stability of the financial markets, and any weaknesses in these areas may have a material adverse effect on our net sales, operating results and financial condition.” in Part I, Item 1A of this Annual Report for additional information.
Description of Sales and Expenses
Net sales
The principal factors that have affected or could affect our net sales from period to period are:
•
The condition of the economy in general and of the semiconductor industry in particular;
•
Political tension, including the implementation of tariffs, among and between the countries in which we do business;
•
Our customers’ adjustments in their order levels;
•
Changes in our pricing policies or the pricing policies of our competitors or suppliers;
•
The addition or termination of key supplier relationships;
•
The rate of introduction and acceptance by our customers of new products;
•
Our ability to compete effectively with our current and future competitors;
•
Our ability to enter into and renew key corporate and strategic relationships with our customers, vendors and strategic alliances;
•
Changes in foreign currency exchange rates;
•
A major disruption of our information technology infrastructure;
•
Unforeseen catastrophic events, such as armed conflict, terrorism, fires, typhoons and earthquakes; and
•
Any other disruptions, such as change in the political or governmental policies, labor shortages, unplanned maintenance or other manufacturing problems.
Cost of goods sold
Cost of goods sold includes manufacturing costs for our semiconductors and our wafers. These costs include raw materials used in our manufacturing processes as well as labor costs and overhead expenses. Cost of goods sold is also impacted by yield improvements, capacity utilization and manufacturing efficiencies. In addition, cost of goods sold includes the cost of products that we purchase from other manufacturers and sell to our customers. Cost of goods sold is also affected by inventory obsolescence if our inventory management is not efficient.
Selling, general and administrative
Selling, general and administrative expenses relate primarily to compensation and associated expenses for personnel in general management, sales and marketing, information technology, engineering, human resources, procurement, planning and finance, and sales commissions, as well as outside legal, investor relations, accounting, consulting and other operating expenses. Also included in selling, general and administrative expenses are acquisition costs from business combinations.
Research and development
Research and development expenses consist of compensation and associated costs of employees engaged in research and development projects, as well as materials and equipment used for these projects. Research and development expenses are primarily associated with our wafer facilities in China and the U.K. and our manufacturing facilities in Taiwan and China, as well as with our engineers in the China, U.K., U.S. and Taiwan. All research and development expenses are expensed as incurred.
38 -
Amortization of acquisition-related intangible assets
Amortization of acquisition-related intangible assets consists of assets such as developed technologies and customer relationships.
Impairment of fixed assets
Impairment of fixed assets consists of the impairment amount recognized as a result of the fair value of an asset being below its recorded value.
Restructuring
Restructuring are one-time charges that must be paid by the Company due to reorganizing or restructuring a part of the business.
Interest income / expense
Interest income consists of interest earned on our cash and investment balances. Interest expense consists of interest payable on our outstanding credit facilities and other debt instruments.
Gain (loss) on securities carried at fair value
We may hold investments in the form of common stock or some other similar equivalent and have elected fair value accounting treatment.
Foreign currency (loss) gain, net
This income account is used to show the amount gained or lost as a result of foreign currency transactions.
Income tax provision
Our global presence requires us to pay income taxes in a number of jurisdictions. See Note 12 of “Notes to Consolidated Financial Statements” for additional information.
Net income attributable to noncontrolling interest
This represents the minority investors’ share of our subsidiaries’ earnings.
Net income attributable to common stockholders
Net income attributable to common stockholders is net income less net income attributable to noncontrolling interest.
Results of Operations
The following table sets forth, for the periods indicated, the percentage that certain items in the statements of income bear to net sales:
Percent of Net Sales
Twelve Months Ended December 31,
2020
2019
Net sales
100.0
%
100.0
%
Cost of goods sold
(64.9
)
(62.7
)
Gross profit
35.1
37.3
Operating expenses
(24.1
)
(21.2
)
Income from operations
10.9
16.1
Interest income
0.1
0.2
Interest expense
(1.0
)
(0.6
)
Foreign currency (loss) gain, net
(0.8
)
(0.3
)
Other income (expenses)
0.5
0.6
Income before income taxes and noncontrolling interest
9.8
15.9
Income tax provision
1.7
3.5
Net income
8.1
12.3
Net (income) loss attributable to noncontrolling interest
(0.1
)
(0.1
)
Net income attributable to common stockholders
8.0
12.3
The following discussion explains in greater detail our consolidated operating results and financial condition. This discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Annual Report (in thousands) .
39 -
Twelve Months Ended
December 31,
2020
2019
Increase/(Decrease)
% Change
Net sales
$
1,229,215
$
1,249,130
$
(19,915
)
(1.6
%)
Cost of goods sold
798,094
783,323
14,771
1.9
%
Gross profit
431,121
465,807
(34,686
)
(7.4
%)
Operating expenses
Selling, general and administrative
185,067
181,343
3,724
2.1
%
Research and development
94,288
88,517
5,771
6.5
%
Amortization of acquisition-related intangible assets
16,261
18,041
(1,780
)
(9.9
%)
Loss (gain) on disposal of fixed assets
106
(24,429
)
24,535
(100.4
%)
Other operating income
1,067
1,727
660
38.2
%
Other income (expense)
Interest income
1,066
2,189
(1,123
)
(51.3
%)
Interest expense
(11,662
)
(7,893
)
3,769
47.8
%
Foreign currency loss
(9,814
)
(3,737
)
6,077
162.6
%
Other income
6,419
7,079
(660
)
(9.3
%)
Income tax provision
21,112
44,131
(23,019
)
(52.2
%)
Net Sales
Net sales decreased for the twelve months ended December 31, 2020, compared to the same period last year due to the negative effect of COVID-19 on the global economy and our business. This decrease in net sales was partially offset by $ 16 .9 million of net sales from LSC.
The table below sets forth our revenue as a percentage of total revenue by end-user market:
Twelve Months Ended
December 31,
2020
2019
2018
Industrial
23
%
28
%
26
%
Consumer electronics
25
%
23
%
25
%
Communications
21
%
23
%
24
%
Computing
20
%
16
%
17
%
Automotive
11
%
10
%
9
%
Cost of Goods Sold
Cost of goods sold increased approximately $14.8 million for the twelve months ended December 31, 2020 compared to the same period last year, primarily as a result of operations at GFAB for four quarters of 2020 compared to three quarters of 2019 and the one month of operations at LSC during 2020. As a percent of sales, cost of goods sold was 64.9% for the twelve months ended December 31, 2020, compared to 62.7% for the same period last year. Average unit cost increased 1.5% for the twelve months ended December 31, 2020, compared to the same period last year, due to lower capacity utilization for the year, driven by COVID-19 pandemic related manufacturing plant closures and the associated slowdown in customer demand in early 2020. For the twelve months ended December 31, 2020, gross profit decreased approximately 7.4% when compared to the same period last year. Gross profit margin for the twelve month periods ended December 31, 2020 and 2019, was 35.1% and 37.3%, respectively.
Operating expenses
Operating expenses for the twelve months ended December 31, 2020 increased approximately $31.6 million, or 11.9%, compared to the same period last year. A significant contributing factor to the increase in 2020 compared to 2019 was a $24.3 million one-time gain we realized in 2019 upon selling land. The land was acquired in past years in anticipation of building a new corporate headquarters building in Texas. Selling, general and administrative expenses (“SG&A”) increased approximately $3.7 million. The increase in SG&A was driven by increases in wages and benefits and freight and duty charges, partially offset by reductions in travel and entertainment expenses. Research and development expenses (“R&D”) increased approximately $5.8 million primarily due to increases in wages and benefits and depreciation, associated with new product and new process development activities. Amortization of acquisition-related intangibles decreased approximately $1.8 million reflecting the overall reduction in the balance of intangible assets subject to amortization. SG&A, as a percentage of sales, was 15.1% and 14.5% for the twelve-month periods ended December 31, 2020 and 2019, respectively. R&D, as a percentage of sales, was 7.7% and 7.1% for the twelve-month periods ended December 31, 2020 and 2019, respectively.
40 -
Other (expense)/income
Interest income decreased $1.1 million for the twelve months ended December 31, 2020, due to a lower amount of invested funds. Interest expense increased $3.8 million or 47.8% for the twelve months ended December 31, 2020. The increase in interest expense for the twelve months ended December 31, 2020 was due to higher levels of debt resulting from the draws on our U.S. credit facility to finance the closing of the LSC acquisition. The increase in interest expense due to higher levels of debt was partially offset by lower interest rates. Foreign currency losses increased $6.1 million during the twelve months ended December 31, 2020.
Income tax provision
We recognized income tax expense of approximately $21.1 million for the twelve months ended December 31, 2020, and income tax expense of approximately $44.1 million for the twelve months ended December 31, 2019, resulting in effective income tax rates of 17.5 % and 22.3%, respectively. The decrease in the effective tax rate for 2020 compared to 2019 is primarily attributable to decrease in non-U.S. withholding taxes. Our undistributed foreign earnings continue to be indefinitely reinvested in foreign operations, with limited exceptions related to earnings of European and Asian subsidiaries. Any future distributions of foreign earnings will not be subject to additional U.S. income tax, but may be subject to foreign withholding taxes. As of December 31, 2020, our foreign subsidiaries held approximately $267 million of cash, cash equivalents and investments of which approximately $9.5 million would be subject to foreign withholding tax if distributed outside the country in which the related earnings were generated.
Financial Condition
Liquidity and Capital Resources
Our primary sources of liquidity are cash and cash equivalents, short-term investments, funds from operations and, if necessary, borrowings under our credit facilities.
Liquidity requirements
Our primary liquidity requirements have been to meet our capital expenditure needs and to fund ongoing operations. For 2020 and 2019 our working capital was $514.2 million and $524.6 million, respectively. In 2020, our working capital decreased due to increases in short-term debt and other current liabilities assumed as a result of the LSC acquisition. We expect cash generated by our operations together with existing cash, cash equivalents, short-term investments and available credit facilities to be sufficient to satisfy our working capital needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations for at least the next 12 months.
Short-term investments
As of December 31, 2020, we had short-term investments of approximately $6.1 million. These investments are highly liquid with maturity dates greater than three months at the date of purchase. We generally can access these investments in a relatively short amount of time but in doing so we generally forfeit a portion of interest income.
Short-term debt
Our Asia subsidiaries maintain credit facilities with several financial institutions through our foreign entities worldwide totaling $307.1 million. At December 31, 2020, borrowings were $140.6 million and letters of credit were $0.5 million under our Asia credit facilities. Other than two Taiwanese credit facilities that are collateralized by assets, our foreign credit lines are unsecured, uncommitted, repayable on demand, terminable by the lender at any time and contain no restrictive covenants. These credit facilities bear interest at LIBOR or similar indices plus a specified margin. Interest payments are due monthly on outstanding amounts under the credit lines.
Long-term debt
On May 29, 2020, the Company, Diodes Holding B.V. (the “Foreign Borrower” and, collectively with the Company, the “Borrowers”), and certain subsidiaries of the Company as guarantors, entered into a Second Amended and Restated Credit Agreement (the “Second Amended and Restated Credit Agreement”) that amends and restates that certain Amended and Restated Credit Agreement dated as of October 26, 2016 (as amended, modified and/or supplemented from time to time prior to May 29, 2020, the “Existing Credit Agreement”). On December 31, 2020, Diodes Holding B.V. merged into Diodes Holdings UK Limited, which following the merger became the Foreign Borrower under the Credit Agreement, and in connection with the merger, the parties to the Second Amended and Restated Credit Agreement entered into a Consent and Amendment No. 2 to Second Amended and Restated Credit Agreement (“Consent and Amendment No. 2”; the Second Amended and Restated Credit Agreement as amended by Consent and Amendment No. 2 is referred to as the “Credit Agreement”). Certain capitalized terms used in this description of the Credit Agreement have the meanings given to them in the Credit Agreement, the current form of which is set forth in Exhibit A to Consent and Amendment No. 2, which is attached as an exhibit to this report. The Company analyzed the amendment and restatement of the Existing Credit Agreement pursuant to the guidance in ASC No. 470-50, Debt—Modifications and Extinguishments. The Company determined that certain lenders had changes in cash flows which were substantially different as a result of the amendment and
41 -
restatement of the Existing Credit Agreement, which resulted in a debt extinguishment of $52.2 million and a loss on extinguishment and third-party fees of $0.7 million being expensed in the nine-month period ended September 30, 2020.
The Second Amended and Restated Credit Agreement rebalanced the Company’s then-existing senior credit facilities under the Existing Credit Agreement from (x) aggregate credit facilities of $500,000,000, consisting of (A) a $250,000,000 revolving senior credit facility, which included a $10,000,000 swing line sublimit, a $10,000,000 letter of credit sublimit, and a $20,000,000 alternative currency sublimit, and (B) a $250,000,000 term loan to (y) aggregate credit facilities of $670,000,000 consisting of (A) an acquisition draw term commitment of $340,000,000 (the “Acquisition Draw Term Commitment”), (B) an initial term commitment of $180,000,000 (the “Initial Term Commitment” and, together with the Acquisition Draw Term Commitment, the “Term Loan”) and (C) a $150,000,000 revolving senior credit facility (the “Revolver”), which includes a $20,000,000 uncommitted swing line sublimit, a $10,000,000 letter of credit sublimit, and a $40,000,000 alternative currency sublimit.
The Revolver and the Term Loan mature on May 29, 2023 (the “Maturity Date”). Both the term loan portion and the revolving portion of the Credit Agreement bear an interest rate at LIBOR or similar other indices plus a specified margin. The Company used a portion of the proceeds available under the Revolver and the Term Loan (i) to finance the Company’s acquisition of Lite-On Semiconductor Corporation, which is described more fully elsewhere in this report, (ii) to refinance certain existing indebtedness of the Borrowers and their subsidiaries under the Existing Credit Agreement and (iii) for working capital, capital expenditures, and other lawful corporate purposes, including, without limitation, financing permitted acquisitions.
The Credit Agreement contains certain financial and non-financial covenants, including, but not limited to, a maximum Consolidated Leverage Ratio, a minimum Consolidated Fixed Charge Coverage Ratio, and restrictions on liens, indebtedness, investments, fundamental changes, dispositions, and restricted payments (including dividends and share repurchases). These covenants are generally similar to the corresponding covenants in the Existing Credit Agreement, except that certain amounts permitted as exceptions to negative covenants restricting liens, indebtedness, investments, dispositions and restricted payments have been revised, and additional exceptions to certain negative covenants have been added, including increased capacity for certain intercompany Indebtedness and Investment (including existing Lite-On Indebtedness), and the right to enter into certain securitization transactions and receivables facilities, subject to limitations set forth in the Credit Agreement. Furthermore, under the Credit Agreement, restricted payments, including dividends and share repurchases, are permitted in certain circumstances, including while the pro forma Consolidated Leverage Ratio is, both before and after giving effect to any such restricted payment, at least 0.25 to 1.00 less than the maximum permitted under the Credit Agreement.
Capital expenditures and investments
In 2020 and 2019, our capital expenditures were approximately $75.8 million and $96.2 million, respectively, which includes approximately $15.4 million and $9.3 million of capital expenditures related to the investment agreement with the Management Committee of the Chengdu Hi-Tech Industrial Development Zone (the “CDHT”) for 2020 and 2019, respectively. Our capital expenditures for these periods were primarily related to manufacturing expansion in our facilities in China and, to a lesser extent, our office buildings. Capital expenditures in 2020 were approximately 6.2% of our net sales.
In 2010, we announced an investment agreement with the Management Committee of the CDHT. Under this agreement, we formed a joint venture with a Chinese partner, Chengdu Ya Guang Electronic Company Limited (“Ya Guang”), to establish a semiconductor assembly and test facility in Chengdu, China. In December 2016, we increased our investment and currently own approximately 98% of the joint venture entity. The CDHT granted the joint venture a 50 year land lease, provides corporate and employee tax incentives, tax refunds, subsidies and other financial support. We believe that this will be a long-term, multi-year project that will provide us additional capacity as needed. As of December 31, 2020, we have invested $193.7 million in this joint venture, primarily for infrastructure, buildings and equipment related capital expenditures.
The Company’s restricted cash primarily consisted of the cash required to be on deposit under contractual agreements with banks to support outstanding loan and import/export guarantees. As of December 31, 2020, restricted cash of $52.5 million was pledged as collateral for issuance of bank loans, bank acceptance notes and letters of credit.
Our foreign operations expose us to unique intellectual property technology risks compared to a company with fewer or no international operations. For example, we are exposed to potential cyber security breaches that may target our employees or infrastructure outside the United States. These risks may result in material and adverse impacts on our financial condition and results of operations. See “Risk Factors – Risks Related to Our International Operations” in Part I, Item 1A of this Annual Report for a more detailed summary of the intellectual property technology risks associated with our international business operations.
42 -
Discussion of Cash Flows
Cash and cash equivalents, including restricted cash, increased approximately $61.0 million to $320.5 million in 2020 from $259.5 million in 2019. The table below sets forth summary information from our statements of cash flows:
Twelve Months Ended December 31,
2020
2019
Change
Net cash provided by operating activities
$
187,220
$
229,772
$
(42,552
)
Net cash used in investing activities
(106,772
)
(100,426
)
(6,346
)
Net cash used in financing activities
(54,302
)
(112,432
)
58,130
Effect of exchange rates on cash and cash equivalents,
including restricted cash
34,876
760
34,116
Net increase in cash and cash equivalents, including restricted cash
$
61,022
$
17,674
$
43,348
Operating Activities
Net cash provided by operating activities for 2020 was approximately $187.2 million, due primarily to $99.2 million of net income, $108.0 million in depreciation and amortization of intangible assets and $25.3 million from non-cash share-based compensation. These increases were partially offset by a decrease in deferred taxes of $14.5 million, and a net decrease in operating capital assets and liabilities of $31.4 million.
Investing Activities
Net cash used in investing activities for 2020 was approximately $106.8 million, due to the purchase of property, plant and equipment of $75.8 million, acquisitions net of cash acquired of $24.6 million, primarily LSC, and $6.1 used for purchase of equity securities.
Financing Activities
Net cash used in financing activities for 2020 was approximately $54.3 million, due $296.8 million related to the Diodes shares reacquired in connection with the LSC acquisition and the payment of taxes on net share settlement of $8.3 million. These outflows of cash were partially offset by an inflow form a net increase in borrowing of $249.1 million to close the LSC acquisition.
Debt instruments
The U.S. credit facility contains certain financial and non-financial covenants, including, but not limited to, a maximum consolidated leverage ratio, a minimum consolidated fixed charge coverage ratio, and restrictions on liens, indebtedness, investments, fundamental changes, dispositions, and restricted payments (including dividends and share repurchases).
As of December 31, 2020, our Asia subsidiaries had unused and available credit lines of up to an aggregate of approximately $166.0 million, with several financial institutions. In some cases, our foreign credit lines are unsecured, uncommitted and may be repayable on demand, except for two Taiwanese credit facilities that are collateralized by assets. Our foreign credit lines bear interest at LIBOR or similar indices plus a specified margin. At December 31, 2020, $140.6 million was outstanding under these lines of credit. In addition to our credit lines, our 51% owned subsidiary, ERIS Technology Corporation (“ERIS”), has long-term debt of $30.0 million on a long-term basis from local Taiwan banks. The ERIS debt matures in various periods from 2021 through 2033. See “Liquidity and Capital Resources” above and Note 8 of “Notes to Consolidated Financial Statements” of this Annual Report for additional information.
Off-Balance Sheet Arrangements
We do not have any transactions, arrangements and other relationships with unconsolidated entities that will affect our liquidity or capital resources. We have no special purpose entities that provided off-balance sheet financing, liquidity or market or credit risk support, nor do we engage in leasing, hedging or research and development services, that could expose us to liability that is not reflected on the face of our financial statements.
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Contractual Obligations
The following table represents our contractual obligations as of December 31, 2020 (in thousands):
Less than
More than
Total
1 year
1-3 years
4-5 years
5 years
Debt
$
312,247
$
21,861
$
272,514
$
17,872
$
-
Interest on long-term debt 1
22,810
8,048
14,551
211
-
Operating leases
44,795
11,842
15,618
6,101
11,234
Finance leases
175
151
21
3
-
Defined benefit contribution obligations
24,031
3,004
6,008
6,008
9,011
Purchase obligations
74,911
74,911
-
-
-
Total obligations
$
478,969
$
119,817
$
308,712
$
30,195
$
20,245
(1)
Interest on long-term debt assumes there are no changes in current interest rates and no changes in long-term debt from the balance outstanding as of December 31, 2020, other than required principal payments. The Revolver and Term Loan mature in May 2023.
Tax liabilities are not included in the above contractual obligations as we cannot make reasonable estimates of the amount and period in which those tax liabilities would be paid. See “Accounting for income taxes” below and Note 12 of “Notes to Consolidated Financial Statements” of this Annual Report for additional information. In addition to these purchase commitments, we have been party to an agreement in which we were obligated to make equity investments and capital investments in our Chengdu facilities. That agreement is expired, but we anticipate renewing it later in 2021.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally accepted principles in the United States of American (“U.S. GAAP”) requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, which are based upon historical experiences, market trends and financial forecasts and projections, and upon various assumptions that management believes to be reasonable under the circumstances at that certain point in time. Actual results may differ, significantly at times, from these estimates under different assumptions or conditions.
We believe the following critical accounting policies and estimates affect the significant estimates and judgments we use in the preparation of our consolidated financial statements, and may involve a higher degree of judgment and complexity than others.
Revenue recognition
We generate revenue primarily through the sale of semiconductor products either directly to a customer or to a distributor. We typically have contracts with our direct customers and distributors and in determining whether a contract exists we evaluate the terms of the agreement, the relationship with the direct customer or distributor and their ability to pay.
Under revenue recognition guidance, a performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is considered the unit of account. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Generally speaking, our primary performance obligation is the delivery of a specific good through the purchase order submitted by our customer and revenue is recognized at the time of shipment or delivery, depending on the contract terms.
We record allowances/reserves for the following items: (i) ship and debit, which arise when we, from time to time based on market conditions, issue credit to certain distributors upon their shipments to their end customers; (ii) stock rotation, which are contractual obligations that permit certain distributors, up to four times a year, to return a portion of their inventory based on historical shipments to them in exchange for an equal and offsetting order; and (iii) price protection, which arise when market conditions cause average selling prices to decrease and we issue credit to certain distributors on their inventory. Ship and debit accruals comprise both claims in process and anticipated claims arising from the eventual sale of distribution inventory that is subject to claim activity. Ship and debit reserves are recorded as a reduction to net sales with a corresponding reduction to accounts receivable. Stock rotation reserves are recorded as a reduction to net sales with a corresponding reduction to cost of goods sold for the estimated cost of inventory that is expected to be returned. Price protection reserves are recorded as a reduction to net sales with a corresponding increase in accrued liabilities.
We also assess our customer’s ability and intention to pay, which is based on a variety of factors including our customer’s historical payment experience, their financial condition and the condition of the global economy and financial markets. Payment terms and conditions typically vary depending on negotiations with the customer.
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Certain customers have limited rights of return or are entitled to price adjustments on products held in their inventory or upon sale to their end customers. We reduce net sales in the period of sale for estimates of product returns, distributor price adjustments and other allowances. Our reserve estimates are based upon historical data as well as projections of sales, distributor inventories, price adjustments, average selling prices and market conditions. Actual returns and adjustments could be significantly different from our estimates and provisions, resulting in an adjustment to net sales.
Inventories
Inventories are stated at the lower of cost or net realizable value. Cost is determined principally by the first-in, first-out method. On an ongoing basis, we evaluate our inventory for obsolescence and slow-moving items. This evaluation includes analysis of sales levels, sales projections, and purchases by item, as well as raw material usage related to our manufacturing facilities. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis. If future demand or market conditions are different than our current estimates, an inventory adjustment may be required, and would be reflected in cost of goods sold in the period the revision is made.
Accounting for income taxes
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the tax jurisdictions in which we operate. This process involves using an asset and liability approach whereby deferred tax assets and liabilities are recorded for differences in the financial reporting bases and tax bases of our assets and liabilities. A valuation allowance is provided against deferred tax assets unless it is more likely than not that such deferred tax assets will be realized. This analysis requires considerable judgment and is subject to change to reflect future events and changes in the tax laws.
The benefit of a tax position is recognized only if it is more likely than not that the tax position would be sustained based on its technical merits in a tax examination, using the presumption the tax authority has full knowledge of all relevant facts regarding the position. The amount of benefit recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on ultimate settlement with the tax authority. For tax positions not meeting the more likely than not test, no tax benefit is recorded.
Goodwill and other indefinite lived intangible assets
Goodwill and other indefinite lived assets are tested for impairment on an annual basis or when an event or changes in circumstances indicate that its carrying value may not be recoverable. Goodwill impairment is tested at the reporting unit level, which is defined as an operating segment or one level below the operating segment. Diodes has one operating segment. Goodwill is reviewed for impairment using either a qualitative assessment or a quantitative goodwill impairment test. If we choose to perform a qualitative assessment and determine the fair value more likely than not exceeds the carrying value, no further evaluation is necessary. When we perform the quantitative goodwill impairment test, we compare fair value to carrying value, which includes goodwill. If fair value of exceeds carrying value, the goodwill is not considered impaired. If the carrying value is higher than the fair value, the difference would be recognized as an impairment loss.
Business Combinations
We account for acquired businesses using the acquisition method of accounting, which requires that once control of a business is obtained, 100% of the assets acquired and liabilities assumed, including amounts attributed to noncontrolling interests, be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.
For significant acquisitions we may use independent third-party valuation specialists to assist us in determining the fair value of assets acquired and liabilities assumed.
Significant judgment is often required in estimating the fair value of assets acquired and liabilities assumed. The Company makes estimates and assumptions about conditions of the assets, other costs not captured in the base costs, and consideration for entrepreneurial profit, depreciation, functional obsolescence, and economic obsolescence allocated to the various property, plant and equipment categories considering the perspective of marketplace participants.
While management believes those expectations and assumptions are reasonable, they are inherently uncertain. Unanticipated market or macroeconomic events and circumstances may occur, which could affect the accuracy or validity of the estimates and assumptions, which could result in subsequent impairments.
Recently Issued Accounting Pronouncements
See Note 1 of “Notes to Consolidated Financial Statements” of this Annual Report for additional information regarding the status of recently issued accounting pronouncements.
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Ite m 7A.
Quantitative and Qualitative Disclosures About Market Risk.
Foreign Currency Risk
We face exposure to adverse movements in foreign currency exchange rates, primarily in Asia and Europe. Our foreign currency risk may change over time as the level of activity in foreign markets grows and could have a material adverse impact upon our financial results. Certain of our assets, including certain bank accounts and accounts receivable, and liabilities exist in non–U.S. dollar denominated currencies, which are sensitive to foreign currency exchange fluctuations. These currencies are principally the Chinese Yuan, the Taiwanese dollar, the Euro, and the British Pound Sterling and, to a lesser extent, the Japanese Yen and the Hong Kong dollar. We have entered into hedging arrangements designed to mitigate foreign currency fluctuations. See “Risk Factors – We are subject to foreign currency risk as a result of our international operations.” in Part I, Item 1A of this Annual Report for additional information.
Foreign Currency Transaction Risk
We are subject to foreign currency risk arising from intercompany transactions that are expected to be settled in cash in the near term where the cash balances are held in denominations other than our subsidiaries’ functional currency. If exchange rates weaken against the functional currency, we would incur a remeasurement gain in the value of the cash balances, and if the exchange rates strengthen against the functional currency, we would incur a remeasurement loss in the value of the cash balances, assuming the net monetary asset balances remained constant. Our ultimate realized gain or loss with respect to currency fluctuations will generally depend on the size and type of transaction, the size and currencies of the net monetary assets and the changes in the exchange rates associated with these currencies. Based on balances at December, 31, 2020, if the Chinese Yuan, the Taiwanese dollar, the Euro and the British Pound Sterling were to weaken (or strengthen) by 1.0% against the U.S. dollar, we would experience currency transaction gain (or loss) of approximately $2.4 million (partially offset by any foreign currency hedges). Net foreign exchange transaction gains (or losses) are included in other income and expense.
Foreign Currency Translation Risk
For our subsidiaries that maintain their books in a foreign currency, fluctuations in that foreign currency will impact the amount of total assets and liabilities that we report for our foreign subsidiaries upon the translation of these amounts into U.S. dollars. All elements of the subsidiaries’ financial statements, except for stockholders’ equity accounts, are translated using a currency exchange rate. Assets and liabilities denominated in foreign currencies are translated at the exchange rate on the balance sheet date. Income and expense accounts denominated in foreign currencies are translated at the weighted-average exchange rate during the period presented. Resulting translation adjustments are recorded as a separate component of accumulated other comprehensive income or loss within stockholders’ equity in the consolidated balance sheets, which are accumulated in this account until sale or liquidation of the foreign entity investment, at which time they are reported as adjustments to the gain or loss on sale of investment.
Foreign Currency Denominated Defined Benefit Plans
We have a contributory defined benefit plan that covers certain employees in the U.K., which is closed to new entrants and frozen with respect to future benefit accruals. The retirement benefit is based on the final average compensation and service of each eligible employee. December 31 is our annual measurement date, and on the measurement date, defined benefit plan assets are determined based on fair value. Defined benefit plan assets consist primarily of high quality corporate bonds and stocks that are denominated in the currency in which the benefits will be paid and that have terms to maturity approximating to the terms of the related pension liability. The net pension and supplemental retirement benefit obligations and the related periodic costs are based on, among other things, assumptions of the discount rate, estimated return on plan assets and mortality rates. These obligations and related periodic costs are measured using actuarial techniques and assumptions. The projected unit credit method is the actuarial cost method used to compute the pension liabilities and related expenses.
As of December 31, 2020, the plan was underfunded and a liability of approximately $27.4 million was reflected in our consolidated financial statements as a noncurrent liability. The amount recognized in accumulated other comprehensive income was a net loss of $50.3 million. If the British Pound Sterling were to (weaken) or strengthen by 1.0% against the U.S. dollar, we would experience currency translation liability (decrease) or increase of less than $0.5 million. The weighted-average discount rate assumption used to determine benefit obligations as of December 31, 2020, was 1.3%. A 0.2% increase/(decrease) in the discount rate used to calculate the net period benefit cost for the year would reduce/increase annual benefit cost by less than $0.5 million. A 0.2% increase/(decrease) in the discount rate used to calculate the year-end projected benefit obligation would increase/(decrease) the year–end projected benefit obligation by approximately $7.1 million. The expected return on plan assets is determined based on historical and expected future returns of the various assets classes and as such, each 1.0% increase/(decrease) in the expected rate of return assumption would increase/(decrease) the net period benefit cost by approximately $1.3 million. The asset value of the defined benefit plan has been volatile in recent years due primarily to wide fluctuations in the U.K. equity markets and bond markets. See “Risk Factors – Changes in actuarial assumptions for our defined benefit plan could increase the volatility of the plan’s asset value, require us to increase cash contributions to the plan and have a negative impact on our cash flows, operating results and financial condition ” in Part I, Item 1A of this Annual Report for additional information.
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Interest Rate Risk
We have credit facilities with financial institutions in the U.S., Asia and Europe as well as other debt instruments with interest rates equal to LIBOR or similar indices plus a negotiated margin. A rise in interest rates could have an adverse impact upon our cost of working capital and our interest expense. Through the use of financial instruments, we have hedges in place designed to offset the interest rate risk for $140.0 million of floating rate debt. As a matter of policy, we do not enter into derivative transactions for speculative purposes. As of December 31, 2020, our outstanding principal debt included $282.3 million outstanding under our revolving senior credit facility and term loan, $140.6 million outstanding under foreign long term liabilities and $0.5 million used for import and export guarantees and bank acceptance notes. Based on our debt balances at December, 31, 2020, an increase or decrease in interest rates by 1.0% for the year on our credit facilities would increase or decrease our annual interest rate expense by less than $1.7 million, net of the amounts realized from our interest rate swaps. See “Risk Factors,” – “ We are subject to interest rate risk that could have an adverse effect on our cost of working capital and interest expenses, which could adversely affect our business, operating results and financial condition” in Part I, Item 1A of this Annual Report for additional information.
Political Risk
We have a significant portion of our assets in mainland China, Taiwan and the U.K. The possibility of political conflict between any of these countries or with the U.S. could have a material adverse impact upon our ability to transact business through these important business channels and to generate profits. See “Risk Factors” – Risks Related to our International Operations” in Part I, Item 1A of this Annual Report for additional information.
Inflation Risk
Inflation did not have a material effect on net sales or net income in fiscal year 2019. A significant increase in inflation could affect future performance.
Credit Risk
The success of our business depends, among other factors, on the strength of the global economy and the stability of the financial markets, which in turn affect our customers’ demand for our products, the ability of our customers to meet their payment obligations, the likelihood of customers canceling or deferring existing orders and the strength of consumer demand for items containing our products in the end-markets we serve. We provide credit to customers in the ordinary course of business and perform ongoing credit evaluations, while at times providing extended terms. We believe that our exposure to concentrations of credit risk with respect to trade receivables is largely mitigated by dispersion of our customers over various geographic areas, operating primarily in electronics manufacturing and distribution. We believe our allowance for doubtful accounts is sufficient to cover customer credit risks.
Item 8. Financial Statements and Supplementary Data.
See Part IV, Item 15 “Exhibits and Financial Statement Schedules” for our consolidated financial statements and the notes and schedules thereto filed as part of this Annual Report.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
Not Applicable.