| DIODES INC /DEL/ Item 1A Risk Factors RISKS RELATED TO OUR BUSINESS Downturns in the highly cyclical semiconductor industry or changes in end-market demand could affect our operating results and financial condition |
| The semiconductor industry is highly cyclical, and periodically experiences significant economic downturns characterized by diminished product demand, production overcapacity and excess inventory, which can result in rapid erosion in average selling prices |
| For example, beginning in the fourth quarter of 2000 and continuing into 2003, the semiconductor industry experienced order cancellations and reduced demand for products, resulting in significant revenue declines, due to excess inventories at computer and telecommunications equipment manufacturers and general economic conditions, especially in the technology sector |
| The market for semiconductors may experience renewed, and possibly more severe and prolonged downturns in the future, which may harm our results of operations and reduce the value of our business |
| 11 _________________________________________________________________ In addition, we operate in the discrete (and now analog) semiconductor segment of the broader semiconductor market and, as a result, cyclical fluctuations may affect this segment to a greater extent than they do the broader semiconductor market |
| This may cause us to experience greater fluctuations in our results of operations than compared to some of our broadline semiconductor manufacturer competitors |
| In addition, we may experience significant changes in our profitability as a result of variations in sales, changes in product mix, changes in end-user markets and the costs associated with the introduction of new products |
| The markets for our products depend on continued demand in the consumer electronics, computer, industrial, communications and automotive sectors |
| These end-user markets also tend to be cyclical and may also experience changes in demand that could adversely affect our operating results and financial condition |
| The semiconductor business is highly competitive, and increased competition may harm our business and our operating results |
| The semiconductor segments of the semiconductor industry in which we operate are highly competitive |
| We expect intensified competition from existing competitors and new entrants |
| Competition is based on price, product performance, product availability, quality, reliability and customer service |
| We compete in various markets with companies of various sizes, many of which are larger and have greater resources or capabilities as it relates to financial, marketing, distribution, brand name recognition, research and development, manufacturing and other resources than we have |
| As a result, they may be better able to develop new products, market their products, pursue acquisition candidates and withstand adverse economic or market conditions |
| Most of our current major competitors are broadline semiconductor manufacturers who often have a wider range of product types and technologies than we do |
| In addition, companies not currently in direct competition with us may introduce competing products in the future |
| Some of our current major competitors are Fairchild Semiconductor Corporation, International Rectifier Corporation, ON Semiconductor Corporation, Philips Electronics NV, Rohm Electronics USA LLC, and Vishay Intertechnology, Inc |
| We may not be able to compete successfully in the future, and competitive pressures may harm our financial condition or our operating results |
| We receive a significant portion of our net sales from a single customer |
| In addition, this customer is also our largest external supplier and is a related party |
| The loss of this customer or supplier could harm our business and results of operations |
| In 2004 and 2005, LSC, our largest stockholder and our largest customer, accounted for 11dtta1prca and 9dtta6prca, respectively, of our net sales |
| LSC is also our largest supplier, providing us with discrete semiconductor products for subsequent sale by us, which represented approximately 14dtta7prca and 17dtta2prca, respectively, of our net sales, in 2004 and 2005 |
| The loss of LSC as either a customer or a supplier, or any significant reduction in either the amount of product it supplies to us, or the volume of orders it places with us, could materially harm our business and results of operations |
| Delays in initiation of production at new facilities, implementing new production techniques or resolving problems associated with technical equipment malfunctions could adversely affect our manufacturing efficiencies |
| Our manufacturing efficiency has been and will be an important factor in our future profitability, and we may not be able to maintain or increase our manufacturing efficiency |
| Our manufacturing and testing processes are complex, require advanced and costly equipment and are continually being modified in our efforts to improve yields and product performance |
| Difficulties in the manufacturing process can lower yields |
| Technical or other problems could lead to production delays, order cancellations and lost revenue |
| In addition, any problems in achieving acceptable yields, construction delays, or other problems in upgrading or expanding existing facilities, building new facilities, problems in bringing other new manufacturing capacity to full production or changing our process technologies, could also result in capacity constraints, production delays and a loss of future revenues and customers |
| Our operating results also could be adversely affected by any increase in fixed costs and operating expenses related to increases in production capacity if net sales do not increase proportionately, or in the event of a decline in demand for our products |
| Our wafer fabrication facility is located in Kansas City, Missouri, while our facilities in Shanghai, China provide assembly, test and packaging capabilities |
| Any disruption of operations at these facilities could have a material adverse effect on our business, financial condition and results of operations |
| 12 _________________________________________________________________ We are and will continue to be under continuous pressure from our customers and competitors to reduce the price of our products, which could adversely affect our growth and profit margins |
| There is substantial and continuing pressure from customers to reduce the total cost of purchasing our products |
| To remain competitive and retain our customers and gain new ones, we must continue to reduce our costs through product and manufacturing improvements |
| We must also strive to minimize our customers’ shipping and inventory financing costs and to meet their other goals for rationalization of supply and production |
| We experienced an annual decrease in average selling prices for our products of 3dtta1prca and 15dtta0prca for 2004 and 2005, respectively |
| At times, average selling prices for some of our standard discrete semiconductors have been below our costs |
| Our growth and the profit margins of our products will suffer if we cannot effectively continue to reduce our costs and keep our product prices competitive |
| Our customer orders are subject to cancellation or modification usually with no penalty |
| High volumes of order cancellation or reductions in quantities ordered could adversely affect our results of operations and financial condition |
| All of our customer orders are subject to cancellation or modification, usually with no penalty to the customer |
| Orders are generally made on a purchase order basis, rather than pursuant to long-term supply contracts, and are booked from one to twelve months in advance of delivery |
| The rate of booking new orders can vary significantly from month to month |
| We, and the semiconductor industry as a whole, are experiencing a trend towards shorter lead-times, which is the amount of time between the date a customer places an order and the date the customer requires shipment |
| Furthermore, our industry is subject to rapid changes in customer outlook and periods of excess inventory due to changes in demand in the end markets our industry serves |
| However, we must still commit production and other resources to fulfilling these orders even though they may ultimately be cancelled |
| If a significant number of orders are cancelled or product quantities ordered are reduced, and we are unable to timely generate replacement orders, we may build up excess inventory and our results of operations and financial condition may suffer |
| New technologies could result in the development of new products by our competitors and a decrease in demand for our products, and we may not be able to develop new products to satisfy changes in demand, which could result in a decrease in net sales and loss of market share |
| Our product range and new product development program is focused on discrete and analog semiconductor products |
| Our failure to develop new technologies, or anticipate or react to changes in existing technologies, either within or outside of the discrete semiconductor market, could materially delay development of new products, which could result in a decrease in our net sales and a loss of market share to our competitors |
| The semiconductor industry is characterized by rapidly changing technologies and industry standards, together with frequent new product introductions |
| This includes the development of new types of technology or the improvement of existing technologies, such as analog and digital technologies that compete with, or seek to replace discrete semiconductor technology |
| Our financial performance depends on our ability to design, develop, manufacture, assemble, test, market and support new products and product enhancements on a timely and cost-effective basis |
| New products often command higher prices and, as a result, higher profit margins |
| We may not successfully identify new product opportunities or develop and bring new products to market or succeed in selling them into new customer applications in a timely and cost-effective manner |
| Products or technologies developed by other companies may render our products or technologies obsolete or noncompetitive and, since we operate primarily in the discrete segment of the broader semiconductor industry, this may have a greater effect on us than it would if we were a broad-line semiconductor manufacturer with a wider range of product types and technologies |
| Many of our competitors are larger and more established international companies with greater engineering and research and development resources than us |
| Our failure to identify or capitalize on any fundamental shifts in technologies in our product markets, relative to our competitors, could harm our business, have a material adverse effect on our competitive position within our industry and harm our relationships with our customers |
| In addition, to remain competitive, we must continue to reduce package sizes, improve manufacturing yields and expand our sales |
| We may not be able to accomplish these goals, which could harm our business |
| We may be subject to claims of infringement of third-party intellectual property rights or demands that we license third-party technology, which could result in significant expense and reduction in our intellectual property rights |
| The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights |
| From time to time, third parties have asserted, and may in the future assert, patent, copyright, trademark and other intellectual property rights to technologies that are important to our business and have demanded, and may in the future demand, that we license their patents and technology |
| Any litigation to determine the validity of allegations that our products infringe or may infringe these rights, including claims arising through our contractual indemnification of our customers, or claims challenging the validity of our patents, regardless of its merit or resolution, could be costly and divert the efforts and attention of our management and technical personnel |
| We may not prevail in litigation given the complex technical issues and inherent uncertainties in intellectual property litigation |
| If litigation results in an adverse ruling we could be required to: 13 _________________________________________________________________ Ø pay substantial damages for past, present and future use of the infringing technology; Ø cease the manufacture, use or sale of infringing products; Ø discontinue the use of infringing technology; Ø expend significant resources to develop non-infringing technology; Ø pay substantial damages to our customers or end-users to discontinue use or replace infringing technology with non-infringing technology; Ø license technology from the third party claiming infringement, which license may not be available on commercially reasonable terms, or at all; or Ø relinquish intellectual property rights associated with one or more of our patent claims, if such claims are held invalid or otherwise unenforceable |
| We depend on third-party suppliers for timely deliveries of raw materials, parts and equipment, as well as finished products from other manufacturers, and our results of operations could be adversely affected if we are unable to obtain adequate supplies in a timely manner |
| Our manufacturing operations depend upon obtaining adequate supplies of raw materials, parts and equipment on a timely basis from third parties |
| Our results of operations could be adversely affected if we are unable to obtain adequate supplies of raw materials, parts and equipment in a timely manner or if the costs of raw materials, parts or equipment were to increase significantly |
| Our business could also be adversely affected if there is a significant degradation in the quality of raw materials used in our products, or if the raw materials give rise to compatibility or performance issues in our products, any of which could lead to an increase in customer returns or product warranty claims |
| Although we maintain rigorous quality control systems, errors or defects may arise from a supplied raw material and be beyond our detection or control |
| Any interruption in, or change in quality of, the supply of raw materials, parts or equipment needed to manufacture our products could adversely affect our business and harm our results of operations and our reputation with our customers |
| In addition, we sell finished products from other manufacturers |
| Our business could also be adversely affected if there is a significant degradation in the quality of these products |
| From time to time, such manufacturers may extend lead-times, limit supplies or increase prices due to capacity constraints or other factors |
| We have no long-term purchase contracts with any of these manufacturers and, therefore, have no contractual assurances of continued supply, pricing or access to finished products that we sell, and any such manufacturer could discontinue supplying to us at any time |
| Additionally, some of our suppliers of finished products or wafers compete directly with us and may in the future choose not to supply products to us |
| If we do not succeed in continuing to vertically integrate our business, we will not realize the cost and other efficiencies we anticipate and our ability to compete, profit margins and results of operations may suffer |
| We are continuing to vertically integrate our business |
| Key elements of this strategy include continuing to expand the reach of our sales organization, expand our manufacturing capacity, expand our wafer foundry and research and development capability and expand our marketing, product development, package development and assembly/testing operations in company-owned facilities or through the acquisition of established contractors |
| There are certain risks associated with our vertical integration strategy, including: Ø difficulties associated with owning a manufacturing business, including, but not limited to, the maintenance and management of manufacturing facilities, equipment, employees and inventories and limitations on the flexibility of controlling overhead; Ø difficulties in continuing expansion of our operations in Asia and Europe, because of the distance from our US headquarters and differing regulatory and cultural environments; Ø the need for skills and techniques that are outside our traditional core expertise; Ø less flexibility in shifting manufacturing or supply sources from one region to another; Ø even when independent suppliers offer lower prices, we would continue to acquire wafers from our captive manufacturing facility, which may result in us having higher costs than our competitors; Ø difficulties developing and implementing a successful research and development team; and Ø difficulties developing, protecting, and gaining market acceptance of, our proprietary technology |
| The risks of becoming a fully integrated manufacturer are amplified in an industry-wide slowdown because of the fixed costs associated with manufacturing facilities |
| In addition, we may not realize the cost, operating and other efficiencies that we expect from continued vertical integration |
| If we fail to successfully vertically integrate our business, our ability to compete, profit margins and results of operations may suffer |
| 14 _________________________________________________________________ Part of our growth strategy involves identifying and acquiring companies with complementary product lines or customers |
| We may be unable to identify suitable acquisition candidates or consummate desired acquisitions and, if we do make any acquisitions, we may be unable to successfully integrate any acquired companies with our operations |
| A significant part of our growth strategy involves acquiring companies with complementary product lines, customers or other capabilities |
| For example, (i) in fiscal year 2000, we acquired FabTech, a wafer fabrication company, in order to have our own wafer manufacturing capabilities, and (ii) in January 2006, we acquired Anachip as an entry into standard logic markets |
| While we do not currently have any agreements in place, or any active negotiations underway, with respect to any acquisition, we intend to continue to expand and diversify our operations by making further acquisitions |
| However, we may be unsuccessful in identifying suitable acquisition candidates, or we may be unable to consummate a desired acquisition |
| To the extent we do make acquisitions, if we are unsuccessful in integrating these companies or their operations or product lines with our operations, or if integration is more difficult than anticipated, we may experience disruptions that could have a material adverse effect on our business, financial condition and results of operations |
| In addition, we may not realize all of the benefits we anticipate from any such acquisitions |
| Some of the risks that may affect our ability to integrate or realize any anticipated benefits from acquisitions that we may make include those associated with: Ø unexpected losses of key employees or customers of the acquired company; Ø bringing the acquired company’s standards, processes, procedures and controls into conformance with our operations; Ø coordinating our new product and process development; Ø hiring additional management and other critical personnel; Ø increasing the scope, geographic diversity and complexity of our operations; Ø difficulties in consolidating facilities and transferring processes and know-how; Ø difficulties in reducing costs of the acquired entity’s business; Ø diversion of management’s attention from the management of our business; and Ø adverse effects on existing business relationships with customers |
| We are subject to many environmental laws and regulations that could affect our operations or result in significant expenses |
| We are subject to a variety of US federal, state, local and foreign governmental laws, rules and regulations related to the use, storage, handling, discharge or disposal of certain toxic, volatile or otherwise hazardous chemicals used in our manufacturing process both in the United States where our wafer fabrication facility is located, and in China where our assembly, test and packaging facilities are located |
| Some of these regulations in the United States include the Federal Clean Water Act, Clean Air Act, Resource Conservation and Recovery Act, Comprehensive Environmental Response, Compensation, and Liability Act and similar state statutes and regulations |
| Any of these regulations could require us to acquire equipment or to incur substantial other expenses to comply with environmental regulations |
| If we were to incur such additional expenses, our product costs could significantly increase, materially affecting our business, financial condition and results of operations |
| Any failure to comply with present or future environmental laws, rules and regulations could result in fines, suspension of production or cessation of operations, any of which could have a material adverse effect on our business, financial condition and results of operations |
| Our operations affected by such requirements include, among others: the disposal of wastewater containing residues from our manufacturing operations through publicly operated treatment works or sewer systems, and which may be subject to volume and chemical discharge limits and may also require discharge permits; and the use, storage and disposal of materials that may be classified as toxic or hazardous |
| Any of these may result in, or may have resulted in, environmental conditions for which we could be liable |
| Some environmental laws impose liability, sometimes without fault, for investigating or cleaning up contamination on, or emanating from, our currently or formerly owned, leased or operated properties, as well as for damages to property or natural resources and for personal injury arising out of such contamination |
| Such liability may also be joint and several, meaning that we could be held responsible for more than our share of the liability involved, or even the entire share |
| In addition, the presence of environmental contamination could also interfere with ongoing operations or adversely affect our ability to sell or lease our properties |
| Environmental requirements may also limit our ability to identify suitable sites for new or expanded plants |
| Although we conduct environmental due diligence on properties that we operate, our diligence may not have revealed all environmental conditions on those properties |
| Discovery of additional contamination for which we are responsible, the enactment of new laws and regulations, or changes in how existing requirements are enforced, could require us to incur additional costs for compliance or subject us to unexpected liabilities |
| 15 _________________________________________________________________ Our products may be found to be defective and, as a result, product liability claims may be asserted against us, which may harm our business and our reputation with our customers |
| Our products are typically sold at prices that are significantly lower than the cost of the equipment or other goods in which they are incorporated |
| For example, our products that are incorporated into a personal computer may be sold for several cents, whereas the computer maker might sell the personal computer for several hundred dollars |
| Although we maintain rigorous quality control systems, we shipped approximately 10dtta2 billion individual semiconductor devices in 2005 to customers around the world, and in the ordinary course of our business, we receive warranty claims for some of these products that are defective, or that do not perform to published specifications |
| Since a defect or failure in our products could give rise to failures in the end products that incorporate them (and consequential claims for damages against our customers from their customers), we may face claims for damages that are disproportionate to the revenues and profits we receive from the products involved |
| In addition, our ability to reduce such liabilities may be limited by the laws or the customary business practices of the countries where we do business |
| Even in cases where we do not believe we have legal liability for such claims, we may choose to pay for them to retain a customer’s business or goodwill or to settle claims to avoid protracted litigation |
| Our results of operations and business could be adversely affected as a result of a significant quality or performance issue in our products, if we are required or choose to pay for the damages that result |
| Although we currently have product liability insurance, we may not have sufficient insurance coverage, and we may not have sufficient resources, to satisfy all possible product liability claims |
| In addition, any perception that our products are defective would likely result in reduced sales of our products, loss of customers and harm to our business and reputation |
| We may fail to attract or retain the qualified technical, sales, marketing and management personnel required to operate our business successfully |
| Our future success depends, in part, upon our ability to attract and retain highly qualified technical, sales, marketing and managerial personnel |
| Personnel with the necessary expertise are scarce and competition for personnel with these skills is intense |
| We may not be able to retain existing key technical, sales, marketing and managerial employees or be successful in attracting, assimilating or retaining other highly qualified technical, sales, marketing and managerial personnel in the future |
| For example, we have faced, and continue to face, intense competition for qualified technical and other personnel in Shanghai, China, where our assembly, test and packaging facilities are located |
| A number of US and multi-national corporations, both in the semiconductor industry and in other industries, have recently established and are continuing to establish factories and plants in Shanghai, China, and the competition for qualified personnel has increased significantly as a result |
| If we are unable to retain existing key employees or are unsuccessful in attracting new highly qualified employees, our business, financial condition and results of operations could be materially and adversely affected |
| We may not be able to maintain our growth or achieve future growth and such growth may place a strain on our management and on our systems and resources |
| Our ability to successfully grow our business within the discrete and analog semiconductor markets requires effective planning and management |
| Our past growth, and our targeted future growth, may place a significant strain on our management and on our systems and resources, including our financial and managerial controls, reporting systems and procedures |
| In addition, we will need to continue to train and manage our workforce worldwide |
| If we are unable to effectively plan and manage our growth effectively, our business and prospects will be harmed and we will not be able to maintain our profit growth or achieve future growth |
| Our business may be adversely affected by obsolete inventories as a result of changes in demand for our products and change in life cycles of our products |
| The life cycles of some of our products depend heavily upon the life cycles of the end products into which devices are designed |
| These types of end-market products with short life cycles require us to manage closely our production and inventory levels |
| Inventory may also become obsolete because of adverse changes in end-market demand |
| We may in the future be adversely affected by obsolete or excess inventories which may result from unanticipated changes in the estimated total demand for our products or the estimated life cycles of the end products into which our products are designed |
| In addition, some customers restrict how far back the date of manufacture for our products can be, and therefore some of our products inventory may become obsolete, and thus, adversely affect our results of operations |
| 16 _________________________________________________________________ If OEMs do not design our products into their applications, a portion of our net sales may be adversely affected |
| We expect an increasingly significant portion of net sales will come from products we design specifically for our customers |
| However, we may be unable to achieve these design wins |
| In addition, a design win from a customer does not necessarily guarantee future sales to that customer |
| Without design wins from OEMs, we would only be able to sell our products to these OEMs as a second source, which usually means we are only able to sell a limited amount of product to them |
| Once an OEM designs another supplier’s semiconductors into one of its product platforms, it is more difficult for us to achieve future design wins with that OEM’s product platform because changing suppliers involves significant cost, time, effort and risk to an OEM Achieving a design win with a customer does not ensure that we will receive significant revenues from that customer and we may be unable to convert design into actual sales |
| Even after a design win, the customer is not obligated to purchase our products and can choose at any time to stop using our products, if, for example, its own products are not commercially successful |
| We rely heavily on our internal electronic information and communications systems, and any system outage could adversely affect our business and results of operations |
| All of our operations, other than FabTech and Anachip, operate on a single technology platform |
| To manage our international operations efficiently and effectively, we rely heavily on our Enterprise Resource Planning (ERP) system, internal electronic information and communications systems and on systems or support services from third parties |
| Any of these systems are subject to electrical or telecommunications outages, computer hacking or other general system failure |
| Difficulties in upgrading or expanding our ERP system or system-wide or local failures that affect our information processing could have material adverse effects on our business, financial condition, results of operations and cash flows |
| We are subject to interest rate risk that could have an adverse effect on our cost of working capital and interest expenses |
| We have credit facilities with US and Asian financial institutions, 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 |
| As of December 31, 2005, our outstanding interest-bearing debt was dlra10dtta7 million |
| An increase of 1dtta0prca in interest rates would increase our annual interest rate expense by approximately dlra107cmam000 |
| If we fail to maintain an effective system of internal controls or discover material weaknesses in our internal controls over financial reporting, we may not be able to report our financial results accurately or detect fraud, which could harm our business and the trading price of our Common Stock |
| Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud |
| We are required to periodically evaluate the effectiveness of the design and operation of our internal controls |
| These evaluations may result in the conclusion that enhancements, modifications or changes to our internal controls are necessary or desirable |
| While management evaluates the effectiveness of our internal controls on a regular basis, these controls may not always be effective |
| There are inherent limitations on the effectiveness of internal controls including collusion, management override, and failure of human judgment |
| In connection with their audit of our financial statements, our independent registered public accounting firm identified several deficiencies in our internal controls, including a need for additional accounting personnel |
| If we fail to maintain an effective system of internal controls or if management or our independent registered public accounting firm were to discover material weaknesses in our internal controls, we may be unable to produce reliable financial reports or prevent fraud and it could harm our financial condition and results of operations and result in loss of investor confidence and a decline in our stock price |
| Terrorist attacks, or threats or occurrences of other terrorist activities whether in the United States or internationally may affect the markets in which our Common Stock trades, the markets in which we operate and our profitability |
| Terrorist attacks, or threats or occurrences of other terrorist or related activities, whether in the United States or internationally, may affect the markets in which our Common Stock trades, the markets in which we operate and our profitability |
| Future terrorist or related activities could affect our domestic and international sales, disrupt our supply chains and impair our ability to produce and deliver our products |
| Such activities could affect our physical facilities or those of our suppliers or customers |
| Such terrorist attacks could cause ports or airports to or through which we ship to be shut down, thereby preventing the delivery of raw materials and finished goods to or from our manufacturing facilities in Shanghai, China or Kansas City, Missouri, or to our regional sales offices |
| Due to the broad and uncertain effects that terrorist attacks have had on financial and economic markets generally, we cannot provide any estimate of how these activities might affect our future results |
| 17 _________________________________________________________________ RISKS RELATED TO OUR INTERNATIONAL OPERATIONS Our international operations subject us to risks that could adversely affect our operations |
| We expect net sales from foreign markets to continue to represent a significant portion of our total net sales |
| In addition, the majority of our manufacturing facilities are located overseas in China |
| In 2004 and 2005, net sales to customers outside the United States represented 71dtta3prca and 74dtta4prca, respectively, of our net sales |
| There are risks inherent in doing business internationally, and any or all of the following factors could cause harm to our business: Ø changes in, or impositions of, legislative or regulatory requirements, including tax laws in the United States and in the countries in which we manufacture or sell our products; Ø compliance with trade or other laws in a variety of jurisdictions; Ø trade restrictions, transportation delays, work stoppages, and economic and political instability; Ø changes in import/export regulations, tariffs and freight rates; Ø difficulties in collecting receivables and enforcing contracts; Ø currency exchange rate fluctuations; Ø restrictions on the transfer of funds from foreign subsidiaries to the United States; Ø the possibility of international conflict, particularly between or among China and Taiwan and the United States; Ø legal regulatory, political and cultural differences among the countries in which we do business; and Ø longer customer payment terms |
| We have significant operations and assets in China, Taiwan and Hong Kong and, as a result, will be subject to risks inherent in doing business in those jurisdictions, which may adversely affect our financial performance |
| We have a significant portion of our assets in mainland China, Taiwan and Hong Kong |
| Our ability to operate in China, Taiwan and Hong Kong may be adversely affected by changes in those jurisdictions’ laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters |
| In addition, our results of operations in China, Taiwan and Hong Kong are subject to the economic and political situation there |
| We believe that our operations in China, Taiwan and Hong Kong are in compliance with all applicable legal and regulatory requirements |
| However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations |
| Changes in the political environment or government policies in those jurisdictions could result in revisions to laws or regulations or their interpretation and enforcement, increased taxation, restrictions on imports, import duties or currency revaluations |
| In addition, a significant destabilization of relations between or among China, Taiwan or Hong Kong and the United States could result in restrictions or prohibitions on our operations or the sale of our products or the forfeiture of our assets in these jurisdictions |
| There can be no certainty as to the application of the laws and regulations of these jurisdictions in particular instances |
| Enforcement of existing laws or agreements may be sporadic and implementation and interpretation of laws inconsistent |
| Moreover, there is a high degree of fragmentation among regulatory authorities, resulting in uncertainties as to which authorities have jurisdiction over particular parties or transactions |
| The possibility of political conflict between these countries or with the United States could have an adverse impact upon our ability to transact business in these jurisdictions and to generate profits |
| We are subject to foreign currency risk as a result of our international operations |
| We face exposure to adverse movements in foreign currency exchange rates, primarily to some Asian currencies and, to a lesser extent, the Euro |
| For example, many of our employees, who are located in China are paid in the Chinese Yuan and, accordingly, an increase in the value of the Yuan compared to the US dollar could increase our operating expenses |
| In addition, we sell our products in various currencies and, accordingly, a decline in the value of any such currency against the US dollar, which is our primary functional currency, could create a decrease in our net sales |
| Our foreign currency risk may change over time as the level of activity in foreign markets grows and could have an adverse impact upon our financial results |
| These currencies are principally the Chinese Yuan, the Taiwanese dollar, the Japanese Yen, the Euro and the Hong Kong dollar |
| The Chinese government has recently taken action to permit the Yuan to US dollar exchange rate to fluctuate, which may exacerbate our exposure to foreign currency risk and harm our results of operations |
| We do not usually employ hedging techniques designed to mitigate foreign currency exposures and, therefore, we could experience currency losses as these currencies fluctuate against the US dollar |
| 18 _________________________________________________________________ We may not continue to receive preferential tax treatment in China, thereby increasing our income tax expense and reducing our net income |
| As an incentive for establishing our first Shanghai-based manufacturing subsidiary, which we refer to as Diodes-China, in 1996 and in accordance with the taxation policies of China, Diodes-China, received preferential tax treatment for the years ended December 31, 1996 through December 31, 2005 |
| Diodes-China is located in the Songjiang district, where the standard central government tax rate is 24dtta0prca |
| However, as an incentive for establishing Diodes-China, the earnings of Diodes-China were subject to a 0prca tax rate by the central government from 1996 through 2000, and to a 12dtta0prca tax rate from 2001 through 2005 |
| For 2006 and future years, Diodes-China’s earnings will continue to be subject to a 12dtta0prca tax rate provided it exports at least 70dtta0prca of its net sales |
| In addition, due to an dlra18dtta5 million permanent re-investment of Diodes-China earnings in 2004, Diodes-China has applied to the Chinese government for additional preferential tax treatment on earnings that are generated by this dlra18dtta5 million investment |
| If approved, those earnings will be exempted from central government income tax for two years, and then subject to a 12dtta0prca tax rate for the following three years |
| In addition, the earnings of Diodes-China would ordinarily be subject to a standard local government tax rate of 3dtta0prca |
| However, as an incentive for establishing Diodes-China the local government waived this tax from 1996 through 2005 |
| Management expects this tax to be waived for the year of 2006; however, the local government can re-impose this tax at any time at its discretion |
| In 2004, we established our second Shanghai-based manufacturing facility, Diodes-Shanghai, located in the Songjiang Export Zone of Shanghai, China |
| In the Songjiang Export Zone, the central government standard tax rate is 15dtta0prca |
| There is no local government tax |
| During 2004, Diodes-Shanghai earnings were subject to the standard 15dtta0prca central government tax rate |
| As an incentive for establishing Diodes-Shanghai, for 2005 and 2006 the earnings of Diodes-Shanghai are exempted from central government income tax, and for the years 2007 through 2009 its earnings will be subject to a 7dtta5prca tax rate |
| From 2010 onward, provided that Diodes-Shanghai exports over 70prca of its net sales, its earnings will be subject to a 10dtta0prca tax rate |
| We may not be able to continue receiving this preferential tax treatment, which may cause an increase in our income tax expense, thereby reducing our net income |
| The distribution of any earnings of our foreign subsidiaries to the United States may be subject to US income taxes, thus reducing our net income |
| We are currently planning, and may in the future plan, to distribute earnings of our foreign subsidiaries from Asia to the United States |
| We may be required to pay US income taxes on these earnings to the extent we have not previously recorded deferred US taxes on such earnings |
| Any such taxes would reduce our net income in the period in which these earnings are distributed |
| On October 22, 2004, the American Jobs Creation Act, or AJCA, was signed into law |
| Among other items, the AJCA establishes a phased repeal of the extraterritorial income exclusion, a new incentive tax deduction for US corporations to repatriate cash from foreign subsidiaries equal to 85prca of cash dividends received in the year elected that exceeds a base-period amount, and significantly revises the taxation of US companies doing business abroad |
| At December 31, 2004, the Company made a minimum estimate for repatriating cash from its subsidiaries in China and Hong Kong of dlra8dtta0 million under the AJCA, and recorded an income tax expense of approximately dlra1dtta3 million |
| Under the guidelines of the AJCA, the Company developed a required domestic reinvestment plan, covering items such as US bank debt repayment, US capital expenditures and US research and development activities, among others, to cover the dividend repatriation |
| During 2005, the Company completed a quantitative analysis of the benefits of the AJCA, the foreign tax credit implications, and state and local tax consequences of the impact of the AJCA on the Company’s plans for repatriation |
| Based on the analysis, the Company repatriated dlra24dtta0 million from its foreign subsidiaries in 2005 |
| The Company is evaluating the need to provide additional deferred taxes for the future earnings of its foreign subsidiaries to the extent such earnings may be appropriated for distribution to the Company’s corporate office in North America, and as further investment strategies with respect to foreign earnings are determined |
| Should the Company’s North American cash requirements exceed the cash that is provided through the domestic credit facilities, cash can be obtained from the Company’s foreign subsidiaries |
| However, the distribution of any unappropriated funds to the US will require the recording of income tax provisions on the US entity, thus reducing net income |
| As of December 31, 2005, the Company has recorded approximately dlra1dtta1 million in deferred taxes for earnings of its foreign subsidiaries |
| We may experience substantial variations in net sales, gross profit margin and operating results from quarter to quarter |
| We believe that the factors that influence this variability of quarterly results include: Ø general economic conditions in the countries where we sell our products; Ø seasonality and variability in the computing and communications market and our other end-markets; Ø the timing of our and our competitors’ new product introductions; Ø product obsolescence; Ø the scheduling, rescheduling and cancellation of large orders by our customers; Ø the cyclical nature of demand for our customers’ products; Ø our ability to develop new process technologies and achieve volume production at our fabrication facilities; Ø changes in manufacturing yields; Ø changes in gross profit margins due to the Anachip acquisition; Ø adverse movements in exchange rates, interest rates or tax rates; and Ø the availability of adequate supply commitments from our outside suppliers or subcontractors |
| Accordingly, a comparison of our results of operations from period to period is not necessarily meaningful to investors and our results of operations for any period do not necessarily indicate future performance |
| Variations in our quarterly results may trigger volatile changes in our stock price |
| We may enter into future acquisitions and take certain actions in connection with such acquisitions that could affect the price of our Common Stock |
| As part of our growth strategy, we expect to review acquisition prospects that would implement our vertical integration strategy or offer other growth opportunities |
| While we have no current agreements and no active negotiations underway with respect to any acquisitions, we may acquire businesses, products or technologies in the future |
| In the event of future acquisitions, we could: Ø use a significant portion of our available cash; Ø issue equity securities, which would dilute current stockholders’ percentage ownership; Ø incur substantial debt; Ø incur or assume contingent liabilities, known or unknown; Ø incur amortization expenses related to intangibles; and Ø incur large, immediate accounting write-offs |
| Such actions by us could harm our results from operations and adversely affect the price of our Common Stock |
| Our directors, executive officers and significant stockholders hold a substantial portion of our Common Stock, which may lead to conflicts with other stockholders over corporate transactions and other corporate matters |
| Our directors, executive officers and our affiliate, LSC, beneficially own approximately 32prca of our outstanding Common Stock, including options to purchase shares of our Common Stock that are exercisable within 60 days of December 31, 2005 |
| These stockholders, acting together, will be able to influence significantly all matters requiring stockholder approval, including the election of directors and significant corporate transactions such as mergers or other business combinations |
| This control may delay, deter or prevent a third party from acquiring or merging with us, which could adversely affect the market price of our Common Stock |
| LSC, our largest stockholder, owns approximately 22dtta9prca (5cmam777cmam187 shares) of our Common Stock |
| Some of our directors and executive officers may have potential conflicts of interest because of their positions with LSC or their ownership of LSC Common Stock |
| Some of our directors are LSC directors and officers, and our non-employee Chairman of our Board of Directors is Chairman of the board of LSC Several of our directors and executive officers own LSC Common Stock and hold options to purchase LSC Common Stock |
| Service on our Board of Directors and as a director or officer of LSC, or ownership of LSC Common Stock by our directors and executive officers, could create, or appear to create, actual or potential conflicts of interest when directors and officers are faced with decisions that could have different implications for LSC and us |
| For example, potential conflicts could arise in connection with decisions involving the Common Stock owned by LSC, or under the other agreements we may enter into with LSC LSC was our largest external supplier of discrete semiconductor products for subsequent sale by us |
| In 2004 and 2005, approximately 14dtta7prca and 17dtta2prca, respectively, of our net sales were from products manufactured by LSC In addition to being our largest external supplier of finished products in each of these periods, we sold silicon wafers to LSC totaling 11dtta1prca and 9dtta6prca, respectively, of our net sales during such periods, making LSC our largest customer |
| 20 _________________________________________________________________ We may have difficulty resolving any potential conflicts of interest with LSC, and even if we do, the resolution may be less favorable than if we were dealing with an entirely unrelated third party |
| Our early corporate records are incomplete |
| As a result, we may have difficulty in assessing and defending against claims relating to rights to our Common Stock purporting to arise during periods for which our records are incomplete |
| We were formed in 1959 under the laws of California and reincorporated in Delaware in 1969 |
| We have had several transfer agents over the past 46 years |
| In addition, our early corporate records, including our stock ledger, are incomplete |
| As a result, we may have difficulty in assessing and defending against claims relating to rights to our Common Stock purporting to arise during periods for which our records are incomplete |