Earnings Call: Q2 2018

Aug 7, 2018

Good afternoon, and welcome to Diodes Incorporated Second Quarter 2018 Financial Results Conference Call. Instructions will be given for the question and As a reminder, this conference call is being recorded today. Tuesday, August 7, 2018. I would now like to turn the call over to Leanne Sievers of Shelton Group, Investor Relations. Leanne, please go ahead. Good afternoon, and welcome to Diodes' 2nd Quarter 2018 Financial Results Conference Call. I'm Leanne Sievers, President of Shelton Group, Dowd's Investor Relations firm. Joining us today are Diodes' President and CEO, Doctor. Keishu Lu, Chief Financial Officer, Rick White, Vice President of Worldwide Sales And Marketing, Emily Yang, and Director of Investor Relations, Laura Merle. Before I turn the call over to Doctor. Lu, I'd like to remind our listeners that the results announced today are preliminary as they are subject to the company formalizing the closing procedures and customary quarterly reviewed by the company's independent registered public accounting firm. Assets, these results are subject to revision until the company files its Form 10Q for its second quarter 2018. In addition, management's prepared remarks contain forward looking statements which are subject to risks and uncertainties, and management may make additional forward looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today, and therefore, we refer you to a more detailed discussion of the risks and uncertainties in the company's filings the Securities And Exchange Commission, including forms 10K10Q. In addition, any projections of the company's future performance represent management's estimates as of today, August 7, 2018. Diodes assumes no obligation to update these projections in the future as market conditions may or may not change. Except to the extent required by applicable law. Additionally, the company's press release and management statements during this conference call will include discussions of certain measures, and financial information and GAAP and non GAAP terms. Included in the company's press release are definitions and reconciliations of GAAP to non GAAP items, which provide additional details. Also, throughout the company's press release and management statements during this conference call, we refer to net income attributable to common stockholders as GAAP net income. For those of you unable to listen to section of Diodes' website at www.diodes.com. Please see the company's press release for more information. And now, I'll turn the call over to Dow's President and CEO, Doctor. Kaishou Lu. Doctor. Lu, please go ahead. Thank you, Diane. Welcome, everyone. And thank you for joining us today. Diodes achieved a number of key milestones in the second quarter. Reaching record level across multiple financial metrics, driven by continuous revenue growth, market share gain and the further traction on our telecom product. Our exceptionally strong performance reflect record sales in both our automotive and industrial end markets. Which contributed to new record revenue level being achieved across all regions. Our automotive revenue was up 50% year over year. And our international revenue and the 27% of total revenue was the first time that industrial was our largest representative end market. Additionally, through revenue growth, we continue to increasing operating expense as a percent of the revenue. Also contributing to our achievement of record EBITDA and record non GAAP earnings per share in the quarter. In fact, EBITDA increased over 40% and the non GAAP net income over 60%. As compared to the prior year period on revenue growth of 15%. With further demonstrate the significant leverage in our operating model. As a result, we generated strong cash flow that enabled us to further pay down our long term debts. Also, highlighting those solid results is our expectation for continued growth in the third quarter. Where we expect to again set new records across our business. Our strong results and the growth this year has positioned us with the potential to achieve our most profitable year in the company's 3. With that, let me now turn the call over to Rick to discuss our 2nd quarter financial results. And our third quarter guidance in more detail. Thanks, Doctor. Lu and good afternoon, everyone. As part of my financial review today, I will focus my comments on the sequential change for each of the line items and would refer you to our press release for a more detailed review of our results as well as the year over year comparisons. Revenue for the second quarter 2018 was a record $304,100,000, a 10.8% increase from the $274,500,000 in the first quarter of 2018. GAAP gross profit for the second quarter of 2018 was also a record at $107,300,000 or 35.3 percent of revenue, representing an 8.8 percent increase on a dollar basis from the $98,600,000 or 35.9 percent of revenue into first quarter 2018. Pricing improved in 2nd quarterversus first quarter, which offset some lower margin inventory sales due to our inventory reduction efforts. GAAP operating expenses for the second quarter of 2018 were $69,400,000 or 22.8 percent of revenue. And $64,200,000 or 21.1 percent of revenue on a non GAAP basis, which excludes $4,700,000 of amortization acquisition related intangible asset expenses and approximately $500,000 of K Fab restructuring costs. This compares with GAAP operating expenses in the first quarter 2018 of $71,700,000 or 26.1 percent of revenue. And $64,700,000 or 23.6 percent of revenue on a non GAAP basis. First quarter included $2,600,000 of officer retirement expenses, which were not repeated in the 2nd quarter. Total other expenses amounted to approximately $1,400,000 for the quarter including $2,500,000 of interest expense. Income before taxes and non controlling interest in the second quarter 2018 amounted to $36,400,000 compared to 26 $300,000 in the first quarter 2018. Turning to income taxes. Our effective income tax rate for GAAP net income for the second quarter 2018 was a record $25,100,000 or $0.49 per diluted share. Compared to GAAP net income of $18,500,000 or $0.37 per diluted share in the first quarter 2018. The share count used to compute GAAP diluted EPS for the second quarter of 2018 was 50,800,000 shares. Second quarter 2018 non GAAP adjusted net income was $29,300,000 or $0.58 per diluted share. Both of which were records. The adjusted net income excluded net of tax $3,800,000 of non cash acquisition related intangible asset amortization costs and $400,000 of restructuring expenses. This compares to non GAAP adjusted net income of $24,200,000 or $0.48 per diluted share in the first quarter of 2018. We have included in our earnings release a reconciliation of GAAP net income to non GAAP adjusted net income, which provides additional details. EBITDA, which represents earnings before net interest expense, income tax, depreciation and amortization was a record $64,500,000 or 21.2 percent of revenue in the second quarter 2018. Compared with $54,200,000 or 19.7 percent of revenue in the first quarter of 2018. Cash flow generated from operations was $34,400,000 for the second quarter of 2018. Free cash flow was $13,100,000 for the 2nd quarter, which included $21,400,000 Net cash flow was a negative $30,100,000 including the paydown of approximately $36,100,000 of long term debt. Turning to the balance sheet. Totaled approximately $160,000,000. Working capital and long term debt including the current portion was $185,800,000. At the end of the second quarter, inventory decreased by approximately $14,000,000 from the first quarter of 2018 to approximately $223,000,000. The decrease in inventory reflects an $18,700,000 decrease in finished goods, a $900,000 increase in work in process and a 4.1 on reducing finished goods inventory after 4 consecutive quarters of finished goods increases. Finished goods inventory days were 38 in the quarter compared to 44 in the first quarter. Total inventory days were 106 in the quarter compared to 116 days in the first quarter of 2018. Capital expenditures 7% of revenue. This CapEx was to put capacity in place for the expected strong revenue growth in the second half of twenty eighteen. We expect CapEx for the full year 2018 to return to our target model of 5% to 9% of revenue. Now turning to For the third quarter of 2018, we expect continued strong growth with revenue increasing to a range of $313,000,000 to $329,000,000 or up 2.9% to 8.2% sequentially. At the midpoint, this represents a 12.5% growth versus third quarter 2017. We expect GAAP gross margin to Non GAAP operating expenses, which are GAAP operating expenses adjusted for amortization of acquisition related intangible asset assets are expected to be approximately 21 percent of revenue plus or -1 percent. We expect interest expense to be approximately 2,500,000 dollars. Our income tax rate is expected to shares used to calculate diluted EPS for the third quarter are anticipated to be approximately 51,400,000 Please note Thank you, Rick, and good afternoon. As previously highlighted, 2nd quarter revenue was up 10.8% sequentially and up 15.1% year over year. Q2 distributor POS increased by 15% and POP was up by 14%. All regions reach new record revenue levels on record POS results. Channel inventory decreased 1.3% sequentially. During the quarter, we set revenue records on 10 product categories, including ACDC, battery management, BTRX, connect ASIC, DPNS, interface, LED, MOSFET, standard linear, and switch. We also achieved continued strong momentum in CMOS LDO, ARRIS, power protection, sensor and signal integrity, driven by recent design wins on new products. Our consistently strong success over the past several quarters with new product introductions, design win momentum and expanding content at customers. We expect to continue making additional progress in the second half of twenty eighteen. Looking at global sales in the second quarter, Asia represented 78% of the revenue, 0 13% or 9%. In terms of our end markets, industrial represent 27 percent of revenue, consumer 25%, communication 23, computing 816 and automotive 9% of the revenue. This was the first time that industrial was our largest representative end market as a result of a continued expansion effort in this growing market. Starting with industrial market, Diodes continue to see strong demand for LDOs and LED driver in the Selenium lighting as well as increasing demand for audio products in the smoke detector, alarm related applications with audio alarming features. We also continue to penetrate the industrial space using normal density trench mask technology in key mouse applications. Such as brushless DC motor and LED lighting. Also during the quarter, we introduced new products in our high performance haul ESET launch product, that are specifically designed for communication of brushless motor, flow meters, linear encoders and position sensors in the industrial application. Turning to our automotive market, which remains a key focus area for Diodes and was up 50% year over year. Our design win momentum continues in the 3 application areas I discussed in detail last quarter. Connected driving, which consists of ADAS, telematics and infotainment systems, comfort style and safety including lighting and brushless DC motor control, and powertrain covers conventional hybrid electric vehicles. Contributing to our growth was the successful renting of our past design wins for power transistors for driving LEDs in the car lighting. There is also increasing demand for USB Type C product in the automotive applications, like infotainment, connected driving in the newer models, along with strong interest in packet switches in telematic applications. Additionally, with record increase of tronics in today's highly connected cars. Robust ESD protection is also important. We expect to see strong growth our protection products with a focus gear, state, and motor applications. Additionally, market growth for automotive and MOSFET continue to be strong in especially in China, where we've seen significant demand for automotive semiconductor. Significant monotherapy sign ins are being a achieved on brushless DC motor, water pump, power windows, electric horn, infotainment, battery management system, and ADAP. In the consumer market, we continue to see growth in charging applications such as quick charger, direct charger, and wireless power charging as well as in IoT applications, such as smart devices and smart audio and wireless speakers. In addition, we see growing demand for USB Type C interface in mobile and IoT devices. The accessory market is responding to customers' demand regarding multiple USB chargers, and we expect strong demand for our SDPD decoder devices that have passed USB PD device certification. Our large selection of protection devices are also gaining momentum in the panel market, mobile, TV, monitor and mobile panels, as well as earphones, wearable, portable and smart speakers applications. Turning next to communication market, we continue to see new design wins in mobile market for charging power management and discrete products. We are seeing strong demand for high voltage charging using USB 2 interface in mobile and smartphone segments. We have secured an increasing number of design wins for our mid to switch solution driven by increasing demand for camera module in mobile phones. Specifically in smartphones, power density remains a key concern for both manufacturers and consumers. Diodes has been actively addressing this area of the market with its comprehensive small footprint DFM and CFP MOSFET portfolio. In addition, Diodes continue to expand our portfolio of battery protection MOS us with our most recent new product release in Q2. Lastly, in the computing market, we have continued to see strong growth momentum for data centers, Server, Storage, AI, and deep learning, along with PCs and notebooks, we have launched several new products, including PCIe packet switch, PCIe clock generator, offers and retailers that are suitable for this application. We are also seeing increasing interest in our protection devices in the computing market as well since USB Type C is a major growth engine for these devices. Our existing solution to protect all teams on Type C connectors is being well received by customers. We have new design wins for our USB Type C cross bot mocks, the DT switches in local docking application beyond our current success in PC hold line. In summary, we are very pleased with our performance in the quarter. Reaching record levels across a number of financial metrics as well as end markets, target geographies and product categories, These achievements are underpinned by our market share gains, customer contact expansion initiatives, as well as continued traction with our pericom products. With continued growth expected in the third quarter, we anticipate once again setting new records across our business. With that we now open the floor to questions. And our first question comes from the line of Tristan Gerra from Baird. Your line is now open. Hi, good afternoon. Looks like end demand trends remain very strong, but also that the industry is seeing some pressure in terms of manufacturing costs. Could you quantify perhaps the gross margin impact embedded in Q3 guidance from those higher manufacturing costs and plans you have to mitigate those higher costs going forward? Yes, so hang on just a second Tristan. It's Justin. Number 1, if you see the guidance for our third quarter, our gross margin actually from 35.3 increased to 35.8, okay. So even some of our material costs went up but we still due to the cost reduction effort due to the mix improvement effort we still able to increase our gross margin by 50 basis points. Okay, okay. I appreciate the feedback. And perhaps we can take it offline. Is that something pretty much completed or do you expect to further reduce channel inventories in Q3? Yes. So Tristan, the inventory reduction let me comment about the Diodes inventory reduction. And then Emily can talk about the distributor inventory. So from a diodes perspective, we had a plan to reduce the inventory. We had noted that it had gone up over the last year, every quarter was just up a little bit, up a little bit. And we had a plan internally to reduce that inventory. And you can see that that we reduced at about $19,000,000 from a finished goods perspective. From the in the 3rd quarter, I think we're going to have an additional inventory reduction, but it's not going to be as significant as it was in the second quarter. Interesting for the channel inventory as you noticed that we have a record POS record in Q2 and our inventory actually went down in Q2. So I think the key focus is really keeping a healthy inventory profile in the channel to support and sustain our growth. So we monitored this very closely. I think that he is really healthy inventory to support. Typically our DC war would like to have more inventory when the revenue going up in the future. But we actually you can see the effort we put in in the 2nd quarter but in the second quarter, even days thinking 3rd quarter revenue would be up, their inventory actually went down and that's because POS is very strong, but we are not pushing the POP we try to deduce and deduce the inventory, the inventory and keep it healthy such that we don't need to worry about double ordering, worry about inventory too much. In the disti site. Right. So our goal is that inventory days in the channel will now increase. Okay, that's that's the reason. So then just last one for me in the context of the tariffs how much of Diodes business is Silicon shaped to the U. S, not final end products sold to U. S. OEMs, but city council to disease and EMS and therefore subject to potential tariff. I'm just trying to get a sense of your potential exposure there? Yes. So, let me answer that. So, Diodes is the products that we import into the United States from China, all of those products are going to be ultimately affected by the tariffs. Right now, there are 2 tariff lists. The first tariff list was a smaller list and it was effective on July 6. And we think that the impact of that is about $1,100,000 per quarter of tariff costs. Now there's another list that hasn't been actually put in place yet, but the list is out there. And we've looked at that And we're uncertain about the implementation date, but based on the estimate, we think that that impact is going to be about $2,500,000 a quarter. So if you take the total of those 2, it's about $3,600,000 per quarter. But we plan to pass these tariff charges on to our customers. Okay. Thank you. And our next question comes from the line of Gary Mobley from Benchmark. Your line is now open. Hello, everyone. Thanks for taking my question. In the quarter, in the 2nd quarter or even embedded in your outlook for the 3rd quarter, Were there any supply chain constraints that restricted your revenue? And if so, can you speak about them and what revenue could have been if you weren't capacity constrained? Okay. We really that 80 and certain certain degree affect the wafer do have some shortage. Not all the product lines have the shortage. The shortage is most coming from the most fab. And that is really start with 80 shortage then cost a certain degree of the most fab wafer shortage. And it affects us, but a lot of customer is a hand to mouth type of situations. But I could not or I cannot give you the forecast if there are no shortage for computer remedies because we just, you know, we're just driving our best weekend to support the customer demand, but virtually we are able to keep the line to not have a dynamic situation, okay. But that's really limited to certain product lines. Okay. Typically, in fourth quarter, you see sequential revenue decline somewhere in the neighborhood of mid single digit percent sequentially. Would you based on your visibility sitting here today, would you call the 4th quarter as typical or atypical as a matter seasonality? Well, I don't know very clear yet, but so far, I'm hoping it's not typical, okay, would be better than typical, but I really don't know, okay. By now, I'm focused on the third quarter and we do seeing a very strong third quarter above the cynical typically 2nd quarter to 3rd quarter is about 5% or between 0 to 5% growth and we are able to guide above 5% growth So we see better than cynical cycles. Now in the fourth quarter right now, not very clear, And but we watch out, okay, and hoping it's still better cynical is a 5% down and I hope it's better than that. But I don't know Thank you. And our next question comes from the line of Sean Harrison from Longbow Research. Your line is now open. Thank you. The first question has to do with the gross margin performance for the June quarter. If there is a way to delineate maybe how much of a negative impact the inventory drawdown represented on gross margin as well as the incremental CapEx investment from prior quarters? And how much of that maybe rolls off into the September quarter? I probably cannot give you the exact number, but if you took it, we dropped the finished goods $17,000,000 and if you think it's about $17,000,000 assume this is not the ITP stuff. I assume this is the image. If you are talking about, let's say, 10%. That means you're going to reduce $1,700,000 operate the GP to the average. So you can feel it's a big numbers. And even in the third quarter, we still intend to reduce more. Basically what I want to do is by end of thirdquarter, the inventory level will be equal to last year 3rd quarter, enter 3rd quarter levels. With the revenue, if you compare this year third quarter based on our 1st last year third quarter, the revenue is going to grow quite a bit but we're hoping we try to try to convince that our own inventory is this Well, the same level that means as a percentage will be matched. That's the goal. Okay. That's helpful, Doctor. Levin. And as a follow-up, I was hoping you could speak on the ramping of the agents capacity as well as the transferring of equipment from the CapeAT closure into existing sites and where you're at on progress with both? Okay. Let's talk about 8 inches equipment. We continue ramping up. Okay. I think last time we're talking about in 1Q, we only ramped up now. There's 800 something wafer based on 1000 wafer And then in the 2Q, I think that we are now somewhere end of 2Q, we are somewhere around 5000 to 6000 wafer per month long run. We ramped it up to probably end of the second quarter to about 5000, 6000 wafer per month. Then we go to the third quarter, we are continuing to ramp it up. I don't know Well, they started not yet, come out yet, but we'll continue to ramp it up. By end of fourth quarter, are hoping we are running somewhere around 9000 wafers per month. So we continue to ramp it up. Yeah, so from a 6 inches perspective, we've moved all of the Kfab equipment to SFAB 1. It's in the process of being qualified and ramping up, but Kfab has been closed. All of the equipment and everything has been moved. So it's basically finished. Okay. Then last, if I may. I know last quarter there were some, I think, determined been equity investments in the Chengdu that could limit your ability to pay down debt in the back half of the year, but given through the increased profitability, do you think you'll be in a net cash position, exiting 2018 now? We will make that investment in Chengdu probably in the next 4 or 5 months. We hope to be able to fund that internally, which would preclude us probably from paying down the debt as much as we would like. But We're still at the process. You can see the results are good and the operating cash flow is $35,000,000. So if that could continue, then we should be in a pretty good position to at least continue to pay down some debt. Okay, perfect. Thank you very much. Thank you. And our next question comes from the line of Edgar Roche from Sidoti and Company. Your line is now open. So to lead off, earlier in the year, industrials saw a lot of strength from Europe. I think that led the gains Did you see that broaden out or is that really still a center of activity for your business? This is Emily. We actually have seen across the board strength in the industrial segment, not only in Europe, but also in North America as well as in Asia, So this is across the board. So that's how we can achieve a 27% overall to the, you know, end market percentage rate. Okay, got it. And do you have any exposure to home appliances and can you remind me which category in which that would fall? Yes, we do. I think a whole lot of science would be under the consumer settlements that we include that over there. Well, in Nashville, like a tool and tool. Right. So home appliance is actually under consumer. But we also have a lot of, right, industrial application similar stuff, but that would be under the industrial. Okay. Thanks. And then I think you recently or earlier this year, you launched some higher voltage products IGBTs and some other products. And I was wondering, do you feel like you have on the power management side pretty good range of voltages covered? Or is that an area where you will have some new product activity to augment your portfolio? I think we have a overall coverage from the product, you know, when you really look at across the product line, right? There's quite a number of products we have in the higher dosage area, but there's still room for us to expand. And one of things that we're working aggressively is actually continue to develop new products targeting higher voltage areas. Yeah. Well, ICT is we just started that is in the past. It's not our focus area. And with the gate driver, our then the gate driver and our MOSFET we think we are on the position now to get into the ICPT areas. So we start with buying resale for the IGBT parts, but eventually we'll get into the super junction to IGBT, but that right now that's very beginning of our actions. Okay. That's helpful. All right. I think that does it for me. Thank you. Thank you. Thank you. And that concludes our question and answer session for today. I'd like to turn the call back over to Doctor. Lu for closing remarks. Thank you for your participation on today's call. We're looking forward to providing an update on our business next quarter. Operator, you may now disconnect.