Diodes Incorporated (DIOD) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon, and welcome to Diodes Incorporated Third Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. At the conclusion of today’s conference call, instructions will be given for the question-and-answer session. [Operator Instructions]. As a reminder, this conference call is being recorded today, Wednesday, November 9, 2016. 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 third quarter 2016 financial results conference call. I am Leanne Sievers, Executive Vice President of Shelton Group, Diodes’ Investor Relations firm. Joining us today are Diodes’ President and CEO, Dr. Keh-Shew Lu; Chief Financial Officer, Rick White; Senior Vice President of Sales and Marketing, Mark King; and Director of Investor Relations, Laura Mehrl. Before I turn the call over to Dr. Lu, I would like to remind our listeners that 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 with the Securities and Exchange Commission. In addition, any projections as to the Company’s future performance represent management’s estimates as of today November 9, 2016. Diodes assume no obligation to update these projections in the future as market conditions may or may not change. Additionally, the Company’s press release and management’s statements during this conference call will include discussions of certain measures and financial information in GAAP and non-GAAP terms. Included in the Company’s press release are definitions and reconciliation of GAAP to non-GAAP items, which provide additional details. Also throughout the Company’s press release and management’s statements during this conference call, we refer to net income attributable to common stockholders as GAAP net income. As a reminder, the results today are preliminary and are subject to Diodes finalizing its closing procedures and customary quarterly review by the Company’s independent registered public accounting firm. As such, these results are subject to revision until the company$ files its quarterly report on Form 10-Q for the quarter ending September 30, 2016. For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 60 days in the Investor Relations section of Diodes’ website at www.diodes.com. And now, I’ll turn the call over to Diodes’ President and CEO, Dr. Keh-Shew Lu. Dr. Lu, please go ahead.

Thank you, Leanne. Welcome everyone, and thank you for joining us today. I am pleased to report that our results this quarter represented the second consecutive quarter of record revenue and gross profit, with revenue reaching $250 million, a key milestone toward achieving our goal of $1 billion in annual revenue. Additionally, our automobile business reached a record increasing to 7% of the revenue. We continue to invest in automotive market through a combination of new products and target customer development, as we walk towards our near-term goal of 10% of the revenue. Also during the quarter we completed the sale integration of Pericom in China and the rest of the Asia after successfully completing those efforts in North America and Europe during the first half of the year. We are now well positioned across the customer base with a still 90 sale channel and a broader product portfolio. In fact, we have recently made solid progress on the residing opportunities as a direct result of our cross selling efforts in support of the revenue growth and the market share gain in 2017 and beyond. Lastly, after the growth of the quarter, we successfully renewed our syndicated loan for a new five-year term, resulting in low interest payments and greater flexibility to return value to shareholders through our stock buyback program. With that, I would now turn the call over to Rick to discuss our third quarter financial results, as well as fourth quarter guidance in more detail.

Thanks Dr. Lu, and good afternoon, everyone. Revenue for the third quarter 2016 was a record $250.7 million, increasing 6% from the $236.6 million in the second quarter 2016 and 20% from the $208.9 million in the third quarter 2015. Gross profit for the third quarter 2016 reached a record $80.6 million, or 32.2% of revenue, compared to the second quarter 2016 of $74.8 million, or 31.6% of revenue, and the third quarter 2015 of $61.6 million, or 29.5% of revenue. The sequential increase in gross profit margin was due primarily to improve capacity utilization. GAAP operating expenses for the third quarter 2016 were $60.7 million, or 24.2% of revenue, and on a non-GAAP basis were $55.2 million, or 22% of revenue, which excludes $5.5 million of retention and amortization of acquisition related intangible asset expenses. This compares to GAAP operating expenses of $63.5 million, or 26.9% of revenue in the second quarter 2016, or 24.8% on a non-GAAP basis. Looking specifically at selling, general and administrative expenses for the third quarter, SG&A was approximately $38.3 million or 15.3% of revenue compared to $41.4 million, or 17.5% of revenue in the second quarter 2016. Investment in research and development for the third quarter was approximately $17.1 million or 6.8% of revenue, compared to $17 million or 7.2% of revenue in the second quarter 2016. Combined, SG&A plus R&D was $55.4 million or 22.1% revenue, compared to $58.4 million or 24.7% of revenue in the second quarter 2016. Total other expense amounted to approximately $4.3 million for the quarter, including $3.7 million of interest expense and approximately $900,000 in currency losses, which was partially offset by $300,000 interest income. Income before taxes and non-controlling interest in the third quarter 2016 amounted to $15.6 million, compared to $8.8 million in the second quarter of 2016. Turning to income taxes, our effective income tax rate for the third quarter was approximately 26.2%. Third quarter 2016 GAAP net income was $10.6 million or $0.21 per diluted share, compared to $5.8 million $0.12 per diluted share in the second quarter 2016, and $2.8 million or $0.06 per diluted share in the third quarter 2015. The share count used to compute GAAP diluted EPS for the third quarter 2016 was 49.9 million shares. Non-GAAP adjusted net income was $15.1 million or $0.30 per diluted share, which excluded net of tax $4.4 million of non-cash acquisition related intangible asset amortization cost. This compares to non-GAAP adjusted net income of $9.8 million or $0.20 per diluted share in the second quarter 2016, and $6.3 million or $0.13 per diluted share in the third quarter 2015. We have included in our earnings release, a reconciliation of GAAP net income to non-GAAP adjusted net income, which provides additional details. Included in the third quarter, 2016 GAAP and non-GAAP adjusted net income was approximately $2.9 million net of tax, non-cash, share-based compensation expense. Excluding share-based compensation expense, both GAAP and non-GAAP adjusted EPS would have increased by $0.06 per diluted share in the third quarter. Cash flow generated from operations was $33.1 million for the third quarter. Free cash flow was $15.1 million for the third quarter, which included $18 million of capital expenditures. Net cash flow for the quarter was $28 million, including additional borrowing of $7 million. Turning to the balance sheet, at the end of the third quarter, cash and cash equivalents totaled approximately $221 million, and short-term investments totaled $35 million. Working capital was approximately $567 million. At the end of the quarter, inventory decreased approximately $6 million from the end of second quarter 2016 to approximately $204 million. Inventory in the quarter reflects a $7 million decrease in finished goods and a $1 million decrease in raw materials, and a $2 million increase in working process. Inventory days were 112 in the quarter compared to 117 last quarter. At the end of the third quarter, accounts receivables were approximately $239 million, an increase of $9 million from the second quarter. AR days were 86, comparable to last quarter. Our long-term debt net of the current portion totaled approximate $407 million. Capital expenditures for the third quarter were $18 million or 7.2% of revenue. As we have mentioned in the past, Chengdu is included in our full year target model for CapEx, which is 5% to 9% of revenue. Depreciation and amortization expense for the third quarter was $24.4 million. Now turning to our outlook. For the fourth quarter 2016, we expect revenue to range between $232 million and $248 million or down 7.5% to 1.1% sequentially, and in line with typical seasonality. We expect gross margin to be 32.2% plus or minus 1%. Non-GAAP operating expenses, which are GAAP operating expenses adjusted for retention costs and amortization of acquisition related intangible assets and are expected to be approximately 23.5% of revenue plus or minus 1%. We expect other expense to be approximately $3.9 million and our income tax rate to be 29% plus or minus 3%. Shares used to calculate diluted EPS for the fourth quarter are anticipated to be approximately $49.5 million. Please note that purchase accounting adjustments for Pericom and previous acquisitions of $4.4 million after tax are not included in these non-GAAP estimates. With that said, I will now turn the call over to Mark King.

Thank you, Rick and good afternoon. Revenue growth in the third quarter was led by Asia, along with record sales in automotive, which increased almost 70% over the prior year period. Additionally, the consumer, computing and communications market increased sequentially with North American sales also up in the quarter. The industrial market was down sequentially as a percentage of revenue due to muted demand in Europe but yet flat to last quarter on a dollar basis. OEM sales were up 18.5%, while distributor POP was flat. Distributor inventory decreased 3.1%, while POS grew 8.9%. Customer activity remained strong across all regions, coupled with strong design activity and design wins. As Dr. Lu mentioned, we completed the sales integration of Pericom in China and the rest of Asia as Q3 planned. We continue to penetrate our key customer based with a broader product line and see significant customer synergy and cross-selling opportunities across the Pericom products. We also continue to make great progress in the automotive market with record revenue combined with increasing new product introductions and design win. From a product perspective, the third quarter was also another record quarter for our MOSFETs and CMOS LDOs, driven primarily by strong smartphone sales, as well as our protection, bipolar transistors, and timing products. Turning to global sales, Asia represented 80% of revenue, Europe 10% and North America was also 10%. In terms of our end markets, consumer represented 29% of revenue, communications 24%, industrial 20%, computing 20% and automotive was the record 7% of revenue. Let me now provide more detail within each of our end markets. For the consumer market, we saw several exciting wins in the camera market with new sockets for our You-Art [ph] devices on an SLR camera platform, as well as wins for our analog and MOX single switches for wearable cameras. Also in the wearable market, we continue to see interest in our Hall sensors and secured a key design win on a market leading fitness tracking device. In the mobile communications market, including portable device charging, Diodes launched a diverse range of products reflecting our leading position with several major customers. From our MOSFET platforms, we introduced DFN and CSP packaged parts for USP power delivery on tablets and mobile applications which were selected by a well-known customer for a Quick Charge application. Also during the quarter, Diodes released additional high surge and general protection devices that were designed specifically around the needs of several U.S. and Asian customers and provide the highest surge and lowest clamping capability of its kind. Also in the communications market, we achieved record revenue for our CMOS LDO product line with nearly 40% of our revenue coming from new products. This growth has been driven mainly by broad adoption of our [RS] CMOS LDOs in the cell phone market. Other key handset wins during the quarter included an analog switch and a USB ReDriver, both into the China cell phone market. We are also expanding our position in data communications market with new design wins on a clock generator for a market leading maker of routers and network switches, a MOX switch win in a KVM device as well as several CMOS LDO sockets for a telecom system power applications. In the computing market, we again expanded our support of the emerging USB Type C connector market with the release of a new bi-directional Mox, DMox switch. Key wins during the quarter for this large and growing market included USB signal switching wins in a large notebook platform, a USB crossbar switch in a gaming platform as well as several wins for China cell phone application. Also in the computing space, we released a new 14 bit SSD switch design for DDR2 and DDR3 memory bus applications for servers and enterprise systems with high density memory requirement. We also achieved significant design win activity for our ReDriver [ph] product family with key wins across multiple notebook, workstation, server and storage applications. Our new products are gaining solid traction in this space with nearly 45% of our signal integrity revenue in Q3 coming from new devices. For the industrial space, we released several new families of products including high voltage, high-performance Industrial unipolar Hall-switches, single stage fly-back and buck-boost controllers for dimmable LED lighting application, as well as a family of primary side switches for power adapter and charging applications. Also during the quarter, we saw a new point of entry in the industrial market through several surveillance equipment design wins in China for our PCI-E switches. Other design wins of note included a Hall sensor win for e-metering applications as well as a win for our RF CMOS LDOs for an industrial imaging application. We also continue to see very strong design win activity and traction on LED lighting products for retrofit application. And finally, in the automotive market, Diodes continue to make great progress with a number of significant wins and product introduction. During the quarter, we introduced a USB charging port controller for using car chargers as well as a family of adjustable automotive grade chunk [ph] regulators that have already been design into an automotive lighting module. Key new automotive design wins include a PCI-E clock buffer and an HDMI switch, both of which were designed into a car infotainment system. We also had new winds on our AC to DC PC TV controller for chargers and continue to expand our position in LED lighting application, including a win for automotive logo lighting. Additionally, we further expanded our family of automotive qualified MOSFETs with the addition of 8, 40 volt, 60 volt and 100 volt products from our innovative Shield Gate [ph] platform. Diodes now has a highly competitive portfolio auto optimized MOSFETs, which are driving strong design win and sales momentum. In addition, we launched a family of high voltage automotive GPP rectifiers in the low-profile Di Flat [ph] package, launched in response to several customer requests from the U.S. and Europe. Also launched during the quarter were two auto qualified super barrier rectifiers, developed specifically for a European tier 1 customer for a reverse battery blocking application. Our SBR technology is being recognized by a growing number of customers for the significant benefit it provides for automotive application. In summary, we had a solid third quarter, highlighted by the achievement of record revenue and gross profit, as well as record revenue in our automotive market. We also completed the sales integration of Pericom, which positions us well for expanding cross selling opportunity to drive market share expansion and revenue growth into 2017 and beyond. With that, I’ll open the floor to questions. Operator?

[Operator Instructions] Our first question comes from the line of Steve Smigie with Raymond James. Your line is open.

Great thanks a lot guys, congrats on getting the record revenue and hitting run rate for your billion-dollar revenue. I know you guys have been working on it for a while. So it's great to see you get that. Also, it seems like the auto business has done pretty well here, which is another big objective. I was hoping you could talk about margins on the automotive business? As it's been growing, I think one of the objectives there was to help improve overall gross margin. Just curious if you’re seeing gross margin on auto come in sort of where you had hoped it be and is it that going to continue the march up there and help overall gross margins? Thanks.

Well the margin fall or the motive is above our pin -- our model. 35%, that’s our model. We typically run much higher than that. And but the product in the automotive will take time to rent it. It take time to design in, and then -- well, we can do the design in but from there, it would take couple of years for them to ramp. So right now it's small percent, 7% of our total revenue. So that high margin do not affect us that much. But physically it is higher than our model.

Okay great and then, I was just hoping to get an update on overall factory loading. It sounds like utilization was better. I know you been trying to fill up a number of facilities, including over in Asia. So just kind of curious if we could get an update on factory utilization?

Sure SAT, our Shanghai Assembly Test facility was in between 80% and 85%. CAT, which is the Chengdu facility was 85%. OFAB, which is the facility in England, the wafer fab in England was right at 90%, SFAB 1, which is the Shanghai fab in -- the order Shanghai fab is a little bit above 80%. And SFAB 2 has increased to 76%. For instance, in fourth quarter ’14 they were at 35. So the loading utilization has doubled there. And then, KFAB was around 65%.

Okay, great. Great, nice progress.

As you know all definition is, when the wafer fab around 85%, we consider that as fully loaded. Even you can, up to 90 something that can offer that, but 85% consider as fully loaded. For assembly, 95% consider as fully loaded. So you can see most -- the 80 is still under loaded.

Okay, great. And then, I was just curious, Dr. Lu, as we think about seasonality for March, I'm not asking you to guide per se, but typically if I just do it mathematically, it looks like you guys are typically up about 1% in March. With that said, if you look at global GDP, like the U.S., for example, it only went about 1%. So it seems like a weak environment. Is it fair to think you could sort of still be thinking about business in terms of seasonality or is it more, you just got a weak macro and we should just take that into consideration as we look forward?

So he is asking about seasonality in the first quarter, first quarter seasonality.

Yes. We are a talking about four. You are talking about first?

Yes, first, first, so March quarter. I know it’s a little bit beyond your guidance time frame. So I'm just trying to maybe back into it, and not that you are guiding it, but just puts and takes around that of, say, weak global macro versus strength of seasonality.

Yes, but typically seasonality in the first quarter, March quarter is down 5% from 4Q. So that’s really typically seasonality. So if I put it typically, 1Q from 4Q previous year down between 0% to 5%, typically 0% to 5%, then 1Q to 2Q typically up 5% to 10%, then 2Q to 3Q again typically up 5% to 10%, then 3Q to 4Q typically down 0% to 5%. So that is the seasonality and each year is within this range.

Thank you. Our next question comes from the line of Tristan Gerra with Robert W. Baird. Your line is open.

Hi. Good afternoon. Given the utilization rates that you’ve mentioned, what are the incremental gross margin opportunities coming from mix? As we know, you tend to increase the mix of higher-margin products as your utilization rates get close to full capacity. So how could we quantify this as an upcoming opportunity in terms of gross margin points going forward?

Okay. Actually, our gross margin coming from two factor. One is coming from product mix, which means when you can sale at a high GP, that kind of product. So -- and for example from the new product that's our larger [ph] measurement -- we measure with new product okay, but that's one. But the other one is coming from inter-directions and inter-direction, like I already mentioned, we have the model and our wafer fab is 85%, assembly is 95%. So today if you look at -- I think we can just give you the direction way of each operation, and if you look at those, we still around room by fully diluted the maximum functions to make the GP to our model. But at the same time when automotive get higher percent, when industrial getting higher percent, then we should be able to get a higher margin.

Okay, and then could you remind us your plans for A range capacity migration and what type of cost saving would you realize relative to 6 inch?

Okay, for [Indiscernible] most -- the wafer is in 6 inch internally, and if we do 8 inch we go to outside. For discreet today it's the same thing. Our internal and 6 inch -- our 8-inch requirement equal to outside. Now, I think in the past I already talking about in our extra tool, we are putting that 8-inch capability for our discreet product okay, and that could probability right now we are in the qualification and then we are see in this quarter after we finish core then we would the PCN, product changing notice. We see it by probably end of this quarter, 4Q. Then we will start to ramp probably second half of next quarter because we wait for the customer to accept in next year, second half of next year waiting for customer accept the PCN and other rank. Okay, so that's where, the timing we are looking at. Then we will probably -- in second half we will probably start to put in the next chunk of the capacity for 8 inch and then to support the 2018 requirement. So second half of next year we use in our current capacity when we start to ramp and then we will put out the second chunk of the capacity.

Thank you. And our next question comes from the line of Gary Mobley with Benchmark. Your line is open.

If I take a look at the midpoint of your fourth quarter revenue guide, it seems about a 4.3% sequential revenue decline, but you are expecting to hold gross margin flat and so obviously utilization isn’t helping preserve the gross margin, probably more so headwind. Therefore, are we looking at a situation where we got decreasing mix of consumer in Q4 and a greater mix of higher margin auto? Any detail there would be helpful?

Number one, yes utilization will probably go down a little bit because of revenue going down. But what we try to do is we’ll focus more on the product mix, not necessary coming from automotive. Of course automotive will of the factor, but it's really a small portion of our revenue, 7% of our revenues. So we won't expect that much. Even we can continue growing automotive digits. But I think, now new product announced in the last couple of years, they are going to start some of the ramp and so when we put in all those together, we can keep the KP [ph] the same as the third quarters to compensate for the utilization down.

Okay, I know you’re not going to share with us, what your organic growth rate is, if we back out any contribution from acquisitions this year. But I know as well that you guys are incentivized by outperforming some bench mark of industry performance. And so can you at least share with us what your view is on your share gain opportunity for 2016, and maybe as well provide specifics on the benchmark that you’re looking at in terms of market performance?

How about, I answer this way. 2016, we had record revenue due to Pericom oppositions. But the growth organically is really coming from our Dio ET [ph] sales. So you do have the Pericom history on 2015 and take that Pericom history of 2015 and assume Pericom, some growth, then you can see the growth we have is coming from Dio ET [ph] sales. But we do not provide that information. But in our, I think we do separate Pericom business and own business, right? In the Q we do separate. So, you can take that and see, how much is Pericom how much is Diodes. Then you can do the comparison. Maybe I think it work. I don’t have, we cannot really share, but in the Q, we do separate the revenue from Pericom and Diodes, in that one year. After one year we don’t. So for 2016 you actually can do that, because 2016 Pericom is the first year and from Q we do separate Diodes pitches and Pericom pitches.

Okay. Rick, I think, if I'm not mistaken, you under spent fairly significantly on the OpEx side in the September quarter. I think you were looking for, what, 24% -- 24% of revenue in OpEx, and you delivered, what, 22% on in line revenue. And basically, you have been holding OpEx flat all year, if not decreasing. So why do you anticipate increasing OpEx roughly $1 million sequentially in Q4 with expected revenue decline?

So the issue here is that if you look at just SG&A, it has been, it went down a little bit in the third quarter because of some actions that we took. We expect that to go back up in the fourth quarter to a more normal range. And R&D is basically we have got it in at flat, right? So with SG&A going back up a little bit, I don’t know, in the $1 million range from where it was in the third quarter, you get this increase in percentage. But it's still, even if you take that number, it's still flat with first quarter below second quarter, and slightly above third quarter. So when you said we’re holding it flat all year along, that is basically true. And the issue is here just quarter-to-quarter adjustments that you have in SG&A.

Thank you. [Operator Instructions]. Our next question comes from the line of Shawn Harrison with Longbow. Your line is open.

Hi. Good evening. This is Gausia Chowdhury calling on behalf of Shawn. A competitor of yours is saying that there is PC inventory correction coming. So are you building that into your guidance or assumptions for the fourth quarter at all? And are you seeing that?

Okay, hang on just a second. So she said that there is -- a competitor of ours has said that the PC inventory, I guess, in the marketplace is growing, and are we seeing any weakness in the PC market due to this inventory situation? That was your question, right?

Yes, right.

Mark, do you want to answer this?

Yes, I would say, it would be built into our guidance. Fourth quarter is traditionally a little bit softer than the third quarter from the PC industry. So as we went through and we looked at our forecast, I don’t think we saw anything out of the ordinary that was going to impact our numbers.

Okay, great, that's helpful. And then, second, with Pericom fully integrated, you noted some better design in activity. Can you maybe provide some more comments or color on how it is progressing, specifically in Asia? Any positive surprises at all?

Do you want me to take that, Dr. Lu?

Yes.

I think Pericom’s Asia team was integrated last quarter into our team, is progressing quite well with their design win activity. From a North American and European standpoint, we had several significant wins in North America and developed some significant longer term opportunities for Pericom in Europe from Diodes’ traditional customer base that maybe got us over the edge. Maybe they were present there, but weren’t doing as well as expected. And we have some really nice opportunities going forward that we’ve already announced. Our uniform team was starting to get closer and more comfortable with each of the product lines and so we're seeing more and more opportunities within our customer base as well as in some of the customers that they did business with, that weren’t focusing on as much. So I think it's going quite well.

All right, thank you. And then last from me. Can you remind us of the interest rate on your syndicated loan and how much savings will you see on an annual basis? And also your thoughts on the cadence of the stock buyback, does that change at all?

So from a syndicated loan standpoint there are I think five or six different tiers within the loan for interest. And the most expensive is LIBOR plus 250, and that's where we are right now and we expect the savings from the new loan versus the old loan because of the changes in those rates and those tiers to be about $2 million a year, $500,000 a quarter. And what was the other one?

Sorry, just about the stock buyback. Any changes in?

No, there were some relaxing of the other covenants in the loan itself, which is going to make it easier to meet the covenants associated with being able to do stock buybacks.

I think last year we announced we’re going to have $100 million in four years, something like that, stock buying back. And we did that 4Q last year. Then because the Pericom acquisition and due to all this covenant, therefore we don’t have cash and we have some regulation from the bank. We cannot spend more money to buying back. Now with this time, we negotiate new loan and they relax this requirement and then we are able to go back to assume our stock buying back program.

Thank you. And I am showing no further questions at this time. I'd like to turn the call back to Dr. Lu for closing remarks.

Thank you for your participation today. Operator, you may now disconnect.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.