Diodes Incorporated (DIOD) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to Diodes Incorporated Third Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. At the conclusion of today's conference call, instruction will be given for the question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded today, Tuesday, November 7, 2017. 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 2017 financial results conference call. I'm Leanne Sievers, 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'd like to remind our listeners that the results announced today are preliminary as they are subject to the company 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 Form 10-Q for its third quarter 2017. In addition, management's prepared remarks contain forward-looking statements, which are subject to risk 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 including forms 10-K and 10-Q. In addition, any projections as to the company's future performance represent management's estimates as of today, November 7, 2017. Diodes assumes 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 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 reconciliations 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. 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'm pleased to report that Diodes achieved another quarter of record results. Taking new heights of revenue, gross profit and operating income. Our growth continues to be broad-based across all regions and end markets. We also achieved record revenue in our computing and communication end markets complemented by 30% year-over-year growth in both automotive and industrial. In fact our automotive end market reached a record 8% of the revenue which is even more notable considering the higher revenue base. Revenue from Pericom also continued to grow from the high level achieved last quarter, with solid margin contribution as we integrate those products into our complete customer offerings. Additional, continued improvement in product mix and the utilization across our facilities, results in non-GAAP gross margin across to our target model of 35% in the quarter. We have completed wafer manufacturing at our KFAB facility and demand on track to return the property to the vendor by November 15. Consistent with our focus on driving increased profitability and expanding shareholder value. We recently established new long-term financial targets, which includes gross margin of 40% and operating margin of 20%. As a result of the strategic actions we have taken over the past few years, we have positioned the business to drive significant earnings expansion serving as a basis of introducing those increased targets. Our business is also generating significant amount of cash. We plan to continue allocating cash toward reducing our long-term debts while also maintaining the flexibility to support our future expansion initiatives, potential strategic acquisition as well as our existing buyback. Looking forward we well positioned to benefit from our solid operating leverage to deliver increased profitability and shareholder value. With that I will not turn the call over to Rick to discuss our third quarter financial results and our fourth quarter guidance in more detail.

Thanks Dr. Lu and good afternoon everyone. Revenue for the third quarter 2017 was $285.2 million, an increase of 8% from the $264.2 million in the second quarter of 2017 and an increase of 13.8% from the $250.7 million in the third quarter of 2016. The sequential increase in revenue was due primarily to continued strength across our target end markets and geographies combined with continued growth of Pericom products. GAAP gross profit for the third quarter was $96.3 million or 33.8% of revenues, including approximately $2.7 million of KFAB closure costs. Non-GAAP gross profit was $99 million or 34.7% of revenue excluding these costs. This compares to $90.1 million or 34.1% of revenue in the second quarter of 2017 and $80.6 million or 32.2% of revenue in the prior-year quarter. The increase in gross profit margin was due primarily to continued improvements in product mix and utilization combined with another strong quarter in North America and Europe as well as the Pericom business. GAAP operating expenses for third quarter 2017 were $72.6 million or 25.5% of revenue and $63.9 million or 22.4% of revenue on a non-GAAP basis, which excludes $4.7 million of amortization of acquisition related intangible asset expenses, $2 million of KFAB restructuring charges and $2 million for the impairment of fixed assets. This compares to GAAP operating expenses of $66.3 million or 25.1% of revenue in the previous quarter and $59.8 million or 22.6% of revenue on non-GAAP. Looking specifically at selling, general and administrative expenses for the third quarter, SG&A was approximately $43.5 million or 15.3% of revenue, which is our operating model. This compares to $39.7 million or 15% of revenue in the previous quarter and $38.3 million or 15.3% of revenue for the third quarter 2016. Investment in research and development for the third quarter was approximately $20.4 million or 7.1% of revenue. This compared to $19.8 million or 7.5% of revenue last quarter and $17.1 million or 6.8% of revenue in the third quarter 2016. Combined SG&A plus R&D for the third quarter of 2017 was $63.9 or 22.4% of revenue compared to $59.5 million or 22.5% of revenue in the previous quarter and $55.4 million or 22.1% of revenue in the third quarter of 2016. GAAP income from operations was $23.7 million or 8.3% of revenue. Non-GAAP income from operations excluding intangible asset amortization costs and KFAB shutdown costs was a record $35.2 million or 12.3% of revenue. This compared to $29.9 million or 11.3% last quarter and $25.5 million or 10.2% in the year ago quarter. Total other expense amounted to approximately $3.9 million for the quarter, including a $1.3 million negative currency impact. Income before taxes and non-controlling interest in the third quarter 2017 amounted to $19.8 million compared to $19.9 million last quarter and $15.6 million in the third quarter of 2016. Turning to income taxes, our effective income tax rate for the third quarter of 2017 was approximately 25.5%. GAAP net income for the third quarter 2017 was $14.5 million or $0.29 per diluted share compared to $13.2 million or $0.26 per diluted share in the second quarter of 2017 and $10.6 million or $0.21 per diluted share in the third quarter of 2016. The share count used to compute GAAP diluted EPS for the third quarter 2017 was 50.4 million shares. Third quarter 2017 non-GAAP adjusted net income was $22.6 million or $0.45 per diluted share, which excluded net of tax, $3.8 million of noncash acquisition-related intangible asset amortization costs, $3.1 million KFAB restructuring and closure costs as well as $1.3 million in fixed asset impairment charges. This compares to non-GAAP net income of $17.8 million or $0.36 per diluted share last quarter and $15.1 million or $0.30 per diluted share in the third quarter 2016. 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 of 2017 GAAP net income and non-GAAP adjusted net income was approximately $3.2 million net of tax of noncash share-based compensation expense. Excluding share-based compensation expense both GAAP diluted EPS and non-GAAP adjusted diluted EPS would have increased by additional $0.06 per diluted share in the third quarter. Cash flow generated from operations was $40.9 million for the third quarter 2017. Free cash flow was $2.9 million for the third quarter, which included $38 million of capital expenditures. Net cash flow was a negative $65.4 million including the pay down of approximately $75.2 million of long-term debt and $38 million of CapEx during the quarter. Turning to the balance sheet, at the end of the third quarter, cash and cash equivalents plus short-term investments totaled approximately $214 million. Working capital was approximately $476 million. Long-term debt including the current portion was $325.8 million. At the end of the third quarter, inventory increased by approximately $3.7 million from the second quarter 2017 to approximately $211.4 million. The increase in inventory reflects a $1.7 million increase in finished goods, a $7.1 million increase in raw materials and a $5.1 million decrease in work in process. Inventory days were 102 in the quarter compared to 104 days last quarter. At the end of the quarter, accounts receivable was approximately $230.5 million, an increase of $7 million from last quarter. AR days were 73 compared to 74 last quarter. Capital expenditures for the third quarter were $38 million or 13.3% of revenue, with the majority of the expenditures related to newer advanced packaging capacity expansion in our assembly test operations in China. We believe full-year 2017 CapEx which is focused on capacity expansion related to the current favorable market environment and growth projections for 2018 will be approximately 11% of revenue, which will be higher than our 5% to 9% revenue model. Depreciation and amortization expense for the third quarter was $24.1 million. Now turning to our outlook, for the fourth quarter 2017, we expect typical seasonality with revenue to range between $260 million and $280 million or down 8.9 to 1.8% sequentially. We expect GAAP gross margin to be 34.9% plus or minus 1% and non-GAAP gross margin to be 35% plus or minus 1%. Non-GAAP operating expenses which are GAAP operating expenses adjusted for KFAB closure and retention costs and amortization of acquisition-related intangible asset expenses are expected to be approximately 23.5% of revenue plus or minus 1%. We expect interest expense to be approximately $3 million. Our income tax rate is expected to be 29% plus or minus 3% and shares used to calculate diluted EPS for the fourth quarter are anticipated to be approximately 50.8 million. Please note that purchase accounting adjustments of $3.9 million for Pericom and previous acquisitions and KFAB closure costs of $3.8 million, both after tax are not included in these numbers. With that said I will now turn the call over to Mark King.

Thank you Rick, and good afternoon. As Dr. Lu and Rick highlighted third quarter revenues set another record, up almost 8% sequentially on top of a 12% increase last quarter. Our growth continues to be driven by strong sales in all regions and end markets including record revenue in both Asia and Europe and the best quarter in North America since Q3 2010. Distributor POS set records both globally and regionally was up 12.9% while distributor inventory rose 5.6% in support of expanded POS. Channel inventory days at the end of Q3 are down from Q4 2016 and well within our target range. As indicated by our record sales, customers activity in the third quarter was strong in all regions with increasing design activity and design wins. We continue to penetrate our key customer base with an expanded sales footprint, broader product line and see significant cross-selling opportunities with the Pericom products. We set revenue records on nine products during the quarter including MOSFETs and CMOS LDOs, hall sensors, protection, timing, switching, interface ICs, connect basic and battery management. These record results reflect past design wins on new products ramping into production. We expect to drive continued revenue growth and momentum with our expanding new product introductions and design wins. Turning to global sales in the quarter, Asia represented 79% of revenue, Europe 11% and North America 10%. In terms of our end markets, consumer represented 26% of revenue, communications 24, industrial 23%, computing 19 and automotive 8% of revenue. Let me now provide more detail within each of our end markets. In the consumer market, our ultralow power CMOS LDOs and audio products continue to gain strong acceptance in the IoT area. Our next generation ultralow quiescent current CMOS LDOs supported the pilot run of an advanced new bio activity tracker that monitors changes in breathing as well as physical activity. Our 18 volt peak at peak output Piezo Sounder driver released last quarter is already being used to produce a highly efficient sounder function in multiple mobile tracking applications that use Bluetooth low energy technology. We also secured multiple new design wins for our low switch product line in set-top boxes and CVR applications as well as CMOS LDO wins in a Bluetooth headset application and IP camera. In the communications market, we had significant activity with seven major new timing product wins across several switch, router and optical line card applications. During the quarter, our micropower hall sensors ramped aggressively in a market leading smartphone platform. Notable new product releases for the communications market including constant voltage/constant current secondary side control for smartphone adapters compatible with book quick charge and adaptive fast charging protocols. We also released a new 8-line PCI Express switch specifically designed for networking and telecom applications. Also for mobile communication applications including charging of portable device and wearables, Diodes launches six TVS devices including [indiscernible] devices developed specifically for two key mobile customers. We also launched a common-drain MOSFET pair with extremely low source-to-source resistance with a small and ultrathin footprint that is ideally suited for bidirectional load switching and space constrained mobile applications. For computing applications, Diodes launched two additional MOSFETs targeted at motherboard and vCORE applications. These MOSFETs are based on Diodes Split Gate technology and extend our offering to the sub-one mOhm market space as these applications require very low RDS on and excellent thermal properties for high efficiency performance. Also in the computing market, MUX devices for solid state drives continue to see strong tractions with drives ramping this quarter at two market leading enterprise customers. Our SSD MUX devices offer best-in-class performance with high bandwidth to support data rates that exceed 400 megabits per second. Also, also in the server space, we saw multiple new engagements by our signal integrity product line, including a new serial APA and PCI Express ReDriver socket. We secured several new wins for our LDO product line in notebooks, including a significant new socket for our high voltage CMOS LDO family. For industrial applications, we launched the first devices in a range of low voltage 50 volt gate drivers aimed at motor driving. Increasingly, brushless DC motors are replacing brush motors due to their superior efficiency, power conservation and compact size. Also launched this quarter was another device in our series of synchronous controllers to once again meet the needs of more efficient green power supplies. Diodes' rugged split gate MOSFET technology that I just mentioned is also well suited for the demanding investor environment, including machinery and synchronous rectification. These split gate MOSFETs were complemented by three MOSFETs from our newly introduced Super Junction process technology aimed at AC to DC power supply applications. Also in the industrial end market, we expanded our LED lighting portfolio with the release of two new product offerings, one is a buck LED driver targeted at TRIAC dimmable lamps and the second is a high performance buck boost device for connected tunable LED lighting applications. This second device received strong early adoption and is already ramping in a trend setting connected lighting application. Other notable wins in the industrial space include a voltage regulator socket at any HVAC system, a DC to DC converter win in a security system and a new hall sensor designed for an industrial power tool. And lastly, in the automotive market, we launched four new RDS(ON) MOSFETS together with a dual channel 100 volt MOSFETs for process DC motor driving for a range of applications. Our auto qualified MOSFET products continue to drive strong customer qualification activity and design ins among our major automotive customers. Key factors in Diodes' successful penetration of the automotive market continues to be our shielded gate MOSFET wafer technology together with our power packaging capability and extended at 175 degree C temperature rating. Also during the quarter, we sampled our first [indiscernible] with superior reliability. The full product release is expected in the fourth quarter. Additionally, we released a family of automotive compliant PCI Express switches, specifically designed for low power operation and vehicle systems such as safety and security, traffic mapping and infotainment platforms. These devices support multiple linked power states and offer advanced power management features for high performance, but yet cost effective solutions. Key wins in the automotive space include new sockets for high voltage unipolar hall switch as well as further expansion of our automotive LED lighting presence. In summary, our achievement of another quarter of record results reflects the significant momentum we are generating across the business. Our focus on expanding new product introductions, design win activity and content at new and existing customers continues to show evidence of success across our end markets. Importantly, we're only at the beginning stages of the realization of a full benefit from the Pericom acquisition in terms of cross selling opportunities, revenue expansion as well as gross margin contribution. We expect to finish out the year in a solid position to drive continued growth in 2018. With that, I will open the floor to questions. Operator?

[Operator Instructions] Our first question comes from the line of Tristan Gerra with RW Baird.

Looking at your Q4 revenue guidance, obviously strong year over year growth, but also more or less seasonal sequentially, which is also what you've mentioned on the call. Trying to reconcile on my end the strengths that we're seeing in terms of end markets with your guidance that's just seasonal, particularly in the context of the recent lead time expansion that we've seen in analog. So are you supply constrained or are there any specific end markets that perhaps is striking it a little bit bigger than expected in Q4?

I would say that everything is tracking - I would say, obviously, the consumer marketplace will see the softest Q4. I think some of the supply constraints will be alleviated in the fourth quarter. We still have some packages and certain products that will be pretty relatively tight, but I think we're in pretty good shape in that area.

And then what percent of your products currently have lead times above 12 weeks and when do you expect lead times to return to normal levels?

Tristan, I don't really look at the lead times that way, I can't say. We think that things will normalize probably after the Chinese New Year somewhat because the timing and some of the late launches of certain things, but we expect certain products will be difficult into mid next year, maybe some of our MOSFET products will remain tighter into mid next year, but we, based on our CapEx, we've prepared for - to catch the marketplace in this thing and position ourselves for 2018. So we think we're in pretty good shape to level out the supply.

Okay. And then just one quick last one, if you could give us the utilization rates in Q3 and also both for the whole company and also where BCD2 is currently?

Okay. The assembly test facilities in China, both in Shanghai and CAT were 96%. I'm going to leave KFAB out, since it's being shut down. OFAB, which is the fab in Manchester, England was at 95%. SFAB1 was at 97% and SFAB2 was at 80%.

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

Dr. Lu, what would revenue have been in the third quarter if you weren't capacity constrained and how much revenue might have thrown out of the third quarter because of that constraint into the fourth quarter.

Well, I don't really have that data for you, but we are really in the third quarter still surprised limitation and certainly the limitation and actually even through the fourth quarter, we are in similar situations. Now, with seasonality, we do come down, but just cynical, but if you go to look at, we still are cynical than the history.

Okay. Help me explain how you expect the gross margin to increase sequentially, albeit modestly despite based on the midpoint of your revenue guide of 5% sequential revenue decline. Is that a function of the product produced in the third quarter flowing through the fourth quarter P&L or is it a function of the switchover in cheaper manufacturing away from KFAB?

Well, it's all above, but KFAP expect its best, okay, but majority is really coming from utilization, product mix and new products and new packaging technology. All those is really excess or improve our margins.

Okay. In the past, you talked about maybe a benefit in the gross margin, once manufacturing is fully switched over away from KFAB, I think it might have been 100 basis point impact or so. Could you clarify the amount of the benefit and when you might start to see the positive influence on the overall gross margin?

Okay. Number one, we are shifting down but we've not rented out yet in that respect. Now, some of the demand actually go to subcom and more to OFAB. The one thing to offer is probably in Q4 is start to see some surprise, but if not, there in the third Q of the year. And also SFAB portion, we are qualified that SFAB, but we're waiting for the equipment shutdown from KFAB probably shutdown in the end of September and then we are moving now to SFAB and into that incumbent. So you really cannot see the ramp until the first quarter of next year and then you create or rented out, because we see a need to customer qualification and acceptance. So the one point in subcom which already qualified, that you can see some benefit in third quarter, into the third quarter, but majority of the KFAB effect, the benefit accounting from KFAB effect is not showing up here until next year. Okay. You start to see some in 1Q, but it won't fully benefit it until probably second half of next year.

Okay. And kind of ping you down on any quantifiable benefit in the gross margin?

Yeah. We've said previously that we think it's going to be somewhere about $3 million a quarter, $12 million a year, something like that.

Yeah. I think we said 10 to 15. 10 to 15 is what said and we said it's when we fully rent, okay and that effect, we've always been fully ramped until second half of next year.

[Operator Instructions] And our next question comes from the line of Shawn Harrison with Longbow Research.

The increase to the gross margin target of 40% from - it looks like you'll be at 35% this quarter. Let's say a point of that is tied to the KFAB closure and transfer, but the remaining 400 basis points, how much of that is a function of mix verses, I'm assuming, we're in a better pricing environment if you comment on that versus other factors, pushing up your long term margin targets.

I think it has a lot to do with what our long term focus is going to be and driving the proper mix. And of course as we drive that focus in the product areas at better pricing discipline within our organization and so forth and work to really get the value out of our products and so forth and focus in that area. So I think you'll see over time, we'll be a less commodity based. We'll still be a broad light supplier, but our focus is going to be on key products within our key end equipments and our key customers and that will drive us in that direction.

And you know when I visit in September, this is our investor and analyst, I do mention we come to advance our market segment, okay? Currently, if you look at our automotive and industrial, it's probably somewhere around 30 something percent and it's actually improved from our - 10 years ago. I think I mentioned 80% of our revenue coming from consumer, computer, communication and only 20% coming from industrial and automotive. And I said from the long term, we want to continue focus on industrial and automotive. And today, industrial already on 25%, 26% in average, so it's already up to that and I think today, talking about in the third quarter, our automotive now is 8% of overall revenue. And if we continue to focus on our industrial and automotive, then I am hoping it's in the near term we get to 40% of our revenue coming from automotive and industrial. These two market segments tend to give you higher gross margin than the other three of the consumer, computer, communication. And therefore, by focusing on the right or the higher gross margin market segment, then we should be able to change the mix and accomplish the 40% goal, what I'm really trying to change our focus from 35% to 40%.

And two follow-ups if I may. I know next year's far enough out still, but if we look at capital spending for next year, you'll be at 11% of sales for this year. Do you believe it will drop down in to that 5% to 9% range for 2018 or will you need to be above that kind of normalized range still to add capacity?

I think right now, I didn't say yet, but I think next year, we're hoping we go back to 7% to 9%. This year, we have been - last year, we got down, but this year, due to the shortage, the capacity shortage and due to, we're going to continue a big growth and therefore we're putting our CapEx in high performance new packaging type areas. So I think we will continue and by the money, we spend the money in the 8-inch capacity with respect to as I mentioned in the past. Those are the reasons costs, that the CapEx slightly higher than what I'd like to have of 5% to 9%, midpoint 7%.

And then lastly, Rick, AR days are I think down 10 or so days year-over-year, maybe a little bit more than that and your cash cycle is down pretty precipitously year-over-year as well. I guess maybe the first question is what drove some of the gains and are there further gains being made in the cash cycle or kind of where you're at right now a good to go forward number?

Well, I think where we are right now is a pretty good number. You're right. It's gone down over the last three or four quarters. And so - also you have the US and Europe being strong; North America being strong and their paying terms are less than Asian payment terms. But I think going forward, you will probably won't see it, a huge reduction in the amount of AR days.

Thank you. And I'm showing no further questions at this time. So I'd like to return the call to Dr. Lu for any closing remarks.

Thank you for your participation on today's call. Operator, you may now disconnect.