ALPHA & OMEGA SEMICONDUCTOR Ltd Q2 FY2022 Earnings Call

Good evening. Thank you for attending today's Alpha and Omega Semiconductor Fiscal Q2 2022 Earnings Call. My name is Bethany, and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to our host, Gary Dvorchak with Alpha and Omega. Please go ahead.

Good afternoon, everyone, and welcome to Alpha and Omega Semiconductor's conference call to discuss fiscal 2022 second quarter financial results. I'm Gary Dvorchak, Investor Relations representative for AOS. With me today are Dr. Mike Chang, our CEO; Stephen Chang, our President; and Yifan Liang, our CFO. This call is being recorded and broadcast live over the web. A replay will be available for seven days following the call via the link in the Investor Relations section of our website. Our call will proceed as follows: Mike will begin with strategic highlights then Stephen will provide business updates and a detailed segment report. After that, Yifan will review the financial results and provide guidance for the March quarter. Finally, we'll have the question-and-answer session. The earnings release was distributed over the wire services today, February 7, 2022, after the close of the market. The release is also posted on the Company's website. Our earnings release and this presentation include certain non-GAAP financial measures. We use non-GAAP measures because we believe they provide useful information about our operating performance that should be considered by investors in conjunction with the GAAP measures that we provide. A reconciliation of these non-GAAP measures to comparable GAAP measures is included in the earnings release. We remind you that during this conference call, we will make certain forward-looking statements, including discussions of the business outlook and financial projections. These forward-looking statements are based on management's current expectations and involve risks and uncertainties that could cause our actual results to differ materially from such expectations. For a more detailed description of these risks and uncertainties, please refer to our recent and subsequent filings with the SEC. We assume no obligation to update the information provided in today's call. Now I'll turn the call over to our CEO, Dr. Mike Chang, to provide strategic highlights. Mike?

Thank you, Gary. I would like to welcome everyone to today's call. It is a pleasure to be speaking with all of you again today. To begin, I would like to briefly summarize some of the major achievements from last year and outline why we believe we have achieved a critical milestone in our operations and are in a very strong position to deliver growth and value to our shareholders in the years to come. Looking back, calendar year 2021 was an exceptional year for AOS, both in terms of our business execution as well as our financial results. Due to the global semiconductor supply shortage, we focused on executing our three-pronged production capacity strategy. First, we made a significant investment to expand our capacity and further enhance our R&D capabilities at our Oregon facility. Second, the joint venture in Chongqing completed Phase 1 of its capacity ramp in September, and in December, we sold 3.2% of our equity interest in the JV for approximately $26 million. The strategic intent of this transaction was to reduce our shareholding below 50% to allow the JV more flexibility to one, raise capital as a more independent company. Two, accelerate further expansion plans; and three, pave the way for an eventual IPO on Shanghai's STAR market. Additionally, I am delighted to see that less than two months after our initial sales transaction, the JV successfully raised $80 million from outside investors as part of Phase 2 of its expansion plan, which the JV expects to complete sometime in 2023. To see the first part of our original plan for the JV Company come to fruition has been a joy. One of the core tenets of our three-pronged capacity strategy is ensuring our supply security. Not only do we need to expand our capacity to meet our aggressive growth business plan, but we also need to manage unforeseen risks associated with today's uncertain world, such as natural disasters and geopolitical risks through diversification. In this regard, the JV Company will be one of our important foundry partners. And on the flip side, AOS will continue to be a key customer of the JV Company. Lastly, but not least, we are also actively expanding our relationships with multiple third-party foundry partners for additional capacity to meet the increasing demand for our products. Another dimension of our business that has undergone significant change over the past year that may not be as obvious is the quality of the customers that we are serving. As an example, in our Computing business, we sell to the world's leading PC brands. In our Communications segment, we sell to the number one smartphone brand in the United States, the number one smartphone brand in Korea and all the leading smartphone OEMs in China. In our other business segments, we sell to the number one graphics card maker, the number one gaming console manufacturer, the number one global home appliance manufacturer and the number one power tools provider. In summary, Tier 1 OEMs now make up the majority of our revenue mix. The effect of this dynamic makes our business much more resilient to downturns because during difficult economic conditions, consumer demand typically declines faster for lower-tier brands than it does for premium brands. In addition, due to the uncertainty created by the COVID pandemic, we have worked tirelessly with our customers over the past two years to avoid interruptions to their production lines. As a result of our efforts, our customers' trust and respect for us as a strategic partner has deepened and our relationship with them has never been stronger. Also in 2021, through multiple well-planned initiatives and diligent precise execution, our Power IC business finally has emerged to become a significant portion of our business, representing nearly $200 million annual revenue run rate. This greatly helped AOS pursue our utmost goal of providing system-level total power solutions to our customers, going beyond our traditional pattern of just offering component sales. This not only offers more convenience and value to our customers, but also improves our margin while enabling stickier design wins. 2021 was also a record year in each of our business segments financially. A few years ago, we set out to achieve a target annual revenue of $600 million in calendar year 2021. Today, our business has the product portfolio, customer relationships and the production capacity to deliver well over our original revenue target. In addition, because end market demand was strong across the board, we strategically optimized our product mix, which resulted in gross margin expansion in each consecutive quarter, with the December quarter coming in at 36.7% on a non-GAAP basis, which is a record. All these structures significantly contributed to us crossing $1 quarterly non-GAAP EPS milestone in the last quarter. This quarter, we are happy to report non-GAAP earnings per share of $1.20, which further reinforces our company's strong earnings power of $4 to $5 annual EPS. In summary, we achieved record results in 2021, thanks to our long-term planning and execution, our extensive product portfolio, driven by our R&D capabilities and by serving as a dedicated and trusted partner to our customers. Our confidence in our business model and the strategic positioning has never been greater than it is today. Now with most of our revenue coming from Tier 1 OEMs, I am proud to say that we believe we have crossed the chasm as an established company and are now a leading global power semiconductor supplier. I want to thank our customers, business partners, and shareholders for their support and confidence in the Company. I also want to acknowledge our employees for an outstanding job and for staying focused and engaged with our customers while we navigated this challenging macro environment, especially in the midst of the continuing adversity of the pandemic. I'm proud of the way we have come together while placing our employees' health and their safety at the center of our objectives in achieving our success. As we look to the future, we now have our sights set on actively planning and marching towards $1 billion annual revenue, with much stronger and more sophisticated R&D capability and the supply chain operations, and with most of our customer base consisting of the world's leading OEMs in the market that we serve. We are excited about our growth trajectory. Now, I will turn the call over to Stephen for the updates on our business and the detailed segment report. Stephen?

Thank you, Mike, and good afternoon, everyone. I will start with an update on our business and then provide color on our segment results. In the December quarter, demand for our products remained extremely strong, and we continue to set new records in our revenues and profitability. We continue to work closely with our customers to strategically allocate our production capacity to help them avoid disruptions in the midst of a difficult environment and at the same time, optimize for revenue and gross margins. While we do see some signs that historical seasonal patterns are beginning to return, which is healthy, at least for the remainder of this year, we expect global demand for semiconductors to remain stronger than the industry's ability to meet it. Regarding our capacity plans, we continue to focus on strategically strengthening and diversifying our production capacity. Our Oregon fab is currently undergoing a $100 million R&D facilities upgrade and capacity expansion project, which is expected to be completed in the December quarter of 2022. Equipment has already been ordered and the clean room expansion is already in progress. When completed, we estimate the incremental revenue based on this new capacity to be approximately $70 million annually. As Mike already mentioned, we reduced our equity ownership in our joint venture fab in Chongqing below the controlling threshold of 50%, effectively allowing the joint venture to legally separate its operation as its own independent entity. Yifan will provide more details on this in his section of this call. This transaction marks an important step for both us and our joint venture. For the JV, this means greater flexibility in future capital raises to expand its manufacturing capabilities. For AOS, it allows us to focus our attention towards executing our Oregon fab expansion plans and further diversifying our supply chain across other foundry partnerships. In the years to come, we are looking forward to continuing to work closely with the JV as one of its key customers. Finally, we are focusing on expanding partnerships and increasing wafer supply from existing foundries as well as bringing on new foundries. In summary, these efforts are all part of our long-term strategy for sustainable growth. With current challenges in the semiconductor industry, especially the global capacity shortages, we are thankful to own and control much of our supply chain, while also being strategic about our risk management and capital allocation decisions by diversifying our supply chain with contract foundries. We believe this strategy provides the right kind of flexible capacity that allows us to be nimble during periods of industry overcapacity and economic slowdowns. Now let me drill down into each of our business segments. Unless otherwise noted, the following figures refer to the December quarter of 2021. Let's start with Computing. Revenue was up 35.9% year-over-year and up 11.9% sequentially. This segment represented 45.5% of our total revenue. As expected, end demand for our products was strong. To best allocate capacity, we shifted resources and production to support the Computing segment, especially notebook and desktop applications as well as graphics cards. Looking ahead into the March quarter, which is typically our seasonally slowest quarter following strong holiday shipments, we expect Computing revenue to be slightly lower to about flat. We expect strong demand to continue at our ODM customers for notebooks and desktop applications. This will be partially offset by a slight decline in graphics cards following a strong shipment in calendar Q4 as we reallocate our resources to support demand in other areas such as client computing. Turning to the Consumer segment. Revenue grew 9.9% year-over-year and declined 4.6% sequentially and represented 20.1% of our total revenue. The year-over-year growth was primarily driven by strong demand in home appliances and share gains in gaming, both at Tier 1 OEMs. The sequential results were lower than our original target, primarily due to the timing of shipments in gaming as one of our major customers pushed out orders for our MOSFET and Power IC products to the March quarter due to component delays from another supplier. Our total company revenue was not affected as we were able to quickly shift wafer capacity to other parts of the business. Accordingly, we expect our Consumer segment will achieve strong double-digit sequential growth in the March quarter as we reaccelerate shipment to this particular gaming customer after they resolve their other supply shortages. Next, let's discuss the Communications segment, which was 13.2% of total revenue, down 5.1% year-over-year and down 0.8% sequentially. This segment played out better than we anticipated last quarter as we saw stronger demand from the world's two leading smartphone makers in the U.S. and Korea, which helped offset some weakness that we expected from our China OEM. We continue to believe we are in an excellent position for growth in battery protection over the next couple of quarters as we have secured designs at all the major global smartphone makers. Finally, let's talk about the Power Supply and Industrial segments, which accounted for 19.5% of total revenue. This segment was up 30.7% year-over-year and down 0.5% sequentially, which was largely in line with our expectations. In the December quarter, we slightly reduced allocation to our AC-DC power supply business following two consecutive quarters of strong shipments. However, demand for our power supplies, particularly laptops, remained strong relative to the prior year. Further, we resumed shipments to a top U.S. solar microinverter maker and increased allocation to support the growing demand for our industrial solutions with a Tier 1 U.S. power tool manufacturer. Power tools is an emerging application for us with great synergy, given our product strengths in low- and medium-voltage products targeting battery management and brushless DC motors. Looking ahead, we expect our Power Supply and Industrial segment to decrease slightly in the March quarter due to a temporary slowdown in our AC-DC power supply business due to allocation, while our recently ramped solar and power tool business remains elevated. To wrap up, it was another outstanding quarter for AOS, and our business continues to fire on all cylinders. We continue to work diligently to deliver products to our customers on time and stay laser-focused on executing our capacity expansion and diversification plans. With that, I will now turn the call over to Yifan for a discussion of our fiscal second quarter financial results and our outlook for the next quarter.

Thank you, Stephen. Good afternoon, everyone, and thank you for joining us. Before I start to discuss the financial results for the quarter, I would like to say a few words about the changes in our equity interest in the JV Company and related accounting and financial reporting. As discussed previously on our Form 8-K, we completed a sale of 2.1% of our equity interest in the JV Company for $16.9 million on December 2, 2021, which resulted in the deconsolidation of the financial statements of the JV Company as we were no longer the controlling shareholder. Subsequently, in December, we completed another sale of 1.1% equity interest for $9.4 million and the JV Company also issued approximately 4% equity interest to its employee stock ownership plan. With the above transactions, our equity interest in the JV Company at the end of December was 45.8%, and our equity investment recorded on the balance sheet was $376.1 million. In addition, an after-tax net gain of $358.7 million was recognized on the income statement for the quarter, and we excluded such gain from our non-GAAP financials as it was not related to our ongoing business and operations. Nevertheless, the gain indicated the equity value that we created during the last few years while we built up the JV Company as one of our major suppliers. Subsequent to the December quarter, the JV Company completed an equity financing transaction of $80 million, representing approximately 7.82% of post-transaction outstanding equity of the JV Company, which further diluted our equity interest to 42.2% as of January 26, 2022. In our financial reports, beginning with the month of December, we now account for our equity interest in the JV Company under the equity method of accounting. We also elected to record our pro-rata share of the JV's net earnings on a one-quarter lagging basis. We will exclude it from our non-GAAP results so it's easier for our shareholders to see the financial performance of our ongoing business and operations. Finally, going forward, because we are now a minority shareholder in the JV Company, we will no longer discuss the operations of the JV Company. With that, let's discuss the financial results for the quarter. Unless otherwise noted, the following figures refer to the December quarter of 2021. Revenue was $193 million, up 3.4% from the prior quarter and up 21.7% from the same quarter last year. In terms of product mix, DMOS revenue was $135 million, up 3.3% sequentially and up 13.9% year-over-year. Power IC revenue was $55.1 million, up 5.3% from the prior quarter and up 7.4% from a year ago. Assembly service revenue was $3.2 million as compared to $4 million last quarter and $2.9 million for the same quarter last year. Non-GAAP gross margin was 36.7%, up from 35.3% in the prior quarter and up from 31.4% in the same quarter last year. The quarter-over-quarter increase in non-GAAP gross margin was mainly driven by better product mix. Non-GAAP gross margin excluded $0.8 million of amortization of purchased IP for the December quarter, the prior quarter and the same quarter last year, respectively. In addition, non-GAAP gross margin excluded $1.7 million of share-based compensation charges as compared to $0.6 million for the prior quarter and $0.4 million for the same quarter last year. Non-GAAP operating expenses were $33.5 million compared to $35.1 million for the prior quarter and $31.5 million for the same quarter last year. The quarter-over-quarter decrease was primarily due to the deconsolidation of one month of the JV Company's operating expenses and lower variable compensation accruals this quarter. Non-GAAP income tax expense was $1.3 million, which excluded $32.8 million of tax expense on the gain of our equity interest in the JV Company compared to $1.3 million for the prior quarter and $0.7 million for the same quarter last year. In sum, non-GAAP EPS attributable to AOS was $1.20 per share as compared to $1.06 for the prior quarter and $0.65 for the same quarter last year. Now let's look at the cash flow. Consolidated operating cash flow was $50.8 million, including $11.2 million net customer deposits. Our operating cash flow in the prior quarter was $80.6 million, which included $40.2 million customer deposits. Operating cash flow a year ago was $36.1 million, which included $10 million customer deposits. Consolidated EBITDAS was $46.7 million compared to $45.3 million for the prior quarter and $31.6 million for the same quarter last year. Let's move on to the balance sheet. Please note that the balance sheet accounts at December 31, 2021, no longer consolidated the JV Company anymore. We completed the December quarter with a cash balance of $269.3 million compared to $252.5 million at the end of last quarter, which included $20.9 million cash balance at the JV Company. The cash balance a year ago was $181 million, which included $38.7 million at the JV Company. You will note that our bank borrowing balance was $22.7 million compared to $159.2 million a quarter ago, which included $137 million from the JV Company. During the quarter, we repaid $2.1 million of existing term loans and borrowed $2.5 million of working capital loan. In terms of trade receivables and inventory, Days Sales Outstanding for the quarter was 27 days, flat as compared to the prior quarter. Average days in inventory were 105 days for the quarter compared to 117 days in the prior quarter. The reduction in inventory days was mainly due to the deconsolidation of the JV Company. Finally, our fixed asset balance was significantly reduced, again, primarily due to the deconsolidation. Net Property, Plant and Equipment was $196.7 million, down from $441.3 million last quarter and down from $430.8 million last year. AOS capital expenditures for the quarter were $22.7 million. The deconsolidation of our JV financials really shines a light on the strength of our balance sheet, which has relatively low fixed assets compared to our earnings power and very low debt. Now, I would like to discuss March quarter guidance. We expect revenue to be approximately $194 million, plus or minus $3 million. GAAP gross margin to be 35.1% plus or minus 1%. We anticipate non-GAAP gross margin to be 36% plus or minus 1%. Non-GAAP gross margin excludes $0.8 million amortization of acquired IP and $1 million of estimated share-based compensation charges. GAAP operating expenses to be in the range of $41.9 million plus or minus $1 million. Non-GAAP operating expenses are expected to be in the range of $34.5 million, plus or minus $1 million. Non-GAAP operating expenses exclude $7 million of estimated share-based compensation charges and $0.4 million of estimated legal expenses relating to the government investigation. Interest expense to be approximately $0.5 million and income tax expense to be in the range of $1.2 million to $1.4 million. With that, we will open the call for questions. Operator, please start the Q&A session.

The first question is from the line of David Williams with Benchmark. You may proceed.

Congratulations on another strong quarter. I wanted to touch on the gross margin, which exceeded both guidance and our expectations. You mentioned that product mix was the major factor driving this. Could you provide more specific details on whether this is primarily related to product mix or segments? Or was it more about growth in IP? What are your thoughts on the overall mix? Do you believe this is a structural change that can be sustained throughout the economic cycle?

Sure, David. Yes, in the December quarter, the gross margin increase was primarily due to the better product mix. We are selling more and more higher value and higher margin products. For example, Power IC product line carries a higher margin for us. Our Power IC product line has been growing nicely. In the December quarter, Power IC product line grew 47% year-over-year and the quarter before, I think it grew over 50% year-over-year. So, we are doing well with those Power IC products. Right now, the Power IC product line already crossed the $200 million annual revenue run rate. That's very significant to our business. Even within our DMOS product line, we are replacing older products with more advanced products which provide higher margin for us as well. So more and more of our MOSFET products are industry-leading products in the markets that we serve. So overall, I think I see our gross margin trend as positive and we're happy to see our non-GAAP gross margin improved to 36.7% this quarter, which is well within our current target of mid-30% range. So I would expect that yes, as we continue to grow our business, our gross margin should play well.

Sure. So this is Stephen. Yes, good question. So the gaming console business is a good business for us. We have been prioritizing that. And unfortunately, our customer has been having production issues. And this has been a pretty common story situation that we've seen, even at leading Tier 1 customers, that they have difficulty procuring all the materials they need to produce these consoles. So this is not new to us. We know this issue has been there throughout most of last year. So, we've always been watching the demand situation and their production schedules very closely so that we can internally make sure that we position our production accordingly and to shift into other places. So, the best way to be able to be more agile in shifting production is to have a closer understanding of the demand and what's happening at the customer situation.

Sure. Okay. And one more quickly, if you don't mind. But with the new structure of the JV, what does the Phase 2 opportunity look like in terms of capacity and maybe even the economics? Will it be as attractive as the prior phase? And does it change anything in relation to pricing from the first phase? And I guess if you think about the long-term security agreement, do you have one in place? Just anything around that, the JV would be helpful.

We are pleased to see the joint venture company progressing in their Phase 1. Additionally, we are encouraged by the JV's successful capital raise of $80 billion in January for the initial step of their Phase 2 expansion. Managing suppliers is fundamentally about relationships, and we maintain a strong relationship with the JV company. We do not anticipate any changes in that relationship due to the deconsolidation. In fact, the deconsolidation has granted the JV company greater flexibility to attract investment from outside sources for their expansion plans and has paved the way for a potential listing on the Shanghai STAR market. Overall, we are implementing our three-pronged capacity expansion strategy to secure our supply by diversifying our foundry and subcontractor mix. Therefore, we are confident in our continued growth.

Great. Best luck on the quarter end, I look forward to seeing the next...

This is Mike Chang. I'll just add a few words. Yes. Yes, this is Mike Chang. Yes, the relationship with the JV, of course, is long-term. We've been working with them for so long, but the relationship is good there. Even though the relationship is good there, we do have the agreement contract to secure our future supply. So, I just want to make sure that we don't just count on the relationship, which we do very hard to maintain, but we also have official commitment, yes. Thank you.

The next question comes from the line of Michael Mani with B. Riley Securities. You may proceed.

This is Michael on for Craig. Thanks for letting me ask a couple of questions. To start, I was wondering if you could maybe give us an update on the contour of the Oregon ramp and how you anticipate capacity coming online? Maybe that's following the necessary installations. Could we ramp to most of that $70 million annual potential revenue in the fourth quarter of this year? Or do you anticipate it more spread out across two or three quarters into 2023? And then a follow-up.

Right, sure. I mean, we are undergoing the Oregon fab expansion right now. As Stephen mentioned, we have already placed orders for equipment and clean room expansion is underway. We expect that we can get new additional capacity online in the December quarter of this year. The ramp-up for that additional capacity, we expect to ramp up relatively quickly. So probably by the first quarter of 2023, I would think that we can ramp up to the $70 million annual revenue run rate.

Great. That's helpful. I appreciate that. I guess my next question is on customer deposits. I know we received around $11 million this quarter, falling around $40 million last quarter. The question is this, given that customers are still largely supply anxious, how much further customer deposit activity do you expect this year? And could a return maybe to the same volume you saw towards the second half of last fiscal year? Or do you see it sort of waning off as you go through the year and things in the supply chain set to normalize?

Sure, Michael. Yes, in the December quarter, we received about $11 million of customer deposits. Yes, overall, we are kind of right now hesitant to receive customer deposits, not because all those deposits are earmarked with a commitment of supply. So largely, right now, our Oregon fab expansion already pretty much allocated that out already. So, I would not see a large customer deposits from now on.

The next question comes from the line of Jeremy Kwan with Stifel. You may proceed.

Yes, I want to congratulate you on the strong execution and record gross margins. I would like to delve deeper into your overall capacity available in 2022. There have already been questions about the Oregon ramp and the timeline for getting equipment in place. It appears that initial revenue in Oregon may not materialize until March 2023. Regarding the joint venture, is the timing for them to see an increase in capacity similar?

Sure. I mean, yes, we expect that our Oregon fab to have some capacity online in the December quarter of this year. And at the same time, we are also expanding our relationship with foundry partners. So we are working with them. We have been working with them. So, we should see some capacities and additional ones during the year, along the way. So on the other hand, we're not standing still. So, we are managing our product mix and also continuing to do the business process and operations process improvements at our factories so all those can contribute to additional revenue growth.

Very good. I have a question regarding the pricing. Is the pricing you offer to your customers integrated into the revenue target you have set for March? Additionally, how much do you expect pricing to contribute as a potential advantage for the calendar year 2022?

For the March quarter guidance, as Stephen mentioned, we are allocating based on our production. As you know, the March quarter coincides with the Lunar New Year holidays, which can impact our production. Overall, our March quarter looks strong, and we are confident in our guidance. Regarding pricing pressure, the industry is still facing shortages and remains dynamic. We have noticed some increases in input costs, and we've selectively adjusted some of our average selling prices to account for these cost increases. However, we are committed to avoiding overcharging our customers.

Fair enough. To build off the input pricing, in your discussions with the joint venture, has contract pricing been addressed? The industry has seen leading foundries raise prices by over 20%. Is this something that you have encountered yet, and is it being discussed going forward?

So our pricing with JV Company is to go with the market price. I mean, we pay the market pricing tool to the JV Company.

And so, I would assume that your pricing has gone up since market price seems to have gone up?

Well, that's, yes. I mean, from quarter-to-quarter, from time to time, I mean, that's just the same as what we do with other foundries and subcontractors. Sure. Regarding the capacity allocation that the joint venture has moving forward, I assume they will look to broaden their customer base. Is this related to the growth of capacity available to you? Can you provide more insight into the discussions surrounding future capacity?

Let me add a couple of words. Jeremy, this is Mike Chang, by the way. You know what, as I mentioned a while ago, okay, friendship is friendship, which is definitely needed. Well, however, business is business, right? So, we all have to all the partners; we always have the firm agreement. They know what their obligation. We know what are our obligations, okay? So this business cannot just buy goodwill, okay? So yes, okay, you want goodwill, but then also you need agreement. So to answer your question and maybe also clarify I think the situation agreement, we do have a clear commitment, yes.

There are no additional questions waiting at this time. I would now like to pass it back to the management team for any closing remarks.

This concludes our earnings call today. Thank you for your interest in AOS, and we look forward to talking with you again next quarter. Thank you.

Thank you.

Yes. Thank you and God bless you all.

That concludes the Alpha and Omega Semiconductor Fiscal Q2 2022 Earnings Call. I hope you all enjoy the rest of your day. You may now disconnect your lines.