Earnings Call Transcript - DIOD Q4 2022

Operator, Operator

Good afternoon, and welcome to Diodes Incorporated Fourth Quarter and Fiscal 2022 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. As a reminder, this conference call is being recorded today, Monday, February 6, 2023. I would now like to turn the call over to Leanne Sievers of Shelton Group Investor Relations. Leanne, please go ahead.

Leanne Sievers, President of Shelton Group

Good afternoon, and welcome to Diodes fourth quarter 2022 financial results conference call. I am Leanne Sievers, President of Shelton Group, Diodes’ Investor Relations firm. Joining us today from Taiwan are Diodes’ Chairman, President and CEO, Dr. Keh-Shew Lu; Chief Financial Officer, Brett Whitmire; Senior Vice President of Worldwide Sales and Marketing, Emily Yang; Senior Vice President of Business Group, Gary Yu; and Director of Investor Relations, Gurmeet Dhaliwal. 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 unaudited and subject to revision until the company files its Form 10-K for its full fiscal year ended December 31, 2022. In addition, management’s prepared remarks contain forward-looking statements, which are subject to risks and uncertainties, and management may make additional forward-looking statements in response to your questions. Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today, and therefore, we refer you to a more detailed discussion of the risks and uncertainties in the company’s filings with the Securities and Exchange Commission, including Forms 10-K and 10-Q. In addition, any projections of the company’s future performance represent management’s estimates as of today, February 6, 2023. Diodes assumes no obligation to update these projections in the future as market conditions may or may not change, except to the extent required by applicable law. Additionally, the company’s press release and management statements during this conference call will include discussions of certain measures and financial information in GAAP and non-GAAP terms. Included in the company’s press release and reconciliation of GAAP to non-GAAP items, which provide additional details. Also, throughout the company’s press release and management statements during this conference call, we refer to net income attributable to common stockholders as GAAP net income. For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 90 days in the Investor Relations section of Diodes website. And now, I will turn the call over to Diodes Chairman, President and CEO, Dr. Keh-Shew Lu. Dr. Lu, please go ahead.

Dr. Keh-Shew Lu, Chairman, President and CEO

Thank you, Leanne. Welcome, everyone, and thank you for joining us today. I am pleased to report record performance in 2022, with revenue growth of 10.8% over 2021. Even when considering the COVID-related slowdown and the power outages throughout the year in China, as well as the global economic slowdown. In fact, the fourth quarter represented our ninth consecutive quarter of year-over-year growth. Additionally, our earning power and cash generation in 2022 were also significantly highlighted with gross margin expansion of 422 basis points to 41.3%. Operating margin expanded 510 basis points to 20.4%, and GAAP EPS increased 44% to $7.20, while non-GAAP EPS grew 42% to $7.36. We also achieved record cash flow from operations of $393 million. Underpinning the company’s noteworthy performance was continued strong growth in our automotive end market, which increased 40% over 2021 and reached 15% of product revenue for the year. We also continued to drive growth in our industrial end market through our ongoing content expansion efforts, which contributed to our industrial and automotive end markets representing 42% of product revenue, exceeding our target model of 40%. The growth in those end markets combined with the ongoing increase of our Pericom products also contributed to our strong gross margin expansion throughout the year as part of our product mix improvement efforts. Reaching the $2 billion revenue level in 2022 was a significant and meaningful achievement for the entire Diodes team. With gross profit growing 23% to $827 million for the year, we have taken another giant step towards our next goal in our 2025 financial targets to achieve $1 billion in annual gross profit. I am very proud of our accomplishments and our ability to consistently deliver both top-line growth and significantly expand earnings for our shareholders. With that, let me now turn the call over to Brett to discuss our fourth quarter and full year financial results and our first quarter 2023 guidance in more detail.

Brett Whitmire, Chief Financial Officer

Thanks, Dr. Lu, and good afternoon, everyone. Revenue for the fourth quarter 2022 was $496.2 million, increasing 3.3% from $480.2 million in the fourth quarter 2021, and down 4.8% from the $521.3 million in the third quarter 2022. Full year 2022 revenue grew to a record $2 billion, an increase of 10.8% over the $1.8 billion in 2021. Gross profit for the fourth quarter was $206.2 million or 41.6% of revenue, increasing from $190.7 million or 39.7% of revenue in the prior year quarter and down from $217.8 million or 41.8% of revenue in the prior quarter. For the full year, GAAP gross profit was a record $827.2 million, a 23.4% increase over 2021 and GAAP gross margin improved 420 basis points to a record 41.3%. GAAP operating expenses for the fourth quarter were $109.7 million or 22.1% of revenue, and on a non-GAAP basis were $105.9 million or 21.3% of revenue, which excludes $3.8 million of amortization of acquisition-related intangible asset expenses. This compares to GAAP operating expenses in the fourth quarter 2021 of $104.7 million, or 21.8% of revenue, and in the third quarter 2022 of $105.4 million or 20.2% of revenue. Non-GAAP operating expenses in the prior quarter were $101.3 million or 19.4% of revenue. Total other expense amounted to approximately $1.7 million for the quarter, consisting of $490,000 of other income, $2.9 million in interest expense, a $400,000 foreign currency loss, and $1.1 million of interest income. Income before taxes and non-controlling interest in the fourth quarter 2022 was $94.8 million compared to $108.8 million in the prior year quarter and $109.1 million in the previous quarter. Turning to income taxes, our effective income tax rate for the fourth quarter was approximately 1.5%, which includes taxes related to non-GAAP items. On a non-GAAP basis, the tax rate for the fourth quarter was approximately 18.7%, and for the full year 2022, the non-GAAP tax rate was approximately 18.5%. GAAP net income for the fourth quarter 2022 was $92.1 million or $2 per diluted share, compared to $65.5 million or $1.43 per diluted share in the fourth quarter 2021 and $86.4 million or $1.88 per diluted share in the third quarter of 2022. For the full year 2022, GAAP net income was a record $331.3 million or a record $7.20 per diluted share, which was approximately a 45% increase from the $228.8 million or $5 per diluted share in 2021. The share count used to compute GAAP diluted EPS for the fourth quarter 2022 was 46.1 million shares and 46 million shares for the full year. Non-GAAP adjusted net income in the fourth quarter was $79.6 million or $1.73 per diluted share, which excluded net of tax acquisition-related intangible asset costs. This compares to $73.3 million or $1.60 per diluted share in the fourth quarter 2021 and $92.2 million or $2 per diluted share in the prior quarter. For the full year, non-GAAP adjusted net income was a record $339 million or a record $7.36 per diluted share, an increase of approximately 43% from the $237.2 million or $5.18 per diluted share in 2021. Excluding non-cash share-based compensation expense of net of tax for the fourth quarter and $28.7 million for the full year, both GAAP earnings per share and non-GAAP adjusted EPS would have increased by $0.16 per diluted share and $0.62 per diluted share, respectively. EBITDA for the fourth quarter was $129.6 million or 26.1% of revenue, compared to $139 million or 28.9% of revenue in the fourth quarter of 2021 and $141.9 million or 27.2% of revenue in the prior quarter. We had a gain on investment in the fourth quarter of 2021 that benefited EBITDA, and in that quarter. For the full year, EBITDA improved 19.7% to a record $520.4 million or 26% of revenue, compared to $434.6 million or 24.1% of revenue in 2021. We have included in our earnings release a reconciliation of GAAP net income to non-GAAP adjusted net income and GAAP net income to EBITDA, which provides additional details. Cash flow generated from operations was $102.9 million for the fourth quarter and a record $392.5 million for 2022. Free cash flow was $39.1 million, which included $63.8 million for capital expenditures, and for the full year, free cash flow was $180.8 million, including $211.7 million for CapEx. Net cash flow was a negative $44.7 million, including the paydown of $114 million of total debt, and for the full year, net cash flow was a negative $25.7 million, which includes the net paydown of $112.3 million of total debt. Turning to the balance sheet, at the end of the fourth quarter, cash, cash equivalents, restricted cash plus short-term investments totaled approximately $348 million. Working capital was $729 million and total debt, including long-term and short-term, was $186 million. In terms of inventory, at the end of the fourth quarter, total inventory days were approximately 117, as compared to 113 last quarter. Finished goods inventory days were 33, compared to 32 last quarter. Total inventory dollars decreased $14.5 million from the prior quarter to approximately $360.3 million. Total inventory in the quarter consisted of a $12.1 million decrease in finished goods, a $3.2 million decrease in raw materials, and a $0.7 million increase in work in process. Capital expenditures on a cash basis were $63.8 million for the fourth quarter, and for the full year, approximately $211.7 million or 10.6% of revenue. Full year CapEx was higher than our target model due to targeted expansion of our JK wafer fab in Hsinchu Science Park in Taiwan. Without this investment, we would have been within our target model of 5% to 9%, and we expect to remain in this range this year. Now turning to our outlook. For the first quarter of 2023, we expect revenue to be approximately $467 million plus or minus 3%. GAAP gross margin is expected to be 41.0% plus or minus 1%. Even with the revenue and loading decrease in the first quarter, we expect to maintain our gross margin effectively comparable to the last quarter and above our target model of 40%. Non-GAAP operating expenses, which are GAAP operating expenses adjusted for amortization of acquisition-related intangible assets, are expected to be approximately 22.2% of revenue plus or minus 1%. We expect net interest expense to be approximately $2.5 million. Our income tax rate is expected to be 19% plus or minus 3% and shares used to calculate EPS for the first quarter are anticipated to be approximately 46.5 million. Not included in these non-GAAP estimates is amortization of $3.1 million after tax for previous acquisitions.

Emily Yang, Senior Vice President of Worldwide Sales and Marketing

Thank you, Brett, and good afternoon. As Dr. Lu and Brett mentioned, 2022 was a record year for Diodes across all financial metrics. Fourth quarter revenue was down 4.8% sequentially, which is above our midpoint of our guidance and slightly better than our typical seasonality. Looking more closely at the fourth quarter revenue POS was a record in Europe. Distributor inventory in terms of weeks increased quarter-over-quarter, which is higher than our normal range of 11 weeks to 14 weeks. This increase is due mainly to demand softness in China related to COVID and our anticipation of COVID recovery in Q2, as well as our anticipation of a labor shortage around the Chinese New Year. We positioned more product to minimize the potential impact and quick response once the market recovers. Overall demand and backlog remains stable across all regions, especially for automotive and industrial end markets. Looking at the global sales in the fourth quarter, Asia represented 73% of revenue, Europe 15%, and North America, 12%. In terms of our end market, industrial represented 28% of Diodes product revenue, computing 23%, consumer 18%, communications 14%, and our automotive end market reached a record product revenue. Our automotive and industrial end markets combined totaled 45% of product revenue for the quarter, which is 5 percentage points above our 2025 target and about 40% for the fourth consecutive quarter. This further demonstrates Diodes’ ability to quickly adjust our capacity allocation from low-end PC consumer and smartphone segments to high-demand end markets like automotive and industrial. Now let me review the end markets in greater detail. Our automotive market continued to be a highlight for both the quarter and the full year, setting revenue records for 10 consecutive quarters and growing 40% in 2022. Our consistent strong growth in this market can be attributed to our ongoing demand creation efforts, as well as market share gains across new and existing customers. Our design win momentum continues in our three application-focused areas of connected driving; comfort, style and safety; and electrification. In connected driving, we continue to see increased interest for our USB type-C ReDrivers, analog control which is Diodes controllers, LDOs, DC/DC converters, Zener diodes, and TVS in the real estate entertainment, ADAS, infotainment, smart cockpit, telematics, and instrument cluster applications. We also saw increased design wins for our video switches used in EP, DisplayPort, and USB switches in telematic communication systems by multiple customers. In comfort, style, and safety, linear LED drivers and DC/DC converters were designed into next-generation LED lighting applications. Our sensors business grew significantly driven by applications including electronic steering, control locks, refueling covers, window lifters, and water pumps. High-voltage switching diodes and Zener diodes also grew in the quarter, primarily in the air quality sensors and HVAC applications. Several of our SBR automotive products were designed into battery power electric vehicles and plug-in hybrid vehicles for automotive safety applications. We also secured a number of new design wins for USB charging controllers for in-vehicle USB charging devices. Lastly, in the electrification segment, our 32-bit IO expanders were designed into EV vehicle control units and our TVS product designed into high-speed data lines for in-vehicle display electric vehicles. Our production products also saw strong growth in applications including lean battery control and onboard diagnostic systems. Additionally, we ramped up our MOSFET product in multiple new applications across several different customers, while releasing a number of low voltage MOSFET products for battery management systems and WiFi applications. In our industrial market, revenue also set another record, representing the sixth consecutive quarter of growth. Our PCI Express 3.0 package switch continued to gain traction in industrial automation applications as they enable enhanced performance by connecting SoCs and CPUs to the endpoint. Additionally, our high-voltage industrial IoT devices experienced very strong demand for the smart electric meters. Similarly, our LED controllers excelled in the LED power supply for commercial lighting. Our industrial sensor business continued to gain traction in power tools, air conditioners, DC motors, and washing machines. Additionally, we continue to secure design wins for our CIS products in AOI applications like battery films, PCB, wafer inspection, and check scanners. Our switching diodes, Zener diodes, fast recovery rectifiers, and LED drivers have been helping to support smart, efficient, green factory automation applications, including metering, industrial sensors, cameras, scanners, elevators, and image processing equipment. Diodes’ SBR products are also being widely used in Power over Ethernet, while MOSFET traction increased in new power applications. In the computing market, despite the softness in low-end PC applications, our momentum for SBR, TVS, MOSFET, and current monitoring products continued in the notebook and tablet designs. We secured numerous design wins for I3C switches, FM bus level shifters, analog switching, IO expanders, and TVS in the cloud server protection application. Additionally, our EDP ReDrivers, EDP Max, and 20-gigabit per second DP 2.0 ReDrivers are being adopted in gaming notebooks and in graphics card applications. In the communication market, our USB type-C audio switches, IO expanders, MOSFET, and high-effect switches continue to be designed into a series of smartphone devices, while our LED drivers were designed into mobile phone peripheral products, including wireless chargers. Our Schottky products were designed into 5G WiFi applications, and we continue to see traction for our PCI Express clock buffer family in 5G CPE designs and TVS products in networking applications. Lastly, in the consumer market, we saw increased adoption of our 12-bit high-speed MOSFET embedded multimedia card modules, and our current limit power switches continue to see solid demand from USB power applications in gaming consoles. Our 8.1 10-gigabit bidirectional retimers were also adopted in active cable applications, and our TVS protection products, USB switches, SBR CSP products, and USB power delivery decoders were designed into security keys, sports cameras, next-generation televisions, wearables, and portable applications, as well as war-mounted USB-C power socket applications. In summary, Diodes' achievement of record results in 2022 once again highlighted the ongoing success of our customer expansion initiatives, as well as our focus on product mix improvement towards higher-margin products and end markets to drive increased profitability. Our significant expansion and growth in the automotive and industrial end markets is a direct result of these strategic actions. We look forward to further expanding our momentum and continuing this progress in the coming year. With that, we now open the floor to questions. Operator?

Operator, Operator

Thank you very much. Today's first question comes from William Stein with Truist. Please go ahead.

William Stein, Analyst

Great. Thank you for taking my question. I am hoping you can review the channel inventory trends again. I think you mentioned it briefly in the prepared remarks, but I just want to hear the clarification as to what happened in the channel in the quarter and what you expect will happen in the current quarter in distribution. Thank you.

Emily Yang, Senior Vice President of Worldwide Sales and Marketing

Hi, Will, this is Emily. Let me answer this question. So I did mention the channel inventory was up quarter-over-quarter. It is a little bit higher than our normal range at this moment. But the main reason for this change is actually due to a couple of factors. We definitely see softness in China during the COVID impact in the fourth quarter, and we also have an anticipation of recovery from some of the three Cs we discussed before; they started some of the channel inventory rebalancing for the last few quarters. So there’s an anticipation of that recovery, as well as there being a labor shortage during the Chinese New Year timeframe. So with all these dynamic situations combined, we actually strategically increased some of the channel inventory, ensuring that we can better support customers' last-minute demand changes.

William Stein, Analyst

Great. Thank you. And can you talk about your outlook by end market for the coming quarter?

Emily Yang, Senior Vice President of Worldwide Sales and Marketing

Yeah. Sure. I think in automotive, we are still seeing a lot of strength overall. Our pipeline continues to grow, and our engagement continues to enrich. If I look at the whole year or quarter-over-quarter comparison, automotive is still a record quarter for us by the end of Q4, and if we look at the whole year, year-over-year growth still over 40%. That’s really exciting. For industrial, I think it’s a little bit mixed. Some end applications are softer than others. We are also seeing some inventory rebalancing going on. But when we take everything together, I would say it still represents a really stable end market at this moment. For computing, we talked about how the inventory rebalancing probably started at the beginning of Q3 last year; we are still seeing softness continuing, but there’s also anticipation of recovery, probably in a quarter or two. Consumer shows some softness, particularly from the China market. The communications side, specifically smartphones, we are seeing that inventory rebalancing is still ongoing, but once they get to a certain level, we do expect some recovery.

William Stein, Analyst

It seems that we can expect a similar trend in the upcoming quarter compared to what we observed over the past quarter or two. Is that correct? Should we not expect any differing performance or change in Q1 compared to what we saw in Q4?

Emily Yang, Senior Vice President of Worldwide Sales and Marketing

Yeah. So I would say, there’s no significant change from the end market point of view. But the key thing for us is to continue to focus on our product mix improvement, right? Continue to leverage our capacity to lower the support for the slow end market and focus on supporting the strong demand end markets like automotive and industrial applications.

William Stein, Analyst

Great. I will get back in queue. Thank you.

Operator, Operator

The next question comes from Matt Ramsay with Cowen. Please go ahead.

Joshua Buchalter, Analyst

Hi. This is Joshua Buchalter on behalf of Matt. Congrats on the stellar results, and thank you for taking my question. I wanted to follow up on Will’s question. If I am understanding correctly, the channel is running above the typical 11-week to 14-week range. I know you are taking factory loadings down, but does that mean you are comfortable running above the typical range for a little while in anticipation of the recovery? I just want to make sure I am understanding correctly. Thank you.

Emily Yang, Senior Vice President of Worldwide Sales and Marketing

Yeah. I think, Josh, I did mention a little earlier, right? There’s still a lot of dynamic situation going on with the labor shortage during the Chinese New Year, the softness due to COVID, especially in China, as well as anticipation of some recovery probably around the Q2 quarter. So with all these combinations, we are actually okay with the inventory being higher than our defined normal range. The other angle we look at is the quality of the inventory, right? So it’s not only about the number of weeks on the shelf; it is also about the quality of the product on the shelf. So we actually feel very confident standing behind the numbers.

Joshua Buchalter, Analyst

Okay. Understood. Thank you. And for my follow-up, I wanted to ask about gross margin. It’s down only marginally despite two straight quarters of mid-single-digit revenue declines, and it sounds like it’s lower factory loadings as well. Can you walk through what’s driving so much resiliency in your gross margin line? Is it a mix shift between end markets and products, continued strength in the pricing environment? Any color there would be super helpful. Thank you.

Emily Yang, Senior Vice President of Worldwide Sales and Marketing

It's a great question. Over the past few years, we have focused on two main areas: total solution sales and product mix improvement. Looking at our results in the automotive sector, we achieved 40% year-over-year growth. From 2013 to 2022, our combined annual growth rate exceeded 30%, reflecting significant success and consistency. In terms of the industrial segment, which has become our largest segment by the end of Q4, it made up 28% of our total market share. Together, automotive and industrial accounted for 45% of our total revenue based on Q4 results, and approximately 42% for the entire year. By the end of 2017, we set a goal to reach around 40% for this segment, and we've consistently performed beyond that target. This underscores our efforts in improving our product mix. For instance, the Pericom product family has shown attractive margins and continuous growth in its segment. Even with a slight reduction in revenue guidance for Q1 due to seasonal factors, we're still guiding for a margin of 41%, which is notably higher than the 40% defined in our 2013 model. This reflects our commitment to enhancing our product mix and manufacturing efficiency, which has always been a core strength of the company. With all these factors combined, we are confident that we are progressing well toward our 2025 goals of achieving $1 billion in gross profit and a revenue model of $2.5 billion.

Joshua Buchalter, Analyst

Yeah. Super helpful, and congratulations again on the results.

Operator, Operator

The next question comes from David Williams with The Benchmark Company. Please go ahead. David, your line is open. Once again, David, your line is open. Seeing no further questions in the queue, this concludes our question-and-answer session. I would like to turn the conference back over to Dr. Lu for any further closing remarks.

Dr. Keh-Shew Lu, Chairman, President and CEO

Thank you for your participation in today’s call. Operator, you may now disconnect.

Operator, Operator

Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.