Diodes Incorporated (DIOD) Earnings Call Transcript & Summary

Good morning, and welcome to day 2 of Cowen's TMT Conference. I guess this is the 50th annual version. So I'm sure you'll get a coffee mug or something that lets you know about that. But -- anyway, my name is Matt Ramsay, the semiconductors analyst, and really appreciate everybody's attention. And great to be here with Brett and Emily from Diodes Semiconductor. It's a company that we've been working with for a little while and pretty amazing growth story, and I think may be underappreciated by some. I could say that a lot about semiconductor stocks right now, unfortunately. But it's been a remarkable progress you guys have made. So maybe I'll just ask either one of you who wants to kick off and a bit of -- sort of setting the stage for the conversation. There's a lot of things going on, supply-demand, growth drivers for the company. But if you have any opening comments, we'd be happy to hear them. Thank you.

Yes, sure. I'm Brett Whitmire, I'll make a few comments just to -- for any of you who's not familiar with the story. This is Diodes Incorporated. We're a semiconductor manufacturer, supplier focused on analog, discretes. We focus on targeting 5 market segments with emphasis on automotive, industrial. Also consumer, communications, in those segments as well. Basically, our story is that we're very focused on growth. We're very focused on delivering margin with that. If you look at the last over 10 years, our compound growth rate has been about 14%, and our growth rate on gross profit has been over 15%. In that, we have a very diverse portfolio. Our portfolio covers about 29,000 products. We ship very high volume and scale above 60 billion units. We have a diverse manufacturing footprint globally. We have a hybrid manufacturing model. And what I mean by that is about half of our wafers are sourced inside and half outside and a higher percentage of that on the assembly test. That's really served us well as we manage the cycle, basically being in many different end markets as well as having control of our manufacturing to a large extent. A number of our acquisitions are made with a vision that we've put out on 2025, and that vision is to deliver $1 billion of gross profit. And so our acquisitions are focused on topline growth as well as on manufacturing to continue to serve our hybrid model. For example, we have announced a manufacturer, then ON, semi manufacturing plant in South Portland, Maine. We plan to close out here in June. And it's just another example. We did a similar one back in 2019, bought a factory from Texas Instruments in Greenock, Scotland. That's really served us well. It continues to allow us to bring our cost down, while improving our margin to the customers. So with that, Emily, do you want to make any comments?

No. I think overall, the company is really focused. I think our key action our goal is really to continue to deliver the shareholders' value.

Well, I mean there's a lot to talk about, but Brett, since you kind of -- in your introduction there, talked about manufacturing capacity. You guys have added sort of LITE-ON Semi over the last 2 or 3 years, you talk about Greenock, Scotland, you talk about now what you're buying from ON and the products that come with that. I mean there's no secret that the industry has been supply constrained all the way around, and you guys have been adding capacity at a pretty rapid rate at the same time. So maybe you could talk about what the ramifications of that have been? Is it just you're able to grow more quickly than the industry? Is that you're able to maybe kick in doors on new customers that the company couldn't get into before? Just what are the -- how much growth is left in the capacity you have? And what are the ramifications if you're getting capacity when the industry has been so challenged?

Yes. I would say there's a lot of gun powder still left and our ability to go drive growth. If you go look at it in 2020, we did, I think it was $1.2 billion in revenue. Last year, we did $1.8 billion. We're on a run rate of doing over $2 billion right now. We announced our guidance for second quarter at $500 million for the quarter. So essentially, we're running strong from a capacity perspective. We focus on bringing in and continue to basically be able to support about half of our wafer capacity inside as well as half out. By doing those acquisitions and bringing those in-house, it gives us control. And we have a -- basically, we brought in capacity in a very efficient way. Essentially things we've talked about with our Texas Instruments fab, we bought back in 2019. We bought the factory, and essentially brought it on self-funded because we support TI with wafer support from the very beginning, and that output goes down as our products get qualified. And so it's a very effective way to bring on capacity that's very cost effective. It kind of appreciates the business model we have. And our approach with ON Semi fab is similar. We'll be bringing on that capacity. We'll be supporting them and that will phase out as we bring up our products. And so you -- a lot of semiconductor manufacturers bring on capacity, they talk about having multiple ways to bring capacity. They'll do greenfield or they'll basically create buildings or they'll bring equipment, we do all those things except we really haven't been, except for assembly test, a real fan of the greenfield on the wafer fab just because that's really difficult for us in terms of scale and expense. And so we've used these other models. We think we've got opportunity to really grow into that, and that's what we're going to continue to do.

Any sense of if you look out a year or 2, what kind of revenue levels, the capacity that you have in line could support? I mean, not to say that you're going to get there in any certain period of time, but just how much growth do you have left where capacity is not going to be really an issue for you?

Well, we're focused on the 2025 plan, which is -- I've mentioned the $1 billion of gross profit, but we've modeled that at basically 40% gross profit percent, which is $2.5 billion of revenue. If you look at our results in the first quarter, we did over 40% this past first quarter. We've guided second quarter at 41%. So our focus continues to be in 2025, delivering $1 billion of gross profit. So what that means to us is that we're going to get there probably at a lower revenue level because we think our gross profit percent is going to hold. We think we have traction in that. And so from an overall revenue scale, we're operating to something that will deliver the $1 billion of gross profit, as we've got to get our products qualified in ON Semi fab, we've got to continue to ramp the factory in Scotland. We believe we're in a good position and in the kind of control position to support that business model.

Yes. I think the internal capacity is really important for us, not only we need to grow from $1.1 billion to $2.5 billion in the very near future, we also continue to launch new products as well as improving the product mix. We're also expanding our engagement with a lot of customers that we don't have a relationship with or expanding our content with a lot of existing customers as well. So we strongly believe having the internal control from the capacity point of view, that we can actually drive our destiny within our own control, much better than counting on other people's mercy. That doesn't really change our outsourcing strategy. We continue a hybrid model like Brett mentioned, but it's really, really important to continue to drive the technology, to continue to really kind of pave the path ready for us to grow in the next 2 to 3 years' target.

Got it. I mean, that's a good transition, Emily. Maybe with the capacity that you've had at Diodes and that you both brought online and acquired, while many of your competitors have not had extra capacity or been struggling to get semi-cap equipment or the like, can you give a few business examples of where that's -- with Dr. Lu and I talked a bit about you guys have been banging on the door at certain customers for a long time. And now you kick the door in and all of a sudden, there's this expansion opportunity within new customers that have qualified and found the experience pretty good. But do you have any examples of those things or in certain segments that could sort of highlight what that's been like over the last couple of years?

Yes. I think one good example is actually automotive segment, right? So if you look at our growth path for automotive, since we established back to 2013, our focus automotive till 2021, we actually have a compound annual growth rate of 30%. Just last year alone, we actually grew 59% year-over-year. There's a lot of Tier 1 customers expanding our overall footprint. There's also customers basically give us a long list of parts and welcome Diodes to provide a solution to them. Not only that, we actually expand a lot of executive relationship as well as expanding a lot of, I would say, overall business relationship, long-term agreement with the customers and work out the long-term plan. So don't really want to name any specific, but this is actually not only just in automotive segment, right? We have industrial customers, we have computing customers. In the computing area, we continue to work with an Tier 1 OEM customers like the Intels, AMDs, Nvidia, Qualcomm on the rep and design side. And so each of the segment, we actually have certain area we want to focus. On the communication segment, for example, 5G engagement, not only just the base station, small cell, but really the end product as well. So I would say, all in all, we actually have a really, really good focus overall for the team. We're definitely driving the total solution sales that we've been talking about, really leveraging different product, different accounts to expand the Diodes' overall business. So we're really, really happy with the result that we delivered so far, but the exciting thing is actually the momentum continues.

That's -- no, it's been exciting to watch. And I think from my perspective, we were pretty bullish on the story, but some of the growth has even caught us offguard, given the dynamics in the industry. So you started to touch on a couple of end segments there. And Emily, I wanted to spend some time going through the tech segments and the drivers of growth and the engagements that you're having. So maybe we can start with auto and industrial because they are sort of the most important segments of where you're driving the business. So if you could just give us a bit of an update on where these are?

Right, right. So we actually established a goal back in 2017. We want the industrial automotive about 40% of our total spend and other 3 Cs about 60%. If we just look at end of Q1, between auto, industrial, it's 39%, but we're not going to stop here. The exciting thing about auto, industrial is we have seen a change overall from the design point of view. A lot of new topology being implemented that we've never seen before, a lot of protocol like PCI Express. Gigabit Ethernet, right? It's not something that people use a lot. USB type-C, also really new. The exciting part is, this is the product, for example, Pericom focused on driving the computing area and now being adapted in different market segments like automotive, like industrial, right? So I think that's really exciting because it also help us to expand our overall dollar content in different segments and will continue to help us through the growth momentum. I talked about the auto segment before. The growth rate, we've been 30% compounded annual growth since 2013. The exciting thing is we really focus on 3 areas. The first area is connected driving. This is actually including ADAS telematic infotainment system. And the momentum of new designs, the changes going on, the new content that require overall, it's very, very exciting. Like I mentioned, not only just on the traditional discrete or analog, but also on the mixed-signal area like the Pericom devices, right? The second area we focus are comfort, safety and lighting. So one example I use a lot is brushless motor driver. So within one of this brushless motor cycle, it actually used more than 12 MOSFETs and multiple components, including the screen and a lot on the board. So again, all this are supporting the window and then the moonroof or the oil pump and stuff like that. There's cars have more than 100 of the motors on there. So you can actually see the content. Cameras, other area, right? We used to have maybe one backup camera 20 years ago if we're lucky, otherwise, we have to turn around to look at the back. But now just look at how many cameras for the safety reasons and the different protocols. Lighting again, right? I don't know why people need a color-changing light, but they do. So all of this is actually new, and it's not going back because as a consumer, right, our requirement for those kind of functions and features, it's not going backward. But we'll continue to want more, which really means that digitification, will continue to drive the content. We continue to drive the demand, right? I think our last area is electrification, electric vehicles, hybrid vehicles, the battery manage system continue to drive a lot of good momentum, all in all, in automotive area, right? Even with industrial PC type of protocol, PCI Express, embedded, the IoT drive a lot of different connections, connectivities as well as speed. So we really believe that machine to machine, as an example, will not stop here. So again, that's the reason why we want to focus on automotive, industrial. I think the bigger reason behind it, if we look from the gross margin point of view, automotive gives us more than 60% overall margin. Industrial also give us much higher than 50%. So one of the initiatives we want to continue to drive the margin improvement, gross margin improvement, we want to continue to drive the product mix improvement. So these 2 segments actually give us a very strong reason that why we need to continue to focus overall as a company. But that doesn't mean that we don't think 3 Cs are important. Just taking as a computing, not only -- I know there's a lot of market going on, the low-end PC slow down, which is true. But if we look at the cloud computing, if we look at the server storage, what the data rate is driving, that actually continued to drive a lot of momentum. Enterprise computing is still very strong, right? The low end, definitely, we've seen softness. So having the focus overall in the higher end within the segment, actually, would continue to help Diodes with the growth momentum. This is an area we use a lot of Pericom products. So if you look at the Pericom we sell, we have been -- by the end of Q1, 6 consecutive quarter of record. So that's actually continued. We drive a lot of momentum because the speed and data ray is not going to stop here. Now we're talking about PCI Express Gen 6, pretty soon Gen 7 will come out, right? So all of this will continue to drive new product as well as content expansion from Diodes overall.

Thank you for all the detail there. You mentioned something on gross margin and we're not going to get out of this room without having a conversation on the cycle, right? It's impossible, despite my better efforts. And so I guess the first question, Brett, is, I cover a number of companies that have seen movements in both directions on gross margin. So like input costs going up, but pricing going up as well. And sometimes those things are not correlated in time right? So I've seen a few -- examples of a few companies where they raised price, but they were still selling product that was manufactured on a lower cost base, and then the cost increase is caught up and gross margin expansion was maybe a bit temporary. But from what I can tell, the margin expansion for Diodes is driven by mix. I don't know, do you agree with that? Is that something you feel like it's sustainable here above sort of the target model?

Yes, I'll make a few comments on that. We believe, and our CEO has been open about this, Dr. Lu, that we believe our approach has been different in terms of the whole approach to pricing and the approach to good leveraging cycle versus maybe taking advantage of the cycle. And it's with a more long-term focus. And what I mean by that is that we were not -- we did not take an approach of basically saying, hey, looks like everyone's hungry, all the prices were up 10%. All the prices were up whatever percent. And let's just keep doing that until it turns back and we'll deal with the customer relationship later. We basically mapped the input cost changes to the products and raised prices consistent with the input cost changes as a starter, we then look for opportunity that could help us win next-generation opportunities as well as get in the door with clients that we've been wanting to get in the door with. We've had a list, a long list of opportunities that have come out of that where Emily and the team has been called to customers to basically win whatever we could. And these things have been huge in terms of our driver. And that -- you could say, well, that's pricing. Well, it's pricing on the back of mix, not necessarily on the back of just raising the price on a given product. It's going to flip back over as the supply increases. And so we believe the things we've done have been sustainable and there's traction. We are basically openly talking about the fact that, yes, we've made more traction than we anticipated. The mix has improved faster than we thought. The ramp of certain things have happened faster. And so when we look at our 2025 plan, we're not coming back and changing our goal, which our goal is on $1 billion of gross profit, we are reassuring people that the progress we've made has been real and that we have traction to the model we put around it. We have $1 billion of gross profit goal in 2025. The model we put around it was $2.5 billion of revenue, 40% GP. We believe that we're going to do that $1 billion on lower revenue and higher GP, and we're going to continue to have traction based on where we are today. We've guided second quarter at 41%. And we -- one of the things that we've made a lot more progress faster is, Matt mentioned our LITE-ON Semiconductor acquisition. A couple of years ago, we bought LITE-ON Semiconductor. That was a $200 million business with a suite of factories and it was our largest buyback in company history. They own 15% of our stock. It was a really great deal. And we -- timing is always good when things are strong. Customers want to qualify new factories, customers need more product. And so it wasn't able to pick up a base good business that was running under utilized and penetrate with those products and allow us to sell across the portfolio. That's just one example of where we believe we're getting mixed traction to our margin, and we think that it's sustainable.

No changes to that at all? When you're bringing on these new factories, the stuff that you're buying from ON and a few other additions, there wouldn't be any change to the -- the mix is going to drive in terms of end markets and customers is going to drive the margin rather than the facility that's producing, is that fair?

That's right. And one of the things you have with the ON Semi fab, everybody has their own strategies and their own manufacturing footprint. One of the reasons that's quite attractive is it allows us to -- we talk about our hybrid manufacturing model. We have half of our wafer source is inside and half out. It's important for that to be consistent across the different process nodes. And today, some of the ones that we're going to source into that factory have a little bit heavier percentage outside the company. So we were looking for that. And so that's an opportunity to bring it inside. It gives us control, it also gives us leverage in terms of that, and it allows us to be able to keep that model intact. That helps in terms of overall revenue growth, it also helps managing the cycle. And we're also cognizant of the margins we're delivering and our overall scale. And so that means that as we're picking up some of these more mature factories. It's important that this business model that we did with TI, with the Greenock fab, we repeat that, which is essentially we have a sourcing agreement with ON that allows us to essentially fund the infrastructure, while we qualify our products. And we're a source for them. That's a good news for, I think, everyone. And so -- but that's comprehended when I say, have we comprehended these kind of things in terms of our ability to continue to maintain GP and have traction with that.

Thanks for that. It's interesting too that -- no secret debt at the same time. This fab sale from ON to you guys is happening that ON Semi's new CEO, Hassane, has made some strategic decisions to exit certain parts of the market. It'd be interesting to hear from your perspective, how much overlap there is between the products that they were manufacturing and the facility that you're buying and the markets that they're deemphasizing that you can move into. Is that a big part of the plan? Is things that they were selling that they were manufacturing out of that facility become qualified parts for Diodes that serve the same end markets? Or is that a correlation that I shouldn't draw?

Well, I'll make a comment. I don't think there's any intent to draw that correlation upfront in terms of the factory and there's no arrangement with us and ON in that regard. This is a manufacturing sourcing arrangement that I think they've made open comments about consolidating their sourcing to different places. This is one of their mature factories, but it fits into our roadmap. The other thing that I think they've openly talked about is from a business perspective is one of their businesses didn't even relate to us that they bought and then they're going to reexit, but there are things that they're probably deemphasizing. But I think the overall competitive landscape -- Emily, you want to talk to some of that?

Yes. I think I mentioned this before. Anytime there's a merchant acquisition or any of my peers changing their strategic direction. It's always beneficial to Diodes overall, right? So customers always looking for some alternative solution. And I think people start realizing with Diodes' overall strategy and focus in place, we actually are very valid alternative supplier to a lot of customers. It definitely create a lot of opportunities for us to expand our engagement overall and also grow of the business, not only just ON, right, but any of my peers if they change their overall strategy, right? So we always welcome the opportunities, right? I think someone joked about it, say someone's trash can be other's treasure. So I have no way to comment that. But I think just like Brett mentioned, when we look at the business, when we look at opportunity, the capacity, what can we do with it, I think all in all, that fit really well with our overall focus and growth target that we want to accomplish in the near future. So yes.

No, that makes sense. The other thing I wanted to ask about, for either of you to comment is just, where we are today in the cycle? People have -- I hear companies with book-to-bill ratios of 2.5 and 3 and visibility out 12, 18 months, and there's obviously an investor fear of kind of the thing that I'd pointed about it is the recessionary boogie man that's behind the corner that no one can disprove is there. But when I talk to the management team, they spend half their life on customer escalation calls because there's still shortage of products. And Emily, I'm sure that's a lot of your time.

That's my life for the last 18 months.

Yes. So how do you, I guess, square that circle for investors around your business, given the growth that's happening in supply, growth that is happening in customer acquisitions and content, shift of mix to industrial and auto? You obviously have a backlog that you can't fulfill right now, but capacity is coming online. But just give us some comfort of what you're seeing and the visibility you have relative to the, I guess, the investor fears that were in a bit of a bubble now and things could come down over time.

Right, right. I think I can't really -- I don't have a crystal ball, so I can't really tell what's going to happen for a longer term. But looking at the Diodes business, overall, the demand is still very, very strong. We do see softness in some specific pockets. I mentioned a little bit earlier, the low-end PCs or the consumer, especially in the China area, right? We also know or see some smartphone softness, especially in Asia overall, but with a strong demand. And then the other thing I want to point out is our capacity, doesn't matter front end or back end, a lot of the time is shared among different segments, different product lines and stuff like that. So with a strong demand overall, we're still in a position that in balance between supply as well as the demand. Our booking book-to-bill ratio is still really strong. We didn't really see any significant behavior change from the buying behavior point of view. So just like you mentioned, most of my time every day is talking to the customer, build a relationship as well as solve some of the shortage problems. So I would say all in all, situation didn't really change significantly from last time we spoke to each other. I think the key thing is the end demand, right? When we look at the end of Q1 result, we have worldwide POS record. We have record revenue overall for the company. And we guided $500 million for the Q2. What we've been doing is actually continue to execute and drive into our guidance to the Street, right? So that's pretty much what we see overall, right? The other thing I do want to point out from the supply point of view, we probably need to separate the advanced nodes overall with a mature technology as well. So majority of our products that's on the 8-inch as well as 6-inch technology. We haven't really seen a significant amount of capacity being added in the mature technology area, right? So that's just the other thing I wanted to point it out. The demand continued to be strong. If the supply doesn't really increase significantly. So they're still going to be in balance between those two, for -- at least in the Q2, that's what we provided guidance, right?

Fair enough. I think one of the things that I was impressed by in the last set of earnings, just given the amount of operations that you guys have in Asia and the amount of product that comes through Shanghai, is the resilience of the business to all the lockdowns in China. Supposedly, everything is back to normal as of yesterday. That was a joke. So how -- not a very good one. I just wonder how -- operationally, how has the company been affected by all the things that have happened in China and Shanghai and the lockdowns and whatever? And how was the business able to execute so well with all of that sort of turmoil going on?

Well, I'll make a couple of comments, and I think it's -- the company is very proud of being recognized as -- even in Shanghai as one of the model manufacturing sites we've -- with some press regarding the model we put in place is closed loop manufacturing. We -- almost for a 2-month period, we had a period, a group of people that essentially lived in our factory in our largest assembly test facility as our -- some of them would view that as a huge benefit for many of us that doesn't feel like a huge benefit. When you're working, you're sleeping, you're showering, you're eating, your breaks are there, right? I mean during some of this period, you basically came in and locked up all the individual's homes as well as the factories. And if you didn't have established the close with manufacturing, you are in real trouble. And if you didn't have the staff to the level that was the level that you could run at. And so we thankfully had established that both in our primary assembly test in the area as well as our fab in the area and the assembly test had a couple of different times where local authorities came and did some examples and those kind of things. I think that served us well. We had a great -- we reached out with our relationship with the local authorities and establish ways to move product and to selectively pick up and move employees. We provided food to people that were locked in their homes to keep them sustained, both people from the factory as well as our administrative people that couldn't come in the office. So we do a lot of things. I mean a lot of companies did some things like that. But I think some of it was fortunate that when they came through to lock things up, we had a very significant footprint of people in the factory and could leverage that. And so that's what we did. That one of the things Dr. Lu talked to in the earnings call.

Just really quickly, and I think we're bumping up against time. But any huge differences you've seen in the last 36 hours, I mean that there was stuff that was supposed to be lifted in Shanghai. Is that stuff actually happening? Is it happening quickly? Just any kind of quick comment? That would be really helpful.

Yes. So based on our General Managers' report last night, Shanghai did lift a majority of the -- I call the communities within Shanghai, they have different communities. And based on the COVID cases, they list one by one. But I think by now, it almost seems like majority of the community have been opened. There's -- community people can come and go at their free will without control. There are still a few left with some controls. But all in all, I would say, yes, situation definitely improved quite dramatically within the last 36 hours in Shanghai.

I appreciate you sharing that. And thank you both for your time and telling us a bit more about the Diodes' story today, and I really appreciate the partnership with our team at Cowen. So thank you very much. Thanks for everybody, and have a good day.

Thanks, Matt. Thanks for coming.

Thank you. Yes.