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spk03: Good afternoon, and welcome to the DIODES Incorporated's second quarter 2023 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. If anyone needs any assistance at any time during conference call, please press the star key followed by the zero on your touchtone phone. As a reminder, this conference call is being recorded today, Tuesday, August 8th, 2023. I would now like to turn the call over to Leanne Seavers of Shelton Group Investor Relations. Leanne, please go ahead.
spk07: Good afternoon, and welcome to DIODE's second quarter 2023 financial results conference call. I'm Leanne Seavers, president of Shelton Group, DIODE's investor relations firm. Joining us today are DIODE's chairman, president, and CEO, Dr. Kei-Shu Liu, chief operating officer, Gary Yu, Chief Financial Officer Brett Whitmire, Senior Vice President of Worldwide Sales and Marketing Emily Yang, and Director of Investor Relations Gurmeet Dhaliwal. 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-Q for its fiscal quarter ending June 30, 2023. 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 more detailed discussions 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, August 8, 2023. DAS 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 are definitions and reconciliations 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 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 DIODE's website at www.diodes.com. And now I'll turn the call over to Dr. Liu, DIODE's Chairman, President, and CEO. Dr. Liu, please go ahead.
spk05: Thank you, Leanne. Welcome, everyone, and thank you for joining us today. During the second quarter, the recovery in the Asia market was slowdened we expected, especially in China. But I'm pleased with our team's execution to deliver breaker gross margin. Additionally, our achievement of breaker product revenue in the automotive and natural markets. It is strong testament to the continuous success of our total solution sales approach. and content expansion initiatives. This quarter was six consecutive quarter growth margin was above our target model of 40%. And the six consecutive quarter automotive and industrial increased as a percent of the revenue. With that, let me turn it over to Gary Yu, DIOS Chief Operating Officer, for some additional comment on the quotas.
spk06: Thank you, Dr. Liu. Revenue in the second quarter was $467.2 million, with gross margin reaching a record 41.8% of revenue. The recovery in the consumer, computing, and communications market was much slower than we had originally expected. whereas the trend in the automotive market remained relatively strong. During the quarter, our automotive and industrial product revenue reached a record 48% of total product revenue and enabled us to maintain revenue flat sequentially and in line with our guidance while also delivering record gross margin. Also notable in the quarter, we continued to generate strong cash from operation of 92.6 million that enable us to reduce our total debt by 34.4 million to 89 million as of June 30th. Looking forward, we have begun to see early indication of market improvement with inventory days decreasing in the second quarter coupled with an increase in worldwide POS revenue. Although we expect a further reduction in channel inventory into third quarter, Thou's ongoing strategy to improve sales and product mix, including growing revenue contribution from the automotive and industrial markets, positioned us to continue achieving our long-term growth and margin targets. Let me now turn the call over to Brad to discuss our second quarter financial results and our third quarter guidance in more detail.
spk01: Thanks, Gary, and good afternoon, everyone. Revenue for the second quarter, 2023, was $467.2 million, decreasing 6.8% from $501 million in the second quarter of 2022, and flat with $467.2 million in the first quarter of 2023. Gross profit for the second quarter was $195.4 million, or 41.8% of revenue, compared to $206.5 million or 41.2% of revenue in the prior year quarter, and $194.5 million, or 41.6% of revenue in the prior quarter. GAAP operating expenses for the second quarter were $105.8 million, or 22.7% of revenue, and on a non-GAAP basis were $102 million, or 21.8% of revenue. which excludes $3.8 million of amortization of acquisition-related intangible asset expenses. This compares to GAAP operating expenses in the second quarter 2022 of $100.3 million, or 20% of revenue, and $108 million, or 23.1% of revenue, in the prior quarter. Non-GAAP operating expenses in the prior quarter were $101.3 million, or 21.7% of revenue. Total other income amounted to approximately $11.4 million for the quarter, consisting of $12.2 million unrealized gain on investments, $2.2 million of interest income, $1.4 million of other income, $2.2 million of interest expense, and $2.2 million of foreign currency loss. Income before taxes and non-controlling interest in the second quarter 2023 was $101 million compared to $101.2 million in the prior year quarter and $88.6 million in the previous quarter. Turning to income taxes, our effective income tax rate for the second quarter was approximately 17.1%. Gap net income for the second quarter 2023 was $82 million, or $1.77 per diluted share, compared to $80.2 million, or $1.75 per diluted share in the second quarter 2022, and $71.2 million, or $1.54 per diluted share in the first quarter 2023. Share count used to compute GAAP diluted EPS for the second quarter 2023 was 46.2 million shares. Non-GAAP adjusted net income in the second quarter was $73.3 million, or $1.59 per diluted share, which excluded net of tax $3.1 million of acquisition-related intangible asset amortization and $11.7 million related to equity investments. This compares to $86.9 million, or $1.90 per diluted share, in the second quarter 2022, and $73.4 million, or $1.59 per diluted share in the prior quarter. Excluding non-cash share-based compensation expense of $6 million net of tax for the second quarter, both GAAP earnings per share and non-GAAP adjusted EPS would have increased by 13 cents per diluted share. EBITDA for the second quarter was $133.5 million or 28.6% of revenue compared to $130.6 million or 26.1% of revenue in the second quarter 2022 and $121.8 million or 26.1% of revenue in the prior quarter. 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 $92.6 million for the second quarter. Free cash flow was $55.6 million, which included $37 million for capital expenditures. Net cash flow was a negative, $1.2 million, including the pay down of $34.4 million of total debt. Turning to the balance sheet, at the end of the second quarter, cash, cash equivalents, restricted cash, plus short-term investments totaled approximately $334 million. Working capital was $747 million, and total debt, including long-term and short-term, was $89 million. In terms of inventory, at the end of second quarter, total inventory days were approximately 112. as compared to 1.16 last quarter. Finished good inventory days were 30 compared to 31 last quarter. Total inventory dollars decreased $16.2 million from the prior quarter to approximately $325.7 million. Total inventory in the quarter consisted of a $7.2 million decrease in finished goods, a $7 million decrease in work in process, and a $2 million decrease in raw materials. Capital expenditures on a cash basis were $37 million for the second quarter, or 7.9% of revenue, and within our target model of 5% to 9%. Now turning to our outlook. For the third quarter of 2023, we expect revenue to be approximately $425 million, plus or minus 3%. as we expect to continue reducing channel inventory due to the slower recovery in the consumer, computing, and communications markets. We expect GAAP gross margin to decrease sequentially to 40.0%, plus or minus 1%, primarily due to the impact of our manufacturing service agreements, but remains at our target model. Non-GAAP operating expenses, which are GAAP operating expenses adjusted for amortization of acquisition-related intangible assets, are expected to be approximately 23% of revenue, plus or minus 1%. We expect net interest expense to be approximately $1 million. Our income tax rate is expected to be 20%, plus or minus 3%. And shares used to calculate EPS for the third quarter are anticipated to be approximately $1 46.7 million. Not included in these non-GAAP estimates is amortization of $3.1 million after tax for previous acquisitions. With that said, I will now turn the call over to Emily Yang.
spk08: Thank you, Brad, and good afternoon. Revenue in the second quarter was flat quarter over quarter, reflecting the slower-than-expected recovery in China and the 3C markets. As Gary mentioned, while the automotive industrial market reached a record 48% of the total product revenue, looking more closely at this quarter's revenue, revenue in Europe was a record. Distributor inventory in terms of weeks decreased sequentially. The good news is our worldwide POS revenue increased over the first quarter, and the growth was mainly from Asia. Overall, our design pipelines continues to be very strong, especially in the automotive market, which is expected to serve as a key driver to our long-term future outlook towards our 2025 operating goals. Looking at the global sales in the second quarter, Asia represented 67% revenue, Europe 20%, and North America 13%. In terms of our end markets, industrial was 29% of Dio's product revenue, automotive was a record 19%, computing 22%, consumer 18%, and communication 12% of product revenue. Our automotive industrial end markets combined at 48% of product revenue represented the fifth consecutive quarter, above 40%, and is a percentage point above our 2025 target. This achievement underscores the ongoing success of our compact expansion strategy and market share gains. Now let me review the end market in greater details. In the automotive market, our record revenue represented a growth of 22% year over year. We continue to run past design win while maintaining ongoing design win momentum across multiple applications. Our SBR and bipolar junction transistors, when a new design in both battery and plug-in electric vehicles for battery management system, electric control units, distribution control units, and vehicle control units. Also, our clock buffer and crystal oscillators are being used in the EV for smart optics and AFAS applications. We also saw design wins for TVS products for power line protection and EV charging plugs and data line protection within the domain control unit. Our automotive USB-C power delivery controllers and gate drivers are being designed into car chargers modules and wireless charging solutions. And our rectifier and zener diodes continue to see growth in conventional inverter circuits, wireless power circuits, as well as body controllers. Additionally, our linear LED drivers and controllers are seeing traction in infotainment and heads-up displays, while DC-DC buck converters and transistors continue to see solid demand from LED lighting, audio-video navigation, and instrument cluster systems. Also during the quarter, we introduced 110 new automotive compliance parts, including silicon carbide MOSFETs. These N-channel MOSFETs are designed to address the growing demand for silicon carbide solutions in electric and hybrid vehicle subsystems, such as battery chargers, onboard chargers, high-efficiency DC-DC converters, motor drivers, and traction inverters, along with a series of voltage MOSFETs in battery management systems, Wi-Fi telecommunications, and infotainment applications. In the industrial market, Our silicon carbide shock tube diodes and MOSFETs, along with high current transistors, are seeing increasing traction in the power factor correction application, which helps improve voltage regulation as well as system capacity. Our products are also being used in industrial motor drivers, solar inverters, power supplies, as well as DC converters. Renewable energy. continue to be a key focus area for us with design wings for high-current transistors, bridge rectifiers, and gauge driver ICs into wind energy storage systems. Our rectifier and Zener diode products also continue to see growth in applications ranging from smart energy metering to high-efficiency LED backlighting, factory automation, ESG green building control systems, as well as renewable power generation and distribution systems. We also saw strong growth during the quarter from rectifiers in the embedded computing modules for robotic consoles using automations and point-of-sale terminals. Our SVR power devices and bridge has been adopted in power over Ethernet server applications, while our IntelliFi are being designed into power generator control modules. The ever-increasing data transmission rates and high-frequency switch mode power supplies continue to drive demand for DIA's ultra-fast recovery rectifiers that are also expanding into AI-driven automated vehicle control systems, as well as connected home and smart factory automation control systems. In the computing market, we continue to secure design wins for our PCI Express clock generators and buffers, I2C moxers and current monitor products into data centers and servers, including AI servers, while our low-voltage hall sensors, shock keys, and TVS products are seeing demands in notebooks and Chromebooks. In fact, the computing end market is one area where we start seeing some recovering signs. Also, experience solid growth across multiple rectified products in desktop PCs, high-efficiency switching mode power supplies, and notebook PC adapters, along with high-efficiency brick products for high-voltage surfer power applications. Additionally, momentum for power switches continue in USB Type-A and C power source applications in notebooks, desktops, and docking stations. With our contact image sensor products, saw new designs in scanners and printer applications. In the communication market, our timing product, including clock buffers and differentiated crystal oscillators, are seeing new design ways for noble interface cards and Ethernet switching applications. Our FDR products are being designed into surfer and asset point routers and are also seeing traction in low-Earth orbit or 5G applications. Lastly, in the consumer market, our bridge rectifiers Paul latch switches and TVS products are gaining traction in home appliance applications like air conditioners, washing machines, and refrigerators. Our retrofiring diodes continuously grow from fire and carbon monoxide sensors, LED lighting circuits for home appliances, as well as 4K TV panels. While the momentum for LED drivers, SDRs, and PSO sound drivers continues in virtual reality headsets, TVs, and tracker applications. In summary, we have began to see early indications of market improvement with inventory days decreasing in the second quarter, coupled with an increase worldwide POS revenue. Our focus going into the third quarter continues to be on POS growth and depleting channel inventory. Bayou's ongoing strategy to improve sales and product mix, including growing revenue contribution from automotive and industrial markets, positions us to continue to achieve our long-term growth and margin targets. With that, we now open the floor to questions. Operator.
spk03: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. And to withdraw a question, please press star, then 2. At this time, we will take our first question, which will come from Gary Mobley with Wells Fargo Securities. Please go ahead.
spk02: Good afternoon, everybody. Thanks for taking my question. Emily, I presume that distribution inventory while down sequentially is still above the targeted level. And I ask the question because I'm trying to get a sense of, you know, the seasonal headwinds that you'll face throughout the balance of the calendar year. Would you expect a normal seasonal decline in the fourth quarter or maybe something atypical, you know, one direction or the other?
spk08: Yeah, so Gary, you know, I did mention, unfortunately, the China recovery and 3C recovery is slower than our expectation, right? I think the good news is that we start seeing some signs, especially in the computing segment. You know, as I reported earlier, Q2 POS increased, and the channel inventory decreased, and unfortunately, still higher than our normal range, right? So we'll continue to drive. the inventory depletion in the third quarter, you know, the key is really driving the POS revenue growth, right? Since the market is really dynamic at this moment, and the inventory week is really calculated based on the POS revenue. So I think, you know, just like I said, that will be our continued focus for the coming quarters, and we'll definitely keep you posted when we see some updated information.
spk02: Okay. Appreciate that color, Emily. Can you help me understand what you mean specifically by the gross margin for manufacturing agreements? Are these manufacturing agreements with the sellers of your fab that you recently took over TI and on specifically?
spk06: Yeah, Gary, this is Gary. I won't be able to disclose too much detail about that. But however you know, we do have a manufacturing service agreement in place to supporting our OEM customer in both assembly testing and a service. OK, and due to the soft loading for the third quarter this year by the contract, and this really kind of have our impact for our revenue to be present slightly. So that's all I can talk about it.
spk02: All right, thank you, Gary. No problem.
spk03: And our next question will come from Matt Ramsey with TD Cowen. Please go ahead.
spk04: Yes, thank you very much. Good afternoon. For my first question, I wanted to build on maybe the first question that Gary asked. And as we see some of these maybe trends that haven't recovered in China, as you guys had hoped or expected that they would, it seems like the guide for the September quarter revenue contemplates some softness in the end markets, but also some drawing down of channel inventory. Maybe you could, if you guys could give a little color on where you think your revenue trends are in the third quarter that you've guided versus what sell through actually looks like in your end market. So do you feel like you're under shipping sell through to bring down channel inventory and by how much?
spk08: Yeah, Matt, I think, you know, definitely, if you look at the POS, it's really the sales through revenue, right? So we reported by the end of Q2, we actually seen a POS growth globally, and the majority of the growth is really coming from Asia, which gives us a really good indicator of the actual market, right? Also because, like I mentioned, even there's some signs of recovery, but the recovery is definitely slower than what we expected. So I would say the depleting of the channel inventory is lower than our expectation as well. That's the reason we guided a lower number for the third quarter. So it shifts through into distribution lower, at the same time increasing the POS revenue, right? But, you know, I mean, I also talked about the actual business signs, right? So there's signs of recovering the PC market. There's signs even in the smartphone, especially with you know, the leading manufacturer from the U.S. So not everybody eco, we also talk about it. And so we continue to believe as the inventory or the customer's inventory continue to deplete, as the, you know, the actual business continue to recover, you know, we are, you know, confident that, you know, our inventory position in the channel also help us to support the customer with a last minute or short demand. So that's pretty much what we believe.
spk04: Got it. Thank you for that, Emily. I guess as my follow-up question, I wanted to ask a couple, not on revenue, but on the rest of the P&L. So you guided gross margin and discussed some of the obligations there that are affecting it, but how should we think about margins recovering? I mean, is there some rule of thumb on that? return to revenue growth that would drive a margin recovery? Are some of these obligations things that are going to be there permanently as long as revenues at a certain level? I'd just kind of like to understand that a little bit better. How would we model margins recovering as we come out of this? And the second part is on OPEX. Maybe, Brett, you could talk a little bit about what actions you guys might take given revenues come down, or is this something that you're going to continue to invest through? I'm just trying to understand philosophically how you want to control OPEX with the revenue down, I don't know, close to 20% year over year. Thanks.
spk08: Yeah, so maybe let me answer the first part, right? So, you know, I mean, when the market is a little bit soft, especially in the 3C area, we do see a little bit more price pressure, but majority of price pressure is really coming from the decommodity area. We also, you know, we mentioned strategically we try to walk away from there. And just like you said, right, in the Q3, the major margin impact is really due to some manufacturing service agreements. As we continue to ramp up our internal capacity or internal DIOS product at the same time, that's going to continue to improve. Keep in mind that the key margin improvement initiative from DIOS is actually focused on the product mix improvement. We believe that with the product mix initiative, including a lot of new product introduction, And that will continue to offset some of the price pressure. And that will continue to help us to drive the margin improvement in the longer term. Brad, you want to cover the?
spk01: Yeah, I think, Matt, the way to think about the OPEX is what we would expect us to continue to do. And I think what you see is our R&D, some area we continue to invest in, in terms of our new products, our new processes. and that from an SG&A perspective, we continue to manage that very tightly and work within kind of our model. And I think as we go forward, you would expect that to kind of step back into the model that we advertise more broadly.
spk04: Thank you very much for the detail. Appreciate it.
spk03: And our next question will come from Tristan Guerra with Baird. Please go ahead.
spk09: Hi, good afternoon. I just wanted to go a little bit, some follow-up questions on gross margin in terms of how much of the decline embedded in the Q3 guidance is due to the service agreements that you've referenced versus lower utilization rates on your core business. Could you give us a sense of what gross margin would be if you had shipped in line with end demand? And also, is that headwind from service agreements and presumably foundry customers kind of renegotiating a lower volume? You know, how long that can last? Will it linger for the next few quarters?
spk08: Yeah. So, Tristan, let me try to answer the question, right? Like Brett mentioned in the guidance, majority of the margin impact is due to the surface agreement. As we continue to ramp up our internal product, the utilization will continue to improve. We do expect this is going to be a short period of time. It's not going to be an ongoing issue. related how long it's going to take, it really depends on some of the internal qualifications and progress, and I think overall we're progressing really well.
spk05: Yeah, if you want to talk about timing, you know, I think we noticed the market was slow down, such that our service agreement, you know, caused us to under load the issue. So we are aggressively working on bringing our own polla into our manufacturing to occupy that capacity. And it takes time to qualify and to ramp. But we are not talking about year, two year. You know, we can start to ramp it up In probably six months.
spk06: Yes.
spk05: And then, you know, then from there, we can start to occupy that capacity due to our service agreement, our partner or our competitors who under load it. Okay. Our OEM customer, our financial customer, they... actually under-loaded due to the market situation. But we're working toward taking that capacity. So I don't think it's a long-term problem. It is probably six months or shorter, depending on how do we rent and how do we PCN that polar notification that our customer accept it.
spk06: Yes.
spk09: Great. That's very useful. Thank you. And then for my follow-up question, you've mentioned some pricing pressure in the more commoditized segment of your business that obviously you're de-emphasizing. Is that purely a function of supply-demand and lead-time contracting? Or is it a function of a higher competitive level from a China-based supplier? And if that's the case, trying to understand the overlap from those emerging analog competitors in China relative to your product portfolio. And presumably, if that trend continues, what does that mean in terms of your mix which continues to evolve toward higher margin products. Thanks.
spk08: Yeah, so let me address the question. I think the pricing pressure is really more on the demand-supply side, and then also it's more on the inventory rebalancing, right? So we talk about a lot of customers with a high inventory on hand, mainly in the 3C market, right, the computing consumer and communication, especially on the smartphone area. So that's what we see. We don't really, I would say, interact a lot with the Chinese-based supplier, which is also our strategy, right, walk away from this area. We really see more, you know, the top-tier suppliers, not China-based, that we are really playing with. So we believe that once the demand overall situation improves, and we're also going to see improvement in this area. For the very deep commodity, we also talk about walking away. So, you know, that's really, I would say a lot of area you might see some Chinese-based supplier, but since it's really not our interest, so, you know, that's really not impacting DIOS that much.
spk05: Well, if you look at in the past several years, we have focused our new product from the differential technology-driven type of new product. So that is the evidence of us to get away from the China commodity competitors. Therefore, our current situation is not due to China It's due to the market situation. If you look at from the past, we are talking about even the 3C area. We are more focused on server for computing and smartphone for the communication and IoT for consumer business. If you can see, we're moving our commodity type of product into more differentiated technology enhancement type of new product. And we see the result. And that's why we are able to maintain our growth margin at our business model of 40%. And even The second quarter, we already had the record to get 41.8%, and we believe if we continue working toward this direction, our gross margin should continue to improve.
spk06: Yeah, I think other than the product, you know, the new product introduction from Dr. Liu's point, and also we are focusing a lot on the automotive industry, which the pricing is relatively stable in these two applications. That, you know, you can see our pricing of these two areas increasing quarter by quarter, and I think it's a very good signal for us to keep our pricing stable in all of our dials.
spk09: Great. Thank you very much again.
spk03: And our next question will come from William Stein with Truist Securities. Please go ahead.
spk10: Great, thanks. I didn't see if the queue was filed yet, but in that document you always disclose the revenue from channel versus direct. And I'm wondering if you can tell us what that was in the quarter.
spk08: So usually, we have about 2 thirds of revenue coming from the distribution and 1 third from the direct, roughly. And we don't really expect significant change. But I can double check the ratio. I don't have the actual percentage in front of me at this moment. But I can double check.
spk01: Yeah, so the direct portion this quarter was around 31%. You'd see that in the queue. And we have just filed that as well.
spk10: Oh, okay. I'll check it out. But, you know, this whole dynamic that you've highlighted with channel inventories that continues to flush sort of slower than expected, it sort of reminds me of the various approaches that we've seen semi-companies take in this unusual cycle that we've been through. You know, some of them have put these very sort of long dated agreements in place and, you know, they've sort of transitioned from shortly time and shortly time and very sort of early cycle companies to later. And others have, you know, once they saw demand weakening, they just waved in all the cancels they could take. It looks like you're seeing, you know, I mean, look, revenue growth has faded significantly. over the last seven or eight quarters, so it's not a total surprise, but this looks like a fairly abrupt change next quarter. I'm wondering if you can talk about how you're managing customer orders relative to lead times and customer requests to cancel or push orders. Was there a delay in the willingness to accept these and then they're all being accepted in Q3? Is that a big driver of the Q3 situation? guidance, or is there another dynamic there? Thank you.
spk08: So, Will, I think, you know, we always talk about it, working with the customer closely, understanding their demands, right? You know, I mean, we have been, I would say, case by case, working with the customers, depends on their request, and make certain adjustments, you know, whether it's push-out or cancellation to reflect their true demands. So we have ongoing effort that working with customers. At the end of the day, we want to make sure we have a structure and, you know, nimble to support the customer and build a long-term relationship, right? So we definitely not the style that we're going to push down their throat, whether they like it or not. So there's ongoing effort that continue to drive the relationship and continue to help us to grow to the next level. So I would say that's ongoing. Lead time is definitely slowly coming down. That's also the reason that the backlog, you know, usually customers are based on the lead time to place the backlog. So we're also working with the customers to make sure, you know, we understand their true long-term demands. and make adjustments towards that. So, you know, that has been an ongoing effort. Even when the market is different, we talk about we didn't really increase the price, you know, just blindly, but in return, working on the demand creation, expanding the business, and that will continue to be the strategy and philosophy of DIOS overall.
spk03: Thank you. Again, if you have a question or a follow-up, you may press star then 1 to join the queue. Our next question will come from David Williams with Benchmark. Please go ahead.
spk11: Hey, good afternoon. Thanks for letting me ask the question. Excuse me. I guess on the first, just wanted to touch on the automotive segment. And earlier, Emily, I think you said that the demand there, it remains relatively strong. But just curious if you're seeing any posturing changes in the Tier 1s or the ODMs particularly in the level of inventory they're willing to carry and just in the general demand. Are you seeing anything change there?
spk08: Yeah, I think in general, right, we're still seeing really strong demand from automotive, especially on the design momentum as well as some of the renting of the new design. So, you know, I talked about it. Even for the second quarter, automotive is actually a record percentage, 19%. increased from 18% from the previous quarter. You know, and then you know, right? We start tracking the automotive since 2013 to 2022, we have a compounded annual growth rate of 30%. So, you know, I mean, Q2 represented 22% year over year growth. So yeah, it's maybe a little bit less than 30%, but it still shows a really strong momentum. We do see some customers, automotive customers, adjusting some of the inventory. I also openly talked about it before. That has been an ongoing effort because not everything eco, every part kind of varies a little. So the customer do adjust it. It's not like they're waiting and not doing any action. But putting that aside, right, I think, you know, releasing 68 new product in second quarter just focused on automotive. With 110 new product in Q3, that actually shows the momentum as well as commitment from DIOS, right? So we believe this will continue to help us to outgrow the market and continue to gain the market share. So that will continue to be the number one focus for DIOS for the years to come.
spk05: Well, one more point is Otobo's business is more stable type of business. From the new product design in to the ramp, it takes two to three years. From the time we announce the new product to their ramp, it takes two to three years. And therefore, we know how much new product we introduce in the past and when they're going to re-ramp. And those are much more long-term, stable type of business than consumer, even computer communication. It takes much shorter time. Therefore, we believe since our effort in the past, our CAGR will continue to that kind of the momentum. So when we're tracking, like Emily talking about, you know, since 2013, we are about 30% CAGR. We believe that kind of trend will continue. It won't be affected too much by the real business because obviously our customers the number of cars won't have that much of variance year over year or quarter over quarter.
spk08: Yeah, I think the other key focus is the compact expansion. So we're not only counting on the number of cars per year shipped to the consumer, but really continue to expand in different applications. like the connected driving, you know, the comfort, safety, and lighting, as well as connected cars, right? So there's different areas we focus, and this is all very high-growth area with the contact extension.
spk11: Okay. Thanks so much. Excellent color there. Certainly appreciate it. And then secondly, not to be on the gross margin too much, but just kind of curious, and Dr. Liu, you've been very upbeat on the margin progression and the sustainability there. The resiliency is certainly showing up this quarter in the third quarter guidance down 180 basis points given the magnitude of the revenue decline. But how should we think about the margin given the dynamics of the correction and just kind of thinking about some of these other segments maybe coming back? And as those recover, should we think about maybe a little more pressure on the gross margin side? Or is 40 kind of maybe a trough here that we should think about longer term?
spk08: Well, maybe let me address the question first, and Dr. Liu can add some colors. With the product mix initiative, with the new product introduction, with the total solution sales, we are confident that we continue to drive our margin model ahead of the 2025 model that we share with you guys, which is 40%, right? Short term, we talked about the surface agreement, but in the longer term, we are confident that our strategy and our direction is the right direction. We continue to improve. The other key point is, if you go back to 2021, I believe second quarter, similar revenue range. I think our margin is really in the 36 range, right? 36 range. to the guidance 40%. I know it sounds like we actually have a 1.8% retraction, which is a short term, but that's still significant improvement over the longer term, right? So we understand the concern, but we believe that will continue to drive the improvement over time.
spk05: Yeah. If you want to talk about gross margin, OK, I would say that we The price pressure is offset by our new product and product mix and total solution. Second is when we get the factory or assembly, so factory especially, we negotiate with our factory supplier to go down the price. So we go through both directions. One is the material down. Second is new product mix. Third is market segment. We focus more on automotive industrial and reduce the 3C, which is door. So from all these three directions, that's why our long term, our gross margin, continue improve. And like Emily just said, from 30-something percent, we continue increase to this second quarter, 41.8. Now, the drop down from 41.8 to 40% in this quarter is due to our service agreement. But how do we solve that? It's by ramping our own product into the capacity left over by our service agreement. So you can see all the directions for us. we believe from long-term point of view, we were able to, again, continue improve that margin. And if you remember when I make it our 2025 plan, one billion gross profit, we are setting the model of 40%. And we actually already exceed that. And even with this quarter's service agreement, we're still able to maintain this at our business model. And we will continue to improve. So that's the direction what we are working on toward our business model. And we know we're going to exceed. our business model of 40% and continue our improvement.
spk03: And our next question will be a follow-up from Tristan Guerra with Baird. Please go ahead.
spk09: Thanks for letting me back here in the queue. Just to follow up on what you just mentioned, as you ramp and qualify new product, to switch away from those service agreements, that implies that either you have a recovery in demand and that you're gaining share. And I know there's been share gain just on the basis of some of your peers de-emphasizing some products and doing product printing. But that trend presumably will slow down next year or even later this year as as we see more balanced supply demand. So what's the level of confidence that you can actually find the demand for those products that you're now qualifying at those fabs to replace those service agreements? And embedded in that question, how should we look at the gross margin differential between those service agreements versus what you plan on replacing with internal production?
spk06: Okay, this is Gary. Let me speak for that first, and if Dr. Liu or Emily have any comments, they can always plug in, okay? So, first of all, and the, you know, the project that we've been working on for years, the so-called second source project, which means we are working with our, you know, The FAB or the facility we acquire from our peer, and we identify the process externally, and we want to internally transfer those kind of external wafer FAB loading into our internally. Which being said, the demand is very solid. We already have a customer base on those kind of product we already running for years. OK, so I would say the confidence level of the demand loading for the second source product internally is very high. OK, so as for the GP percent point of view, and I'm not talking about that we are kind of losing GP, but the majority is kind of under low cost that are hitting us at this moment. So as long as we can load up product into the internal wafer file, the under low cost will be significantly reduced. And this way, we can recover GP dollars from those kind of under low cost. And I can tell you, just like Dr. Lim mentioned about probably early next year, we can see those kind of demands that are ramping up internally.
spk08: Yeah, of course, that would couple with market improvement and also market share gain. So we're actually going through all different directions to minimize the impact, so to continue to improve the gross margin percentage. Yeah.
spk05: Well, you know, we have a lot of experience of the semiconductor business. So one of the strategies would be the capacity failures. Okay, they have a lot of, you know, for that, we can load it and use it as a buffer, okay, to the loading. That's one. Second, like we said, we have a lot of OEM and factory business outside, and we can use that to start to develop the process. Our internally... And then, you know, as a second source, like Gary talking about, and then we can move in some of the requirements inside our own manufacturing. So there are so many different ways we can, you know, all using our capacity and to reduce the under low cost and to improve the growth margin. So there are so many different ways, and we are working toward those directions.
spk09: Great. Thanks again.
spk06: Thank you.
spk03: This concludes our question and answer session. I'd like to turn the conference back over to Dr. Keishu Liu for any closing remarks.
spk05: Thank you for your participation on today's call. Operator you may now disconnect.
spk03: The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect your lines.
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