Diodes Inc

NASDAQ:DIOD

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon everyone, and welcome to Diodes Incorporated First 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. [Operator Instructions] As a reminder, this conference call is being recorded today, Tuesday, May 9, 2023.

I would now like to turn the floor over to Leanne Sievers of Shelton Group Investor relations. Leanne, please begin.

[Leanne Sievers, Shelton Group Investor relations]

Good afternoon and welcome to Diodes first quarter 2023 financial results conference call. I'm Leanne Sievers, President of Shelton Group, Diodes Investor Relations firm. Joining us today 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; Chief Operating Officer, 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 March 31, 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 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, May 9, 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, definitions 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 at www.diodes.com.

And now, I will turn the call over to Diodes Chairman, President and CEO, Dr. Keh-Shew Lu. Dr. Lu, please go ahead.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Thank you, Leanne. Welcome everyone and thank you for joining us today. Our first quarter results were highlighted by continued strength in our gross margin performance, which was at the high end of our guidance. Despite the seasonally lower revenue and economic slowdown in the consumer, communications and computing markets. In fact, gross margin has remained over 41% of the past four quarters and above our target model of 40%, underscoring our execution on new product initiatives and product mix improvements.

A key contributor to our improved mix has been our success expanding into the automotive and industrial markets, which together represented a record 47% of total product revenue in the quarter. Another contributing factor to our consistent margin improvement is our manufacturing cost reductions and operational efficiencies, which have also allowed us to maintain healthy margins despite the COVID-related disruptions and the Chinese New Year holiday during the quarter.

Over the past several years, we have taken significant steps to transform our business as well as our customer and market positioning based on a total solutions sales approach, extensive pipeline of new product introductions and design wins. Today, Diodes has a diversified business across product groups, end markets and applications, as well as geographies that are further supported by a flexible manufacturing model and a team that is highly focused on consistent execution and sustainable quarterly performance. These fundamental factors position us well to not only sustain our margin profile during an economic slowdown, but also continue driving even higher profitability and cash flow in more favorable economic environment.

With that, let me now turn the call over to Brett to discuss our first quarter financial results and our second quarter guidance in more detail.

[Brett Whitmire, Chief Financial Officer]

Thanks Dr. Lu and good afternoon, everyone. Revenue for the first quarter 2023 was $467.2 million, decreasing 3.1% from $482.1 million in the first quarter of 2022 and down 5.8% from $496.2 million in the fourth quarter of 2022. Gross profit for the first quarter was $194.5 million or 41.6% of revenue compared to $196.7 million or 40.8% of revenue in the prior year quarter, and $206.2 million or 41.6% of revenue in the prior quarter.

GAAP operating expenses for the first quarter were $108 million or 23.1% of revenue and on a non-GAAP basis were $101.3 million or 21.7% of revenue, which excludes $3.9 million of amortization of acquisition related intangible asset expenses and $2.8 million related to officer retirement. This compares to GAAP operating expenses in the first quarter 2022 of $103.6 million or 21.5% of revenue, and in the fourth quarter 2022 of $109.7 million or 22.1% of revenue. Non-GAAP operating expenses in the prior quarter were $105.9 million or 21.3% of revenue.

Total other income amounted to approximately $2.2 million for the quarter, consisting of a $3.9 million unrealized gain on investments, $1.8 million of interest income, $530,000 of other income, partially offset by $2.1 million in interest expense and a $1.9 million foreign currency loss. Income before taxes and non-controlling interest in the first quarter 2023 was $88.6 million compared to $90.8 million in the prior year quarter and $94.8 million in the previous quarter.

Turning to income taxes. Our effective income tax rate for the first quarter was approximately 18.8%. GAAP net income for the first quarter 2023 was $71.2 million or $1.54 per diluted share compared to $72.7 million or $1.59 per diluted share in the first quarter of 2022 and $92.1 million or $2 per diluted share in the fourth quarter 2022. The share count used to compute GAAP diluted EPS for the first quarter 2023 was 46.2 million shares.

Non-GAAP adjusted net income in the first quarter was $73.4 million or $1.59 per diluted share, which excluded net of tax $3.1 million of acquisition related intangible asset costs, $2.3 million in officer retirement expenses and a $3.1 million gain related to an LSC investment. This compares to $80.3 million or $1.75 per diluted share in the first quarter 2022 and $79.6 million or $1.79 per diluted share in the prior quarter.

Excluding non-cash share based compensation expense of $7.7 million net of tax for the first quarter both GAAP earnings per share and non-GAAP adjusted EPS would’ve increased by $0.17 per diluted share. EBITDA for the first quarter was $121.8 million or 26.1% of revenue compared to $118.1 million or 24.5% of revenue in the first quarter 2022 and $129.6 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 $99.8 million for the first quarter. Free cash flow was $51.8 million, which included $48 million for capital expenditures. Net cash flow was a negative $15.2 million, including the paydown of $60.8 million in total debt.

Turning to the balance sheet. At the end of first quarter cash, cash equivalents, restricted cash plus short-term investments totaled approximately $335 million. Working capital was $731 million and total debt, including long-term and short-term was $125 million. In terms of inventory, at the end of first quarter total inventory days were approximately 116

days compared to 117 days last quarter, finished goods inventory days were 31 days compared to 33 days last quarter. Total inventory dollars decreased $18.3 million from the prior quarter to approximately $341.9 million. Total inventory in the quarter consisted of a $13.7 million decrease in raw materials, a $3.1 million decrease in finished goods and a $1.5 million decrease in work in process.

Capital expenditures on a cash basis were $48 million for the first quarter were 10.3% of revenue. First quarter CapEx was higher than our target model due to the strategic 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 be in that range for the full year 2023.

Now turning to our outlook. For the second quarter 2023, we expect revenue to be approximately $467 million plus or minus 3% with a slower than expected recovery in the consumer computing and communications markets. We are guiding flat sequentially at the midpoint to reduce 3C channel inventory. The automotive and industrial markets are expected to remain strong. We also expect continued driving our strategy of improved product mix and are guiding GAAP gross margin to be a record 41.8%, plus or minus 1%.

Non-GAAP operating expenses, which are GAAP operating expenses adjusted for amortization of acquisition-related intangible assets, are expected to be approximately 22% 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 second 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.

With that said, I will now turn the call over to Emily Yang.

[Emily Yang]

Thank you, Brett, and good afternoon. In the first quarter, revenue decreased 5.8% quarter-over-quarter due to typical seasonality related to the Chinese New Year holiday combined with a slowdown in the 3C markets. Looking more closely at the first quarter, revenue POS was a record in Europe, distributor inventory in terms of weeks increased sequentially and it’s higher than our defined normal range of 11 weeks to 14 weeks. This increase is mainly due to slower than expected recovery in China and in the 3C market channel.

The good news is that we started to see signs of recovery in the computing and consumer markets. Our plan is to decrease some channel inventory in the second quarter, which is reflected in our guidance. We believe our channel inventory position are strategically for the expectation of our continuous recovery so that we can address dynamic demand and faster on business. Automotive and industrial market seminar [ph] expected to remain strong in the second quarter.

Looking at the global sales in the first quarter, Asia represented 68% of revenue, Europe, 17% and North America, 15%. In terms of our end market industrial was a record 29% of Diodes’ product revenue. Automotive was also a record at 18%, computing 22%, consumer 18% and communication 13% of product revenue.

Our automotive, industrial end market combined reach a record 47% of the product revenue, which is the fifth consecutive quarters above 40% and is seven percentage point above our 2025 target. This achievement underscored the ongoing success of our contact expansion strategy and market share gain.

Now let me review the end market in greater details. Starting with our automotive end market. As I mentioned, revenue reach a record 18% of product revenue and representative growth of 33% year-over-year. In our first focus area of connected driving, our PCI Express 3.0 packet switches, PCI Express clock generators, clock buffers, crystal oscillators, USB switches, USB power delivery controllers, multi-level shifters and IO expanders are being designed into ADAS, infotainment, telematics, domain control unit and electric control units applications.

We’re also seeing strong demand for DC-DC buck converters, LDOs, Ideal Diodes Controllers, bipolar transistors and TVS product in the same end application. In the comfort style and safety, we continue to gain tractions for ReDrivers and crossbar switches as USB type C adoption continues to increase in the vehicles. Our solution selling approach is a key driver to this momentum. Additionally, we have been winning the designs for our power deliver solutions that include power deliver protocol decoder along with our usbmuxd [ph], ReDrivers and TVS for the in vehicle USB charging devices.

We’re also seeing an increasing number of design wins in wireless chargers. Thin, lower, thermal management system with our current monitor products, regulator transistors and SBR products. And our linear LED drivers ideal diodes controllers, bipolar junction transistors and LDLs are being designed in several stoplight, taillight, headlight and cluster lighting systems.

In the power trend, which covers conventional hybrid electric vehicles. Our switching diode product helps support conventional applications such as drive train electronics and towing, towing and cargo management system. SBR in [indiscernible] products are also seeing traction in battery management system and in protection control applications for battery electric vehicles as well as plug-in hybrid electric vehicles. We also recently introduced a number of new automotive compliance SBR in power [ph] MOSFET and MPN transistors that has been designed into battery management system.

In the first quarter, we introduced 60 a new automotive compliance product. This is a good demonstration of our focus on various automotive applications and product mix improvement. In our industrial market revenue grows 7% year-over-year to also reach a record percentage of total product revenue at 29%. Our buck converters, LDLs and sensors continue to see strong demand for applications such as PC, power tools, power supplies, circuit breakers, millimeters, embedded systems, and precision control systems. Additionally, our newly released industrial latch switches are gaining traction from low voltage to high voltage applications requiring the harsh environment.

Our SBR product also being widely used in power over ethernet and embedded applications. While our 36 channel linear LED drivers are being adapted in the robotic applications. Our gate driver ICs have one new sockets in power supply units for surfers and energy storage as well as enlighting for the digital addressable lighting interface control board.

Our high performance transistors and high voltage switching diodes have also one desizing in solar inverters for green residential energy generation and transmission systems. Additionally, we are gaining increased traction for our switching diodes and functional array products that are utilized in numerous control systems for applications including HVAC controls, LED lightings, digital printing press machines, printed circle boards, assembly test systems, and imaging circuits for medical and aviation security system.

Early in the first quarter, we’ll pleased to release our first set of silicon carbide Schottky barrier diodes. That includes a series of 11 product rated at 650 volt and other series of eight product rated at 1,200 volt. We also release our first silicon carbide MOSFET to address the demand for high efficiency and have high power density applications such as industrial motor drivers, solar inverters, data center, and telecom power supplies, AC-DC converters, as well as electric vehicle battery chargers.

Despite the softness in global computing market, our design in momentum continues across a portfolio of products. This include wings for our USB type C charging detectors, high speed switches, ReDrivers, retimers, MOSFET, SBR and TVS product in the broad applications including servers, desktops, notebooks, graphic cards, design [ph] cards and USB data line protection. New design win activities continue for our content image sensors in multifunction printers and without adaption of HDMI 2.0 12 gigabit per second ReDriver, EMMC markers in gaming consoles as well as 8.0 and 10 gigabit per second five directional retimers in active cable docking and dunk go applications.

In the communication market, we continue to win new designs in 5G applications for audio switches, IO expanders, USB switches, high PSRR LDO’s and Schottky products. Additionally, our small signal diodes product gain traction in the rapid growing field of industrial communication system and cyber security. While bipolar transistor gain new design wings in IP cameras, GPON and router applications.

Lastly, in the consumer market, we’ve been securing new design wins for USB switches, MOSFET current limit power switches, bridge rectifier in sports camera adapters, gaming consoles and power offering internet devices. Manufacturers of panels of TV and displays continue to adapt our bipolar transistor in their new models. We also continue to see solid growth for our SBR, LED driver, [indiscernible] drivers, USB power delivery sync controllers, switching Diodes and TVS product in the tracker applications displays, wearable, personal care, healthcare devices and the health and safety monitor system as well as in fire and carbon monoxide sensors.

In summary, science performance this quarter highlights the progress we have made increasing our contact and market share gain in automotive industrial markets. Contributing to our overall product mix improvement. Our total solution sales approach and operating efficiency have been a key factor to our success as we continue to drive growth and sustainable margin performance.

With that, we now open the floor to questions. Operator?

[Operator]

[Operator Instructions] Our first question today comes from Matt Ramsay from Cowen. Please go ahead with your question.

[Matt Ramsay, Cowen]

Yes, thank you very much. Good afternoon everybody. I think for the team, my first question obviously there’s a lot of moving parts here in the macro environment and great to hear about the auto and industrial strength and the momentum the business has there. But I guess I’m trying to get a gauge on how you guys are seeing, the potential recovery in China. I mean, it’s anybody’s guess as to when that happens, but it is a return to year-over-year growth for your company sort of predicated on a recovery on selling, and so a lot of these consumer markets in Asia or how do we think about that relative to the design win momentum and the content growth that you’re seeing across the business? I’m just trying to gauge sort of expectations for the next few quarters and the levers macro wise versus sort of secular content wise for your company. Thanks.

[Emily Yang]

Yes, hi, Matt. This is Emily. Let me address your questions first. I think overall like I mentioned earlier, right, we do start to see some recovery in the computing as well as our communication area and also consumer. It’s very I would say slower than our expectation, but the good news is we start seeing signs of recovery. I mean usually for Q3 it is the peak of all this market segments, so that’s also part of our assumption as well.

[Matt Ramsay, Cowen]

Got it. No, thank you Emily. Thank you that for that very much. As my follow up question, I think the some of the longer term financial model metrics, that you guys have shared are a bit older now and the company’s done much, much better than some of those metrics, and one of them is around getting, the business mixed to be 40% or more of revenue coming from auto industrial and you far pasted that. I think we’re at 46%, 47% of the business now and you just put up a really, really strong growth margin quarter and then guided up sequentially. I’m just trying to figure out, if the team thinks about this mix of business and this margin profile in sort of the 41%, 42% range, is that sort of the new way that we should be thinking about the business or if in fact the 3Cs markets come back at some point in the mix that the margin would move up or down with that, but great margins. I’m just trying to figure out if this is sort of the level we should think about for the foreseeable future. Thank you.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Okay. Now let me just answer, number one, the overall market situation, okay, we see some recovery on the 3C market, but the industrial and automotive are still very strong and therefore, we are hoping that second half of this year after the channel inventory or as you said, our customer as a building up and their inventory of the 3C product start to decrease, then, the second half the business should be come back stronger. Okay? That is in general for this year, I believe, first half versus second half could be, more, more than 50-50. It should be probably somewhere, much higher. In second quarter and second half than first half, right?

That’s this year. Then after that, next year we should we’ll believe will be a typical growth year for the semiconductor business because if you look at semiconductor business, traditionally when you go down, it probably won’t go down more than two years and since this down is already start at second half of last year, so I think by end of this year will be one and a half year, then I think, next year, 2024 [ph] should be a growth year for the semiconductor total business point of view.

[Emily Yang]

Right.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Okay.

[Emily Yang]

So let me maybe add one more comment related to the margin improvement that you just mentioned. So product mix improvement has been a big initiative for diodes for the last few years, right, and we definitely will continue to focus and the total solution sales approach as well as manufacturing efficiency with combined of all these three, we are confident that we’ll continue to drive the margin overall improvement and if you look at the Q1 result, auto plus industrial 47 total of our product revenue is a good demonstration of this result and as well as our guidance for Q2 41.8%. So I think, the focus will now change for the company and that will continue to be the direction. If we continue to execute all this initiative and focus, we believe the margin improvement will continue.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Yes, but so when you talking about, when the 3C market coming back up, we able to sustain the gross margin improvement and my answer is yes, because even the two things, the automotive in industrial continue their growth. Okay. And so they are in a much better market and even the consumer or 3C market come back. I think Emily could mention about we are getting away from the commodity

[Emily Yang]

Decommodity

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

And the commodity type of product. So we are carefully to grow our 3C market more concentrate on the high NPC data center, IoT and the 5G type of communication product. Therefore, if you look at, we are intentionally get away from the commodity or deep commodity and compete the price competition and we grow in the area, we do have, we have differentiation, we have, premium, that stuff. So that is the way we have been able to continue improve our gross margin in addition to operational excellence. Okay. So we are not that focus on the volume and manufacturing volume to get us to the gross margin. We are more focused on cost reduction operational efficiency plus product mix improvement.

[Matt Ramsay, Cowen]

Thank you very much for all the color, Dr. Lu and Emily. I really do appreciate it. I'll jump back in the queue. Thank you.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from Gary Mobley from Wells Fargo Securities. Please go ahead with your question.

[Gary Mobley, Wells Fargo Securities]

Good afternoon everybody. Thanks for taking my question. The comments by Dr. Lu that the second half of the year should be better than the first half, I guess, indicates that you're going to expect a normal seasonal uptick in the September quarter. Correct me if I'm wrong there, and I wanted to get my arms around the impact on the reduction in distribution inventory with the understanding that presumably you're above the normal 11 to 14 weeks and each week of distribution inventory is worth what, $22 million in revenue. So how many weeks of distribution inventory, digestion or reduction are we talking about here that is influencing the sub seasonal guide for the June quarter?

[Emily Yang]

Yes, so Gary, let me answer that question. So we don't really disclose the detail about the number of weeks, but in my speech I did mention it's higher than our 11 to 14 weeks range that we define as normal. So our goal is actually expect the POS channel will grow in second quarter and at the same time we want to deplete some of the channel inventory. So we do believe the number of weeks will come down, so that's based on what we see based on the market and the information we have so far.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

And it is very difficult to just look at the overall inventory, okay. Or channel – overall channel inventory week. Because we – the automotive, industrial, they're still very strong. The channel inventory true-up is really due to the 3C business, which most is in Asia. Okay. And we already see the sign and we guide Brett on this quarter is really intentionally to deduce the 3C channel inventory. Okay. We still looking very strong on automotive, industrial and that's the area we do not want to deduce the channel inventory, but as 3C, that's the area we – especially our say, those commodity – commodity we don't want to compete and therefore, we intentionally want to debrief that area of the channel inventory.

[Gary Mobley, Wells Fargo Securities]

Okay. Thank you for that. The follow up I wanted to ask about your operations in China. During COVID, you were operating for so many years in a closed-loop environment. Can you give us an update on whether that's still the case and if not, you know, whether there's any anticipated or already realized cost benefit from that?

[Gary Yu, Chief Operating Officer]

No, actually Gary, this is Gary and the operation in our China, no matter the fab assembly are normal right now. Okay. So that's why we will say, okay, the operation for the China we want to drive is a cost reduction and more operational excellence. Okay. So there's no any special lockdown on closed-loop operation at this moment.

[Gary Mobley, Wells Fargo Securities]

All right. Thank you, Gary.

[Gary Yu, Chief Operating Officer]

No problem.

[Operator]

Our next question comes from David Williams from Benchmark. Please go ahead with your question.

[David Williams, Benchmark]

Hey, thanks so much and congrats on execution and navigating this challenging backdrop. I guess one of my questions is if you kind of think about the margin, and you touched on this a bit earlier, but I guess I'm kind of curious how you think about that. If we saw automotive come down a bit or maybe back off and you start to see the 3Cs really improving, what would you expect to see from the margin impact? Do you think you'd see a significant or would that be moderate and can you – what leverage do you have there, I guess to control that margin profile in an automotive environment that's maybe a little less strong?

[Emily Yang]

Yes, so with the automotive, we actually still seeing pretty strong momentum in general, right. There's a little bit inventory adjustment, but if we look at the overall growth, right, we actually have a record percentage of 18% at the end of Q1 that actually represented 33% year-over-year growth. So we continue to gain market share. So we are pretty confident with the pipeline that we have in place without opportunities we have in place, we are in pretty good shape.

With the 3Cs, I think Dr. Lu mentioned a little bit earlier, we really focus on the premium portion within the 3Cs, right. We are definitely not chasing the deep commodity or commodity business. We are really focusing on the higher end of the applications, the surfers, the storage, the data center, whether it's 5G or even with the consumer. We really focus more on the IoT block, the power block or the timing block. So with this focus and continue to drive the product mix improvement, we actually confident that we continue to drive the improvement over the margin, over the years to come.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Yes. One more thing I want to add to it. Because people start thinking automotive business is very hard but going to be slow down and are you able to continue maintain your growth? And the mindset is since 2013, that is almost 10 years ago, we established automotive business focused, we still CAGR 30% a year of the globe. So we are not really coming on the market growth. We’re coming on additional to the market growth. We’re coming on except that data value for each module and that is what our focus is on automotive business is a module, data module group. And because of that we are able to do much better than automotive business growth and therefore, I believe we'll still continue increase our automotive revenue as a percent of Diodes total business. Okay. Emily already said, 18% in 1Q and you go back 2013, 3%. Okay. So that is how do we drive in the automotive business is not just coming on volume growth. We’re coming on the other module growth.

[David Williams, Benchmark]

Okay. Excellent color, thank you for that. And then maybe secondly, just Diodes has outperformed over the last several quarters, but even – and maybe even more so over the last couple of quarters, relative to peers. What do you think has given you the improved inventory dynamics where you're not seeing the same magnitude of digestion that we've heard from others? Is it more of the managing of the channel or is it just the growth that you're still seeing? Any color there around why you're outperforming the market would be very helpful I think. Thank you.

[Emily Yang]

Well, I think Dr. Lu kind of mentioned earlier, right. So each of the markets, we actually focus really more on the content expansion, right. So that's really the key, especially in the automotive area. I also think the total solution sales approach help us to really sell the value and proposition to the customers solving their problem. And then remember, we also talked about price increase for the last two, three years. We actually strategically choose to build a relationship with the customers, but not to just purely dodge the price up. So I think there’s a lot of long-term strategy including the product mix improvement initiatives, right? So of course, manufacturing efficiency has always a sweet spot for us overall.

So when you combine all this focus and initiatives and the direction overall, I think that’s actually a good demonstration of the result that we delivered to you so far, right? And then with the Q2 guidance on the 41.8% margin, I think that again is a different way of demonstrating our confident of the overall margin dollar or margin percentage improvement.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Yes, even the revenues are spread, it tell us, our margin is not just pure coming from the lowering, coming from the utilization. Our coming is a big portion is product mix, which is what we are focused on. Okay. And another one is the new product in this – okay, we do in every automation just for automotive, we announced 68 new product in 1Q. So you can see we are driving a lot of focus on new product initiative. We even manage the revenue generated by the new product and that is the one we believe we can continue improve our growth.

[Operator]

Our next question comes from Tristan Gerra from Baird. Please go ahead with your question.

[Tristan Gerra, Baird]

Hi. Thank you. Maybe a little tweak on Gary’s question earlier on this call. Is it fair to assume that without the reduction of inventories in the channel that you’re implementing in Q2, there’s may be a 3% impact on the revenue? If I look at kind of normal seasonality, your top line normally will be up about 3% sequentially. Is that in the ballpark? And do you expect that inventory reduction dynamic to be a one quarter issue or do you expect this to linger into Q3? And finally, what’s the delta with the other shipping that you previously expected into – in Q2 in anticipation of China recovery?

[Emily Yang]

Well, I think Tristan, we did mention the good news is we start seeing some of the signs right in – especially in computing and consumer market. So that’s a good news. We also mentioned that slower than expected recovery in China and also the 3C market settlement kind of costing the channel inventory higher than our expectation, right? So we definitely plan to deplete some channel inventory in the second quarter, but unfortunately we don’t really provide guidance how many weeks or anything like that. But we are confident that with the guidance that you see a flash with the expectation of improvement in the POS in the second quarter, you will see the channel inventory start depleting some. So that’s pretty much what we can share at this moment.

[Tristan Gerra, Baird]

Okay. And then from a capacity standpoint, you’ve been able to gain market share as a result of having less supply constraint than your competition, notably last year. Do you think that your peers are still supply constrained? Obviously I can ask them the question, but just interested in your view on the whole industry supply-demand dynamic and whether you think that at some point we get in supply-demand equilibrium in analog? And what does that mean for you guys in terms of capacity management, particularly if end demand trends were to weaken further?

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Okay. Firstly, when you are talking about capacity, we do have enough capacity if want to grow. Okay. And 3C capacity is really cannot just say, I can use it for anything. Okay. Automotive capacity versus consumer capacity, sometimes it’s the same, but most of the time it’s different. Then you need to spend the effort to convert it. And from a strategic point of view, we already decided we are getting away from commodity or commodity, 3C type of port, then we graduate when we need it. We convert our capacity from 3C for industrial and auto market. Okay.

And so look at the market, look at the demand and we will spend the money and gradually convert to the need. Okay. We will not just get the capacity sitting there waiting for the 3C business come back. We intentionally convert to support long-term strategy, higher growth marketing business and our focused business, which is automotive and industrial. And now with 3C we see three area we are focused on, then we support that and we try to get away from the competition very strong, especially the China supplier. We are getting away from that. So you can continue to see our gross margin will continue improve even the 3C business come back.

[Emily Yang]

Yes. I think from the supply point of view, not everything is useful at this moment. All in all, I think it’s still a little bit dynamic. There’s still a lot of pockets of shortage versus we mentioned deep commodity, there’s more supplies, right, which is not a focus in the area that we are chasing after. So I would say not everything equal at this moment, still pretty dynamic.

[Tristan Gerra, Baird]

Great. Thank you very much.

[Operator]

Our next question comes from William Stein from Truist Securities. Please go ahead with your question.

[William Stein, Truist Securities]

Great. Thank you. I had a question about your inventory management. You’ve done certainly very well on your own balance sheet, but you’ve taken it seems to be a different approach from what many others have taken in this regard. What we’ve seen in most of semis in the last couple quarters is pretty significant balance sheet inventory builds and a real restraint at shipping anything into the channel. And diode seems to have done, I don’t know if it’s exactly the opposite, but you’ve managed on balance sheet very conservatively, but you’ve built in the channel. Certainly I recall last quarter that was a change and I think this quarter sounds like you built a little bit again. I’m sure there’s a great reason for this approach, but I’m hoping you can explain it to us a little bit? Thank you.

[Emily Yang]

Yes, so I think, last quarter we mentioned the reason we start building more channel inventory is the expectation of the China recovery. Also the expectation of the 3C market segment recovery. I think we overestimated the recovery speed. So that’s actually what we start seeing channel inventory getting increased a little this quarter as well. That’s also the reason we strategically decided to really deplete some of the channel inventory in the second quarter. We still believe the channel inventory position overall for Diodes is actually in a very good position. We do actually have the good product on the shelf, and we also believe the recovery is going to happen. It just matter the speed. So once the recovery happens we are confident that the channel inventory will be depleted. And also keep in mind the market still really dynamic. We believe having the right product on the shelf, it actually position us better to support the dynamic demand as well as the fast term business, right?

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Yes. But in additional, what Emily talking about, we actually intentionally to doing that, right? And I think one of the reason I look at it, okay, if we want to maintain our operation very smoothly, because if you are way under loaded your cost, your gross margin going to be get hit quite a bit. But if you build it and then build another inventory, internal inventory, then again your cost, inventory cost is a deal too. And therefore, a best way is building consistently. You don’t get the revenue up down so much. You get your manufacturing smoothly, produce intentionally the number, and you get your gross margin. What, okay? Because you don’t want to be the other people, you don’t want to be spent spend so much some overtime and you don’t want have depreciation eating your gross margin. Therefore, we carefully manage the operation.

That’s why I keep to same operation accidents our execution, because that way we have a very smooth margin or very smooth revenue don’t get up and down so much at the same time, we are able to maintain our gross margin, the four quarter above 41% and even this quarter we guide freight manufacturing, but we still have the regular gross margin. Okay? So this is really an accident of operational control to make the output the door in very smoothly, such that you had the best cost reduction of balance, the cost from the manufacturing our cost to the inventory cost. You’ll try to balance that cost to get the best gross margin and we continue to do that.

[William Stein, Truist Securities]

Yes. Both of those were very helpful in clarifying. I appreciate it. If I could follow up with one, I think there’ve been a few questions about this. I just want to make sure I understand what’s going on. Historically, I think we’ve sort of been trained to think about two major drivers of the margin improve – well maybe three drivers of the margin improvement. Operational excellence, I’ll acknowledge is one of them. But I think the two that we’ve been more focused on is end market mix shifting more towards industrial automotive and then product mix, which is a lot harder for us to measure, but we know that you’re leaning into more unique, specialized higher end, however you want to describe it, products and less in what Emily calls deep commodity.

It sounds like on this call what you’re trying to communicate is that the end market mix will matter less going forward, because operational excellence continues and there’s more room to go and perhaps the product mix is maybe a bigger driver. Am I over interpreting what you’re saying? Or…

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

Yes. Yes, you are over interpreting, I’m trying to explain is the last four quarters plus the second quarter this year guidance you can see go through, up and down in the revenue, but we are able to maintain very steady and even a record of the gross margin. And so that is coming from product mix and operational excellence is coming both. So when the revenue go down, we are maintained. That is probably product mix give us, okay. But when we have the better, this is going up and like we say now, okay, assume when 3C start going up, we are able to continue maintain or improve then it coming from operation.

And so I think what we want to do is, focus on how to continue improve the gross margin regardless of the market up and down. And we proof we can do that due to start we already know the first two quarter of that year, this is good, very good. Then second half of that year we can start to slow down. Even this year, first quarter and second quarter, this is slow down, but we are able to continue maintain the gross margin, even setting a real new record. It tell us that’s the right thing for us to do and that’s what we are doing.

[William Stein, Truist Securities]

Thank you.

[Operator]

Thank you. And ladies and gentlemen, with that we’ll be concluding today’s question-and-answer session. I’d like to turn the floor back over to Dr. Lu for any closing remarks.

[Keh-Shew Lu, Chairman, President and Chief Executive Officer]

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

[Operator]

Ladies and gentlemen. With that, we’ll conclude today’s conference call. We thank you for joining today’s call and presentation. Please have a great evening.