Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Diodes, Inc. (NASDAQ:DIOD)

Q3 2008 Earnings Call Transcript

November 6, 2008 11:00 am ET

Executives

Leanne Sievers – IR, Shelton Group

Keh-Shew Lu – President and CEO

Carl Wertz – CFO, Secretary and Treasurer

Mark King – SVP, Sales and Marketing

Richard White – SVP, Finance

Analysts

John Vinh – Collins Stewart

Steven Smigie – Raymond James

Shawn Harrison – Longbow Research

Vijay Rakesh – ThinkEquity

Kevin Rottinghaus – Cleveland Research

Christopher Longiaru – Sidoti

Leanne Sievers

Good morning and welcome to Diodes third quarter 2008 earnings conference call. I'm Leanne Sievers, Executive Vice President of Shelton Group, Diodes' Investor Relations firm.

With us today are Diodes President and CEO, Dr. Keh-Shew Lu, Chief Financial Officer, Carl Wertz, Senior Vice President of Sales and Marketing, Mark King, and Senior Vice President of Finance, Richard White.

Before I turn the call over to Dr. Lu, I would like to remind our listeners that management's prepared remarks contain forward-looking statements which are subject to risks and uncertainties and management may make additional forward-looking statement 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.

In addition, any projections as to the Company's future performance represent management's estimates as of today, November 6, 2008. Diodes assumes no obligation to update these projections in the future as market conditions may or may not change.

Additionally, in the Company's press release and during this teleconference, management will discuss certain measures and information in GAAP and non-GAAP terms. A reconciliation of GAAP to non-GAAP results is provided in the financial tables following the text of the press release.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 60 days in the Investor Relation section of Diodes Web site at www.diodes.com.

I now will turn the call over to Diodes President and CEO, Dr. Keh-Shew Lu, who will be joining us today from Taiwan. Dr. Lu, please go ahead.

Keh-Shew Lu

Thank you, Leanne. Welcome everyone, and thank you for joining us today. In June, we closed the Zetex acquisition. The results released today include our preliminary purchase accounting for the acquisition.

I'm pleased to report another quarter of record revenue is reached. We achieved $134 million in total sales representing growth of 27% over the previous year and 15.5% sequentially.

Additionally, our GAAP earnings per share was a loss of $0.07 when excluding the $0.34 per share in non-cash purchase price accounting adjustments related to the acquisition of Zetex and $0.02 per share of stock option expense. Our adjusted non-GAAP earnings per share in the third quarter were $0.29. The integration of Zetex remain on track and has been progressing well throughout the quarter.

We continue to capitalize on the cross-selling opportunities, and as a result, in process design activity is the hardest it has ever been for the Company. However, as everyone knows, the current macroeconomic environment has made it very challenging for most businesses. We expect market uncertainty to continue with a decrease in global demand, in particular, in the consumer and computer market in Asia as well as general market softness in the United States and Europe.

As a result of current and future expectations for overall economy, we have identified a number of opportunities to optimize our cost structure across the operation. At the top of those efforts, we have been conducting a comprehensive review of our manufacturing operations to further identify additional expense reductions. Those initiatives include a shutdown of Zetex 4-inch wafer fab in Oldham by the end of this year and the consolidation of wafer output to the 6-inch line in Oldham and the 5 and the 6-inch line at the Diodes FabTech, a reduction of our UK fab headcount by approximately 10% by the end of November, immediate reduction in headcount at FabTech in Kansas City of approximately 25%.

Additionally, we will be putting the Zetex products into our packaging facility in Shanghai in the original operators in order to reduce our dependency on several contractors. We believe the majority of this conversion will be completed by the end of first quarter of 2009. Also, as part of our manufacturing strategy, we will be closely evaluating our raw material costs in order to reduce overall consumption while protecting and maintaining our record performance.

Next, we have taken immediate action to reduce CapEx authorization to the minimum from our previous amount of 10% to 12% with the current plan of less than 5% of the revenue until such time that the market recovers and additional manufacturing capacity is needed.

Currently, our China facility are 80% to 85% loaded which would allow for first reporting of Zetex products in conjunction with reduced CapEx.

Lastly, we have implemented a hiring freeze except for critical positions and initiated a fortification for employees during the fourth quarter as well as the first quarter of next year. From our overall expense perspective, we will continue to carefully manage costs in order to protect cash.

Look forward, we expect a weakness and the uncertainty in economic to continue into the coming quarter. And therefore, we want to take the necessary steps to manage through those difficult times. From an overall business perspective, we remain focused on executing the strategy that has proven successful for Diodes over the years.

We are confident that our acquisition of Zetex will continue to add significant value to our business as we further capitalize on the cross-selling opportunities and diversification benefits that the transition offer our Company.

We continue to focus on design wins in order to add new revenue source in the future. Although the current economic creates a more challenging environment for business, I believe that over the long-term, Diodes is in a better position for growth than ever before and we are taking all the right steps to better position our Company for growth when the economics improve.

With that, I will turn the call over to Carl to discuss our third quarter financial results in more detail.

Carl Wertz

Thanks, Dr. Lu. Good morning, everyone. As a reminder, our third quarter financials include a full quarter results from our acquisition of Zetex compared to only one month of Zetex results in the second quarter and reflect our preliminary purchase price accounting adjustments.

Revenue for the third quarter was $134 million, representing an increase of 15.5% sequentially and 27.3% over the prior year period. The third quarter revenue set another all time record for the Company.

Gross profit for the third quarter of 2008 which included a $5.2 million one-time, non-cash inventory purchase price adjustment related to Zetex acquisition or $38.1 million or 28.4% of revenue. Excluding the purchase price adjustments, adjusted gross margin was 32.5% as compared to 34.1% last quarter and 32.4% in the prior year period. The margin is primarily due to lower capacity utilization of our manufacturing operations as a result of market conditions as well as an effort to reduce finished goods inventory.

Selling, general, and administrative expenses for the quarter were approximately $21 million or 15.6% of revenue which was comparable to the second quarter on a percent of revenue basis and slightly above our expected range of 15% to 15.5% due to lower revenue. Absolute dollar increases were primarily due to the addition of Zetex's operations. Included in third quarter, SG&A was $800,000 of non-cash, FAS 123R share based compensation.

Looking forward, and as Dr. Lu mentioned, we remain focused on managing costs in order to keep expenses in line with our revenue. Research and development investments in the quarter were $7.4 million or 5.5% of revenue within our expected range.

Under US GAAP, acquired intangibles must be revalued and amortized over a useful life and acquired in-process R&D must be expensed immediately. Therefore, amortization of acquisition related intangibles and purchased in-process research and development for this quarter was $1.6 million and $7.9 million, respectively. The $7.9 million is a one-time charge. Both of these expenses are non-cash purchase price adjustments related to Zetex acquisition.

Other expense amounted to approximately $2.4 million for the quarter, consisting of $1.8 million of interest income primarily related to our auction rate securities, offset by $3 million of interest expense, primarily related to our convertible bonds and our loan for Zetex. In addition, we had foreign currency losses of $1 million related to existing hedges on the pre-acquisition of Zetex books, primarily related to the strengthening of the U.S. dollar versus the British pound.

For taxes, excluding purchase price accounting adjustments, our effective income tax rate in the third quarter was approximately 15%, which was within our guidance range and is an approximation for the fourth quarter.

Net loss on a GAAP basis was $2.9 million or $0.07 per share. When reporting a net loss, EPS is calculated using basic shares of 41 million. For the fourth quarter, we expect the GAAP EPS to be reported using a fully diluted share count of approximately 43 million shares.

The $2.9 million GAAP loss included $14.8 million or $0.34 in net purchase price charges. The purchase price charges consisted of one-time $5.2 million non-cash inventory write-off to cost of goods sold, one-time $7.9 million non-cash write-off required in-process research and development, and included in the GAAP loss was $200,000 for acquisition related fixed asset depreciation expense, book to cost of goods sold and $1.6 million in amortization of acquisition related intangible assets.

Going forward, we expect to correlate purchase price charges would be approximately $150,000 to cost of goods sold and $1.2 million for acquired intangible assets. Excluding the acquisition charges, adjusted net income was $11.9 million or $0.27 per share. Net income adjusted for the purchase price accounting and excluding $600,000 in after-tax non-cash stock option expense was $12.5 million or $0.29 per share.

One important note, as we mentioned in our earnings release, Diodes intends to change its reporting policy regarding FAS 123R stock option expense. Beginning in the fourth quarter, we will include the expense in our non-GAAP results. It is also important to remind everyone that our current analyst consensus excludes this figure from our pro forma results and therefore it may not provide an accurate comparison in future quarters.

Cash flow from operations for the quarter was $13.5 million and $36.7 million year-to-date.

Turning to the balance sheet, at quarter-end, with $82.7 million in cash and $285 million in long-term investment, which represents the $320 million par value auction rate securities. I will speak about our auction rate securities position in a moment.

Our working capital at quarter-end were $201 million. Long-term debt including convertible bond and the loan related to Zetex acquisition was $400 million. In terms of auction rate securities, as we announced earlier this week we have entered into a settlement with UBS. The major terms of the agreement are as follows: First, at our option, UBS will repurchase our $320 million auction rate security portfolio at 100% of par value beginning June 30, 2010.

Second, we will be permitted to borrow up to 75% of the market value of our ARS portfolio. Currently, we have borrowed $165 million from UBS and this agreement will currently provide an additional $48 million available to the Company.

Thirdly, UBS will provide a no net cost loan to Diodes where our borrowing rate will equal the interest rate earned on our ARS portfolio. In addition, UBS will refund to Diodes approximately $800,000 which is the difference between the interest we have paid on our $165 million acquisition loan and interest rate earned on our ARS portfolio. This settlement is a significant development towards the resolution of the ARS situation. It provides Diodes with additional liquidity and access to this cash without creating additional cost to the Company.

Inventory at quarter-end was $99 million, which was $2.6 million decrease from the second quarter with inventory days at 94. Accounts receivable was $110 million. Accounts receivable days improved from 77 days to 75 days this quarter. Capital expenditures were $13.4 million for the quarter, primarily due to non-cancelable equipment purchase orders.

We will continue to closely manage our capital investments as a result of the current economic environment. As Dr. Lu mentioned, CapEx will continue to remain significantly below our 10% to 12% model, at an amount necessary to meet market and capacity demands. Year-to-date, CapEx was $39 million or 11% of revenue. Depreciation for the third quarter was $11 million and $27 million year-to-date.

Turning to our outlook, as we look to the fourth quarter 2008, we expect market uncertainty to cause revenue decline sequentially between 12% and 20%. We expect GAAP earnings per share to range between $0.07 and $0.13 which includes approximately $0.03 of purchase price accounting adjustment. As such non-GAAP earnings per share is expected to range between $0.10 and $0.16 which includes approximately $0.02 of stock option expenses as I mentioned earlier.

With that said, I will now turn the call over to Mark King, Senior Vice President, Sales and Marketing. Mark?

Mark King

Thanks, Carl, and good morning. As Dr. Lu mentioned, the integration of Zetex has been progressing well in particular from a sales perspective which includes all reps and distributors in North America and Europe. The new organization is trained and moving forward to capitalize on customer traction and cross-selling opportunities.

In Asia, the integration of the direct sales organization is complete and we expect the consolidation of the distributor network to be finalized in the first quarter of 2009.

Let me begin the discussion with a segment breakout of the consolidated businesses. Computing represented 31% of revenue, consumer 29%, industrial 21%, communication 15%, and automotive 4%. The addition of Zetex business has contributed to increased diversification in our market segments which we believe will provide added benefit to the Company over the long-term.

Now, turning to new products, new product revenue was 23% of sales during the quarter. Zetex has traditionally focused on products that tend to operate with longer design cycles, but also longer life cycles which has resulted in a traditionally lower percentage of new product sales than Diodes. We believe this is an area of synergy as we expect to provide greater exposure and more rapid expansion in these new product initiatives.

During the third quarter, we released 54 new products including 15 Analog, 14 MOSFETs, 11 SBR devices, and 6 Bipolar Transistors. The Bipolar Transistors were customer-specific in the areas of power supply, adaptor and voice-over-IP. These transistors are good examples how we have begun to use the Zetex industry leading bipolar technology in Diodes competitive and expanded range of packaging.

In terms of product introduction, we announced a family of 12 new USB power switches that protect USB ports while providing a cost-effective and small form fit package in a wide range of consumer and computing applications. As many of you know, the USB port has become the de facto method of connection between many products and is increasingly used as a convenient way to charge or power these devices. We are very excited about this new family of products and the customer interest is high. We have already sampled these products with five of our major customers within notebook and set top box.

Also in the quarter, we expanded our Zetex LED driver series with the introduction of three new miniature LED drivers offering improved accuracy and thermal performance. These new products bring a smaller footprint and energy savings to lighting applications and are designed for a broad range of automotive, architectural, and industrial lighting applications.

With an output currency accuracy better than 1%, these LED drivers provide highly accurate current matching at working voltages up to 60 volts and will support up to 15 LEDs. We have sampled three customers and have generated significant additional interest from new and existing customers in the quarter. The introduction of these products extends our position as a market leader in the high brightness LED driver space.

In regards to geographic breakout, Asia represented 71.5% of total revenues. We continued to achieve growth in Asia during the quarter, but it was less than what we normally experience at this time of year. Data communications, mobile phones, notebook, and DC fans drove modest revenue growth whereas panels and LCD TV showed a sharp drop in demand.

Design activity for the territory was at its strongest level with 155 wins at 70 customers in the quarter. That included 45 Analogs, 10 Hall, 100 Discrete including 35 MOSFETs, 20 SBR products. 24 of the wins in the quarter were for Zetex products. Design activity was centered around notebooks, LCD TV and panel, mobile phone, and power supply.

Distributor point of purchase was down in the quarter due to lower than expected point of sales and expectations for the fourth quarter. Distributor inventory decreased within the quarter.

Now turning to North America, sales represented 16% of the total revenue. We saw pressure in our industrial accounts due to slowdown in our housing market. Gains in set top box were offset by continued movement of manufacturing to Asia. Distributor point of purchase was up slightly while inventory remained flat. Business moving into the fourth quarter remains soft and the distributor channel is cautious about the market and continues to reduce inventory in response.

In total, we achieved 95 design wins in North America during the quarter at 34 customers, 12 of these Analog, 78 Discrete and 5 in SBR. In terms of wafer sales, we were off 5% in the quarter.

Sales in Europe accounted for 12.5% of revenue. Overall, revenue was down in the region due to greater than normal seasonal slowdowns in the industrial and automotive markets. Distributor point of purchase decreased in the quarter as they continue to reduce inventory due to concerns in the overall global economy. Therefore, distributor inventory decreased 5% in the quarter.

Our design win momentum in Europe continued to expand in the third quarter with 58 wins at 31 accounts including 37 Discrete, 19 Analog, and two Hall sensor wins. In terms of global design wins, it was an exceptional quarter with wins at 135 accounts globally.

In process design activity is at an all-time high. We see this as evidence of our expanded sales and FAE organizations as well as the synergies of the combined lines.

With the addition of our Zetex product portfolio, we have a significant number of products and the interest from the customer base is high. Activity for the quarter featured our recently released USB switch where we have specific interest in our key set top box and notebook customers.

Design wins and in process design activity was also highlighted by SBR with key wins in a broad range of applications including voice-over-IP, power supply, and display module, LED lighting products, and a multiple auto application, white goods, and emergency lighting, current monitors in automotive, DC-to-DC converter, and a money control application, and MOSFET momentum continued with 40 Socket wins in the quarter.

In summary, for the fourth quarter and near-term, we expect market weakness to continue. But, as the economy improves, we believe we are in a better position to grow our business than ever before. We have a high level of new products with strong interest from key accounts as well as a broad portfolio of products that provide increased opportunities for cross-selling and customer expansion.

Additionally, our recent design activity is at the highest level in the history of the Company with wins at more than 135 accounts globally. Our expanded distribution channels as well as global sales and field application teams have further strengthened our organization.

With the progress that we have made to-date integrating Zetex business, we see a strong indication of the success and value that the combined businesses can achieve over the long-term. Diodes strategy for growth has consistently proven successful over the years and we remain focused on execution while carefully managing costs and benefiting from operational and manufacturing efficiencies where available.

With that, I'll open the floor to questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Gentlemen, your first question will come from the line of John Vinh with Collins Stewart. Please proceed.

John Vinh – Collins Stewart

Hi, good morning. The first question is on OpEx. You guys obviously talked about a number of cost cutting initiatives going forward, but also stated that you will continue to invest in R&D in this difficult environment. Can you maybe comment about timing of some of these cost savings initiatives and the net impacts on OpEx going forward? How should we be thinking about OpEx going forward at this point?

Keh-Shew Lu

Well, from the OpEx point of view, we must focus on the manufacturing because we still want to maintain investment in R&D and so therefore we are cutting SG&A and manufacturing and like I mentioned, we are setting down 4-inch lines which will help us to improve the GPM and we reduced about 10% of the fab cost in Oldham and then we reduced about 25% of the workforce in Kansas City, FabTech, and all those will reduce SG&A at the same time improve the TPM. But, probably not Oldham quantity reflect in the fourth quarter because like I mentioned Oldham won't be done until end of the year and FabTech probably done today and therefore probably only affect half the quarter. So I think that's what we think and we will get the full benefit starting from 1Q next year.

John Vinh – Collins Stewart

So should we be thinking about OpEx over the next couple quarters being flat to slightly down then including G&A and R&D?

Keh-Shew Lu

I'm sorry, you said – it would be, yes, it will be – fourth quarter will be slightly down and then 1Q next year will be fully impact the benefit, or fully, they will get the benefit.

John Vinh – Collins Stewart

Right, okay. Next question I had is can you give us a little bit of color on the relative performance and outlook on the Zetex business relative to the core Diodes business? Was the Zetex business also impacted quite similarly relative to the core business?

Keh-Shew Lu

Yes, we both get impacted because Zetex is 50% or it will be more than 50% is still in consumer, in Asia markets, which get impacted and then in Europe, they're very strong in Europe, and Europe is actually going down quite much too especially their automotive business went down, so Zetex impacted just as well as our core business and therefore in the first quarter, we focus throughout 20% down. It's actually both business get impacted.

John Vinh – Collins Stewart

And then final question is on turns business, can you maybe talk about the turns business in the current quarter in terms of what you're seeing there? We're starting to hear that, that turns in general starting to get impacted quite heavily across the industry.

Keh-Shew Lu

On that I would probably turn that question to Mark King.

Mark King

Yes, I think that's one of the overall concerns. We see a lot of – going into the first part of October, the turns were remaining relatively stable although down from traditional levels, but towards the end of October we saw more impact on the overall turns and the key to us is also, we operate on point of purchase rather than point of sale so the impact of the distributors cutting back inventory has an effect on our overall turns ratio and pretty much they've clamped down, everybody is pretty much managing their inventory down to any level that they can get it to so that put a lot of pressure on the overall number.

John Vinh – Collins Stewart

Great. Okay, thank you very much.

Keh-Shew Lu

Thank you.

Operator

And gentlemen, your next question will come from the line of Steve Smigie with Raymond James. Please proceed.

Steven Smigie – Raymond James

Great. Thank you. Mark, I was hoping you could talk a little bit about maybe the difference in book-to-bill that you're seeing or the difference in the turns you're seeing in distributor versus OEM. I guess you guys even don't quantify but if you give some sense is it a pretty big difference with the distributors ordering a lot less in the OEMs?

Mark King

Yes, I think that predominantly our impact in last quarter was based on distributor point of purchase. We did have some product shifts into outside but I think OEM was pretty consistent in Q3 and I think it's showing consistency but at lower rates in Q4. Again, the OEM business is generally pretty forecasted and really isn't turns based, where the opposite is exactly is true on the distributor side. Clearly, the POP trend is worse than the POS trend. Okay. So we're seeing – basically it's not whether it's your product or – it's any product that they're trying to hold out, so, I think yes, the biggest impact is on the POP side from a turns perspective.

Steven Smigie – Raymond James

Okay. Could you guys talk a little bit about what gross margin might look like in Q4 percentage-wise?

Keh-Shew Lu

Well, it probably starting low due to the loading of the SKE and the loading of the FabTech and since we’ve taken cost reduction effort at the mid of the quarter, therefore, we probably won't get the full benefit of that cost reduction in the first quarter.

Steven Smigie – Raymond James

Okay. And then I was wondering if you could talk about who top customers are of Diodes is now that you've merged with two companies, five customers or so?

Mark King

Yes, I don't know if we really lay out exactly who our customers are. I think there was – I think that our top customers remain about the same. We have a couple of customers that we pretty much dominated, but we get some solid new revenue like, say, Samsung or so forth, and in the automotive industry, Diodes had a small position in a customer, say like Hella, where Zetex had a much bigger position. I would say that their business was less concentrated in large accounts at high levels, so, I don't think our top customer base really changed. Our numbers with Arrow improved significantly from a distributor side by picking up their numbers and our numbers at Future Electronics from a distributor standpoint became much larger, adding the two numbers together, if that helps.

Steven Smigie – Raymond James

Okay. And if I squeeze in one more, what will interest expense look like Q4 going into 2009 with the change in the UBS situation here? Thanks.

Keh-Shew Lu

Well, from the ARS – when we borrowed the money against our ARS from UBS, since the agreement, they are going to give us the same cost deposit into our ARS income. Therefore, that portion will be a washout and they're going to refund us $800,000 of the excess charge from June when we spend or borrowed money to the time when we sign the contract agreement and so they are going to refund us those costs. And so I think from the interest point of view, I don't have that in front of me because I'm calling from Taiwan. Rick, you may have that number?

Richard White

Yes, this is Rick White. Basically, the way it works is that, as Keh-Shew said, the interest on the ARS is going to offset the interest expense so basically you can take the $320 million of ARS portfolio and subtract the 165 and that will give you the interest income that we'll have going forward and then we'll have the interest expense – most of the interest expense we'll have will be on the convertible notes, similar to what we've had in the past.

Steven Smigie – Raymond James

Okay. Thank you.

Operator

Thank you. And your next question will come from the line of Shawn Harrison with Longbow Research. Please proceed.

Shawn Harrison – Longbow Research

Hi, it's Shawn Harrison of Longbow. Just a follow up to that last question, what is the interest rate you're earning right now on the combined cash and auction rate securities balance?

Richard White

Yes, in the third quarter, it was a little bit lower because of the impact of the maximum rate that we could earn on the ARSs. Going forward in the fourth quarter, we think that's going to be around 2.5%.

Shawn Harrison – Longbow Research

Okay, so second question –

Keh-Shew Lu

This probably washout with our convertible bonds, it's at 2.25%.

Shawn Harrison – Longbow Research

Yes, I know that, that's again looks like that. Getting back to the restructuring, I guess these cost cutting actions as restructuring question, if dollar sales amount in the March quarter were to stay stable with the December quarter, what would be the total dollar amount of savings that is potentially out there, both on a cost of goods sold basis as well as an operating expense basis from this list of initiatives that you've enacted?

Keh-Shew Lu

I even separate from the GPM portion and then from the SG&A, but I can combine together. (inaudible) probably will give us about $300,000 per quarter savings. And in Zetex, it probably will give us about $200,000 per quarter savings so you're looking at probably somewhere around $500,000 to $600,000 per quarter savings in 1Q.

Shawn Harrison – Longbow Research

From solely the headcount reductions?

Keh-Shew Lu

Yes, we do have the mandatory vacation in fourth quarter and 1Q and in the fourth quarter, it probably won't have all the savings effect in the fourth quarter.

Shawn Harrison – Longbow Research

Okay. And then just I guess unless I missed this, the savings from the 4-inch shutdown in Oldham? Is that included in that number or is that on top of that, say five –

Keh-Shew Lu

That's included to that number. You might save some either 50 – look, by setting down 4-inch line, the people, the operator will move from 4-inch line to 1 and 6-inch line, but some of the direct and indirect people will be cut off, but, so the people is already in the number I'm talking about. But then operation, yes, you might see when you cross that operation; you might save some air-conditioning, some utilities, okay? We are putting up the capacity with 6-inch so basically we invest the money in Zetex for their 6-inch line. I don't remember I mentioned that last quarter now we do authorize, put in some money over there for them to invest in this 6-inch line so they can move the product from 4-inch to 6-inch line, fully yield to [ph] 6-inch line space and then shut down 4-inch line.

Shawn Harrison – Longbow Research

Okay. And then just a follow up on the demand side, a two part question. (NYSE:A), this quarter, if you look at that, the revenue decline, how much of that is pricing dynamics weakening out there versus what you're seeing in terms of weaker volume? And then secondarily, as we look ahead to the March quarter, I know visibility is extremely opaque right now, but typically the March quarter is the weaker quarter for you both on pricing mix and volume. With the revenue pullback here in the December quarter, maybe what would be the expectation in terms of seasonality in the March quarter?

Keh-Shew Lu

Well, if you look at, even look at the so-called, our ASP really didn’t go down. Actually the mix is the one effect but not ASP. If you look at first quarter, ASP may have some effect, but the problem is not really to go down, it’s not really because ASP, it is the cost of usage. That's the reason. If you look at, we said our SKE is 80% to 85% loaded so its number of units actually deduced so the problem is not really coming from ASP. It's coming some, but not majority. The majority of the problem is our end customer just don't build it that many and come back [ph]. For example, LCD TV, they're talking about 30% cut, motherboard, they're talking about 20% cut. Those – it's number of units produced by our customers significantly went down.

Shawn Harrison – Longbow Research

Okay.

Keh-Shew Lu

Then you're talking about 1Q, if the 4Q went down we don’t have visibility, but I look at, we may not have the scenario any more, okay? And with our design win and with our Zetex cross-selling, we're hoping we're going to grow. Even the market is flat or not growing, we are going to account all this in the market share, introduce new product, get into the new customer, get new design, new design wins to help us to grow, grow next year.

Shawn Harrison – Longbow Research

Okay, and then a quick clarification before I hop off, how much is distribution now as a total percentage of sales with Zetex integrated?

Carl Wertz

Distribution is about 45% of our overall number.

Shawn Harrison – Longbow Research

Okay. Thank you very much.

Operator

Thank you. And your next question will come from the line of Vijay Rakesh with ThinkEquity. Please proceed.

Vijay Rakesh – ThinkEquity

Hi guys. Just looking at your guidance here, I guess October is pretty soft for everybody. Just wondering how November is looking. We're just a week into it, but can you give us some color on how November is tracking returns and orders?

Mark King

Yes, I would say that November, there hasn't been a significant change from October. Again, I think it's running at the second half of November rates which is pretty much showing very soft signs and limited turns business.

Vijay Rakesh – ThinkEquity

Got it. Okay. And I know you mentioned motherboard kind of down 20% is what you're seeing, LCD down 30%, just wondering how the channel inventories are. Demand has fallen off. People are cutting orders, but how is inventory in the channels?

Mark King

To be honest with you, our inventory in the channel, we think is clean. I mentioned that I think in Europe, we were down over 5% last quarter. Asian inventories were down; U.S. inventories were relatively flat, but at a very healthy level. So to be honest, I think our inventories are actually going to get lower than they need to be. Okay? And so the turns business should eventually come. I think our inventories are in very good position.

Keh-Shew Lu

That's why we think that 1Q may not have that cynical – sensual any more so bad they need to buy sometimes.

Mark King

The POS has held up better than POP.

Vijay Rakesh – ThinkEquity

Got it. Okay. I know you said your POS is better than POP, but any indication of what – obviously, there still seems to be some caution from the end market, meaning the POS guys so is that an indication of what is causing that?

Mark King

There is definitely a slowdown in overall industrial accounts and so forth, but I think that the POP might be slight over reaction to the POS change. In Asia, yes, the end equipments are quite dramatic in notebook and motherboard and – in all these channels, I don't think they're so dramatic in North America and Europe although Europe, the one area of pretty solid weakness is automotive. We have more exposure there now to the Zetex side and it seems that the automotive market is suffering quite badly; we've seen the most cutbacks in that area.

Vijay Rakesh – ThinkEquity

Got it. Okay. And last question, with shutting down the two, or cutting back on these two fabs in the UK and in Kansas City, let's say you get through most of the cuts through Q4 here, how much of capacity reduction does that amount to from let's say from the Q2 levels?

Keh-Shew Lu

You say how much capacity – ?

Vijay Rakesh – ThinkEquity

Yes.

Mark King

Reduction.

Vijay Rakesh – ThinkEquity

Capacity reduction, yes, between the 4-inch fab and the UK fab where you're –

Keh-Shew Lu

Well, UK is probably not really have that much of capacity reduced, because like I say, I authorize the 6-inch cap money about in June timeframe so they are building up the 6-inch to replace 4-inch, okay? And so what the reason we are able to cut those people is now you have one fab instead of two fabs. You don't need two, 4-inch and 6-inch, but at the end, after review of the 6-inch, that 6-inch capacity is less. At the same time we move the 4-inch capacity down. Some of them we move to Zetex, okay? So if you remember in my speech, we are not just moving that 4-inch line to 6-inch in Oldham. We actually moved some to Zetex too so after all this is done I think we make our equipment capacity is still there except for the main capacity so when the market turns we can hire the operator then the capacity will come back.

Vijay Rakesh – ThinkEquity

Right. I understand. What I'm trying to figure out is obviously your gross margins are a function of your fab loading or the absorption costs so I'm just trying to figure out how much of capacity is being aligned so when do we see margins start to turn? Is it – ?

Keh-Shew Lu

I think like I mentioned, our Kansas City – well, our SKE is about 80% to 85% loaded and our Kansas City 130, after all these cuts, we are probably somewhere short from 80% to probably 60%. If you look at in the past, I mentioned our fab always about 80% to 85% loaded and our SKE typically is almost 90% to 95%, 95% to 100% loaded and now the SKE dropped to about 80% to 85% and Kansas City dropped to about 60%, somewhere around that number.

Vijay Rakesh – ThinkEquity

Got it. Okay.

Carl Wertz

The key is to cut the variable costs as quickly as we can and then watch our capital expenditures and we're doing that very closely.

Vijay Rakesh – ThinkEquity

Got it. Thanks a lot.

Operator

(Operator instructions) Your next question comes from the line of Kevin Rottinghaus with Cleveland Research. Please proceed.

Kevin Rottinghaus – Cleveland Research

Thanks. Can you hear me, okay?

Keh-Shew Lu

Yes. Hi Kevin, how are you?

Kevin Rottinghaus – Cleveland Research

Good. How are you? How much of the Zetex is in-house now and just to clarify, I think you said you'd have it done by the end of 1Q. Is that right?

Keh-Shew Lu

Well, we start to move these type of comps from – probably start from just end of November we start to move because it takes time to do the qualification, to do the PCN, to notify customers, so we will start to ramp probably end of November and have the majority we can move in by the end of the first quarter. That is about probably talking about – it's not of them doing stuff [ph]. Zetex do have their own manufacturing side in Shendu in China and their packaging site in the east Germany, Neuhaus, and those we won't move and then we only move one we currently Sublicom and probably somewhere about, by probably 80% of Sublicom we probably move in to internal around in 1Q of next year.

Kevin Rottinghaus – Cleveland Research

Okay.

Keh-Shew Lu

It takes time to do the qualification and then after that we need to wait customer to approve it and then we need to digest all the inventory so it takes time but our hope is start from end of 1Q, majority of them will move inside.

Kevin Rottinghaus – Cleveland Research

Okay. So kind of follow up on the last question, the margin benefits from that would really be kind of more of a second half type opportunity?

Keh-Shew Lu

Yes, you could say that.

Kevin Rottinghaus – Cleveland Research

Okay. And as far as CapEx, the 13 or so million that you spent this quarter, with you ratcheting it down, is it safe to assume that you've done the CapEx necessary to move those products in-house or is there going to be a ramp up in 1Q?

Keh-Shew Lu

No, the $13 million we spent this quarter, like I said, some of them is for the Oldham 6-inch line and some of them we put in the FabTech to rev up 6-inch line, for the 4-inch constraints [ph] of Oldham. Those I don't want to cut it because I think those are good strategies, it's long term, you don't want to – it takes a long time to transfer the wafer fab, transfer the packaging is much easier. Transfer the wafer fab takes a long time and the right strategy is really to shut down the 4-inch and move from 4-inch to 6-inch and therefore, I spend the money that quarter in Oldham for 6-inch line and I spend some capital for 6-inch line for the bipolar junction which we want to transfer from Oldham to Zetex. Now we do spend some in the SKE. Those will be '09 now that typical spending is about three months or four months later, will be '09.

Mark King

But Kevin, we do have everything we need to bring all the subcontract business into SKE without additional CapEx in Q1.

Keh-Shew Lu

That's right, that's right, that's right. The money we spent in the third quarter is we pay for those.

Kevin Rottinghaus – Cleveland Research

Okay, on the pricing side, you talked about ASP still kind of hanging in there. Why do you think that is? Why do you think it hasn't gotten more price aggressive and have you seen any competitors kind of come back into this market at this point or – ?

Keh-Shew Lu

Mark, do you want to take care of this?

Mark King

Yes, I think that obviously we live in an environment that price competitiveness is a normal part of our lives so we experience quite a bit of ASP pressure quarter in and quarter out. I think the difference from previous times is there hasn't been so much excess capacity built up over the period so I think that people are a lot more careful with their price going forward. Obviously, we'll have more and more price pressure if this is an extended downturn, but we're looking at it. It's just important for us to focus on our mix and our new products and so forth and we should be able to maintain our ASP. Overall, the Zetex product line will increase our ASPs over time because they run at a higher ASP level than we do but – so I think we should see relatively normal price erosion.

Kevin Rottinghaus – Cleveland Research

You're talking for 4Q and –?

Mark King

Yes, 4Q should be pretty consistent with 3Q and then the overall market conditions will drive how much pressure we have. Obviously, if there is a, if everything stays flat I think we should see relative normality going into Q, into next year.

Kevin Rottinghaus – Cleveland Research

Okay, and then last one for me. Mark, I thought in your opening dialogue you said inventory went up in Asia?

Mark King

No, distribution inventory went down in Asia.

Kevin Rottinghaus – Cleveland Research

In Asia.

Mark King

And will go down again in this quarter.

Kevin Rottinghaus – Cleveland Research

Okay, any idea how much? I mean, you said in Europe I think it went down 5%. Any idea how much it went down in Asia and how much you think goes down this quarter?

Mark King

I don't have that in front of me, but I can get that for you.

Kevin Rottinghaus – Cleveland Research

Okay. Thank you very much.

Operator

And gentlemen, your next question will come from the line of Christopher Longiaru with Sidoti. Please proceed.

Christopher Longiaru – Sidoti

Hi, gentlemen.

Keh-Shew Lu

Hi, Christopher.

Christopher Longiaru – Sidoti

My first question – most of my questions have been answered. One thing – this is more for Carl and Rick. Basically, I'm looking at the convertible bond rule changing in 2009. I wanted to know what kind of an impact that should have on you guys. I mean, as long as we're talking about moving our interest expectations, I was wondering if you had any guidance on that?

Keh-Shew Lu

Rick?

Richard White

Yes, okay, so we're going to put in the queue that we think the APB 14 impact is going to be $2.8 million for next year, about $700,000 a quarter which is about a penny, penny and a half, something like that.

Christopher Longiaru – Sidoti

Okay, alright, so essentially without the $700,000, you're looking at interest expense being flat because of the arrangement that you made but then there should be about $700,000 outflow per quarter?

Richard White

Yes, the numbers I gave you previously did not have any APB 14.

Christopher Longiaru – Sidoti

Got it.

Richard White

And it's going to be 700 divided by 43 million shares, 44 million shares so it's somewhere between –

Keh-Shew Lu

Almost $0.02.

Richard White

Yes, penny and a half, $0.02.

Christopher Longiaru – Sidoti

Alright. That's all I have for now. Thanks, guys.

Operator

And at this time that concludes the question-and-answer session. I would now like to turn the conference back over to Dr. Keh-Shew Lu for the closing comments.

Keh-Shew Lu

Well, thank you for your participation today. I know fourth quarter going to be a tough quarter for us but I think future point of view, we believe it is going to be very strong for us and we appreciate your time and consideration. Operator, you may now disconnect it.

Operator

Thank you sir. Ladies and gentlemen, this now concludes today's presentation. You may now disconnect. Have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Diodes, Inc. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts