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Diodes, Inc. (NASDAQ:DIOD)

Q4 2008 Earnings Call

February 09, 2009 11:00 am ET

Executives

Leanne Sievers - IR, Shelton Group

Keh-Shew Lu - President and CEO

Mark King - SVP, Sales and Marketing

Carl Wertz - CFO

Analysts

John Vinh - Collins Stewart

Shawn Harrison - Longbow Research

Kevin Rottinghaus - Cleveland Research

Steven Shein - UBS

Tristan Gerra - Robert Baird

Harsh Kumar - Morgan Keegan

Steven Smigie - Raymond James

Operator

Good morning and welcome to Diodes Incorporated Fourth Quarter and Fiscal 2008 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, Monday, February 09, 2009. I would now like to turn the call to Leanne Sievers of Shelton Group, the Investor Relations agency for Diodes Incorporated.

Leanne Sievers

Welcome to Diodes fourth quarter and fiscal 2008 earnings conference call. I am 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, February 9, 2009. 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 conference call management will discuss certain measures and financial 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 earnings 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 website at www.diodes.com.

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

Keh-Shew Lu

Thank you, Leanne, welcome everyone and thank you for joining us today. As everyone knows there are very challenging time for economy and [adequately] for the semiconductor industry. Nevertheless we end 2008 with record revenue of $433 million an 8% increase over 2007.

For the fourth quarter revenue was $87 million which include $1.7 million reduction as a part of Diodes strategic effort to consolidate our Asia distributors.

Our net income basis for the quarter we achieved GAAP earning of $0.35 per share. Which exceeded our previous guidance, excluding the $22.8 million gains related to the repurchase of convertible notes. And $0.1 million of restructuring charge related to future headcount reductions. Our diluted EPS in the fourth quarter was $0.04.

The restructuring charges were higher than original projected due to one-time charge for additional trended headcount reductions, which I will discuss in greater detail in a minute.

In response to the declined demand resulting from the continued weakness in the economy, we took imminent actions to make incremental change to the operation structure in order to maximize efficiency, reduced cost and conserved cash.

We have reduced our authorization on capital expenditures at the beginning of the fourth quarter 2008. However, due to prior equipment purchase and commitments CapEx will be reduced to less than half of last year's run rate in the first quarter and to a maintenance level in the second quarter.

We also initiate effort to significantly reduce inventory, which will further reduce loading at our manufacturing facilities. Also, during the quarter, we took advantage of 'no net cost loan obtained through our settlement with UBS and repurchased $46.5 million of our convertible senior notes for $23.2 million in cash, which reduced our convertible debts to $183.5 million.

As a result of those actions, we reduced tax by $11.2 million over the third quarter and generated $21 million of net cash flow during the quarter. As I discussed with you last quarter, we implemented a number of cost saving initiatives that beginning in the first quarter and has since executed additional initiative due to the continued weakness in the economy. Those additional initiatives improve our reduction of CapEx authorization. As I mentioned previously, we saw current trend of less than 2% of the revenue, until such time that the market recovers and additional manufacturing capacity is needed.

Accelerating the integrated of the Zetex products into our packaging facility in Shanghai in order to reduce our dependence on several contractors, and the important (inaudible) our internal capacity. We believe the majority of those integration, we have completed by the end of the first quarter with two manufacturing ramp one quarter (inaudible).

A shutdown of our Zetex 4-inch wafer fab in Oldham, UK and the consolidation of wafer output to the 6-inch line in Oldham as well as the 5-inch and the 6-inch lines at Diodes FabTech. Additionally, temporary site shut downs were implemented at Diodes FabTech and in China during both the first quarter last year and the first quarter this year.

Decreasing manufacturing process and raw material cost by reducing overall consumption while protecting and maintaining product quality and performance.

In the fourth quarter, we implemented our whole hiring freeze and strict cost control over discretionary spending including mandatory time-off, reduction of bonuses and the canceling of 41K for official impairments.

Including in 2009, (inaudible) freeze selling at the current labels, suspend bonuses and the other discretionary payments and to continue the hiring freeze and mandatory time-off until the market improves.

In terms of headcount reductions, which we have excluded primarily out our manufacturing operations. In the fourth quarter, we reduced our workforce by approximately 230 people or 7% of our worldwide employees. During the first quarter of 2009, we will be reducing staff by an additional 17% or about 500 employees.

Productively, those reductions represent a 26% decrease of direct and indirect [waiver] in China, 30% at the FabTech, 10% in Taiwan, and it's 13% in Europe. [During], our worldwide Chengdu to above 2,560 employees by the end of first quarter of 2009.

Once all of the cost reduction initiatives that has been announced, since the third quarter of 2008 are fully implemented on top of the manufacturing cost reductions, we estimated quarterly run rate for operating expenses to range between $21 million and $23 million, which represents a reduction of approximately 20% from the third quarter variable of $28 million.

Looking at the first quarter of 2009, we expect that the economy and global demand will continue to deteriorate well beyond the typical seasonality associated with the quarter. We will continue to carefully monitor the market conditions and take decisive actions as needed to sustain cash flow. Most importantly as a result of our recent and (inaudible), we expect to achieve positive cash flow for operations and positive free cash flow in the first quarter.

With that I would turn the call over to Carl to discuss our fourth quarter financial results in more detail.

Carl Wertz

Thanks, Dr. Lu. Good morning, everyone. As Dr. Lu mentioned revenue was a record $432.8 million for the year and increase of 8%. For the fourth quarter, revenue was $87.1 million. Quarterly revenue declined both sequentially and over the prior year period due to the continued deterioration of the global economic environment and related overall decrease in demand. We previously mentioned fourth quarter revenue was reduced by approximately $1.7 million as part of our strategic effort to consolidate our distributors in Asia.

Gross profit for the fourth quarter 2008 was $22.9 million or 26.3% of revenue compared to $38.1 million, the 28.4% in the third quarter. Decrease in gross margin was primarily due to lower capacity utilization and our packaging and manufacture facilities as a result of weaker global demand.

We expect the gross margin will continue to be under pressure as a direct result of decrease in gold demand and lower capacity utilization.

We have historically operated our packaging facilities near full capacity but the fourth quarter was closer to 75% utilized. Our packaging technology and capabilities have always been a strength of Diodes and have contributed to our solid margin performance in the past but this under utilization has a severe impact on our gross margin.

Selling, general, and administrative expenses for the quarter were approximately $16.2 million or 18.6% of revenue compared to $21 million or 15.6% of revenue last quarter. Approximately half of the $4.7 million decrease in SG&A is related to our recent cost reduction initiatives.

Included in fourth quarter SG&A was $729,000 of non-cash FAS 123R share based compensation.

Looking forward, as Dr. Lu mentioned, we will remain focused on reducing cost in order to keep expenses aligned with our revenue.

Research and development investments in the fourth quarter were $6.4 million or 7.4% of revenue compared to $7.4 million or 5.5% of revenue last quarter. Other income amounted to $19.1 million for the quarter consisting of $22.8 million gain from our convertible notes repurchased and $2.2 million of interest income primarily from our auction rate securities, partially offset by $4 million in foreign exchange losses related to foreign currency contracts they were part of the Zetex acquisition and $1.9 million of interest expense primarily related to our convertible notes and our loan for the purchase of Zetex.

Beginning in 2009 the adoption of APB 14-1 requires us to change how we account for our convertible senior notes. APB 14-1 will require us to separately account for liability and equity component and will reflect an estimated non-convertible borrowing rate of 8.5%.

Therefore we expect to record an additional pre-tax, non-cash interest expense of approximately $8 million to $9 million for 2009.

Turning to income taxes, we recorded a $2 million income tax credit related to Zetex purchase price accounting adjustments of our fourth quarter.

Looking into 2009, we expect the affected tax rate to in the mid teens.

Net income on a GAAP basis was $14.6 million or $0.35 per share which included the $22.8 million gain of convertible notes repurchased and $4.1 restructuring charge related to future headcount reductions.

Shares used to calculate GAAP EPS were approximately 41.8 million fully diluted shares.

Net income compared to our non-GAAP basis was $1.7 million or $0.04 per share and excluding the gain on convertible notes repurchased, restructuring chares and $1.1 million of Zetex purchase price accounting. We mentioned last quarter. Non-GAAP net income now includes approximately $0.1 of FAS 123R net stock option expense in the quarter. For the year 123R expense was approximately $0.7.

Cash full from operations for the quarter was $21 million and $57 million for the year. EBITDA for the quarter was $25.8 million and $90.4 million for 2008.

Looking to the balance sheet, at year end we had a $103.5 million in cash, which was an increase of almost $21 million over the third quarter.

Long-term investments were $320.6 million which represents the fair market value of our auction rate securities including the put option as part of the UBS settlement.

Our working capital at year end was $210 million. Long-term debt including the loan related to Zetex acquisition and the convertible notes which we will redeem in October 2011 was $401 million.

Turning to the auction rate securities, during the quarter we announced that we had entered into a settlement with UBS. Further agreement UBS provides us the right to sell our $320 million auction rate security portfolio to UBS at a 100% par value beginning June 30, 2010.

We're also permitted to borrow up to $213 million under a no-net cost loan to Diodes which our borrowing rate equals the interest rate earned in our auction rate portfolio. We'll utilize this credit facility.

Now turning to inventory, at the end of the fourth quarter inventory was $99 million which was essentially flat compared with the third quarter with inventory days at a 139.

As Dr. Lu mentioned, we're working to reduce inventory further.

Accounts receivable was $75 million at 95 days in the fourth quarter capital expenditures were $12.1 million for the quarter which was previously authorized and committed to expenditures.

For the year, CapEx was $53.2 million or 12% of revenue. As Dr. Lu mentioned CapEx will reduce significantly below our 10% to 12% historical model with maintenance goal of goal of less than 2% of revenue in order to better align our expenditures with marketing capacity demands.

In addition to our inventory reduction efforts these initiatives will contribute to a positive free cash flow in the first quarter of 2009.

Depreciation and amortization expense for the quarter was $12 million and $49.5 million for the full year.

Turning to the outlook, looking at 2009 as we have discussed we expected the economy and the global demand will continue to deteriorate and as a result we estimate first quarter revenue will decrease approximately 20% sequentially.

Revenue at this level utilizes approximately 50% to 60% of our manufacturing capacity. We plan to significantly lower our inventory and we will reduce our manufacturing loading by an additional 10% causing our capacity utilization in the first quarter range between 40% and 50% resulting in a gross margin for the quarter to be approximately 16% to 20%.

When combining our cost savings initiatives, lower inventory and capital expenditure reductions, we expect to generate positive cash flow from operations and positive free cash flow in the first quarter.

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

Mark King

Thank you, Carl and good morning. As Dr. Lu and Carl mentioned, the fourth quarter was a challenging quarter across all market segments for Diodes. Although Zetex has improved the diversification of our business, we are still heavily weighted in the consumer and computing market, which represents approximately 60% of our business. Demand in these segments has decreased significantly in recent quarters, but the same can be said for the automotive and industrial segments as well.

In terms of detailed segment breakout, computing represented 31% of revenue, consumer 30%, industrial 20%, communication 15% and automotive 4%. In addition to the expense reductions that Dr. Lu highlighted, we remained focused on maintaining our market share position. We continue to design Diodes products while attracting new costumer with our expanded product line. We believe these are necessary steps to return Diodes to growth when the economy improves.

As I mentioned last quarter, we have integrated the Zetex sales organization and distributors outside of some remaining distributor consolidation in Asia and have been working closely with the combined customer bases.

Additionally, all targeted product conversion to Diodes internal factories should be completed by the end of the first quarter with four manufacturing ramp one quarter later. We also continue to focus on new product development in order to drive additional design win and future revenue opportunities.

Although customer buying patterns are soft at this time, the activity and design is very high. Let me begin with an overview of our global sales in the fourth quarter. We were down approximately 35% led by decrease in wafer sales of 56%, and a 40% decrease in global point of purchase as distributors took a very conservative stance on inventory.

In comparison point of sales were down 23%. The reduction in POP is much higher than POS, which is forcing channel inventory down. The positive point that can be taken from theses numbers is that as long as POS doesn't continue to decline POP will began to stabilize.

In terms of OEM sales which represented 58% of our business in the fourth quarter, sales were down 32% with the largest decrease in Asia and the lowest in Europe. Overall, lower global markets remain uncertain and recovery cannot be predicted at this time.

In regards to specific geographic breakout, Asia represented 73% of total revenues. We saw the greatest decline in demand for panels, mobile phones, notebooks, LCD TVs and the trend is expected to continue into the first quarter of 2009 at rates that are beyond typical seasonality.

Distributor POP it was off significantly as distributors tried to reduce inventory as quickly as possible. Distributor inventory reduced 8% in the quarter and we expected to decrease further in the first quarter.

In North America sales represented 16% of total revenue, where we continue to see pressure in our industrial accounts due to the slowdown in the housing market for applications such as climate control and security system. Distributor point of sales was soft across all market segments. The decline in OEM sales can be attributed to set-top box and audio in particular. Distributor inventory declined 7% as the distributor channel continued to reduce inventory in response to market conditions.

Sales in Europe accounted for 12% of revenues. Revenue declines came primarily from OEM sales within the automotive and consumer segment. Distributor point of purchase decreased significantly in the quarter as they continue to reduce inventory due to concerns surrounding the overall global economy. Distributor inventory decreased 15% in the quarter.

Now turning to new products, new product revenue was 23.5% of sales in the fourth quarter. We release 75 new products consisting of 22 analog, 4 Hall devices and 49 discretes which including 29 transistors, 11 MOSFETs, 7 SBR devices and 4 customer arrays.

The significant number of new transistor devices serves as a good example of how we continue to leverage Zetex technology with Diodes packaging to expand our standard product line.

During the quarter, we announced a first device in a series of high efficiencies synchronous DC-to-DC converters specifically targeting consumer electronics. These buck and boost converters are targeted for the portable market with maximum switching frequencies of 1.2 megahertz and 2.2 megahertz respectively.

With 94% efficiency, these converters extend the battery life and portable applications. Currently, we have sampled the product with five customers in Asia and one in the US and are targeting 13 additional customers.

Also during the quarter, we introduced the first and the news family synchronous controllers optimized for external power adopters, servers, LCD monitors and set-top boxes. This innovative device enables designers to replace Schottky diodes with surface-mount MOSFETs which improves efficiency reduce device temperature and provide the option to reduce the size and the weight of the overall power supply solution.

On the Hall sensor side, we introduced the AH5792 single chip solution for driving low power single coil brushless DC fans and motors for low-voltage, micro motors and ultra-thin cooling fan applications.

This product integrate the Hall sensor, amplifier and a full bridge output driver, providing a complete digital control solution. We are currently sampling three customers. Additionally, in the fourth quarter, Diodes released our new [SBR Intelsat] platform. This new technology platform enables the design, the development and the manufacturing of standard or self-protected MOSFET with a voltage rating upto 200 volts.

First product (inaudible) leads as a part of the ZXMS6000 series is the world's smallest self-protected MOSFET. This is monolithic 60 volt self-protected [batt] that has secured its first design win in an automotive lighting application, just four weeks after its debut.

Production volumes are expected to shift to this customer, starting in the second quarter of 2009. Furthermore, this product is being evaluated by three major European automotive electronic manufacturers for using future platforms.

In terms of global design wins, despite this soft economy, in process design activity remains high. And design wins were strong in the quarter with wins at a 110 accounts globally including 77 wins at 50 accounts in Asia, 72 wins at 37 customers in North America, and 54 wins at 22 accounts in Europe. We continue to gain significant traction with our USB power switch series and end equipment such as server, notebook, LCD monitors, printers, cable modems and set-top boxes.

We had two significant design wins with large key customers and achieved our first production orders during the fourth quarter. We also had a solid quarter with our Omnipolar Hall Center with wins on our new 0.4 millimeter thick AH1802 on a key notebook platform with a popular computer manufacturer as well as a win with one of the largest smartphone manufacturers.

In addition, we secured design wins and two new mobile phone models for our AH1888. Additional highlights on design wins and in-process design activity include two additional smartphone wins for our doable threshold MOSFET and a proprietary [low-bit set] dual transistor, a reference design on a key mobile phone chipset for our proprietary current monitor. Five wins for our PowerDI, SBR device, three in a notebook releases, one for solar panel application and one for a new thin notebook power supply. And wins on lighting products in street lighting and LED projectors, MOSFETs and printer, Voice-over-IP, set-top boxes as well as significant standard linear win in set-top box, cable modem and LCD monitors.

In summary, for the near-term and the first quarter of 2009 we expect the market weakness and the decline in demand to continue. We are monitoring the market conditions closely in order to take the appropriate actions to reduce cost and maintain positive cash flow. We also remain focused on the long-term growth of the company through new product development expanding our position with customers and securing a high level of design wins at key accounts. We believe this is the best strategy for the company at this time and our confidence in our ability to merge a stronger company with expanded growth opportunities as the market recovers.

With that I will open floor to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of John Vinh with Collins Stewart. Please proceed, sir.

John Vinh - Collins Stewart

Yes. Can you remind us again what percent of your OpEx is contributed by the tax. And then if you look at your const cutting initiatives, if I heard you right its sounds like you are pretty much going to be looking at OpEx flattish in Q1. How should we be thinking about OpEx at the rest of the year?

Carl Wertz

Give us second on that, John. We have the data. Yes, I think we mentioned on the total expenses, basically, being in the $21 million to $23 million for the first quarter and it's probably a good assumption they will be flattish in the second. And again I think from the total operating expense side that gives us around 28% to 30% may be close to the 30 with R&D in there.

Mark King

No, that's operations including R&D.

Carl Wertz

Yeah.

John Vinh - Collins Stewart

Okay. And then if things continue to worsen are there other cost cutting measures do you think you can take at this point or is this kind of the levels that we should be thinking about for '09?

Keh-Shew Lu

This is Dr. Lu. We do continue to take in the cost reduction effort depend on market. And like I previously announced we are working on the dues, the headcount in the UK and thus during the process, it will not be 100% deflected until end of February.

Okay, and than at the same time we are cutting down the headcount in China manufacturing and the key people reduction would be in January during the Chinese New Year. So typically, we know we have attrition people do not come back to work after Chinese New Year. We know that and we bring in those number, therefore our major people reduction from our manufacturing SKE will be happen majority would be happened in February. So those will not be refract to 100% in the first quarter. Okay, so basically we announced different action to refract market situation, if the market continually deteriorate then we will take even more cost reduction effort.

For example, we have mandatory, people take off fourth quarter in US, fourth quarter is seven day, and first quarter is seven day. We did not announce the second quarter yet and if the market recover, we do not need, if the market are going worse then we will come down another fourth occasion. And the same thing we are working in UK right now. We do not have a agreement yet. We are negotiating with union but the there is another effort of the cost reduction. So we on the global operation, we look at different area then try to take action differently.

But due to different country requirement, different government requirement, you can not take action immediately. Sometimes you need to go through negotiation, sometime you need to go through consulate and all this. So, we will continue to take action depend on the market.

John Vinh - Collins Stewart

Got it, thank you and can you give us a sense of where you think your cash flow or EPS per given levels on a revenue basis is currently?

Keh-Shew Lu

Well the cash flow breakeven for us is not difficult. I will give you some number that you can feel out yourself, okay. Our depreciation and amortization cost is above the $11 million and $12 million a quarter, okay, that is I think today, you can see was talking above $12 million in 4Q and above almost $49.5 million in the whole year. So our depreciation and amortization is above $12 million a quarter. Okay and stuff on next quarter APB 14-1 will cause us about $2 million which is not cash related, it’s just accounting related. And then you remember we've pushed it's price in adjustment that’s above $1.3 million a quarter, then we have stock option is above $2.5 million a quarter. So if I add all those together our non-cash portion is really above $17 million to $18 million, $12 million on depreciation, $2 million is APB 14-1, $4 million purchase – $1.3 million is purchase price, $2.5 million is stock option.

So somewhere around $17 million and $18 million a quarter of not really cash. So if I had to cut cash flow operation, we can add those numbers back in. Therefore to make a positive cash flow is not that challenging for us; we should be able to do it. And top of that since we have been putting in 12% of our revenue into our capital expenditure and with now load is going down we really do not need that capacity anymore and so we announced we will cut into kind of capital authorization into maintenance available only which is above probably 2%.

So we do not have that much of capital requirement, therefore our free cash flow will be almost equal to our cash flow from operations.

Okay now which ever the case, and that’s quite I am trying to do all the cost reduction effort you probably see today we announced we cancelled this credit line, we quite cancelled it because it costs us a lot of money to maintain that credit line. We really do not need the cash we are I mean we have enough cash flow from operation and free cash flow and even last quarter we generated $20 million of cash and therefore we go ahead, cancel that 22.5 of credit line since we generate $20 million last quarter, we go and cancel it, and now save us the money too.

The money whichever put in the bank, the interest rate is very, very low, but to maintain at credit line, our cost is high and the interest is high too. Therefore the best ones is we got generate $20 million cash, we just go ahead better utilize the cash we have now in hand. I hope that answers your question.

John Vinh - Collins Stewart

Yes, thank you. And my last question is on kind of inventory levels, channel inventories, can you give us a sense of what you are seeing in terms of inventory levels in some of your key markets, consumer, computing and we talked about automotive a little bit. And then obviously maybe still too early to call, but are we at a point where you think you will start to get more replenishment orders Q2 and are you expecting Q2 levels revenues to be higher than Q1 levels at this point?

Keh-Shew Lu

Okay, yeah. Let me answer your question, your several question there. First, I believe our customer their inventory level probably is right and some of them might be cut a little bit too short, because recently we do get some rush order from here layer, so we do and it is different from before, okay? Before, customer always tell us we don't want it, we have enough inventory, but recently right after or right before the Chinese New Year, and here after Chinese New Year, we address some rush order come in, so we believe some of the imbalance of the inventory, do exist in some of our customer and that’s why we get those.

And the market, well, they tell me I need to put these terms. Okay, they're cautiously optimistic. You can tell market is one tell me I use to say that. Okay we are thinking, we don't know yet, we have no visibility in the second quarter. We don't see that, but I assume that their feeling is cautiously optimistic. Did I answer your question?

John Vinh - Collins Stewart

Yeah. Thank you very much.

Operator

Your next question comes from the line of Shawn Harrison with Longbow Research. Please proceed, sir.

Shawn Harrison - Longbow Research

Hi, good morning. I wonder, focusing on the demand side. I am sorry, maybe if I missed this. But if we could talk about the pricing experience, both in the fourth quarter as well as here in the first quarter to-date?

And then secondarily, I know January is a tough data point to use. But if we were to just string along January here, where would we end up in terms of that 20% down guidance rate for the quarter? Would we be within kind of that range, or do you need to see an uptake in demand in quarter end to make that number?

Keh-Shew Lu

Shawn, this is a Dr. Lu Keh. I think from ASP point of view, we really don't see any particularly different from seasonality of the ASP, because, very simple. The customer, they know they have no demand. And typically when they don't have the demand, they cannot come to say cut their price. Especially when they come to say, if I want to cut the price, first thing we are going to ask him. Okay, can you give me double the revenue and the answer is no. Then, why do you change the prices.

So, everybody probably know that, so anyway we don't see major difference from our old patterns, okay? And turning on product mix, we would be changing the ASP, but not much of change from the pricing pressure point of view. And generally, we don't separate but, I can only answer you, we meet our original plan in January.

Shawn Harrison - Longbow Research

Okay, but the guidance here, probably, encapsulates that mix versus plans?

Carl Wertz

Yeah, definitely. We've got the pricing erosion built in to the guidance.

Keh-Shew Lu

Yeah. Every thing is also I'm saying the pricing erosion is put in the guidance and our January is within our guidance.

Shawn Harrison - Longbow Research

Okay. Just maybe another way to ask about the pricing, I guess, if we start to see an environment of distribution restocking or your customers beginning to restock, would you anticipate then maybe a little bit more pricing pressure there?

Mark King

Yeah. I don't think the pricing for first quarter has been totally established yet. In the fourth quarter, we had only about 2% erosion, which was actually very typical. And I think, there is pressure on price, but we always experience a lot of price pressure in Q1. So we expect a greater than normal, compared to other quarters in this quarter, but still the verdict on that is still down there.

Keh-Shew Lu

And that's a seniority anyway in the season. So, as I said, we don't see a particularly out stake on the pricing this is seasonality, 1Q typically going down a little bit, unless it's going to surprise us.

Shawn Harrison - Longbow Research

Okay. And then maybe getting into some greater detail on the cost savings as well as just kind of margins. It looks like the majority of the headcount savings that will be announced here the February timeframe will more benefit kind of fixed costs versus I guess in terms of the [cost] line instead of operating expenses given that your current kind of already within that $21 million to $23 million windows. Is that a correct statement?

Keh-Shew Lu

Yes. Well, I don’t call fixed cost, the cost saving have two, it fell into two category, one is operation nine with R&D and SG&A and I think we have already gave you the guidance of $21 million to $23 million down from 28, but 100% will reflect in the second quarter. In the first quarter it won't 100 reflect. Now the other category is from the labor and the overhead in the [making] function. In the [making] function that will reflect into GPM9 and I think we give the guidance what's the guidance we will give to them.

Carl Wertz

About 16% to 20%

Keh-Shew Lu

16% to 20%, okay. Now 16% to 20% in 1Q is particularly bad because like I mentioned or Carl mentioned we want to cut the inventory to inline with the (inaudible) level therefore, even SKE is under loaded we actually take even further down and to reflect the Chinese New Year and the people cut or this one, so we actually under load additional 10%. So, I think Carl was talking about our first quarter is about 75% loaded, our first quarter we saw inventory effort probably somewhere 50% to 60%.

Okay, and inventory actions try to reduce our finished good inventory than we take additional 10% down. And that will give us small cash from the finished goods at the same time try to get the capacity more aligned than start from second quarter that inventory deduction will be disappeared.

Shawn Harrison - Longbow Research

Okay and maybe as a follow-up to that quickly. My back of the envelope math suggest Carl, that maybe without the inventory pressures you can do something like a 21% gross margin, 22% in the March quarter. Is that a correct statement and then the other question is why maybe the 4 point range in terms of gross margin for the quarter?

Carl Wertz

There's still a lot of ifs out there and that 15% to 20% was our best estimate at the time. And of course, yes, we might be able to do better than the 20%.

Keh-Shew Lu

Well, let me answer this one. Number one, like I said, the fixed cost for our [making] function SKE is there. And this will reduce the people, that number of units in our (inaudible) will give you the profit. So, if we particularly reduce 10% of the capacity the loadings that will reflect quite a bit of the cost. At the same time like I mentioned, our people action will not really come out because for China you cannot just tell them to go home. Okay, there were certain regulations you need to go through. So even we start to take action our first quarter, you cannot really get the people gone until February. Someone will then leave in first quarter, but majority will leave in some in January but majority will be in February. And therefore, when we said 18% to 20%, that particularly is, we do not really detract all the people action until second quarter.

Shawn Harrison - Longbow Research

Okay.

Keh-Shew Lu

And like I said 10% reduction on the [volume] is another significant low 4.2.

Shawn Harrison - Longbow Research

Okay.

Keh-Shew Lu

So we should be able to back to maybe higher number then 16 to 18 in second quarter. Assume the loading back to normal run rate. Even I assume no revenue increase, then by not reduced the inventory you have already additional 10% loading and at the same time the people reaction will be give you additional profit. So, that’s (inaudible) more.

Carl Wertz

That’s part of our cautiously optimistic statements.

Shawn Harrison - Longbow Research

Got you, thank you very much for answering the questions.

Keh-Shew Lu

Okay, thank you.

Operator

Your next question comes from the line of Kevin Rottinghaus with Cleveland Research. Please precede, Sir.

Kevin Rottinghaus - Cleveland Research

Thanks. Do have a goal for where you want inventory to go inside this quarter?

Keh-Shew Lu

Can you repeat the question, Kevin?

Kevin Rottinghaus - Cleveland Research

Can you give a goal for where you want inventory to go inside this quarter?

Keh-Shew Lu

Well our goal is $10 million reduction.

Kevin Rottinghaus - Cleveland Research

Okay.

Keh-Shew Lu

From the first quarter.

Kevin Rottinghaus - Cleveland Research

Okay.

Keh-Shew Lu

And that’s why we cut (inaudible) and that’s you can [carry] a cash flow from there too.

Kevin Rottinghaus - Cleveland Research

Okay.

Keh-Shew Lu

Yeah

Kevin Rottinghaus - Cleveland Research

If you hit that number and you do not have to introduce utilization charges in 2Q what should that do to gross margins?

Keh-Shew Lu

Well I do not have the number it’s only my second quarter so I do not have that number. It should be above $20 million.

Kevin Rottinghaus - Cleveland Research

Why?

Keh-Shew Lu

It should be above $20 million, if that too what Shawn was talking about. Okay so like I say, well our $0.20 in percent EPS reason 1Q is down because we cut the inventory, okay.

Kevin Rottinghaus - Cleveland Research

Okay, the bookings that you have seen kind of pick-up for rush orders when did that start, can you give us any kind of color, what end market that is?

Keh-Shew Lu

I think it started from the, before the Christmas, before the Chinese New Year and I think some of our customers started to get ready for Chinese New Year when it come back and they know most of the manufacturers shut down in Chinese New Year. So they can't kind of say hey my inventory is a little bit too loud too risky and I might need to get some rush order. And then right after Chinese New Year when they really do come back to work they start to see sooner or later they might have need to have stock purchases. So it is right around the Chinese New Year before and after.

Kevin Rottinghaus - Cleveland Research

Okay then where your best perspective business is just restarting inventories is not a reflection of demand?

Keh-Shew Lu

Right, yeah I used the word so I opportunistically, occasionally or by mistake.

Kevin Rottinghaus - Cleveland Research

Okay but Carl, I don’t know if you gave a number from where depreciation will be for 2009?

Keh-Shew Lu

Depreciation for 2009?

Carl Wertz

Yeah it's going to be pretty close to our $12 million a quarter now.

Keh-Shew Lu

Depreciation for us.

Carl Wertz

Because we are pretty much freeze in the CapEx except for maintenance. So and we will have some depreciation falling off.

Kevin Rottinghaus - Cleveland Research

Well it sounded like you had shut down a number of lines as to no February savings from those going away?

Keh-Shew Lu

We shutting down is for the Oldham, 4-inch but there really shut it's just the people actions. We are not really shutting the many, when we say shutting down we are not really take it off the manufacturing floor, except 4-inch line in Oldham, UK due to the Zetex acquisition that is the only one we actually shut it down and then move off the equipment. The rest of it we just scale down due to the demand is more men.

Kevin Rottinghaus - Cleveland Research

Okay, thank you very much.

Keh-Shew Lu

Okay.

Carl Wertz

Thank you.

Operator

Your next question comes from the line of [Steven Shein] with UBS. Please proceed, sir.

Steven Shein - UBS

Thank you. My first question is on cost reductions, you have given that pricing as you mentioned was roughly between 9 in Q4 and part of Diodes pricing pressure to increase in Q1 what is the ability of your manufacturing level to continue maintaining prior levels of cost reductions given the different kinds of loadings and also reduction of CapEx to be in trouble?

Keh-Shew Lu

Okay Steve, there's a different side I can give you and even more detail. Okay from the point of view, I said our people action is, I think in the beginning of February I missed our member we are none, we shutdown said that and we reduce 30% of people.

Okay, and then from there our continued cost reduction would be by effectively shut down we are no longer reduce the people because, we look at it and then we just do the point shut down.

Okay, now if we need it we will continue the pressure that where misses, you don’t walk in, all the time, we just shut down one week or months or some of you just temporary pressure down, one of couple week a quarter something like that. And then you talked while SKE, SKE we still walk in on people reduction okay we do have some people reduce in 4Q but the majority our people reduction will be in January, and majority will be in February.

So that will be people reduction there will in addition to that we will look at the demand and then plan on shutdown. We probably will shut down one week in March if the demand in company, since the visibility is so bad you really only can do as pray by year and then to do that hiring a people is a difficult pressure down so much easier to implement.

So we plan to have pressure down now go to second quarter if the market demand come back and then we will pray with that now measure to then UK, we are working on 4Q, we announced that 4-inch shutdown, and that is completed we shut it down. Then we reduced some people, it was completed too, but then we have additional people actions which majority be down probably by end of February. It is day-to-day different, all of them will be done by end of February.

Then we negotiate with union labor, they don't call fortification, therefore they call I don't know they have a different terminology. Different country have different terminology. Okay? Like Germany, we always implement this short working week. Okay, so Germany, we all implement short working week. And UK, we are working with negotiate with the labor, union and the people and the management about and necessity to reduced their cost, their pay.

Steven Shein - UBS

Okay. Thanks for that additional color, Dr. Lu. The other question I also have was related to manufacturing, so I guess to best that you can quantify this given the many moving peaces right now. What type of impact or effect will you see on your gross margins from the migration of the Zetex products to the Shanghai packaging operations, I guess this would more of a quarter, beyond the Q1 timeframe once the full ramp is initiated again?

Keh-Shew Lu

Yes. The action, we are doing the qualification. Actually, we already finished the qualification. But, we are waiting for customer approval and now since this demand is not very strong, you are really very careful to force the customer to change it, all right?

And so I can here we said or stopped to convert it by end of during the January, but in small portion and then we said ramp it up by end of second quarter. And so we are hoping by staff on third quarter whatever we can convert into SKE or convert it. But it really depends on the market, the customer approval.

If you go to the standard general market, if you don't admit that your problem, and we're hoping that would be during the 1Q, and especially during the 2Q. But we are hoping, we give enough time to our major customer and then we can convert staff on 3Q. So it takes time especially when the time is tough, we are very careful to asking customer to a change.

Steven Shein - UBS

Okay. Thank you.

Operator

Your next question comes from the line of Tristan Gerra with Robert Baird. Please proceed sir.

Tristan Gerra - Robert Baird

Hi. Good morning.

Keh-Shew Lu

Good morning.

Tristan Gerra - Robert Baird

With the understanding that you don't have a much visibility at all, when would you expect that the month-over-month revenue run rate to pick up? If we look at the normal seasonality in semiconductor in Q2, typically there is only a recover in June? Any sense that you could actually see a month-over-month improvement in revenues earlier than that or would you expect normal seasonality in the next few months?

Keh-Shew Lu

I think I let Mark King to answer this one.

Mark King

I think we expect and hope, and more traditionally, we would start to see some increase in March, okay? I think February is still, although I am sure, I think we need another probably a week coming out of the Chinese New Year to understand what February is going look. We hope to start to see some improvements going forward in March and hopefully end of the year.

Tristan Gerra - Robert Baird

Okay. And finally what's the current impact on operating expenses from Zetex if you can breakdown versus the overall number?

Keh-Shew Lu

Well, I don't know, do we separate Zetex that much or not. The reason is the Zetex operation when we start to put it into SKE it was very difficult to separate Zetex versus Diodes anymore, because they are coming from. Most of the operation is in the manufacturing.

Wafer cost is not, that's weakened, okay? So after we putting into SKE, it can be very difficult to say how much they are going through a burden or hell. One thing we know for sure is, they will pursue help for loading SKE. And after we move in you will have.

So, I do not separate into how much burden they are going to give to us, or how many. We are now just a running at a one company. Our sales guy is consolidated in all three regions now US is actually consolidated. And therefore, we probably start a very difficult to see the visibility of their gross margin effect to our gross margin.

Tristan Gerra - Robert Baird

Okay, great. Thank you.

Operator

Your next question comes from the line of Harsh Kumar with Morgan Keegan. Please proceed sir.

Harsh Kumar - Morgan Keegan

I have got couple of questions. I know this is a tough question to ask and answer, but, could you give us maybe in weeks or months a given current level of demand where it is, how much excess inventory there is in your opinion and your channels and either the consumer computing space.

Keh-Shew Lu

Well let me answer some and then Mark King can answer some. I think we only give the guidance on 1Q and we only say January, it's above because we announced it today, therefore, you can see January is above in our plan. And February, Chinese New Year and we already put in that in ours and so, only one week that from Chinese New Year. So, it's very difficult to talking about February. Okay, so all I can say is January meet our plan, February probably will and that's all. And we get 20% down from 4Q and I think we are not that far away from our plans.

When we see it today, now one month better we don't now, but at least today we see the number we don't. And that's the number we see. Now I think you particularly asked in different market segment, I think market.

Mark King

Actually, I thought you had mentioned the channel inventory, we see after channel inventory in Asia as part of our plan to come down further in this quarter. And probably well the same thing will happen in North America and Europe. They are little bit more turns based so we are not sure exactly how they are going to go at this point. I think the customers are in actually pretty good shape. I think so much of our business is combined and just in time and so far that’s, I think that various reductions would be in the channel and I think the channel is starting to get more aligned.

Harsh Kumar - Morgan Keegan

Yeah. I will agree with that Mark. That’s what we are hearing too. And somebody previously asked about or you had mentioned Dr. Lu about spot orders. Let me turn it around and ask you, are you still seeing cancellations in your business or those are pretty much gone away?

Mark King

I don’t think we ever really saw a rush of cancellation. We have seen a little bit of distributor action was there, shortening there. Their stock windows and which is caused some cancellation in the first quarter, but I think it's pretty isolated. It’s been more order flow rather than mass cancellation over the last two quarters. We did see a little bit in Q1 as one of our key distributors made some adjustments in their ordering pattern and then that ordering began the next day. So, I don’t think that mass cancellations, its really more order entry that’s been controlled.

Harsh Kumar - Morgan Keegan

Got it. That’s very helpful and maybe you guys gave this but and I missed it, but could you give me the turns that I needed for the 20% down quarter in March?

Mark King

I don’t think we have that figure right in front of us. We always run a strong turns number and it does require returns but within our normal turns ratios that we established in the fourth quarter. Not our normal what I want adjusted turns ratio that we adjusted, that we established in Q4?

Harsh Kumar - Morgan Keegan

Got it. And just my last question I mean I saw the Oldham fab you are shutting it down. You guys have done a great job taking expenses out of Zetex and in the market the environment is the environment is there lot of room Dr. Lu or Mark or Carl left still in Zetex that you could take out in some of the costs?

Keh-Shew Lu

I think we took it, the way we're going down but like I say Germany we have taken some of the costs down by shutting [Munich] working with the company, with union and with the government and we're doing that and the same thing. It just need to slow down, yeah, this Oldham with not just Zetex. I don’t want to deep of view we've had target at Zetex, no actually we've taken the action globally like a FabTech 30% down, US orders if you go through my presentation, we've all kinds of different cost reductions and actually Zetex is slowly because they have more negotiation need to be done and so we took the action but slowly.

Harsh Kumar - Morgan Keegan

Got it very helpful thanks guys.

Keh-Shew Lu

Thank you.

Operator

Your next question comes from the line of Steven Smigie with Raymond James. Please proceed, sir.

Steven Smigie - Raymond James

Great thank you. Just a follow-up on the question that was asked a little bit earlier on what your depreciation was like in 2009, I feel you have been cutting or in the process of cutting back your CapEx how long does that typically take before those actions flow through on the depreciation lines, you said it seems may be you have '09 level but it maybe third quarter or something. Do you see that depreciation expense drop quite a bit. You are taking a pretty substantial cut in CapEx there. So would I expect your cogs to have some positive impact on that and second question is how long it takes those cuts to go through?

Keh-Shew Lu

Okay number one, we are amongst the capital cut in beginning of December of 4Q, beginning of 4Q. So if you look at our CapEx in 4Q, we actually did not go down, okay. It's up $16 million or something, I forget the number $12 million.

Carl Wertz

$12 million.

Keh-Shew Lu

$12 million.

Carl Wertz

But we use a five year life on our liquidity, so that's straight line is not by units produced. You are right, I think by the end of '09, if we do not have lot of CapEx then you will see a little bit improvement in margin for the depreciation line. And that is a significant part of our building material loan from China.

Steven Smigie - Raymond James

That’s correct.

Keh-Shew Lu

Steve does that answer to your question.

Steven Smigie - Raymond James

Yeah, I’m just trying to get a sense on recovery, I mean you are cutting CapEx, even when you start it up at the end of or the start of 2010 or something like that, you will still be seeing the benefit of that for sometime. Taking quite a bit of people out of manufacturing as well just it seems on recovery, you have a coming next quarter, may be you have the pop up from the inventory reductions and then you have the CapEx benefits and the headcount coming down. So just trying to look at what the trajectory and recovery is going to be assuming sort of a normalized revenue environment and did you get gross margins above previous levels in a normalized environment given all the actions you are taking.

Carl Wertz

You know Steve we have been geared up to run full capacity for years and that's we have been adding 10%, 12% every year in capital. And now they are running in the 50% that definitely is huge detriment on our gross margin line as indicated by the 16% to 20% expectation for first quarter. But as we control that now Dr. Lu has consolidated CapEx authorization expenditures. Mark Howard to give a improved mix and he has always worked to build that factory. So there is whole, that the second half will get back in to more of a normalized swing anyway direction at least.

Steven Smigie - Raymond James

All right, I was talking much further after up until '09. But in anyway also on the follow-up Dr. Lu, you always indicated at least relative to some of smaller competitors you have had a margin advantage. So as the environment gotten tougher here, again, what impact do you have relative to those smaller competitors, are they forced out of business at this point, and do you have any specific competitors advantage in this environment?

Keh-Shew Lu

The answer is now. I did not really pay attention to analysis our small competitor but with the crunch, some of them may not able to have enough money to maintain. So at least virtually we are able to have positive cash flow and free cash flow, even the business go down, we don't worry.

So number one, we do have the scale. Number two, we do have the cost efficiency. Number three, I think we take action earlier and quicker than everybody. And well, I won't say that everybody, but we do take action much quicker. And so if you look at it, we are able to even in 1Q at that kind of revenue and even we can still can maintain positive cash flow and free cash flow. And we believe, next quarter even the after that we don't see any reason to change it.

Therefore we will be pretty strong from cash flow point of view from and very strong, therefore if our small competitor running through the cash problem, then it's opportunity for us to pick up the business. So, I don't pay attention to anonymous who are going to be out of business, but I do know I am okay.

Steven Smigie - Raymond James

Okay. Thanks and final question is, appreciate the operating expense guidance. It's a very helpful. I assume obviously that includes the stock option expense in it, correct?

Carl Wertz

Correct.

Steven Smigie - Raymond James

Okay, great. Thank you very much.

Carl Wertz

Okay.

Operator

Ladies and gentlemen, due to time, this concludes the question-and-answer session. I would now like to turn the call back over Dr. Lu for closing remarks.

Keh-Shew Lu

Well, thank you everybody for join us today for the call. And the time is very bad, but as I mention cautiously optimistic of the future especially, I think our focus for the next couple of quarter going to be continue our cost reduction effort, continue our design win effort, continue our new Florida introduction effort.

Those are all effort we are going to focus on and we are hoping when the market turn with our strong cash flow position, we should be able to grow compare to our growth again the market share price growth. We are already positioned our sale for that. Well, thank you very much for you join us. Operator, you may now disconnect.

Operator

Thank you for joining today's conference. That concludes the presentation. You may now disconnect and have a wonderful day.

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Source: Diodes, Inc., Q4 2008 Earnings Call Transcript
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