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Diodes Incorporated (NASDAQ:DIOD)

Q2 2013 Earnings Conference Call

August 7, 2013 5:00 PM ET

Executives

Leanne Sievers – Executive Vice President, Investor Relations

Keh-Shew Lu – President and Chief Executive Officer

Richard D. White – Chief Financial Officer, Secretary and Treasurer

Mark A. King – Senior Vice President, Sales and Marketing

Analysts

J. Steven Smigie – Raymond James

Gary Mobley – The Benchmark Company

Christopher Longiaru – Sidoti & Company, LLC

Tristan Gerra – Robert W. Baird & Co. Inc.

Vijay Rakesh – Sterne, Agee & Leach

Vernon Essi – Needham & Company

Harsh Kumar – Stephens, Inc.

Suji De Silva – Topeka Capital Markets

Shawn Harrison – Longbow

Operator

Good afternoon, and welcome to Diodes Incorporated Second Quarter 2013 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, Wednesday, August 7, 2013.

I would now like to turn the call over to Leanne Sievers of Shelton Group Investor Relations. Leanne, please go ahead.

Leanne v

Good afternoon and welcome to Diodes Second Quarter 2013 Financial Results 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, Rick White; Senior Vice President of Sales and Marketing, Mark King; and Director of Investor Relations, Laura Mehrl.

Before I turn the call over to Dr. Lu, I’d 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 statements in response to your questions.

Therefore, the company claims the protection of the Safe Harbor for forward-looking statements that is contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from those discussed today, and therefore, we refer you to a more detailed discussion of the risks and uncertainties in the company’s filings with the Securities and Exchange Commission.

In addition, any projections as to the Company’s future performance represent management’s estimate as of today, August 7, 2013. Diodes assumes no obligation to update these projections in the future, as market conditions may or may not change.

Additionally, the Company’s press release and management statements during this conference call will include discussions of certain measures and financial information in GAAP and non-GAAP terms. Included in the Company’s press release are definitions and reconciliations of GAAP to non-GAAP items, which provide additional details. Also, throughout the Company’s press release and management’s statements during this conference call, we refer to net income attributable to common stockholders as GAAP net income.

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

And now, I’ll 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. Our second quarter was highlighted by the achievement of record revenue in the continued gross margin improvement. Revenue grew 21% sequentially and 35% year-over-year due to our past design win momentum and the new product initiatives, combined with our first full quarter of BCD Semiconductor.

We achieved a sequential growth despite the slowdown at a certain major OEM customers, and the continued weakness in the PC market. With the addition of BCD, we have further broadened our product portfolio and increased our market share, especially in aerospace.

Also during the quarter our non-GAAP gross margin improved to 13.3%, the 320 basis points sequential improvement was primarily due to a more favorable product mix lower gold prices, copper wire conversion, as well as our cost reduction efforts. Furthermore, the integration of BCD has been progressing well as we move ahead of schedule in transferring BCD products into our Shanghai packaging facilities. We now expect to complete the transition by the end of the first quarter.

In addition to our continued revenue growth and the gross improvement, our cost controls are helping to move operating expenses toward our target model of 20% on a non-GAAP basis. As a result of those collective factors, we reported solid earnings growth and generated strong cash flow in the quarter.

In summary, I’m pleased with achievement we have met across our businesses from both a sales and operational perspective. We expect to further capitalize on our acquisition of BCD and to deliver additional improvement in the third quarter and so we continue to successfully execute on our business model.

With that, I will now turn the call over to Rick to discuss our second quarter financial results as well as third quarter guidance in more detail.

Richard D. White

Thanks Dr. Lu and good afternoon everyone. Revenues for the second quarter 2013 was $214.4 million an increase $177 million in the first quarter and an increase of 34.6% from the $139.2 million in the second quarter of 2012. The sequential increase in revenue was due to the first full quarter of revenue contribution from BCD compared to only one month in the prior quarter as well as continued design win momentum and market share gains. GAAP gross profit for the second quarter 2013 was $61.3 million or 28.6% of revenues.

As previously disclosed, our GAAP gross profit included $3.7 million of an inventory valuation adjustments related to our BCD acquisition, excluding this amount non-GAAP adjusted gross profit was $64.9 million or 30.3% of revenue compared to non-GAAP gross profit of $48 million or 27.1% in the first quarter 2013. And GAAP gross profit of $41 million or 25.8% of revenue in the second quarter 2012, the 320 basis points sequential improvement was due to a more favorable product mix, lower gold prices, copper wire conversion, and a continued benefit of our cost reduction efforts.

GAAP operating expenses for the second quarter were $51.1 million or 23.8% of revenues which included approximately $2.3 million of amortization of acquisition intangibles, $1.5 million of restructuring expenses and $1.1 million of acquisition related retention accruals compared to $42.4 million or 24% of revenue in the first quarter 2013 and $32.7 million or 20.6% of revenues in the second quarter 2012.

Excluding amortization of acquisition intangibles restructuring expenses and acquisition related retention accruals, operating expenses on a non-GAAP basis for the second quarter 2013 were $46.2 million or 21.5% of revenue compared to $39.6 million or 22.4% of revenue in the first quarter of 2013 and $32.7 million or 20.6% of revenue in the second quarter of 2012. The increase in operating expenses reflects the first four quarters of BCD.

Looking specifically at selling, general and administrative expenses for the second quarter, GAAP SG&A was approximately $35.1 million or 16.4% of revenue compared to $30.4 million or 17.2% of revenue in the first quarter of 2013 and $24.8 million or 15.5% of revenue in the second quarter of 2012. Non-GAAP SG&A was $34.2 million or 16% of revenue compared to $29.5 million or 16.7% of revenue in the first quarter and $24.8 million or 15.5% of revenue in the second quarter 2012.

Investment and research and development for the second quarter was approximately $12.1 million or 5.6% of revenue on a GAAP basis and $12 million or 5.6% of revenue on a non-GAAP basis. This compares to first quarter of 2013 R&D expense of $10.1 million or 5.7% of revenue and $8.2 million or 5.2% of revenue in the prior year quarter. Total other income amounted to $277,000 for the second quarter.

Looking at interest income and expense, we had approximately $1.2 million of net interest expense, which is more than offset by currency gains, mainly in China. Income before taxes and non-controlling interest in the second quarter was $10.5 million on a GAAP basis and $19.1 million on a non-GAAP basis, which excludes the above mentioned acquisition adjustments and other items. This compares to GAAP income of $4.3 million in first quarter of 2013 and $8.6 million in the second quarter of 2012.

Turning to income taxes for the second quarter, our tax rate was 14% including a discrete book-to-tax provision adjustment. For the third quarter, we expect our estimated effective tax rate to range between 18% and 24%. The increase from our previous guidance is due to the amount and the movement of profit between various taxing jurisdictions with different tax rates.

GAAP net income for the second quarter was $8.6 million or $0.18 per diluted share, compared to a GAAP net loss of $1.9 million or negative $0.4 per share in the first quarter and GAAP net income of $6.7 million or $0.14 per diluted share in the prior year quarter.

Second quarter, non-GAAP adjusted net income was $15.5 million or $0.33 per diluted share, which excluded net of tax, $4 million of items related to the BCD acquisition, $1.8 million of non-cash acquisition related intangible asset amortization costs and $1.3 million of restructuring costs.

The fully diluted share count used to compute GAAP and non-GAAP earnings per share for the second quarter was 47.5 million shares. We have included in our earnings release, a reconciliation of GAAP net income to non-GAAP adjusted net income which provides additional details. Included in second quarter GAAP and non-GAAP adjusted net income was approximately $2.1 million net of tax of non-cash share based compensation expense.

Excluding the share based expenses both GAAP and non-GAAP adjusted diluted EPS would have improved by $0.05 per share. Cash flow generated from operations was $29.8 million and free cash flow was $22 million for the second quarter. Net cash flow was a positive $13.3 million for the second quarter.

Turning to the balance sheet; at the end of the second quarter, we had approximately $214 million of cash and cash equivalents. Working capital was approximately $467 million. At the end of the second quarter, inventory was approximately $187 million compared to $182 million of last quarter including BCD.

Inventory days were 110 in the second quarter compared to 115 days last quarter. Inventory in the quarter reflects its $7.2 million increased in finished goods and a $2.1 million increased in raw material due to the additional BCD and a $4.7 million decrease in working process. At the end of the second quarter, accounts receivable was approximately $182 million and AR days were $75 million compared to $82 million last quarter.

Capital expenditures for the second quarter were $8.1 million or 3.8% of revenue including $2.9 million of BCD this compares to 4.3% of revenue in the first quarter excluding the expansion of our Shanghai Sales and Design Center. We expect capital expenditures to range of $25 million and 9% of revenues for the remainder of 2013 which includes BCD and Chengdu. Depreciation and expenses for the second quarter was $18.9 million.

Now turning to our outlook, for the third quarter of 2013, we expect revenue between $220 million and $230 million or up 3% to 7% sequentially. We expect GAAP gross profit margin to be 30.3%, plus or minus 2%. As a remainder the non-GAAP purchase price accounting adjustments in cost of good sold we are completed in the second quarter. Included in the third quarter gross margin guidance is the impact of a disruption and manufacturing operations and one of our Shanghai wafer fabs due to an incident in our landlord’s power station that caused a power outage to the fab.

The power outage occurred on July 26 causing some work-in-progress inventory to be scrapped and approximately one-half month of output to be lost. Power has now been restored to the manufacturing operations. GAAP operating expenses are expected to be 22.5% of revenue, plus or minus 1%.

Non-GAAP operating expenses, excluding amortization of intangible expenses and acquisition-related employee retention accruals, are expected to be 21% of revenue, plus or minus 1%. We expect our income tax rate to range between 18% and 24%, and shares used to calculate GAAP earnings per share for the third quarter are anticipated to be approximately $48.3 million. For more detail on the outlook, please see our press release.

With that said, I will now turn the call over to Mark King.

Mark A. King

Thank you, Rick, and good afternoon. Second revenue was up 21% sequentially at record levels driven by strength in Asia as resulted design win-win momentum and share gains including three months of BCD.

North America and Europe combined were up slightly after a very strong first quarter. We continue to increase share as well as new design win revenue at Asian smartphone manufacturers while LED TV also showed strength. The growth in both of these markets offset continued softness in Q3. Generally speaking in industrial and automotive sectors remain relatively consistent in both North America and Europe.

Distributor POP was up 33% and distributor POS was up 28%. The solid growth in both POP and POS was driven by several new project ramps being supported by these channels during the quarter. In addition, we had a full quarter of BCD revenue, which runs 90% of its business through distribution as compared to one month in the first quarter.

Distributor inventory rose 13% with the addition of the BCD channel inventory. Global inventories in line and remains under three months. OEM sales, which were up 3% were negatively affected by the slowdown of certain key OEM customers as well as the ongoing softness in the computer sector.

Turning to global sales, Asia represented 82% of revenue, North America and Europe each represented 9%. In terms of our end market breakup, as I mentioned last quarter, we realigned our market sector definitions in the second quarter to more accurately reflect our business following a recent acquisitions of BCD and PAM. We utilized the product classifications of the World Semiconductor Trade Statistics, WSTS and we’ll continue using this guideline going forward and therefore the percentages are no longer directly comparable to prior quarters. These numbers are preliminary and we will continue to refine them, so they should be used more as a guide rather than an absolute.

As the result, the breakdown to the second quarter consistent consumer representing 32% of revenue communication 23%, computing 22%, industrial 20% and automotive 3%. Major end equipment changes were smartphone and cellphones are now under communications rather than consumer, tablets are in computer also from consumer and lighting now falls with industrial.

In trends of design wins activity once again remain very strong across all regions and end markets. We have a solid pipeline of designs as a result of our expanded customer engagement. There are also significant cross selling opportunities emerging with the addition of BCD products and we are very encourage by the initial response from the customers.

On the product side it was record quarter for BCD, AC to DC line. Diodes also had a very strong revenue quarter on DC to DC converters, CMOS LDiodes and SCI products along with positive momentum in Hall sensors, MOSFETs, and protection devices across broad-based markets and end equipments.

On our discrete products, introductions totaled 50 new products across 14 product families, addressing a wide range of application segments in markets. We continue to focus a significant portion of new product development at high volume portable device market in particular for smartphones and tablets including energy-efficient power adapters.

In addition, other development happens when specifically aimed at the automotive market where ruggedness and reliability is key. Speaking of the portable adaptor market we were please to launch the first devices from Diodes proprietary new trend SBR technology aims specifically at this markets. These new devices enable adapter designer to meet the stringent efficiency and temperature requirement imposed as part of the consumer green initiative.

Within weeks of being introduced, we secured multiple significant design wins that actually began shipping in the quarter, which is a testament to trench SBR’s performance. Diodes also continue to leverage its expertise in the miniature packaging for portable device markets by lunching the world’s smallest (inaudible) device packaged in a tiny DFN0806 package.

These were complimented by Chip Scale package Schottky and (inaudible) of devices. Diodes also launched this quarter our first range of SBR products targeted specifically in the automotive market. Our SBR technology has a reverse avalanche capability that is between three and ten times higher than competing devices resulting in greater protection in (inaudible) environments.

This enhanced ruggedness and reliability is a major advantage when compared to conventional technologies. Also in this quarter were additional devices in a range of regulator transistors created specifically for telecommunications, networking and Power-over-Ethernet application. And we expanded our TDS portfolio, introducing our first ever (inaudible) devices satiable for USB 2.0 and HDMI application.

Now turning to analogue new product introduction, we released 43 new products across seven product families during the quarter. New product highlights include continued expansion of our standard and logic products. During the quarter we announced the addition of the standard strip register and decoder logic ICs to our standard high speed CMOS logic families.

We also released our first family of voltage translators. In addition to these new product introductions, we announced several exciting new miniature packages to serve the standard logic market. Whereas our DFN1409 package offers a safe-driving efficiency of Chip-Scale packaging with the benefits of improved cost effectiveness and ease of handling.

And our new DFN0808 packaging, one of the world’s smallest logic package that allows Diodes to offer a highly advanced packaging of our single-gate logic product lines. Similarly the DFM-0910 is one of the world’s smallest fixed single logic packages. These very small packages are well suited for use in cell phones, tablets and markets. It is designed perspectives specifically as a result of these new package, we secured two significant wins in smartphone marks for our single-gate logic products and our dual base advanced ultra world power logic products.

We also saw a significant design and strength for our analog products in the flat panel two new markets as newest sockets one across several product family including low drop op regulators and load typically as a result to beat new package, we secured two significant wins in smart phone market for us inculcates low-voltage products and our (inaudible) against ultra-low tower logic products. We also saw significant design and strength for our analog products in the flat panel TV market with new sockets one across several product family including low dropout regulators and load switches.

We were also pleased to see growing traction for our audio ample products and AC-DC PWM controllers in this target application space strengthening the value of our recent acquisitions of the BCD and PEM. Also during the quarter, we saw strong design win growth for our AC-DC primary-side controller products in mobile phone chargers and adapters with specific strength in cellphones. We further expanded our position in the AC-DC market with a release of three new secondary-side controllers.

Building upon our strong momentum in Wi-Fi modules last quarter, we continue to see strong design win activity with our low voltage AC-DC inverters. More consumer applications are including the Wi-Fi connectivity including TVs, set-top boxes, as well as printers and other desktop peripherals. With this increased adoption of Wi-Fi functionality, we’re seeing a sustained interest in our DC-DC converters in Wi-Fi module reference designs. We’re very encouraged by the progress we are making with our expanded product line and new product opportunities generated by our recent acquisition.

With that I’ll open the floor to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steve Smigie with Raymond James. Please proceed.

J. Steven Smigie – Raymond James

Great, thanks a lot. Dr. Lu, it looks like another good quarter here. Looking forward to the guidance, it looks like, as it is with your guidance, EPS is ahead of the Street; but it also seems like there was some additional potential benefit that you would’ve had. The gross margin had the power plant issue. Can you talk about what magnitude of impact the gross margin was hit by from the power plant?

Keh-Shew Lu

Well, since the power outage just happened on July 26, and so it just back to install the power one week later, which was last Friday. The power just gradually come back, then it take time to ramp the equipment and the qualified equipment then put into production. That’s why we if make all does, the output above a month and obviously is not completely recovered yet. So we really don’t have the final number, but I would say somewhere around 0.5% to 0.1% GPM programs, but we don’t know for sure yet.

J. Steven Smigie – Raymond James

Okay, great, thanks; and would we assume that there is also publishing sort of revenue impact due to the third quarter because of the disruption here in your manufacturing?

Unidentified Company Representative

It is, but we tried to since we still have two months to make it up. And with flip cycle time, with assembly cycle time, I’m hoping that is minimal. But like I said, it just happened. We are assessing the damage of everything, so very difficult right now for me to say. So we just put conservative number that we have. And when we go to the update guidance next month then we’ll have much more clear picture.

J. Steven Smigie – Raymond James

Right, makes sense. Last question is just for the reported quarter, I think you guys did relatively well coming in above the midpoint – or coming in above consensus in the face of the computing weakness out there. I know you mentioned some new design wins ramping and some share gains as well. Is there one or the other of those that was more significant in your being able to outperform here?

Unidentified Company Representative

I think it was both – I mean, I think that the new design wins were share gains. Okay. So I think that they’re kind of one in the same. So we have some pretty significant new projects that came in the quarter that were quite helpful to us.

J. Steven Smigie – Raymond James

Okay, great. Thanks a lot, appreciate it.

Operator

Your next question comes from the line of Gary Mobley with Benchmark. Please proceed.

Gary Mobley – The Benchmark Company

Hi, guys. Could you share with us whether the book to bill ratio for the quarter was above 1 or below 1?

Unidentified Company Representative

I would say it was above 1.

Gary Mobley – The Benchmark Company

Okay. And Mark you mentioned the distribution inventory being up 13%. Could you clarify whether that was quarter-over-quarter comparison? And I’m assuming that was clouded by BCD as well?

Mark A. King

Yeah, most of that was just adding the BCD inventory into the mix.

Gary Mobley – The Benchmark Company

Do you have any sense what the organic growth rate in the distribution inventory would be?

Mark A. King

I would say, to be honest with you, I didn’t even really look at it. They gave me a total number. So I can’t give you again. But I won’t say it would be very high.

Gary Mobley – The Benchmark Company

Okay. And just to clarify, maybe you can just tell me if I am in the ballpark, the organic growth adjusting for the BCD contribution was that some on the neighborhood of 5% to 7% sequential for Q2?

Keh-Shew Lu

Well from 2Q, those Q1?

Gary Mobley – The Benchmark Company

Yes.

Keh-Shew Lu

Organically it’s above 5% and yeah, it’s above 5%.

Gary Mobley – The Benchmark Company

Okay. That’s it from me. Thanks guys.

Keh-Shew Lu

Thank you. And you know the reason is because supposedly second quarter is a good quarter for us. But this year on a computer market is not as strong as in the past. And we have very significant revenue from consumer market, I mean it’s a computing market, okay. But we’re still happy because 5% over the first quarter and you know first quarter is a very strong quarter for us. So it’s very strong first quarter then we are able to grow 5%. I think we are happy with even the soft computer market.

Operator

Your next question comes from the line of Christopher Longiaru with Sidoti. Please proceed.

Christopher Longiaru – Sidoti & Company, LLC

Hey, guys congratulations on those gross margin guide, considering this power outage?

Keh-Shew Lu

Thank you.

Christopher Longiaru – Sidoti & Company, LLC

So my question actually has to do, is there any recourse against the landlord or anything that you’re talking about in terms of future payments that would maybe inflate either your gross margin in the December quarter or future quarter or possibly deflate your operating expenses, can you comment on it?

Keh-Shew Lu

Well, you know we are in the age of negotiation for the next rental contract. So yeah, you can demand on those, but it’s not that easy to demand and then go to pay us back, right.

Christopher Longiaru – Sidoti & Company, LLC

All right, so basically you’re going to try your best.

Keh-Shew Lu

We always try our best.

Christopher Longiaru – Sidoti & Company, LLC

Okay. My other question just has to do in terms of just on the communication side, you talked about just a little bit of slower order rates, can you talk about the trends there over the course of the quarter and you know how it looked through July?

Unidentified Company Representative

Obviously, we see some improvements into July and I think into the third quarter and into the second half of the year and in some of our key customers. So I think basically it’s in line with our guidance.

Christopher Longiaru – Sidoti & Company, LLC

Okay. And then just in terms of the tax rate continuing, it kind of come down a little bit, should we still be modeling 20% for the year Rich or should we kind of think of that more in the mid teens range?

Richard D. White

No I think you need to push it more to the 20%, 21%, so that that’s where the effective tax rate midpoint is for the third quarter.

Christopher Longiaru – Sidoti & Company, LLC

Okay. That’s all I have. Thanks, guys.

Leanne Sievers

Thank you.

Operator

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

Tristan Gerra – Robert W. Baird & Co. Inc.

Hi. Good afternoon. The slowdown that you mentioned at certain customers, could you remind us how big they are as a percent of your revenue, and maybe some commentary around the content you have at those customers?

Richard D. White

We don’t really want to get into that detail, but – we don’t have any customers that are over the 10% range. So I think that’s as far as we want to get into the detail of that.

Tristan Gerra – Robert W. Baird & Co. Inc.

Okay. And then, in terms of the transfer of BCD’s packaging to your Shanghai facility, how much room do you have left for BCD products at that facility? And then, is it going to be all of BCD’s products, or just part of it? And then finally, if you could give us some sense of how much that will benefit gross margin?

Keh-Shew Lu

Okay. Number one, not all the BCD packaging they used we are able to produce in SKE, okay, like TO92. We don’t have that package inside Diodes ourselves. So the number, that package we weren’t able to, okay. And then, some of the package we start to qualify, but not all the customers will allow us to change that easily. So what we do is we will do all the qualification, all the PCN by end of September and then assume three month PCN change, and then we should be finished our conversion by the end of the year, which is one quarter ahead of schedule. But I won’t expect everything we want to pull in, can pull in before the end of the year.

Tristan Gerra – Robert W. Baird & Co. Inc.

Okay. And any benefit that you’re willing to talk about in terms of your COGS?

Keh-Shew Lu

What?

Tristan Gerra – Robert W. Baird & Co. Inc.

I was wondering if you would be willing to elaborate a little bit on the type of savings that you would expect from that migration in packaging for BCD.

Keh-Shew Lu

Yeah, you will be helped, but actually you will be helped as a little bit on our loading, but it’s more will be helped BCD, because we will provide them lower costs than they get it from outside.

Tristan Gerra – Robert W. Baird & Co. Inc.

Okay, thank you.

Operator

Your next question comes from the line of Vijay Rakesh with Sterne Agee. Please proceed.

Vijay Rakesh – Sterne, Agee & Leach

Yeah, hi guys, good work on the gross margin side. I was wondering, you mentioned product mix improvement in your prepared remarks, and you alluded to some smartphone wins or handset wins picking up. Can you give some more color on where the mix is now? How should we look at mix as you go out next one, two quarters with BCD or analog picking up?

Keh-Shew Lu

Well, we measure our ASPs by two index, one we call a mix dependent; one we call mix independent.

Vijay Rakesh – Sterne, Agee & Leach

Okay.

Keh-Shew Lu

For mix independent point of view, that means the same product sale last quarter price sale in last quarter both exist the same product sale in this quarter. That actually is higher that price drop is higher than our typical I remember I mentioned in the past before.

Typically we have look at 1.5% to 2% a quarter ASP drop and this quarter is actually higher than number but then we took another index call mix dependent which means we don’t here which customers we just look at the total ASP regardless of the product type that mix dependent and actually from mix dependent point of view. We are happy because ASP is actually going up. And that’s why what we say CPM improvement we credit that to the mix change, which means that ASP due to mix dependent is in the positive is that a negative range.

Vijay Rakesh – Sterne, Agee & Leach

Got it and you mentioned to (inaudible) with DFN, CSP packaging do see more wins on that side are sound that smaller package is going forward.

Unidentified Company Representative

Yeah, we think that that’s a really strong point for us and we think the packaging in our logic series is going to be a big winner for us in the long run so we think there were right in the edge of the technology we think we have a smaller step out there and we think we are going to do very well in that sector.

Unidentified Company Representative

Typically that kind of product give us a better CPM of better ASP.

Vijay Rakesh – Sterne, Agee & Leach

Got it on the utilization side, can you give us some trends – what speed utilization is running in the last two, three quarters? And where is it now?

Keh-Shew Lu

Well we separate it into two categories right? One is the most advanced in a new package switch is the one we’re driving very heavily on the loading and on the business. In that portion we are full. And that is where we still spend some capital money to increase the capacity for those standard, very small (inaudible) package for the standard commodity package.

The market is still weak and so our loading in that area from assembly point of view still somewhere around 75% to 80%. I don’t know the exact number but is not really improve the loading because that is the area that we are not driving our revenue. That is why when we say improve the mix, we are pushing more product out of advance package instead out of commodity package which is low GPM and that’s not where we focus our revenue at.

Vijay Rakesh – Sterne, Agee & Leach

Got it. And last question, BCD. You are pulling it in, you said. You said you’d be done by first quarter? Or you think you will get it done earlier or how far is the BCD pulling done here?

Keh-Shew Lu

Well, we would start it Wednesday in probably September, but then a big benefit probably in 4Q.

Vijay Rakesh – Sterne, Agee & Leach

Got it. Great thanks

Keh-Shew Lu

Thank you.

Operator

Your next question comes from the line of Vernon Essi, with Needham & Company. Please proceed.

Vernon Essi – Needham & Company

Thank you for taking my questions. I was wondering if you all had any color now that you’ve got BCD sort of settled in as to what things might look like from a seasonality perspective in the fourth quarter. You usually tend to have a little bit of a decline. Is there any reason to think that might be a little bit different this year? Are there any trends that you can see now that might offset that?

Keh-Shew Lu

That’s too early to talking about fourth quarter. I’m trying to concentrate to make my third quarter guidance. And so we are not really spent effort to looking into the fourth quarter business yield.

Vernon Essi – Needham & Company

Okay. At least I tried there. A couple of questions for you, Rick. Wondering on the depreciation front, it was a little bit lighter than I would’ve anticipated in the second quarter. Should we expect it to go up a little bit more in the third quarter? Or is this about the run rate we should be looking at on a go-forward basis, at least for the time being?

Richard D. White

I think this is about the run rate we’ve cut our CapEx down to 5% to 9%, so I don’t see any big increases it may turned up a little bit but this is about the run rate.

Keh-Shew Lu

If you remember our own business model is a 10% to 12% of our revenue, but since now we have still a commodity packaging, available, past available we’ve only spend the money in the three areas, we will spend the money one is BCD, and you know BCD but two still need to after coming to put it up. And then Chengdu is in our future. So we need to start to do something with Chengdu. And then the third one will be at advanced package in our SKE. And if you look we even consider all of those three together, our guidance now is 5% to 9%. So you can see with significant reduced our CapEx expenditure.

Vernon Essi – Needham & Company

Okay. And just moving to the balance sheet, Rick, the payables were up pretty sharply there, obviously a good source of cash for you. What was the reasoning? And I assume that’s probably going to come back to trend line or is there a reason it might stay up at this range, just looking at cash flow next quarter?

Richard D. White

I missed what was up?

Vernon Essi – Needham & Company

Payables, account payables?

Richard D. White

Payables, yeah, I think the payables days were down. So we had three months of BCG in there and only one month of BCD last time. So it will change around as we move through time. But I think payables days were down.

Vernon Essi – Needham & Company

Okay.

Richard D. White

Payables days were up, but I don’t have that in front of me.

Vernon Essi – Needham & Company

Yeah I mean, I just I’m showing an increase, but it’s pretty dramatic at least on the formulas I’m using. Although I’m probably not using an exhaustive method like you are behind the scenes there. But yeah, I just was curious, I assume it’s probably going to trend back a little bit on a go-forward basis, and not a big deal. But finally, just wondering on the tax front to follow-up to a prior question, should we be thinking about this level going into 2014 in that 20%, 21% range or we expect that to moderate lower?

Richard D. White

No, I think it’s going to stay in that 20% to 21% range.

Vernon Essi – Needham & Company

Okay, all right. Thanks a lot guys.

Keh-Shew Lu

Thank you.

Richard D. White

Okay.

Operator

Your next question comes from the line of Harsh Kumar with Stephens. Please proceed.

Harsh Kumar – Stephens, Inc.

Hey guys a couple of questions. Rick, I wanted to clarify. Your press release says that your GAAP gross margins are expected to be 30.3%. Usually the non-GAAP margin is a little bit higher. We model non-GAAP when we model your company. Should I be thinking of a little bit higher number on the gross margin side? Or should I be thinking 30.3? And same question for taxes.

Richard D. White

The gross margin was the GAAP and non-GAAP was only for the first quarter and second quarter because of the BCD purchase price of adjustment. We don’t normally have a difference between GAAP and non-GAAP. So those purchase price adjustments where finished in the second quarter and going forward in the third quarter GAAP and non-GAAP margin is the same.

Harsh Kumar – Stephens, Inc.

Got it

Richard D. White

30.3%, okay.

Harsh Kumar – Stephens, Inc.

Got it.

Richard D. White

The tax rate is approximately same for both GAAP and non-GAAP standpoint.

Harsh Kumar – Stephens, Inc.

Fair enough. Thanks, Rick. And then Dr. Lu, I know you talked about weakness at certain OEM customers. Was that the factor in the 3% to 7% guidance, which is a little less than seasonal? Or was it the fact that you had to leave revenues on the table, because you couldn’t make enough because of the accident at the power supply power station?

Keh-Shew Lu

I think, we are talking about third quarter we still affect by two factors. One is the PC market is not going like in the past and that since we have 13%, 17 % of revenue 22% of our revenue coming from computing market is affects us the growth because in the PC is very strong in third quarters and this year PC is not that strong, okay. And another one is couple of OEM is not very strong, they had some view of inventory in the second quarter. And so it effect us that overall we feel gaining the market share because this 5% at mid point still is a pretty good growth – net average.

Harsh Kumar – Stephens, Inc.

No totally, totally and Dr. Lu, what’s the biggest driver to get to your target 20% operating margin goal that you have? What’s the biggest thing you need for that to happen?

Keh-Shew Lu

Well, I think ASP is one and most important is not independent, ASP independent, mix independent ASP, most important is mix and then second one will be when the markets have the turn we can start to our commodity type of packaging that is going to increase our profitability from our making functions.

So if you ask me those two – is very important for us. High end advance package I think that we are fully happy with the progress and we continue in putting more capacity over there. But we will have a certain capacity due to the general market still not a strong, if you go to look at overall semiconductor especially our same group is not really strong and I hope when the markets started turning that will grow our GPM percentages.

Harsh Kumar – Stephens, Inc.

Got it. And last question, Dr. Lu. In the past cycles you’ve been able to get to gross margin of – this is a long-term question – gross margin of 34%, 36% somewhere in that range; call it 35%. You’ve got more analog now. You probably will have better utilization. Is it fair to think that you can get back at least there if not higher, Dr. Lu?

Keh-Shew Lu

Well, you know my business model always 35% now when everything is in the right, we think in the right direction last time we are able to get 38% but our business model is 35% and I’m confident that the market really turning strong. We should be able to get 35%.

Harsh Kumar – Stephens, Inc.

Great, thank you Dr. Lu congratulations.

Keh-Shew Lu

Thank you.

Operator

Your next question comes from the line of Suji De Silva with Topeka. Please proceed.

Suji De Silva – Topeka Capital Markets

Hi Dr. Lu, Hi Rick nice job on the quarter and the margins. My first question is about your smartphone tablet exposure. I know you have good share position at the Tier 1s. If the market is stronger the next few quarters in the low-end smartphone market, can you talk about your share position there, A and B, can you talk about whether it’s the premium products that go into those devices, or maybe the more commodity products for you guys?

Richard D. White

Okay. So I would say that historically our position is stronger in the Tier 1s than it is in the Tier 2 but I think you’ll see an emerging presence in the Tier 2 in the coming quarters and the focus. Somehow as we focus more towards it as we, we kind of like to focus on the leaders and then move to the second Tier. So I think that that’s part of our strategy.

And I would say that it is a pretty good mix between products. But most of the smartphones in Tier 1s use premium products. Okay, as we go to the Tier 2, it’ll be more broad based and maybe more, may be less sophisticated or slightly less premium than in these, than the Tier 1. So but obviously we see there’s some emerging dynamics in these markets in Mainland China that we’re very, very interested in. And I think that our BCD acquisition and the additional sales force and the coverage we have there should help us in that long-term. So I think we’re well positioned to continue to exploit those markets as they emerge.

Suji De Silva – Topeka Capital Markets

Great. And my second question is about gross margins and some of the tailwinds there. Can you talk about how far along you are long, Dr. Lu, on the copper conversion, and also moving any of Diodes’s analog products over to BCD’s fab. Can either of those be meaningful gross margin help in the next couple of quarters?

Keh-Shew Lu

Well I think yes, in a couple of quarters when the market has started to turn, I think our margin improvement will be there. Okay and right now, everything is really holding there. Gold price is no longer going down, and no longer going up, so gold price is probably price stable. Okay, and copper wire conversion, we convert most of what we want to convert. Now on the one or two customer still not ready for us yet but majority of our customer is already then as convert, and from BCD like I said we will started to ramp.

We finish every thing in the end of this quarter and we’ll start to probably they filed September and then will try to rent what ever we can rent by end of the this year and then could be a couple of key customer may not let us to convert then after that majority of what we can convert will be convert. So I saw you as next year we will be if the markets turn then we should have a hope to significant including increase our gross margin.

Suji De Silva – Topeka Capital Markets

Good to hear, Dr. Lu. And last question is it’s hopefully not too soon since you closed BCD and got that integrated, but can you give us the updated thoughts on further acquisition at this point? Thanks.

Keh-Shew Lu

Acquisition to give us or let us set up of the growth is always in my strategy and so I cannot talk about it until we are ready to make up the announcement, but like I said that’s always one of my growth strategy and I’m not going to give up that yet.

Suji De Silva – Topeka Capital Markets

Okay. Thanks guys.

Operator

Your next question comes from the line of Shawn Harrison with Longbow

Shawn Harrison – Longbow

Hi, good evening everybody.

Keh-Shew Lu

Hi Shawn

Shawn Harrison – Longbow

I guess two follow-up questions. I know earlier of the topic was broached upon the savings at BCD that from integrating it into your facilities. But how much of the margin improvement is that, exactly, for BCD? Is that five points and I think too aggressive in that type assumption?

Richard D. White

I don’t think we’ve really quantified it.

Shawn Harrison – Longbow

Yeah.

Richard D. White

That might change.

Shawn Harrison – Longbow

5%?

Richard D. White

5%, I mean on their share.

Keh-Shew Lu

No, no.

Shawn Harrison – Longbow

5% is too high.

Keh-Shew Lu

Yeah, 5% is too high because they are arranging it, if not the much that compare with our total revenue.

Shawn Harrison – Longbow

I think you meant 5% of 30% of the revenue?

Richard D. White

5% of 30% of the revenue, correct.

Keh-Shew Lu

Okay, okay. Okay that could be, like I say, we do not have the detailed number put in yet, yeah.

Richard D. White

So think about where it really helps is in the overhead absorption, because we have to buy lead frames, we have to buy gold wire, we have to buy more compound, all those things that they are buying externally. So where it helps from a Diodes perspective is more unit absorbing, indirect overhead and indirect labor. So it’s gradual as that stuff moves to the line. So it’s not like it’s just a immediate flip up.

Shawn Harrison – Longbow

Okay.

Richard D. White

There’s other advantages to it of consistency, capacity, quality, and all those other things too. So there is a lot of motivational point in doing it beyond just the margin, all right

Shawn Harrison – Longbow

Gotcha, yeah, greater control to the supply chain?

Keh-Shew Lu

Yes, correct.

Shawn Harrison – Longbow

Okay.

Richard D. White

And one thing that Keh-Shew talked about earlier was the adoption into the simply test area in the fourth quarter. So the movement of products into the BCD wafer fabs is going to take a lot longer than that. That won’t be done until next year, right.

Keh-Shew Lu

Next year.

Richard D. White

Next year, right; so that’s also an improvement, but a longer term improvement.

Keh-Shew Lu

Yeah.

Richard D. White

So don’t get too confused with, we’re going to be done in the fourth quarter not with the wafer fab.

Shawn Harrison – Longbow

In all those dynamics you rolled up into that 35% gross margin target.

Richard D. White

Yeah sure.

Shawn Harrison – Longbow

Okay.

Richard D. White

Plus a good market, plus strong pricing all the things that goes along with that. Right.

Shawn Harrison – Longbow

That’s more than fair. Then two brief follow-ups I guess, I know that there was a restructuring announcement made last quarter was I think about $3 million in annualized savings, how is that progressing. And then the second question is with the good free cash flow your year-to-date and what looks to be a really good free cash flow in the back half of the year. How quickly are you looking to pay down your debt break?

Keh-Shew Lu

Okay number one, the reduction is actually completed. Okay. It’s completed and so then second pay down the debts, that I say M&A is still one of the key strategy to me so instead of pay down the debts, I might have more focus on using that to do M&A.

Shawn Harrison – Longbow

That’s more than fair, it’s a good strategy. Thanks a lot Dr. Lu.

Keh-Shew Lu

Thank you.

Operator

This includes a question-and-answer session; I would now like to turn the call back over to management for closing remarks.

Keh-Shew Lu

Thank you for your participation today. Operator you may now disconnect.

Operator

Ladies and gentlemen thank you for your participation. You may now disconnect. Have a great day.

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