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Diodes Incorporated (NASDAQ:DIOD)

Q3 2013 Earnings Call

November 12, 2013 5:00 PM ET

Executives

Leanne Sievers – IR

Keh-Shew Lu – President and CEO

Richard White – CFO, Secretary and Treasurer

Mark King – SVP, Sales and Marketing

Analysts

Gary Mobley – The Benchmark Company

Steven Smigie – Raymond James

Christopher Longiaru – Sidoti & Company, LLC

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

Harsh Kumar – Stephens, Inc.

Vijay Rakesh – Sterne, Agee & Leach

Shawn Harrison – Longbow Research

Lena Zhang- Blaylock Robert Van

Suji De Silva – Topeka Capital Markets

Operator

Good afternoon, and welcome to Diodes Incorporated’s Third 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, Tuesday, November 12, 2013.

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

Leanne Sievers

Good afternoon and welcome to Diodes third 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, November 12, 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 Diodes’ 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. I am pleased to report another quarter of record revenue include market share gain and solid operational performance across our divisions. Our past design momentum and the strength in the TV market and at certain major OEMs were able to offset the continued weakness in the TV market. Also during the quarter we further improved gross margins through our cost reduction efforts and improved BCD wafer fab loadings.

Additionally we reduced our operating expense on a data basis and as a percentage of the revenue, demonstrating further progress towards achieving our target model of 20% of the revenue. These achievements are even more notable when considered in the weakness of the U.S. dollar relative to most currency where we have operations, especially the British pound and the euro.

Our improved operational efficiency and the cost reductions were able to mostly offset these currency impact and allow us to exceed our operational expectation for the quarter. As we look to the fourth quarter it is shaping up to be weaker than our normal seasonality, due to above mentioned weakness, especially the continued weakness in the PC market. However we believe we are well positioned to benefit from ongoing operational improvement as we leverage our broadened product portfolio and the additional cost from transferring for B2B product into our ticketing facility by the end of the year and then eventually lowering our analog foundry wafer loadings into BCD wafer fabs.

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

Richard White

Thanks Dr. Lu and good afternoon everyone. Revenue for the third quarter 2013 was $224.5 million, an increase of 4.7% over the $214.4 million in the second quarter and an increase of 34.7% from the $166.6 million in the third quarter of 2012. The sequential increase in revenue was primarily due to our past design win momentum and strength at certain major OEMs.

Gross profit was $69.6 million or 31% of revenue, compared to $61.3 million or 28.6% of revenue in the second quarter 2013 which included $3.7 million of an inventory valuation adjustment related to our BCD acquisition and $43.6 million or 26.2% of revenue in the third quarter of 2012. Gross profit margin improved as a result of our cost reduction efforts and improved BCD wafer fab loadings.

GAAP operating expenses for the third quarter were $49.3 million or 22% of revenue which included approximately $1.9 million of amortization of acquisition intangibles and approximate $800,000 of acquisition related employee retention accruals, compared to $51.1 million or 23.8% of revenue in the second quarter 2013 and $36.1 million or 21.7% of revenue in the third quarter 2012. Even with the addition of BCD, we were able to sequentially reduce our operating expenses on a dollar basis and as a percentage of revenue, putting us closer to our target model of 20% of revenue.

Excluding amortization of acquisition intangibles and acquisition related employee retention accruals operating expenses on a non-GAAP basis for the third quarter 2013 were $46.6 million or 20.8% of revenue, compared to $46.2 million or 21.5% of revenue in the second quarter of 2013 and $34.9 million or 20.9% of revenue in the third quarter 2012.

Looking specifically at selling, general and administrative expenses for the third quarter, GAAP SG&A was approximately $33.8 million or 15.1% of revenue compared to $35.1 million or 16.4% of revenue in the second quarter 2013 and $25.8 million or 15.5% in the third quarter of 2012. Excluding acquisition related employee retention accruals non-GAAP SG&A was $33 million or 14.7% of revenue compared to $34.1 million or 15.8% of revenue in the second quarter and $25.8 million or 15.5% in the third quarter 2012.

Investment in research and development for the third quarter was approximately $13.6 million or 6.1% of revenue on a GAAP basis. This compares to second quarter 2013 R&D expense of $12.1 million or 5.6% of revenue and $9.1 million or 5.5% of revenue in the prior year quarter. Total other expense amounted to $2.8 million for the third quarter. We had approximately $1.6 million of interest expense and approximately $600,000 of interest income. In addition, we sustained approximately $2.5 million of currency losses due to the weaker US dollar relative to the British pound down by 6% plus and the euro down by 4%. Our favorable operation results most of the offset this currency impact on net income and earnings per share.

Income before tax is a non-controlling interest in the third quarter was $17.5 million on a GAAP basis which compares to income of $10.5 million in the second quarter 2013 and $9.4 million in the third quarter of 2012.

Turning to income taxes for the third quarter, our tax rate was 20.5% which was within our estimated range of 18% to 24% reflecting the increased amount and movement of profit between various taxes in jurisdictions with different tax rates.

GAAP net income for the third quarter was $13.6 million or $0.28 per diluted share, compared to a GAAP net income of $8.6 million or $0.18 per diluted share in the second quarter and GAAP net income of $8.6 million or $0.18 per diluted share in the prior year quarter.

Third quarter, non-GAAP adjusted net income was $15.8 million or $0.33 per diluted share, which excluded net of tax, $1,5 million of non-cash, amortization of intangible asset costs and approximately $700,000 of acquisition related employee retention accruals.

The fully diluted share count used to compute GAAP and non-GAAP earnings per share for the third quarter was 48 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 third quarter GAAP and non-GAAP adjusted net income was approximately $2.3 million net of tax of non-cash share based compensation expense.

Excluding 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 $16.7 million and free cash flow was $9.6 million for the third quarter. Net cash flow was a negative $9.3 million for the third quarter. Two specific items reducing our net cash flow was $7 million payment to reduce our revolver and the purchase of $22 million in short-term investments. For more details about our cash flow statement please see our Form 10-Q.

Turning now to the balance sheet; at the end of the third quarter, we had approximately $204 million in cash and cash equivalents and $22 million of short-term cash investments. Working capital was approximately $489 million. At the end of the third quarter, inventory was approximately $194 million compared to $187 million last quarter.

Inventory days were 113 in the third quarter compared to 110 days last quarter. Inventory in the quarter reflects $2 million decrease in finished goods and a $7 million increase in raw material and a $2 million increase in working process. At the end of the third quarter, accounts receivable was approximately $192 million and AR days were 77 compared to 75 last quarter.

Capital expenditures for the third quarter were $12.4 million or 5.5% of revenue. This compares to 3.8% of revenue in the second quarter. We expect capital expenditures to remain between 5% and 8% of revenue for the full year which includes both BCD and Chengdu. Depreciation and amortization expense for the third quarter was $18.5 million.

Now turning to our outlook, for the fourth quarter of 2013, we expect revenue to range between $205 million and $220 million or down 2% to 9% sequentially. We expect GAAP gross margin to be 28%, plus or minus 2%. GAAP operating expenses are expected to be approximately 22.7% plus or minus 1%. We expect our income tax rate to range between 18% and 24% and shares used to calculate GAAP EPS for the fourth quarter are anticipated to be approximately 48.2 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 King

Thank you Rick and good afternoon. Our record third quarter was driven by growth in all regions with strong increases in North America and Europe after a relatively flat second quarter in the regions. We also achieved the record sales in China local markets where we are making great progress. In the communications and market our solid position with Smartphone manufacturers continues to be a key driver of sales as a result of our growing new design win revenue.

Computing grew slightly in a quarter primarily due to increased sales for our products used in tablets partially offset by weakness in notebook and motherboard. The auto and industrial markets were also up in the quarter and they strengthen both North America and Europe. OEM sales were up 2% and distributor POS was up 8.6%, distributor inventory rose 6% and global inventory remained in line and under three month. In terms of global sales Asia represented 82% of revenue North America and Europe each represented 9%. Our end market break up consisted of consumer representing 32% of revenue computing and communications each 23%, industrial 19% and automotive 3%.

Beginning last quarter we realigned our market product classifications according to the guidelines of the world semiconductor trade statistics. As a reminder Smartphones and Cellphones are now classified under communication, tablets and computing and lighting now fall within industrial.

In terms of design wins activity once again remained very strong across all regions as well as end equipment and markets. We had a solid pipeline of design as a result of our expanded costumer engagements. There continues to be a significant cross selling opportunities with the BCD product in fact we achieve another record quarter for BCD from AC to DC line. In addition we achieved record quarterly revenue on DC and DC converters, CMOS Diodes, LED drivers and MOSFET products. We also had strong revenue quarter and Hall Sensors SPR and logic products across broad based market and end equipment.

In fact our logic product had another record quarter and continues to remain on a positive trend. Our discrete products introductions sold 63 new products across 14 product families aimed at diverse range of markets and applications. Once again several new products were launched for the high volume portable devices such as smartphones, tablets and energy efficient power adapters. Other product developments were internet applications such as LED lightings, touch screens, USB, HDMI and other industrial applications.

Several products were launched specifically for the high growth automotive electronics market where ruggedness for liability and quality are key attributes. During the quarter Diodes launched additional products based on its performance leading trends SBR technology. These new products are aimed at the thermally demanding small form factor portable adaptor market and enable power supply designers to meet efficiency and temperature targets.

We also launched the first French SBR products for the LED lighting markets that offer reduced power consumption and improved efficiency and higher temperature operation resulting in better thermal stability. As I’ve mentioned in the past miniature packaging remains a core strength for Diodes and building upon this expertise we introduced new Chip-Scale packaged products for the portable applications. These FDICST occupied less forward space and have 50% thinner off-board profile.

Also new in this third quarter were high voltage technologies to complement our MOS and diode ranges. 300 volt manufacture or at least based on the new mid ranged trench MOS platform. This innovative process platform allows Diodes to offer up to 300 volt MOSFETs with low [RDS] in a small package. In addition new switching diode products feature our proprietary industry leading 400 volt technology and are suitable for many new applications employing high voltage including capacitive touch screens and LED lighting circuits.

Diodes also added to our performance TDS portfolio with a release of a wide range of devices doable for USB 2.0, HDMI and USB 3.0 application.

Now turning to analog products we released 21 new products across four product families during the quarter. New product highlights include the significant expansion of diodes low voltage high performance all effect products with the addition of the family of the Omni polar and unipolar switches. This product family offers a range at medium and high sensitivity devices as well as programmable sensitivity device or a CAM system flexibility.

Additional new releases during the quarter include two new offerings in our growing family of AC to DC power devices. We released our high performance power supply control over the excellent standby power performance. In addition we introduced a secondary side synchronous rectifier who fast response to secondary side voltage can effectively improve transient performance in assistance primary regulation. Both of IC’s are targeted at high efficiency charges and set top box market.

Also during the quarter we released two high performance LED drivers that offer protection features to further enhance system components and cost effectiveness. The first is an AC to DC power effect or correction controller that provide accurate constant current regulation while eliminating the need for an after coupler and secondary control circuitry at the system level.

The other new products is the primary side TFC controller for dimmable LED driver applications. In terms of design win for our analog products Diodes continued to gaining traction to our Hall Sensor product with significant wins in the smartphone and gaming markets. During the quarter we secured a large win for our AC to DC devices in the set-top box market as well as continued traction for our AC to DC products in smartphone chargers.

Our USB power switch is also continuing to receive excellent market acceptance with multiple wins across essentially all major notebook manufactures. We also secured a number of wins for our DC to DC converts across a broad range of applications including light goods and communication data cards as well as continued expansion and LED TV, Wi-Fi modules and set top box applications.

We also obtained two significant new designed wins in the European Set Top Box markets for our low voltage DC to DC converters that we acquired from PAM. Also from PAM our audio and amplifiers were awarded sockets in flat panel TV and monitor markets. In summary we are very pleased with the operational achievements we made in the quarter as evidenced by our solid results. We also continue to aggressively expand our new products introductions which has been a key driver of our design win momentum and market share gains.

Going forward we remained focused on leveraging our expanded product portfolio the addition of the VCD products and capitalizing our cross selling opportunities in order to fuel our future growth. With that I’ll open the floor to questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Gary Mobley of Benchmark.

Gary Mobley – The Benchmark Company

Hi guys thanks for taking my question. If I look at the midpoint of your guidance from the fourth quarter of full revenue it’s caused about a 5.5% sequential decline and in your third quarter I think you grew 5% sequentially which was in line with peers but your fourth quarter revenue guides below the peer group which is guiding for about 1% to 3% sequential decline. So I am just wondering where is that Diode that has historically taking market share and what, should we read anything sinister into that sequential comp?

Keh-Shew Lu

Well Gary, I don’t think the peer, I don’t know where you get the peer is at 2% down. I think when we look at our peer company we feel it’s somewhere around 8% down. So that may be different company you use but the key thing really you need to compare is in the third quarter we actual grew and then in fourth quarter we are down and then you need to if you compare with third quarter and fourth quarter then you might come up different numbers. Okay, but in general what we see is a general market slowdown, especially is in the PC market. And you can see that the PC market continue weakness and at the same time some of our OEM companies, they are not as strong as the third quarter.

So overall that’s why we guidance 5.5% is worse than our normal seasonality, somewhere around 0% to 5% down that’s normal seasonality, it’s worse than that. But I think really majority was due to the weak PC market and the general market weakness. And we still believe we don’t know yet but still believe in the fourth quarter we may still can gain the market share.

Gary Mobley – The Benchmark Company

Okay. If I look at your, the midpoint of gross margin guidance costs were about 300 basis points sequential decline. Could you give us sort of relative ranking of what the impacting factors are there whether it the lower manufacturing load, currency so and so forth?

Keh-Shew Lu

This majority is really the manufacturer under loaded and especially this time what you have some impact by the packaging but the majority of impact is really by the wafer fab. If you look at our from the first quarter, 1Q wafer inventory to end of 3Q wafer inventory we are up almost $10 million and the reason we start loading wafer fab is we think we in 1Q we look at 2Q going to be strong and 3Q going to be strong. And so we started loading wafer fab.

But now I look at it, 4Q we know is weak and we’re thinking traditionally 1Q will be a weak quarter too. Therefore we take this time try to reduce the output of the wafer fab and such that we can hopefully reduce our wafer fab inventory to align with our operations for 4Q and 1Q. So yes the packaging under load has some impact the majority of the impact coming from BCD Fab, our [Odum] fab and especially our Kansas City fab.

Gary Mobley – The Benchmark Company

Okay. Let me ask a follow up somewhat of a hypothetical situation. Let’s assume your inventory was sequentially into the third quarter and your revenue for the fourth quarter is expected to be sequentially flat with the third. Would your gross margins stay the same or increase?

Keh-Shew Lu

Well if you make that assumption if the revenue is the same and wafer fab loading is the same and then you’ll obviously the TPM will be flat 31% on, yes your cost might going up but our cost reduction effort will be able to balance that. So this time we look at it as pure due to the loading factor of the making functions.

Gary Mobley – The Benchmark Company

That’s it for me, thanks guys.

Operator

Your next question comes from the line of Steve Smigie of Raymond James.

Steven Smigie – Raymond James

Great, thanks a lot, you had obviously a softer volume out there if I look at maybe that’s the perfect comp but from [inaudible] semiconductor they guided about down about 8% and they did have a lot of computing exposure there and so it seems like there is a lot of that computing weakness out there. And I was just curious if you could talk a little bit about how you see that may be even into next year generically an estimate but it seems like that’s a little bit soft should we think about that is you are diversifying you’ve got other categories growing, or that’s going down a little bit or is it even a potential that because you guys gained share and you have new products coming out there, it might be down next year but not as bad as you might think?

Keh-Shew Lu

Yeah, I think we originally very heavy in the PC market and if you notice the notebook went down quite a bit even the desktop and motherboard kind of flat or slightly down. But PCs, notebook is the major softness. But fortunately we are working our way to taper us and that kind of market so that will help to reduce some of the burden of the PC centric. But at the same time we have an outer design win cell phone and the other applications and that’s why we can still continue gaining the market share so far.

Mark King

If I could add on that on the PC side we do see some significant opportunities for us to balance out decline with new products and we’re looking into that. I mean we’re moving in that direction for next year. So we see some ways that we can mitigate softness in that market either way.

Steven Smigie – Raymond James

Okay, great. That’s very helpful. And how should we think about Q1 it sounds like Q1 is probably little bit softer for everybody out there again computing probably continues to rollout you got some seasonality in stuff like handsets typically. So is it fair to say that you guys would likely be similar to other folks where you probably have a soft seasonal Q1 followed by typical pattern like stronger Q2, Q3 you guys have always done well there plus BCDs always had sort of very strong Q2 Q3 period as well?

Keh-Shew Lu

Well it is too early to call 1Q even right now the visibility is very short. Three months ago you asked me what will be the 4Q look like I won’t say it will be so soft. So obviously now to look in 1Q I really don’t know. And even this 4Q is worse than seasonality. So either 1Q it seasonally you go down but since 4Q is so soft I don’t know 1Q will be better or will be the same, that really very hard for me to see.

Steven Smigie – Raymond James

Okay, great. And I just was looking for a little bit of commentary around operating expenses and currency impacts – like the OpEx seems a little bit higher in Q4 than I otherwise would have thought and is there going to be some cost controls coming in but some of that going forward post Q4 and then just on the currency stuff is that sort of one time in nature or would be potentially see some more impacts going forward as well?

Keh-Shew Lu

Yeah you are talking about the currency exchange impact is actually in 3Q. And the 3Q is just because our currency U.S. currency against euro and against English pound is significantly low. Against Renminbi that’s above is still going down but is in the range you can normal going down type of performance. But euro and the English pound is the one have significant change. So I don’t think that will be repeat because if the U.S. dollar start getting stronger then you will be pursed. This is just it will be automatically balanced if you go down then you go up then we can...

Richard White

So basically the issue with the guidance is if there are no currency impacts in the guidance we just assume the same currency going forward that we closed at the third quarter with? And so there is no significant currency up or down in the guidance numbers. So from ex-expense stand point we were slightly over $49 million in the third quarter at 22% and if you just take the midpoint of our guidance it’s a little bit over $48 million but because the revenue goes down it ends being 22.7% from a GAAP perspective.

So the dollars did not increase they’re going to go down.

Steven Smigie – Raymond James

Okay. I may be looking at GAAP versus non-GAAP, I didn’t make sure. All right great. Thanks very much.

Operator

Your next question comes from the line of Christopher Longiaru of Sidoti & Company.

Christopher Longiaru – Sidoti & Company, LLC

Hello, can you hear me?

Richard White

Yes we can hear you.

Christopher Longiaru – Sidoti & Company, LLC

Hey guys how are you? My question has to do with the just the supply chain in general. I know that you are manufacturing in China but in terms of the situation in the Philippines are there any parts that are in the food chain of customers that your partner in the food that you might see delays on because they can’t get product at least in the short term from their Filipino suppliers?

Keh-Shew Lu

No, I am aware of it?

Richard White

I don’t think we have a significant customer base in the Philippines and we don’t have any raw material base in the Philippine. So we haven’t seen any impact of it as of yet.

Christopher Longiaru – Sidoti & Company, LLC

And then just in terms of the utilization rates that you are assuming for the fourth quarter guide can you just give us what that, what the number was in September and kind of what you are expecting for December?

Richard White

So in the, so from a wafer fab perspective we were it really depends on the wafer fab but we were around 85% and most of them except for our K fab which is the Kansan City fab and it was a little bit lower. We basically conclude the 85% is fully loaded for the wafer fab simply from a fourth quarter perspective two of them are in the 80% range and one of them is below 70%.

Christopher Longiaru – Sidoti & Company, LLC

Okay. Just in terms of the packaging and test facility you moved BCD in there. So you had a lot of capacity there may be just give us an update on where you are as you moved BCD into the packaging facility or you are saying that is going to take some time but just in terms of where you are?

Richard White

It’s about 85%, 86% in the third quarter and it’s about that in the fourth quarter.

Christopher Longiaru – Sidoti & Company, LLC

Great. All right, I will jump back. Thank you guys.

Keh-Shew Lu

Thank you.

Operator

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

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

Hi, good afternoon. Could you give us an update on the manufacturing transition at BCD to fab 2 how that going? It sounds like BCD utilization rates are higher than they’ve been in the past but how loaded or unloaded is fab one and if we assume normal demand what will be the utilization rate outlook for BCD a year from now when we look at both fabs?

Keh-Shew Lu

Okay. Actually what we try to do now is moved from fab one which is old fab, some of the product to the fab two which is the new one. So basically the fab two is ramped up and so it is 100% loaded all the time but don’t forget it’s ramping up. So basically we try to keep fab two while they are ramping they then fully load it. And therefore the fab are going to be in the 4Q going to go down.

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

So is the expectation that in the future you will still be using fab 1 or is that say fab that you actually planned on using for certain just some lower product, lower end products?

Keh-Shew Lu

Okay. For the fab 1 what we intend to do move the – outside wafer into the BCD fab 1. Currently Diode wafer majority of them is using foundry, and that is the one we plan to do is moved inside the BCD fab1 while BCD fab 1 moved their – to fab 2 for the high end product. So we eventually will be filled up the fab 1 by Diode product.

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

Okay, that’s very useful. And then in PCs you mentioned opportunity to offset declines with opportunities industry wide do you think that is quite honest to some data firms thinking that the notebooks units could be down next year?

Richard White

Yeah I think the industrial segment for us specifically with our MOSFED product ISB and quite strong. I don’t think seeing a significant weakness movement in the industrial market I think it’s kind of been up to flattish over the last couple of quarters. So we don’t see any declines so we see continued upside with new product additions that we are adding.

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

Okay. Thank you.

Keh-Shew Lu

Okay.

Operator

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

Harsh Kumar – Stephens, Inc.

Hey Dr. Lu couple of questions are you seeing anything strange in the end markets at this point for your seasonality to be worse than historical let’s say even some of the industry players in your category. Is it inventory shift issue or is it inventory of finished goods or is it just a slower market?

Keh-Shew Lu

Well what I see the cumulative slowing market if you look at euro typically third quarter euro is a vacation quarter in fourth quarter we’ll recover. But this year for some reason Europe third quarter is strong and then fourth quarter it’s relative to third quarter is weak. So this is a normal situation. Then you go to the PC but we already know PC is really slowdown while especially in notebook. And then you go to the similar general market again – channel market we suppose to see a high in 4Q but we do not see that.

So it just a normal typical year but the case is really I don’t know how to define typical yield because since every year the track is different so I don’t know what is the typical year but it’s a different from my past 20 years of experience.

Harsh Kumar – Stephens, Inc.

Okay. That’s helpful Dr. Lu and then you have actually tablets in your computing business and my understanding is the tablets should continue to build through December may be towards the midpoint of the December quarter or is the build in tablets not strong enough to offset some of the PC weakness and notebooks?

Keh-Shew Lu

Probably not strong enough to offset the weakness in PC and notebook.

Harsh Kumar – Stephens, Inc.

Okay and then last question from me Mark may be you can answer that but as you look across your four or five end markets which will be the best faring and which will fare the worst?

Mark King

I think probably computer is going to fare the worst.

Harsh Kumar – Stephens, Inc.

Okay. Any more color on which like any kind of industrial versus telecom versus consumer more color on that?

Mark King

To be honestly I think that the auto and industrial will be relatively flat the impacts that we’ve seen in regions or some might be PLP versus POS I think the POS is remaining relatively stable but the channel might be a little bit less interested in investing over the fourth quarter. I think I mean it’s choppy market in general and there is bright spots and there is weak spots and we just have to navigate through them. But I don’t think it’s such a clear pattern.

Harsh Kumar – Stephens, Inc.

Okay. Thanks guys, thanks Dr. Lu, Rick and Mark.

Operator

Your next question comes from the line of Vijay Rakesh of Sterne, Agee.

Vijay Rakesh – Sterne, Agee & Leach

Hi, guys just looking at your look at the last four years your March quarter score at top line has been flat to up when I look at your Disti inventories do you see for the March quarter do you see you are loadings improve into the March quarter

Mark King

I mean I think our just the inventories in pretty good and the market is going more than we should have a good position alone. I mean we are not over inventories in our channel we are very, very happy with our channel position right now, it’s relatively clean. So again if there is any feeling that the market is going to growing in 2014 we’ll see a stronger loading in that period.

Vijay Rakesh – Sterne, Agee & Leach

Okay. And really look at your gross margins obviously Dr. Lu mentioned two things. You’ve done some cost reduction efforts and on the BCD side some loading but when you look at the cost reduction side and the product mix what is the sustainable growth – that you guys can hit obviously – came down a little bit it looks like fab loading but if you look at next year given your cost reduction and the mix what is sustainable margin level that you can achieve?

Keh-Shew Lu

I think I need to make some correction. When I say wafer fab loading down I am not just saying BCD wafer fab loading down, I say in general especially one of the fab which is the biggest fab and that loading down because we had too much of wafer inventory. So I am not saying BCD is the only wafer loading down. And you are talking about you know what will be the GPM we can sustain, you know we measure our GPM percent the actual berth under loaded numbers. You know fully loaded number versus under loaded number and I think we still able to maintain or go up to biggest motor. Our biggest motor is 35% GPM and we believe we can hit there, it’s just because the under loaded factor won’t affect that GPM percent. And if you look at third quarter we are up to 31% and that again is not fully loaded yet. Our wafer fab is kind of there but the summary is not there yet.

So if we can assume all the fab is dotted up to 85% or the summary all the above 95% then I think we should be happy, very good chance to get our repeated model of 35%.

Vijay Rakesh – Sterne, Agee & Leach

Got it. So when you look at your 35% and that’s simply in fab loading, is that like a mid-term timeline, which you are looking at to get to those kind of levels on the gross margin side and that’s the last question. Thanks.

Keh-Shew Lu

Mark?

Mark King

So exactly what do you mean by mid-term? What does that mean?

Vijay Rakesh – Sterne, Agee & Leach

Looking at given, are you looking at improving the assembly loading over the next couple of quarters based on keeping the capacity their flattish and improving the loading on the assembly side how do you envision getting to those gross margin?

Keh-Shew Lu

Number one, if they are, if your revenue let’s say if our revenue go back to 225 million like the third quarter or above that, our wafer fab will be kind of equal to above 85% volume. In our third quarter we are doing that and BCD should be you know if it continue to grow they will continue growing and we can pull move our wafer fab loading in next year from our [inaudible] into the BCD then the fab will be there so then we can get to third quarter number 31% or above.

And then you look at the packaging and the packaging we have been have a problem to load it up, right? So if we can get another 10% or more modem up than that will be another stable points of the GPM improvement. Now another key factor which you know we probably you know talking about is we start cut down our capital investment. If you remember our biggest model in the past is 10% to 12% of revenue and now we are cutting down our expense.

This year we say 5% to 8% and our biggest model we will go into talking above 5% to 8% or 5% to 9% so basically we cut down our capital from 11% midpoint of our revenue to 7% midpoint of our revenue and if we continue to do that 4% capital reductions then you know several year later that automatically improves your GPM 4%. So this is what we try to do to improve our GPM from long term point of view, our model is at 35% obviously we are not happy from long term point of view using 35% as the model.

So one is design more new product with more differentiate type of new product to get a better GPM but the other thing is we reduce our capital investment you know our target is reduce 4% and if we are able to do this 4% continuously for four-five years then our GPM will be automatically improved 4%-5% and that will be making better than biggest model.

Vijay Rakesh – Sterne, Agee & Leach

Got it. Thank you very much.

Operator

Your next question comes from the line of Shawn Harrison of Longbow Research.

Shawn Harrison – Longbow Research

Hi, evening everybody.

Keh-Shew Lu

Hi, Shawn.

Shawn Harrison – Longbow Research

I don’t think I heard it specifically asked but on the gross margin declines sequentially for the December quarter how much of that is related to the inventory you want to take out of your system in terms of the finished goods. So is that inventory decline a 100 basis points of the 300 basis points? I am just trying to get a triangulation of that figure?

Keh-Shew Lu

Okay, talking about finished good out of the inventory number, we’re talking about reduced wafer fab. I mean the wafer inventory. What I am talking about is if you look at our wafer inventory for 1Q to end of 3Q our wafer inventory up about $10 million and that is quite a bit and that is because we predict second quarter and third quarter going to be – we’re thinking fourth quarter is going to be a good quarter too and you know my strategy always. You do up the wafer and then we put in different package because of the D for packaging shop and that way you can easily support the customer and take advantage of the shop D time and then when the market turn you can take advantage of the customer and gain the market share.

That really is the strategy. I make that strategy and has been working fine. But now since we started to see fourth quarter and 1Q going to be slow quarter then we try to say okay they should reduce our wafer inventory and therefore we significantly cut in the wafer fab. And if you said how much PPM point how much base point it affect, I would say, two to three, I said we’re talking about probably 250 basis points.

Richard White

Yes, something like that, 200 basis points.

Keh-Shew Lu

200 basis points just by the wafer fab is of 200 basis points.

Shawn Harrison – Longbow Research

Okay that’s extremely helpful. The other thing I just wanted to clarify I think last quarter it was mentioned that there was a power outage that affected your business and I was just wondering kind of what the cost drag on the September quarter was relating to that power outage.

Keh-Shew Lu

I think at that time, I don’t know, I don’t remember talking about how much or not but I remember we say that have million dollar impact. I don’t remember. I don’t know. I don’t remember what I told you or not. At end we do write-off the inventory and is less than that, is less than that number. Capacity loss is not a major issue because wafer fab is not fully loaded but we do have some quick on the knife, it end up to be you know a square and I don’t remember what did I say something but right now we have the number is different.

Richard White

About half a million.

Keh-Shew Lu

About half a million and that’s why we are able to get 31%.

Shawn Harrison – Longbow Research

Okay, perfect. You know then Mark I guess it’s a question for you on distribution of this revenue decline for the December quarter is there any abnormal destocking activity occurring at distribution? Is there any risk of that heading into the March quarter? It doesn’t sound like there is but I just want to be 100% clear on that.

Mark King

Well I mean certainly they not robustly placing inventory orders, okay? So they are definitely being careful and then so I think that is putting a little bit of drag and it will put little drag on this quarter and next quarter. But if the POP I mean if the POS holds up then we should be remain little consistent but there you know again distributors towards the end of the year are very habit based at not placing stocking orders or restocking in that period.

So yeah I mean I definitely think that they are being conservative.

Shawn Harrison – Longbow Research

Well if I am correct it sounds as if your point of purchase for the third quarter distribution was higher than the product sale is that correct?

Mark King

Not correct.

Shawn Harrison – Longbow Research

Okay I guess it was generally less sell-through or it was sell-in below sell-through.

Mark King

It always kind of matches in that areas I think we did have some inventory increase because they were expecting may be slightly better than they expected but our POS was up 8.6% in the quarter. So I think that was all healthy.

Shawn Harrison – Longbow Research

Got you. Thanks so much everybody.

Operator

Your next question comes from the line of Lena Zhang of Blaylock Robert Van.

Lena Zhang- Blaylock Robert Van

Hi thank you for taking my question. And can you talk about the ASP erosion in Q3 and also given general weakness in the market how about ASP you are seeing right now for the current quarter? Thank you.

Keh-Shew Lu

Well I think I’ve been talking in a typical ASP going to be go down almost every quarter, that is our weakness and typically we said it’s normal typically it’s like go down 1.5% to 2% a quarter and third quarter it turn out to be mix independent to go down slightly worse than 2%, 3% then are typical. Okay we define typical above 1.5% to 2% down each quarter and third quarter is worse than typical.

Lena Zhang- Blaylock Robert Van

And how about the current quarter?

Keh-Shew Lu

Oh current quarter I don’t know because we don’t have the number yet.

Richard White

Lot of moving targets.

Keh-Shew Lu

Yeah.

Lena Zhang- Blaylock Robert Van

Okay, thank you.

Operator

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

Suji De Silva – Topeka Capital Markets

Hi guys I am curious on the BCD and analog side are you seeing design wins accelerate there as you bring the BCD products into your company in term of merger synergies there?

Richard White

Yeah I mean to be answer we are really happy with what we are seeing in the customer base and the interest at the customers. North America and Europe has a whole new energy towards analog and frankly I think that they are pretty excited about being able to lock in every customer in North America and Europe where they couldn’t before. So I think there is a significant amount of opportunity for us to develop these designs wins over the next year and beyond.

Again an analog design win takes a little longer to get to production then in some of the discrete design wins. But the progress is quite good in the activity is very, very strong.

Keh-Shew Lu

When you look at the top of the revenue and so and almost double the number of the product you make sales more exciting, our sales team very exciting.

Suji De Silva – Topeka Capital Markets

Okay. And then my other question should we still think of your phone exposure as more high end or are you making progress in a low end smartphone markets and also converse to that, can you talk about the momentum in the charger market I know that’s an area of strength the last few quarters?

Keh-Shew Lu

I think that you’ll probably say that we are driven by the higher end of the smartphone market but we have a lot of interest and a lot of activity in mid side may be the larger Chinese and moving forward on there. And the charger progress continues both on the Diode side as well as on the BCD side. So there is some pretty good synergies between our key companies in that area.

Suji De Silva – Topeka Capital Markets

Okay, great, thanks guys.

Operator

This ends today’s question and answer session. I would like to hand the call back to management for closing remarks.

Keh-Shew Lu

Well thank you everyone for joining us today. Operator you can now disconnect.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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