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Diodes Inc. (NASDAQ:DIOD)

Q4 2009 Earnings Call

February 9, 2010 5:00 pm ET

Executives

Leanne Sievers – IR, Shelton Group

Keh-Shew Lu – President and CEO

Richard White – CFO, Secretary and Treasurer

Mark King – SVP, Sales and Marketing

Analysts

John Vinh – Collins Stewart

Shawn Harrison – Longbow Research

Brian Piccione – BMO Capital Markets

Ramesh Misra – Brigantine Advisors

Steve Smigie – Raymond James

Christopher Longiaru – Sidoti & Co.

Stephen Chin – UBS

Operator

Welcome to the Diodes Inc. fourth quarter and fiscal 2009 financial results conference call. (Operator instructions) I would now like to turn the call over to Leanne Sievers of Shelton Group, the Investor Relations Agency for Diodes Incorporated. Leanne, please go ahead.

Leanne Sievers

Good afternoon and welcome to Diodes fourth quarter and fiscal 2009 earnings conference call. I am Leanne Sievers, Executive Vice President of Shelton Group, Diodes' Investor Relations firm. With us today are Diodes' President and CEO, Dr. Keh-Shew Lu, who is joining us from Taiwan; Chief Financial Officer, Rich White; Senior Vice President of Sales and Marketing, Mark King; and Vice President of Finance and Investor Relations, Carl Wertz.

Before I turn the call over to Dr. Lu, I would like to remind our listeners that management's prepared remarks contain forward-looking statements, which are subject to risks and uncertainties and management may make additional forward-looking 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 projection as to the company's future performance represent management's estimate as of today, February 9, 2010. 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 earnings release is a reconciliation of GAAP net income to non-GAAP adjusted net income, which provides additional details.

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

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

Keh-Shew Lu

Thank you, Leanne. Welcome everyone and thank you for joining us today. I am pleased that once again we saw another solid quarter of profitable growth for Diodes. Our fourth quarter was highlighted by a 50% increase in revenue over the prior year period and a 50% increase in gross profit.

Revenue for the quarter increased primarily due to market share gains as new and existing customers combined with continued strength in Asia and the further improvement in North America and Europe. Our revenue results are evidence of our market share gains and the design win momentum.

Our revenue this quarter was 97% of the $134 million record revenue we achieved in the third quarter of 2008. Gross margin improved to 32.1% as our packaging facility continued operating at full capacity and utilization improved at our wafer fabs in Kansas City and the U.K. We expect additional upside in gross margin in the coming quarters due to further improvement in utilization of our wafer fab combined with our new product initiatives.

For the year, revenue reached a record of $434.4 million which is a significant accomplishment during one of the most challenging periods our industry and economy has experienced in quite some time. Other noteworthy accomplishments in 2009 included first we implemented cost reduction initiatives in response to the economic environment that improved our profitability while growing revenue resulted in our 19th consecutive year of profitability.

GAAP net income was $7.5 million or $0.17 per share and non-GAAP adjusted net income was $24.1 million or $0.55 per share. Second, we achieved positive cash flow from operations in every quarter during the downturn as a result of our efforts to reduce expenses, inventory levels and authorization of capital expenditures. For the year, cash flow from operations amounted to $65.5 million. [net cash] $138.5 million and free cash flow was $43.1 million. The significant improvement in our cash position enables further expansion opportunities for the company in the future.

Third, we consistently improved our factory utilization at our packaging facilities and wafer fabs throughout the year increasing gross margin to 32.1% in the fourth quarter from the goal of 18.6% in the first quarter of 2009. Fourth, we also continued to invest in new product development and achieved a high level of design wins that contributed to increased market share and the strong revenue growth in the last three quarters of the year. We expect to continue that momentum into 2010.

Lastly, we continue to strengthen our balance sheet and repurchased approximately $48 million of our convertible senior notes reducing the notes outstanding to $135 million [inaudible]. As a result of those achievements, the company has returned to our profitable growth model and I believe we have emerged from the downturn as a stronger company with expanded growth opportunities as we enter 2010. We expect continued growth momentum in the first half of the year and remain positive of our outlook due to desired win traction and new product introductions.

Despite the first quarter being a typically seasonally slow period for our markets, we are seeing stronger customer demand in the consumer and communication markets. In particular, for our [portable] for LCD and LED TVs as well as Smart Phones in the set top box. We are also continuing to see market separation in North America and Europe. As a result, the first quarter of 2010 will represent our fourth consecutive quarter of growth corresponding to a year-over-year increase of approximately 70%.

With that I will turn the call over to Rick to discuss our fourth quarter financial results and first quarter guidance in more detail.

Richard White

Thanks Dr. Lu. Good afternoon everyone. As Dr. Lu mentioned revenue for 2009 was a record $434.4 million, an increase over the $432.8 million in 2008. For the fourth quarter revenue was $130.3 million, an increase of 50% over the $87.1 million in the same period last year and an increase of 7% over the $122.1 million in the third quarter of 2009.

Gross profit for the fourth quarter 2009 was $41.8 million or 32.1% of revenue compared to $22.9 million or 26.3% in the fourth quarter of 2008 and $37.6 million or 30.8% of revenue in the third quarter of 2009. The 130 basis point sequential increase in gross margin was primarily attributable to continued improvements in utilization at our wafer fabrication facilities as well as the stable pricing environment.

During the quarter our packaging capacity continued to be fully utilized with output from our China facilities at 5.2 billion units, up over 5% from the third quarter. Our wafer fab utilization continues to increase at both facilities which we expect to further benefit gross margin in the first quarter of 2010.

Total operating expenses amounted to $28 million or 21.5% of revenue in line with the 21.6% last quarter. Looking specifically at selling, general and administrative expenses for the fourth quarter, SG&A was approximately $20 million or 15.4% of revenue compared to $19.1 million or 15.6% of revenue last quarter. Investment in research and development for the fourth quarter was $6.8 million or 5.2% of revenue which was comparable on a percent of revenue basis to the $6.3 million or 5.1% of revenue in the third quarter.

Total other expenses amount to $2.3 million for the fourth quarter. Looking first at interest income and expense we had approximately $1 million of interest income primarily related to our portfolio of auction rate securities and interest expense of $1.8 million primarily related to our convertible senior notes and our loan for the acquisition of Zetex.

During the fourth quarter of 2009 we recorded a pre-tax, non-cash amortization of debt discount of approximately $1.8 million. As stated previously, effective January 1, 2009 US GAAP requires us to separately account for a liability, equity component of our convertible senior notes. For the full year 2009 this additional pre-tax amortization of debt discount expense amounted to approximately $8.3 million.

Turning to income taxes our income tax benefit was approximately $3.6 million which was basically in line with our previous guidance. Fourth quarter GAAP net income was $14.2 million or $0.32 per diluted share as compared to net income of $7 million or $0.16 per diluted share last quarter. The fully diluted share count used to compute GAAP earnings per share for the fourth quarter was 45.1 million. Non-GAAP adjusted net income was $16.3 million or $0.36 per diluted share which excluded net of tax $1.1 million of non-cash interest expense related to the amortization of debt discount on the convertible senior notes, $900,000 of non-cash acquisition related intangible asset amortization costs and nominal amounts for forgiveness of debt and loss on extinguishment of debt.

This compares to adjusted net income of $9.1 million or $0.21 per diluted share in the third quarter of 2009. 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 fourth quarter GAAP and non-GAAP adjusted net income was approximately $2.2 million net of tax, non-cash share based compensation expense. Excluding this expense both GAAP and non-GAAP adjusted diluted EPS would have increased by an additional $0.05 per share.

Cash flow for the fourth quarter amounted to $21.5 million from operations, $115.9 million net cash flow and $12 million free cash flow. For the year, cash flow from operations was $65.5 million. Net cash flow was $138.5 million and free cash flow was $43.1 million.

Turning to the balance sheet at the end of the fourth quarter we had $539 million in cash and short-term investments consisting of approximately $242 million in cash and $297 million in short-term investments of par value auction rate securities. The auction rate securities which have been fully borrowed against resulting in a related current liability no debt cost loan of $297 million can be put back to UBS-AG at par on June 30, 2010 under the previously disclosed settlement. Our working capital at quarter end was approximately $354 million and long-term debt including the convertible notes which are redeemable in October 2011 was approximately $125 million carrying value.

Now turning to inventory at the end of the fourth quarter inventory was approximately $90 million which was an increase of approximately $7 million from the third quarter due mainly to an increase in raw materials and [whip] which was in line with the revenue increase. Finished goods at $32.3 million was down 30% from year-ago levels. Inventory days were 88, the same as the third quarter of 2009. Accounts receivable was approximately $103 million and AR days were 71.

Capital expenditures were approximately $10.1 million during the fourth quarter or 8% of revenue and $25.9 million for the full year 2009. We continue to authorize CapEx at our model rate of between 10-12% of revenue to grow our packaging capacity in line with demand. However, lead times on equipment are extending causing a delay in the booking of expenditures relative to the respective authorizations. Depreciation and amortization expense for the fourth quarter was $12.1 million and $47.2 million for the full year of 2009.

Turning to our outlook, as previously discussed we expect a stronger first quarter than our typical seasonality and estimate revenue to range between $131-137 million, up ½ of 1% to 5% sequentially. Additionally, with a favorable pricing environment and continued improvements in utilization at our wafer fabrication facilities we expect first quarter gross margin to range between 32-33%. First quarter operating expenses are anticipated to decrease slightly from fourth quarter levels on a percent of revenue basis.

In terms of capital expenditures, as I just mentioned we continue to authorize at our model rate of between 10-12% of revenue. We also expect our income tax rate for the first quarter and full year 2010 to range between 10-17%.

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

Mark King

Thank you Rick. Good afternoon. As Dr. Lu mentioned we achieved another solid quarter of growth due to continued market share gains and design win momentum.

Overall our markets are solid driven by continued strength in Asia as well as steady improvement in North America and Europe. These positive trends across all regions of our business are setting the stage for a strong first half for Diodes going into 2010. In particular we continue to achieve significant gains in MOFSETs, SBR devices and bipolar transistors as well as increases in analog new product revenue from LED drivers, Hall sensors and USB power switches.

Diodes MOFSET portfolio had record bookings during December and lead times are lengthening. This bodes well for continued growth in this product line throughout 2010. We also achieved strong momentum on SBR products in Asia with significant demand and volume growth as well as continued upside in all areas from LCD and LED televisions to laptop power supply. There is also growing interest in these products in Europe and North America. The competitive advantage of SBR over conventional Diodes technology is evident in the increasing number of design wins.

Additionally our Zetex mid and high performance bipolar transistor also achieved strong growth in the quarter primarily due to ramping of designs in smart phones as well as increased momentum in the distribution channel. The increased opportunity in VoIP, LED driving and various phone applications for these products provide a strong foundation for continued growth in 2010.

In terms of our end market break out, computing represented 31% of revenue, consumer 32%, industrial 18%, communications 16% and automotive 3%. Asia represented 77% of total revenue growing 5% over the third quarter led by continued strength in LCD and LED TVs as well as panels, set top box and low noise block LMB converter products. We did see a slight decline in notebooks during the quarter yet performance was still better than typical seasonality.

Distributor POP grew as a result of an aggressive effort by our Chinese distributors to rebuild strategic inventory in support of the Chinese New Year. Distributor inventory increased to approximately two months. This level is less than the normal year-end distributor inventory level in Asia and less than the fourth quarter of 2008 which was 2.8 months.

Design activity in Asia remained strong in the fourth quarter and included 16 different wins for our USB switches, power ICs and LED lighting products. In total we had 17 wins at 62 customers during the quarter. As I mentioned last quarter we are pleased with our continued progress in account development in the China markets. Increasing our market share in China is a key strategic initiative for Diodes as we consider the China market a major growth driver.

In North America, fourth quarter sales represented 13% of total revenue and increased 20% over the third quarter. OEM sales were driven by strength in set top box as well as initial signs of improvement in our industrial account base. Distributor POS and POP grew in the quarter while inventory was up 2% but still remained at all time lows. Our backlog was strong once again positioning us for further growth in North America in the first quarter.

Overall, near to mid term outlook from both OEMs and distributors is positive. Design activity in North America also remained strong as momentum continued with 62 total design wins highlighted by 9 analog wins, 1 hall sensors, 2 LED drivers, 3 SBRs and 20 MOFSETs.

Sales in Europe accounted for 10% of total revenue in the quarter and increased 17% from the third quarter. The growth demonstrates further signs of recovery in the region following solid sequential growth achieved last quarter. OEM sales grew double digits for the second consecutive quarter with sales to automotive customers up 6% sequentially. Direct sales to consumer accounts gained 7% and sales to industrial customers grew for the first time in 2009 with a strong rebound of 49% quarter-over-quarter. Distributor POS exceeded distributor POP and was up 16% over the third quarter. Inventory remained flat and the distributor outlook is positive. We begin 2010 with a very strong customer backlog and expect further improvements in the first quarter.

Now turning to new products. New product revenue was $16.2 million in the fourth quarter representing 12.5% of total revenue compared to 16.5% of sales last quarter. The decrease in new product revenue was primarily due to the aging out of some MOFSET, ASMIC and [TVS] products as well as quarterly end equipment mix. During the fourth quarter we released 54 new products consisting of 20 analog products across five device families including 3 LED drivers, 8 USB switches and 7 Hall sensors and 34 discrete consisting of 8 bipolar devices, 9 SBR devices and 17 MOSFETs for notebook, PC, VoIP and mobile phone applications.

We continue to see new product revenue increase from our USB power switch family with further penetration in notebook and set top box. The quarter-over-quarter growth rate was almost 50% for this product line. This trend is expected to continue in 2010 as more new products are released to the market that offer higher current, lower [RDSON] and discharge features. The reset devices are gaining popularity in applications where particular power rails are monitored for better systems power management. More development in the reset family is underway to further expand our device portfolio in 2010.

For hall sensors, new product represented over 60% of the revenue in this product line driven by Asian notebook and cell phone markets. Similarly, new LED products represented 77% of total family revenue and we anticipate the percentage of new LED driver revenue to continue to increase.

In terms of global design wins in process design activity remained high with wins at 146 accounts globally. 75 wins at 60 customers in Asia, 62 wins at 32 customers in North America and 76 wins at 54 accounts in Europe. Design wins and in process design activity were broad based in both product and equipment. Design activity was highest in our core products and target end equipment at key accounts which we believe will drive additional revenue growth in 2010.

We continue to see the strongest momentum in the analog side on USB switch, LED drivers and LDOs as well as MOFSETs, bipolar transistors and SBRs on the discrete side.

In summary, our continued strong performance and revenue growth is evidence of our successful execution on new product initiatives and market share gains. The expanded customer based we obtained through our acquisition of Zetex has provided Diodes a larger sales footprint and broadened our global presence. We continue to maintain our investment in technology innovation to enhance our design activity and further capitalize on the product synergies and cross-selling opportunities which I believe have just begun to be exploited.

As Dr. Lu mentioned, we expect the first quarter to be stronger than normal seasonal patterns as a result of increased customer demand for our products that are utilized in panels for LCD and LED TVs, smart phones and set top boxes. We are very encouraged by the positive trends we are seeing for our business and believe that Diodes is well positioned for increased growth opportunities in the first half of the year.

With that I will open the floor to questions. Operator?

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of John Vinh – Collins Stewart.

John Vinh – Collins Stewart

On the guidance, the guidance obviously is above seasonal but slightly below some of the guidance some of your peers have given. Is your guidance still capacity constrained? Can you talk a little bit about that?

Keh-Shew Lu

Let’s look at how we go through. We grew 33% and then 18% and then 7% quarter-over-quarter through last year. If you look at our guidance despite the seasonally 1Q typically is the lowest quarter of the year. We have a very good possibility we are going to set a new revenue record for our company. Therefore the reason is we have grown very strongly quarter-over-quarter the last three quarters and now 1Q is the fourth consecutive quarter of continued growth. I think we actually recovered much faster and earlier than our peers. So when you focus on the Asian markets and you focus on consumer, computer communications type of markets I think we have been growing faster and recovering faster than our peers.

John Vinh – Collins Stewart

To clarify it doesn’t sound like capacity is going to be an issue for you in Q1?

Keh-Shew Lu

It is still but we continue to invest…if you remember last quarter conference call we said we returned into the profitable growth mode and therefore since September we have been starting to put in investments in our capacity expansion and therefore we still continue constrain by our packaging…I am talking about packaging output. We are still really constrained by that but we have increased our capacity too.

John Vinh – Collins Stewart

Turning to inventory, you talked about some of the inventories increased slightly in Q4. What do you anticipate the distributors are going to do with inventories in Q1? Are they going to be able to continue to build a little bit of inventory in Q1? The follow-on to that is what does that imply for kind of your seasonality and the rest of the year if they are building inventory in Q1 does that imply Q2 might be a little bit less than seasonal?

Keh-Shew Lu

In our business typically 4Q the distributors build up some inventory. That is because every year everyone gets ready for the Chinese New Year in 1Q. So they typically build up some inventory. This year in 2009 the inventory build is extra than in the past. Typically in 1Q they continue to build up some because typically the start of second quarter and into third quarter our capacity will be starting to tighten up and they have the best possibility to get the parts from us and therefore they typically always build up more inventory in 1Q. It would not surprise us if they increased but so far we do not forecast there will be an increase. Typically there may be.

John Vinh – Collins Stewart

You anticipate they will continue to build up inventory into Q2 or do you think they will get to a level of inventory they are comfortable with after Q1?

Keh-Shew Lu

They would like to build up additional inventory but depending on our growth and depending on our output of our manufacturing facilities they may not be able to build up additional inventory.

John Vinh – Collins Stewart

Can you give some color on the end markets in terms of your expectations for Q1? Do you expect that all your end markets will be tracking to above seasonal in Q1? Are there any that are going to be at or slightly below seasonal in Q1?

Keh-Shew Lu

If you compare with seasonable we have seen now all the markets, even in the computer typically 1Q is slower from our point of view but we see some slow down but it is still higher than seasonal. So if you consider adjustment for seasonality our opinion is all the end markets we participate are growing.

Operator

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

Shawn Harrison – Longbow Research

Looking at capacity utilization within the fabs I think last quarter it was mentioned you were targeting about 75% utilization at Zetex and about 85% at Fabtech. I wonder where those ended 2009?

Keh-Shew Lu

Rick has the number.

Richard White

That is about where we ended up. Fabtech we were middle 80’s and in Zetex we were right below middle 70’s.

Shawn Harrison – Longbow Research

Given those capacity utilization rates is it safe to say the majority of the CapEx spending in 2010 will be then focused more on the packaging side and not trying to increase efficiency at the fabs?

Keh-Shew Lu

You are right.

Shawn Harrison – Longbow Research

Beyond that as we look to 2010, Rick maybe you could talk about this, do you think you will be free cash flow positive for the year and how should we think about that cash being deployed in terms of more convertible debt being repurchased or some other uses?

Richard White

I think we of course don’t make statements for the full year but we do expect positive cash flow. I would say that convertible notes are if you look at the discounts versus the par value I don’t think you are going to see us purchase too many convertible notes back. We have plenty of opportunities in the assembly tech area for CapEx. I think Keh-Shew is going to concentrate on capacity expansion and other M&A opportunities that come along.

Shawn Harrison – Longbow Research

Two brief questions to wind up for me, with your comment on good pricing right now does that mean you are getting any price increases in the market or does that just mean generally flattish pricing? Secondly, there was a news release I believe out last week saying a company called Dialogue Semiconductor acquired some power management technology from you. If you could just elaborate for me on exactly what that was.

Keh-Shew Lu

From the pricing point of view we typically don’t like to go to our customers to raise the price. So as you said, the price is stabilized. Then what we can do typically is adjust through the price of product mix and that product mix will enable us to increase the average selling price. What is your second question?

Shawn Harrison – Longbow Research

There was a news article that came across the wire that it looked like Diode had sold some power management technology to a European semiconductor firm. Maybe if you could elaborate on exactly what that was?

Keh-Shew Lu

We sold our [inaudible] technology to Dell and actually G Tech acquired that technology through some acquisitions several years ago. That technology is really a good technology. It is just not really aligned with our product development actions or our product strategy. It is great technology and [inaudible]. Therefore, we made the deal to the company. It is not a bit acquisition but the key thing is the technology is great and it is good for them but for us it just wasn’t aligned with our product strategy or product directions.

Operator

The next question comes from the line of Brian Piccione – BMO Capital Markets.

Brian Piccione – BMO Capital Markets

To get back on the issue of seasonality, obviously given the acquisition of Zetex and the economic environment and the recovery from the economic environment filtering through all of that how would we try to paint the picture for what normal seasonality would be when business stabilizes, understanding there is likely to be growth on top of that?

Keh-Shew Lu

If you look at [back] typically 1Q is a 5-10% negative or drop from 4Q the previous year. So that is typical. With the Zetex acquisition enabled us to gain more markets especially enabled us to sell those Zetex products into the Asian markets including our own customers, our Asia customers. Therefore, it has enabled us to start the record setting in the quarter instead of the negative growth quarter. So I am very pleased with the acquisition and opportunity for setting a record in 1Q.

Brian Piccione – BMO Capital Markets

I am sure you don’t want to give us an outlook for Q2 and Q3 but normally speaking would we expect Q2 to be a higher quarter than Q1 or a lower quarter than Q1? Again, now that you have no sooner brought the two businesses together than we ran into the economic problems and are recovering from them so we don’t see a clear pattern from the historical quarterly seasonality. What would the quarter-to-quarter seasonality probably look like when things stabilize?

Keh-Shew Lu

Second quarter is very difficult to predict especially if you look at typically 1Q goes down and 2Q comes up and 2Q is typically even to 4Q the previous year or 3Q previous year numbers. But this year because 1Q didn’t go down therefore it is very difficult to see if Q2 is going to be continued growth or not. The thing is everybody here, I am in Taiwan and everybody here tries to understand and actually look at the March month because after Chinese New Year if the March month is very hard then you see the momentum continue through 2Q. If March starts to slow down then 2Q will be probably flat. We don’t know. Everybody is looking at the March month.

Brian Piccione – BMO Capital Markets

In the press release and in the spoken comments you were referring to continued momentum in the first half. Presumably that was just a statement of visibility not as much that you saw something bad happening in the second half. Is that correct?

Keh-Shew Lu

You are right. We just say we don’t know the second half but 1Q we can feel the first half. Stronger than normal. That is all we are talking about.

Brian Piccione – BMO Capital Markets

Finally you mentioned new product directions and that sort of thing. Is there anything you can share with us, markets you hope to open up, new product verticals or anything like that, would you rather it be a surprise to your competitors?

Keh-Shew Lu

I will refer some surprise.

Operator

The next question comes from the line of Ramesh Misra – Brigantine Advisors.

Ramesh Misra – Brigantine Advisors

In regard to your CapEx level up 10-12%, how much capacity expansion would that support on your [inaudible] back in China?

Keh-Shew Lu

The majority of our capital expenditures I think like we have mentioned previously will be focused on packaging capacity. 10-12% and we intend to be closer to 12% than 10% and we might spend because it depends on third quarter situations, we might spend earlier in the second quarter for first quarter growth.

Ramesh Misra – Brigantine Advisors

How much increase in capacity would that result in approximately?

Richard White

I think it is really hard to say because there is a different mix of packages and some packages generate more units and revenue. I think it is really hard to classify it in just units because for our analog product lines we had some more sophisticated packaging that we don’t get as many units but we get more revenue value. The key picture is we are positioning all of our key packages for growth and evaluating it monthly to make sure we don’t stymie any product lines or any of our new product lines with insufficient capacity.

Ramesh Misra – Brigantine Advisors

If it is difficult to gauge on a unit basis is it easier to gauge on a dollar basis?

Richard White

It goes the same way. I think you understand our typical growth patterns and objectives. I think there should be nothing to say that we are not trying to drive ourselves in those directions.

Ramesh Misra – Brigantine Advisors

In regard to the LED drivers you have been talking about are these predominately for the handset market or are they also for laptops and does that even include TVs?

Richard White

Most of our LED drivers legacy from the Zetex side has been more about in driving higher powered LEDs. Some of our recent product announcements have been looking at the last couple of quarters ago we announced something for small diameter displays and so forth so I think you will see our product direction moving more into the display world rather than flash lights and outdoor lighting and so forth. I would say the predominate amount of our revenue now is coming from the present historical Zetex product line with the direction moving towards the display market.

Ramesh Misra – Brigantine Advisors

In regard to Q1 ordering patterns, I guess since Dr. Lu is in Taiwan you might be able to comment on this, any difference in regard to order patterns out of Asia surrounding the lunar new year? Or is it pretty in line with the historical trends in Asia?

Keh-Shew Lu

Actually in February even until today a lot of customers want us to ship ahead because this year Chinese New Year is a different date. Chinese New Year starts on February 14 which is second half of February so this year Chinese New Year is later than normal. We can see a lot of [inaudible] for February and even until today because they are preparing for gear back up at Chinese New Year shut down. That is why it is very difficult to see and earlier I mentioned I will know more after Chinese New Year in the March ordering pattern and that will tell me how strong the second quarter will be.

Ramesh Misra – Brigantine Advisors

A very quick follow-up on that, the strength in your guidance for Q1 is that driven predominately by strength out of Asia or is it 50/50 Asia versus North America and Europe?

Keh-Shew Lu

I think in our speech we said actually U.S. is not just stabilized. We see some recovery. If you look at the growth U.S., Europe and Asia, all regions are growing.

Ramesh Misra – Brigantine Advisors

In terms of M&A activity are there any product area holes you see that you would like to fill or any particular direction that you see transitioning Diodes towards through M&A?

Keh-Shew Lu

Well we look at different opportunities and previously I said I prefer some surprise. If we get into the new areas.

Operator

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

Steve Smigie – Raymond James

I was hoping you could talk a little bit about option expense. I’m not sure if you gave a break out with R&D, SG&A versus COGS? If you could give that?

Richard White

It is not in the press release. We didn’t give a break out of that. I don’t have that right in front of me.

Steve Smigie – Raymond James

Could you give us some sense of what you are thinking expense might be in Q1?

Richard White

It is probably going to be about the same as it was in the fourth quarter.

Steve Smigie – Raymond James

Turning to utilization it seems like you are still at pretty low utilization in your fabs. Would it be reasonable to expect that since things are tight you would see both a mix improvement plus some continued pickup in cost coverage or offsetting higher utilization that would drive higher gross margin throughout the balance of the year potentially?

Keh-Shew Lu

You are talking about the back end or the front end?

Steve Smigie – Raymond James

The front end. It seems like the front end still has some utilization to recover.

Keh-Shew Lu

Let’s separate from Zetex and [inaudible]. [tech] is we try to grow ourselves in the past, almost 50% of that capacity was essentially for other customers. We have been growing ourselves to deal with [inaudible] and unfortunately our customer who buys from us, they are not fully recovered yet and that is why cost utilization is not fully loaded. We will continue to grow our areas. We still have the room to grow in our fab techs. In the Zetex, if you remember we shut down the four inch line and now we are trying to grow the six inch line. We actually authorized some capital improvements for which during the downturn last year and then we tried to balance that and so we authorized another year of equipment based on last year and tried to balance the line.

So we still have some more room and actually the capacity is still growing some until the second quarter. So that keeps some key pieces of equipment will be installed and delivered during 1Q and start production from Q2. So it starts from 2Q with even more capacity.

Steve Smigie – Raymond James

I was hoping you could talk a little bit about how you are thinking about guidance here in terms of how are turns this quarter in terms of your guidance versus what you did in Q4. You are pretty conservative in terms of how you guide. You beat the last couple of quarters, coming in at the high end of your range. Is it fair to say that you are behaving in your typical manner or are you more aggressive in the guidance this quarter?

Keh-Shew Lu

You know me, right. I am a little conservative. I prefer if we want to be surprised we would prefer a positive surprise than a negative surprise.

Operator

The next question comes from the line of Christopher Longiaru – Sidoti & Co.

Christopher Longiaru – Sidoti & Co.

M question has to do with the fact that a lot of my peers are concerned about inventory levels going forward. I wanted to know if there was anything you were seeing in the sales channels or any of the inventory channels that would lead you to believe there is an inventory problem or there is double ordering going on? What is your take on that?

Keh-Shew Lu

I will agree [inaudible] because I think in our speech we typically have a much higher inventory level than our December inventory. If you remember 2009 we actually hit 2.8 months and end of December of this year we were only at 2 months. I am not really concerned about the inventory our distributors have because this is our distributors build up some inventory in 4Q and then build up some more at the end of 1Q and then start to decrease inventories in 2Q and 3Q. Then they come back to build up again. So we are not concerned. From the double order point of view, our lead time is very short and so therefore there is no reason they keep us double ordered. I am not concerned. Diodes [inaudible] double order either.

Christopher Longiaru – Sidoti & Co.

The other question I have was on the gross margin line. You still have a bit more utilization to fill and I know you are going to spend money on the packaging side of that to get that up. What do you think your gross margin can go to at full utilization at this point?

Keh-Shew Lu

Our goal is always to try to get to 35%. That is our 35% GPM. That is our business model. I always let investors know we focus more on the GPM dollars instead of GPM percent. If you see our announcement most important is gross profit increased 83% over prior year quarter. So this is more important is gross profit instead of gross margin as a percent. Our direction for the company is growth as fast as we can such that your gross profit dollars will be continuing to grow at a much rapid rate. Our business model is 35% but I am not…if I get a growth opportunity I prefer growth instead of getting a percent higher.

Operator

The next question comes from the line of Stephen Chin – UBS.

Stephen Chin – UBS

First thing, in terms of the Shanghai back end packaging facility is that facility going to be normal Chinese New Year holiday shut down that it normally would? If it is, I am curious as to how you are able to meet the additional unit growth for Q1 along with the longer lead time you mentioned. Has that all largely been fulfilled during the January month and also the first part of February or is there additional unit growth you expect there in March to fulfill the overall demand you are guiding to?

Keh-Shew Lu

Number one, we do not really plan for the Chinese New Year shut down. February we are working on 26.5 and we only shut down for one day, for the Chinese New Year day and then put a half day for [inaudible] everything else so we see our capacity based on 26.5 days in February. What we actually do is we hire more people starting in December and January trying to build up more units at the same time, prepare for people who don’t return from Chinese New Year. Actually we do some more actions. We pay for the people willing to stay over the Chinese New Year and give them a bonus if they stay. If they for the whole Chinese New Year holiday nobody takes any vacation they get even more bonus. So we have taken a lot of actions to prevent any Chinese New Year slow down.

At the same time, you are right our capital equipment will come in which we authorized in the October/ November timeframe and they were installed and give us more capacity in the March month.

Stephen Chin – UBS

Since you are on Asia, is this approach to meeting some of the upside in demand in Q1 is this something that is somewhat more common this quarter as some of your customers and your peers from what you can hear out there?

Keh-Shew Lu

Well, I do stay here and talk to a lot of customers and a lot of peers. Right now everybody is asking for more shipments and everybody is very bullish. Again, very cautious and I think the picture won’t be clear until Chinese New Year and until March. If March continues the strength that we see then we will know what will be happening in the second quarter. I am very clear, that is why I am personally here and make sure if we see a sign then we will authorize more capital equipment because even until today we still have a month. I [inaudible] just ahead of the needs. I just need to understand in person what will be happening and especially…if the second quarter is weak I am not worried because then we will use it up in third quarter.

If the second quarter is very strong, then I need to prepare for the third quarter growth and even fourth quarter growth. Then I need to get more capital equipment. I just don’t want to lose the opportunity for growth by not investing enough.

Stephen Chin – UBS

On the product side, you mentioned earlier I think in terms of your Asia distributors they are building some strategic inventory. Are there certain products within the Diodes portfolio that they are building a little bit of inventory in or maybe perhaps end markets like…

Mark King

I think it is pretty broad based and I think our distributor inventory is customer specific so they have drained it down and they are trying to put it back in shape to go forward with their customer base. I think that we have also been able to position more of our USB switch product as well as more of our MOFSET product in positioning for some new design wins we expect to ramp in the coming quarters. Both inventories are specific for customers on a broad based level as well as some positioning due to design wins for ramp up in both Chinese New Year and early end of first quarter and beginning of second quarter ramps.

Stephen Chin – UBS

Related to set top box products and also related to TVs and other products that take your USB switches, is it fairly share gains or new customer design wins that helped drive that growth or are there also underlying upgrade cycles and product cycles that may be happening or maybe customers [are helping] to drive that growth. Can you help qualify how that would…where to go….

Mark King

I would say it is a little bit of all. Clearly as we grow, everything we grow in USB switch is a market share gain since we were a newcomer a year ago and as you saw when we talked about our revenue growth doubling in the quarter clearly we are taking share and we are making significant progress in that area. We are in our second and third generations of some notebooks or set top box with new products so I would say it is passing onto new units and new products into new units as well as just overall gains.

Operator

I would now like to turn the call back over to Dr. Keh-Shew Lu for closing remarks.

Keh-Shew Lu

Thank you for your participation. 2009 was sure a tough year for us but with our strong recovery efforts we actually grew 33%, 18% and 7% quarter-over-quarter and positioned Diodes at the possible record revenue setting quarter in this quarter. I think we are very pleased with the results of 2009 and looking forward to a good, strong 2010. Thank you very much for participating. Operator you may now disconnect.

Operator

Ladies and gentlemen that concludes today’s presentation. Thank you for your participation. You may now disconnect. Have a great day.

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Source: Diodes Inc. Q4 2009 Earnings Call Transcript
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