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Diodes Incorporated (NASDAQ:DIOD)

Q1 2014 Results Earnings Conference Call

May 08, 2014, 5:00 pm ET

Executives

Leanne Sievers - Executive Vice President Shelton Group Investor Relations

Dr. Keh-Shew Lu - President, Chief Executive Officer, Director

Rick White - Chief Financial Officer, Treasurer, Secretary

Mark King - Senior Vice President - Sales and Marketing

Analysts

Steve Smigie - Raymond James

Gary Mobley - Benchmark

Christopher Longiaru - Sidoti & Company

Tristan Gerra - Baird

Suji Da Silva - Topeka

Vernon Essi - Needham & Company

Vijay Rakesh - Sterne Agee

Shawn Harrison - Longbow Research

Liwen Zhang - Blaylock

Operator

Good afternoon, and welcome to Diodes Incorporated first quarter 2014 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, Thursday, May 8, 2014.

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

Leanne Sievers - Executive Vice President Shelton Group Investor Relations

Good afternoon, and welcome to Diodes first quarter 2014 financial results conference call. I am Leanne Sievers, Executive Vice President of Shelton Group, Diodes' Investor Relations firm. With us today are Diodes' President and CEO, Dr. Keh-Shew Lu, Chief Financial Officer, 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 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 projections as to the company's future performance represent management's estimate as of today, May 8, 2014. 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' website at www.diodes.com.

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

Dr. Keh-Shew Lu

Thank you, Leanne. Welcome everyone and thank you for joining us today. I am pleased to report first quarter revenue s essentially flat, which was better than our typical seasonal results. We also overcame the Chinese New Year slowdown, which included fewer working days in the quarter as well as the typical label shortages, by shipping from inventory that we have strategically built up last quarter. Also notable in the first quarter, we improved gross margin by 50 basis points sequentially and 320 basis point year-over-year. The increase was driven by improved wafer fab performance, especially at the BCD Fab 2 where the ramp-up is going smoothly, as well as an overall improvement in product mix.

We also continued to execute on cost control, we operating expense declining sequentially on a dollar basis and as the percentage of the revenue. Collectively, those factors contributed to 65% sequential improvement to GAAP net income of approximately $0.08 per share, which is significant when considering the flat is soft for the quarter.

Also during the quarter, we generated a significant amount of cash achieving approximately $46 million in cash from operations, including a $4 million reduction of inventory and the free cash flow of approximately $34 million including approximately $12 million of CapEx. As a result of our strong cash generation, we were able to reduce our long-term debt by approximately $17 million, which followed a reduction of almost $20 million last quarter, bringing our long-term debt to approximately $165 million.

As we look to the second quarter, we expect revenue to increase sequentially, highlighted by continued gross margin improvement as well as an ongoing commitment to cost control, driving further profitability and cash generation.

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

Rick White

Thanks, Dr. Lu and good afternoon, everyone. Revenue for the first quarter of 2014 was $210 million, a decrease of 0.5% from the $211 million in the fourth quarter of 2013 and an increase of 18.6% from the $177 million in the first quarter of 2013, which included one month of revenue from BCD Semiconductor. Revenue was essentially flat from the fourth quarter despite the Chinese New Year slowdown, which included fewer working days in the quarter as well as the associated workforce shortage.

Gross profit for the first quarter 2014 was $61.6 million or 29.3% of revenue, compared to the fourth quarter of 2013 of $60.8 million or 28.8% of revenue, and first quarter of 2013 of $46.2 million or 26.1% of revenue. The increase in gross profit margin was primarily due to improved wafer fab performance, especially at BCD Fab 2, combined with overall better product mix.

GAAP operating expenses for the first quarter were $47.2 million or 22.5% of revenue compared to $52.8 million or 25% of revenue in the fourth quarter of 2013 and $42.4 million or 24% of revenue in the first quarter of 2013. Non-GAAP operating expenses, excluding non-cash acquisition related intangible asset amortization costs, were $45.2 million or 21.5% of revenue in the first quarter of 2014.

Looking specifically at selling, general and administrative expenses. SG&A was approximately $32.3 million for the first quarter or 15.4% of revenue compared to $32.8 million or 15.6% of revenue in the fourth quarter and $30.4 million or 17.2% of revenue in the first quarter of 2013. Investment in research and development for the first quarter was approximately $12.9 million or 6.1% of revenue compared to $12.5 million or 5.9% of revenue last quarter and $10.1 million or 5.7% of revenue in the first quarter of 2013. SG&A plus R&D combined equaled 21.5% of revenue, which was comparable to the 21.5% last quarter and down 140 basis points from first quarter of 2013 at 22.9%.

Total other expense amounted to $1.4 million for the first quarter. We had approximately $1.3 million of interest expense and approximately $400,000 of interest income. Income before taxes and non-controlling interest in the first quarter of 2014 amounted to $13 million, compared to income of $6.3 million in the fourth quarter of 2013 and $4.3 million in the first quarter of 2013.

Turning to income taxes. Our effective income tax rate for the first quarter was approximately 19.6%, which was at the low end of our guidance of between 19% and 25%.

GAAP net income for the first quarter of 2014 was $10.2 million or $0.21 per diluted share, compared to fourth quarter of 2013 GAAP net income of $6.2 million or $0.13 per diluted share, and first quarter 2013 GAAP net loss of $1.9 million or negative $0.04 per share. The share count used to compute GAAP diluted EPS for the first quarter of 2014 was 48 million shares.

First quarter non-GAAP adjusted net income was $12.4 million or $0.26 per diluted share which excluded net of tax $1.6 million of non-cash acquisition related intangible asset amortization costs and $600,000 of retention costs related to the BCD acquisition. This compares to non-GAAP adjusted net income of $11.3 million or $0.24 per diluted share in the fourth quarter 2013 and $7.5 million or $0.16 per diluted share in the first quarter 2013. 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 the first quarter 2014 GAAP and non-GAAP adjusted net income was approximately $2.1 million, net of tax, non-cash share-based compensation expense. Excluding share-based compensation expense, both GAAP and non-GAAP adjusted diluted EPS would have increased by an additional $0.04 per diluted share in the first quarter.

Cash flow generated from operations for the first quarter 2014 was $46.1 million, which included a reduction in inventory by approximately $4 million. Free cash flow for the first quarter 2014 was $34.3 million, which included $11.8 million of capital expenditures and net cash flow for the first quarter was a positive $15 million, which includes the pay down of approximately $17.3 million on our long-term debt.

Turning to the balance sheet. At the end of the first quarter, we had approximately $212 million in cash and cash equivalents and $21 million in short-term cash investments. Working capital was approximately $495 million.

At the end of the first quarter, inventory decreased by $4 million to approximately $177 million compared to approximately $180 million at the end of the fourth quarter 2013. Inventory in the quarter reflects a $6 million decrease in finished goods and a $2 million increase in work in process and $200,000 increase in raw materials. Inventory days were 108 in the first quarter compared to 115 days last quarter.

At the end of the first quarter, accounts receivable was approximately $176 million, down about $17 million from fourth quarter. AR days were 80 compared to 84 last quarter. Our long-term debt totaled approximately $165 million.

First quarter capital expenditures were $11.8 million or 5.6% of revenue, which is at the low-end of our reduced CapEx spending target range of 5% to 9% of revenue. Depreciation and amortization expense for the first quarter was $19.2 million.

Now turning to our outlook. For the second quarter 2014, we expect revenue to increase to a range of $216 million to $229 million, or up 2.9% to 9.1% sequentially. We expect gross margin to be 30.5%, plus or minus 2%. Operating expenses are expected to be approximately 21.8% of revenue, plus or minus 1%. We expect our income tax to range between 19% and 25% and shares used to calculate EPS for the second quarter are anticipated to be approximately 48.2 million.

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

Mark King

Thank you, Rick, and good afternoon. During the first quarter, we experienced a rebound in Europe after a soft fourth quarter with North America also showing some strength. Distributor PLP was up 5% and inventory increased 7.4%, following a 6.5% decrease in Q4 as distributors began rebuilding inventory, indicating a more positive outlook for 2014. OEM sales were down 10% as expected and distributor POS was down 5.2% after stronger than expected Q4 up 2%. Global channel inventory is healthy and in line and remains under three months.

In terms of our end markets, consumer represented 34% of revenue, communications 22%, computing and industrial were 20% each and automotive was 4%. Our strongest markets in the quarter were the automotive and industrial markets largely offset by softer conditions in the computing and communication markets. However these markets are expected to strengthen in the second quarter.

Turning to global sales. Asia represented 80% of revenue, North America 10% and Europe also 10%. Design activity remained strong across all regions and product lines. We have a solid pipeline of design wins as a result of expanded product portfolio and customer engagements from cross-selling opportunities with BCD. Our new LED drivers for bulb replacement and AC/DC products acquired from BCD continue to gain traction in the quarter. In fact we achieved a record revenue quarter for AC-DC products as well as LED lighting and protection devices. We also had a very strong revenue quarter on load switches, DBS products and bipolar transistors.

Throughout the first quarter, Diodes continued to execute our strategy of expanding broad-based product offerings aimed at diverse range of markets and applications. On the discrete side, we released 116 new products across 23 product lines including additional products aimed at improving energy efficiency in high volume applications such as LED TVs, set-top boxes, smartphones, tablets, as well as power adapters and wireless charging.

Diodes also substantially increased its range of products designed and characterized for the fast-growing automotive electronic segment, including expanded families of MOSFETs, rectifiers and DBS products. During the quarter, we continued to make strides towards advancing our technology and manufacturing innovation on new products.

One example of this was our efforts to aggressively expand our product portfolio based on our proprietary trench SBR technology. This platform provides designers with a Schottky rectifier alternative that helps meet the efficiency requirements and space constraints of next-generation adapters and charger applications. We expanded our trench SBR technology portfolio to a voltage range from 40 volts to 100 volts with a current range from three amps to 25 amps. Two products were launched specifically for wireless charger applications and the power adapter market, which are markets which we are gaining significant traction and content.

Another example relates to our new state-of-the-art split gate process. Last quarter, I had mentioned that Diodes had reached a milestone with the launch of our first 60 volt MOSFET developed using the split gate process. To further expand this product family, during the first quarter we released 30 volt and 80 volt process variance. These products enable high-power density switching package in small form factors reaching very low Rds(on) and balance gate charge. In the same innovative package, we released another product that shows industry-leading Rds(on) performance. These products significantly improve power efficiency and are ideally suited for a range of demanding consumer, computing, telecommunications and industrial applications.

Turning to analog. We had a very strong quarter on new product releases with 83 new products across seven product lines. In support of the consumer products market, we released a family of high efficiency synchronous four amp and five amp DC-DC converters. These devices operate at a high efficiency across light load and full load conditions, making them well-suited for distributed power architectures in large-scale consumer products including TVs, set-top box and gaming consoles.

For the portable market specifically, we are receiving strong customer interest for our newly released filterless Class D audio amplifiers. This product's high-efficiency and miniature footprint make these devices attractive for battery-powered applications such as wireless speakers.

For the communications market, our new analog product consisted of our recently released LVC and AUP single gate logic families in one of the world's smallest logic packages ideally suited for use in smartphones. We also offer these products in a package that is footprint compatible to chip scale devices, but more robust and at more attractive price points than chip scale alternatives.

For cell phone chargers and adapters, we released a low-cost secondary side synchronous rectifier with built-in MOSFETs that offer improved power efficiency and better thermal performance than traditional solutions. In addition, we also introduced a high performance AC-DC power supply controller for chargers and adapter applications that achieve excellent regulation at high average efficiency.

Our AC-DC product line continues to see very strong market acceptance with 16 major wins for cell phone charger and adapter applications across 10 different customers. In addition, we secured several large wins with communication customers for our low voltage DC-DC converters for WiFi module as well as Hall sensor adoptions in cell phone and smartphone platforms.

During the first quarter, we continued to expand our family of LED drivers for use in bulb replacement and general lighting applications. For the industrial market, we released a 60 volt DC-DC converter specifically designed to meet the demands of dimmable MR16 LED lamps as well as single phase, brushless DC motor controller for fans and blowers.

In summary, we are pleased with our above seasonal results in the first quarter, which further demonstrate our operating leverage in our model and our ability to grow profits and generate cash. We continue to increase our content at existing customers with our expanded product portfolio while leveraging our innovative manufacturing and packaging expertise. Diodes once again secured impressive design wins across portable, consumer, computing, automotive and industrial applications and continues to deliver a consistent stream of new products to ensure further growth in these markets.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Steve Smigie from Raymond James. Your question, please?

Steve Smigie - Raymond James

Great. Thanks a lot. I appreciate the opportunity to ask the questions. Just first, looking at gross margin, it looks like you got some nice leverage in the quarter here and guiding for some continued improvement. As we think about that here and going forward, if we were to assume seasonal revenue patterns, given your general thoughts on the decent environment here, should we expect we can continued to see pretty decent gross margin leverage for the rest of the year?

Dr. Keh-Shew Lu

Steve, the answer is yes. We now carefully adjust our product mix and you can see the 1Q, the Renminbi is about the same and actually the manufacturing output due to the Chinese New Year, due to the labor shortage, we are able to improve the gross margin, majority of it really coming from product mix and so we continue when the market is getting better and we will continue working on our product mix.

Another thing is, we are careful to expand our capacity. You can see we changed our capital expenditure original amount from 10% to 12% to 5% to 9%. It just indicates that we are carefully expand our capacity such that we can control our product mix. So we should continue to benefit on the GPM percent point of view.

Steve Smigie - Raymond James

Great. Thanks a lot. And then the revenue seems like it's done pretty well here as well. Also you had a decent guide. I think you did better than seasonal. As we think about the trends you guys seem to be to introducing a lot of new products plus the market seems pretty decent, so is it fair to think that we are in an environment where doing, at least seasonal, is as likely?

Dr. Keh-Shew Lu

I would like to say, my answer is yes, but then my crystal ball is just similar to you. Nobody can really talk about looking beyond the second quarter, but the market feels pretty good. Well, I want to say, it's (inaudible) than our expected. Okay, so that's all I can say, but I think I hope this year is going to turn out to be a reasonable year. But we don't know, maybe wake up next day, it could be a different story. But so far I think the management team feels quite exciting.

Steve Smigie - Raymond James

Okay. That sounds great. And then if I could sneak one more in. Just on the AC-DC adapter. It sounds like you guys are picking up to some DC share in that market. I guess as we look at that market, maybe over the next year, something maybe close to two million phones are going to ship globally, how much of the market that your picking up is traditional chargers and how much you guys are thinking about getting involved in the fast charger market?

Dr. Keh-Shew Lu

Well, the majority is actually still traditional AC-DC traditional chargers. I don't think the fast charger is really ramping up yet. Okay. We are here and we participate on that and we have the product to address the market, but I don't really think in the market really pick it up, especially if you go look at the 5 watts cell phone, really that market then really going strong and the reason is, people can spend. You take a one hour or so is good enough to charge the whole thing then people may not want to spend the money for it. So it's more on the high power type of application like notebook or like tab: Those kind of application may use it. But if you go talking about (inaudible) then regular cell phone, since the charging time is not that long, people may not necessarily willing to pay for it. So we don't see that market really picking up that strong.

Steve Smigie - Raymond James

Okay. Great.

Dr. Keh-Shew Lu

But Diodes do participate. Diodes do have the product from discrete, from analog point of view, we do have a product participate in this market.

Steve Smigie - Raymond James

Okay. Great. Thanks a lot. I appreciate it.

Dr. Keh-Shew Lu

Thank you.

Operator

Thank you. Our next question comes from the line of Gary Mobley from Benchmark. Your question, please?

Gary Mobley - Benchmark

Hi, guys.

Dr. Keh-Shew Lu

Hi, Gary.

Gary Mobley - Benchmark

Congrats on a very good execution in the quarter. Here we sit in the, almost the dead point in the quarter, and your second quarter revenue guidance range is about $13 million. At this point in the quarter, what do you see as the difference between hitting the lower end of the guidance range and hitting it at the high end of the guidance range?

Dr. Keh-Shew Lu

Well, this is very difficult for me to answer. We just announced the guidance and so we are not going to change from that guidance. I just came back from Asia and the reason when I look at it, consolidate everybody's input and we put a pretty good guidance. We believe we can hit it. So very difficult for me now to say that guidance is going to be one way or the other, change it.

Gary Mobley - Benchmark

Okay, fair enough.

Dr. Keh-Shew Lu

We stick to that guidance.

Gary Mobley - Benchmark

All right, fair enough. I am looking here at your estimates as a percentage of sales, your depreciation and your CapEx to sales, the difference this quarter was about 350 basis points. That's the biggest difference on a quarterly basis, plus I have been measuring to stats. And then as well, you are guiding for a long-term CapEx as a percentage of revenue 5% to 9%, the midpoint is 200 basis points below what your depreciation as a percentage of sales. So should we think about a 200 basis point benefit to gross margin as the CapEx and the depreciation converge over time?

Dr. Keh-Shew Lu

Well, you know the depreciation take five years or even longer. So when you do the reduce, we started from last year we reduced the capital expenditure but it won't reflect right away on the depreciation. It takes time to gradually reflect that depreciation on that cap expenditure reductions. Okay. So this year is the second year we try to do it and we just started from last year. So you won't see that impact for several years down the road.

Gary Mobley - Benchmark

Thanks very much. I appreciate it.

Rick White

Basic answer to your question is that over time you will see this difference between the 10% to 12%, and the 5% to 9% because it's just less expenditure and less cost, right.

Gary Mobley - Benchmark

Okay. Understood. Could you give us an update on where you stand with front ended integration between BCD and Diodes? How far along you are in moving BCD production at Fab 2? And how far along you are in bringing Diodes production into the existing Fab 1?

Dr. Keh-Shew Lu

Well, number one, the integration went very smoothly and you can see we are talking about our gross margin improvement in 1Q was due to one of the reason due to the Fab 2 ramp up smoothly. So integration is better than expected. Okay.

Now for the Fab 2, they have two limitation. One is equipment capacity. One is the clean room capacity. And if you look at the Fab 2, they do not put it fully equipped to die capacity. Okay. So we ramp it up to the equipment capacity, probably one more quarter on this quarter, right. In the second quarter, we should be go to equipment fully loaded capacity. Okay.

But that means, then the next step we will put in some more capital to make sure it is cost effective using that wafer fab. But that will be when the market started getting warmer and demand start to increase, then we will start putting more capital for that clean room capacity.

Gary Mobley - Benchmark

Okay. All right. Thanks for taking the questions. That's it for me, guys. Thanks.

Operator

Thank you. Our next question comes from the line of Christopher Longiaru from Sidoti & Company. Your question, please?

Christopher Longiaru - Sidoti & Company

My congratulations, nice quarter.

Dr. Keh-Shew Lu

Thank you, Chris.

Christopher Longiaru - Sidoti & Company

I have a couple of questions. First just kind of breaking down the integration, there were two parts of that integration. I think you mentioned last time, one was just integrating the production itself and one was training the personnel. Could you comment on just what progress you have made on each of those fronts since the last quarterly conference call?

Dr. Keh-Shew Lu

Okay. We qualify most of the BCD product into our assembly site. That we have already done. But some of them, we are waiting for the major customer approval. We do not have all of the major customer approval yet.

Christopher Longiaru - Sidoti & Company

Okay.

Dr. Keh-Shew Lu

Probably one more quarter or maybe longer to get all the customer, the key customer, make their customer approval. But from qualification point of view, whatever we want to move things, we already, almost done.

Christopher Longiaru - Sidoti & Company

Okay.

Dr. Keh-Shew Lu

Okay. Now, the critical move in, we do run into some of the, not all the packaging, but some of the package started getting tighter. So we sometimes we are not moved in. okay. So customer approval is the limitation. The move in due to some of the package we are not, we don't have enough capacity, we don't move in. So we are not fully utilized that synergy yet.

Christopher Longiaru - Sidoti & Company

Okay. That is helpful. And just on your visibility relatively into the quarter and how it trended over the course of the quarter. Can you comment on it? It sounds like it's getting better but I just want to ask the question.

Dr. Keh-Shew Lu

Like I said, we just mentioned it. We feel second quarter is warmer and is follow the seasonality and that's why we give the guidance and we have confidence, we will be meeting the midpoint. That's why we give the guidance.

Rick White

Yes, obviously March was better than February because of the Chinese New Year, but I think that there has been strong momentum as the second quarter's progress.

Christopher Longiaru - Sidoti & Company

Okay. That's helpful. Okay, guys. That's all I have. Thank you very much.

Dr. Keh-Shew Lu

Thank you

Operator

Thank you. Our next question comes from the line of Tristan Gerra from Baird. Your question, please?

Tristan Gerra - Baird

Hi. Good afternoon. You mentioned at the beginning of the Q&A that you are carefully adjusting product mix. It seems to me and correct me if I am wrong, that you haven't don't that in a while. Typically that's a sign that you finally see utilization rate picking up enough that you can actually start playing with mix, and as such that's very encouraging. Could you perhaps help us quantify the gross margin upside that will result on the higher utilization rate versus how much mix can help over the next (inaudible) quarter assuming that and demand continues to pick up? Because I think that years back you had a downward adjustment in gross margin driven by mix as demand was weakening, so conversely now we should see a nice benefit that going forward on this. If you could perhaps help us quantify that?

Dr. Keh-Shew Lu

Number one, if you look at 1Q revenue versus 4Q revenue, it's almost there, understand. It is only 210 versus 211. So it's really a part of stand. But the manufacturing cost is actually slightly higher in 1Q versus 4Q because of the Chinese New Year, because of the shut in working day, and we really need to spend more overtime to doing it and then 4Q, we expect actually produce more. I think in older speech, you can see, we ship out from the inventory because we know 1Q is going to be slowdown, obviously the manufacturing is going to be slowdown. So we keep some inventory and so from that you can see the manufacturing cost is actually higher than 4Q but we are able to change the GPM, it actually improved 50 basis point. So from there you can see major reason and I think we are talking about that but one of the major reason is product mix change. So I know, mix dependent is actually ASP is a positive. Okay. We still have traditional mix independent ASP true up but it is actually we have seen better than our expectation, but that is mix dependent is actually a positive, ASP is positive. So we are very happy with the product mix adjustment.

Rick White

And I wouldn't say that this is a sudden mix change. I think we been subtly changing the mix over the last four to five quarters and it continues. So I think you will just see, we were not shocking the market with the change. But as we change the CapEx model, the mix is required to change. But this has been going on for several quarters.

Tristan Gerra - Baird

Okay. Thank you for the feedback. And then looking at BCD, any way you can quantify where we stand in terms of Fab 2 that you mentioned. It has been progressing better than expectation. How much positive contribution the continued ramp is actually will bring to gross margin? In other words, are we half-way there or are we most of the way there?

Dr. Keh-Shew Lu

Well, like I said, if you look at the Fab 2, because the equipment capacity is not very cost effective yet. Okay. Like I say, clean room capacity is a good, but because we don't put enough capital, yet to fully occupy that clean room, therefore the equipment capacity, even when fully loaded still not very cost-effective. That's why I said, by this quarter, we probably will be fully loaded to the equipment capacity then our next step is to fill out how much more and we will start to put in some more capital to increase that capacity gradually until the whole space was fully utilized, our clean room is fully utilized. We believe when we get there, that will be very cost effective. So if you as me today, it's probably still, we are a negative ourselves of the GPM. I think last year, we talk about the status, 1.3% or something, 120, 130 basis points and so we already know it improved but that is still not 100% helping us from that point of view, but it is getting there.

Tristan Gerra - Baird

Great. Thank you very much.

Operator

Thank you. Our next question comes from the line of Suji Da Silva from Topeka. Your question, please?

Suji Da Silva - Topeka

Hi, guys. Nice job on the gross margin execution here.

Dr. Keh-Shew Lu

Thank you, Suji.

Suji Da Silva - Topeka

The analog and discrete segments, which one do you think provides to the higher mix driven gross margin opportunity for you in the next three quarters?

Mark King

I think there is equal opportunities. I think we are improved. Probably there is more adjustment in the mix on the discrete side, but the product on both sides have the opportunity.

Dr. Keh-Shew Lu

It is about similar.

Mark King

Very similar.

Suji Da Silva - Topeka

Okay. Great, and then you talked in the prepared remarks about computing and communications being stronger in 2Q 2014. Is that simply seasonal recovery? Or are there segments that you are doing better? Any color there would be helpful. Thanks.

Mark King

I think we continue to do well in both segments but I think it would be seasonal recovery.

Dr. Keh-Shew Lu

Yes, and it is a U.S., European market. So U.S., European is more in automotive and industrial, and China market typically is in consumer. So if you are getting stronger on the U.S., Europe market, then you will see the automotive industrial improvement.

Suji Da Silva - Topeka

Okay. That's great. Last quick question. What do you think on pricing relative to the goal to 3% quarterly declines?

Dr. Keh-Shew Lu

Typically, our motto is less than 2% a quarter mix independent. Mix independent, we typically talking about 1.5% to 2%, somewhere around there as a typical.

Mark King

I think we would expect the pricing environment to firm up a little bit going into the third quarter.

Dr. Keh-Shew Lu

Yes. If market continues getting harder, then you will see some stability of the price.

Suji Da Silva - Topeka

Okay. Great. Thanks, guys.

Operator

Thank you. Our next question comes from line of Vernon Essi from Needham & Company. Your question, please.

Vernon Essi - Needham & Company

Thank you very much. I was wondering if you could just dive into the computing side a little more. I don't know if this is sort of a response to the mix question earlier, but it looks like you it are going to have a pretty close comp year-over-year for the calendar 2014 timeframe. I am trying to understand, are you perhaps moving away from this market a little bit because it does seem to be a little lower than I would have expected, especially relative to some of your peers that have already reported on this earnings season. Can you just discuss that a little more?

Mark King

I would say that we are doing a little bit of shift in our product mix there and we are focused on maybe some different opportunities within that segment. But I wouldn't say it's a dramatic change.

Vernon Essi - Needham & Company

Is it fair to say that it has gotten more competitive, possibly, in sort of the areas where you have traditionally been?

Mark King

It's a very solid commodity-base there that isn't as interesting as it always has been.

Vernon Essi - Needham & Company

I hear the chocolates in the background there. Okay, and then if I could just move over to another segment there. Obviously doing much better on a relative basis at least in dollar terms in automotive. Where specifically are you seeing the most traction, from an application standpoint in that market? And you usually when you get design and these things are very hard for you to lose those sockets, can you characterize the potential growth rate of that going forward over the next, say, two years? How do you see that shaping up?

Mark King

Well, we see it as a very important market going forward for us. We have opened an automotive BU within our organization. It's operating within all of our other business units. We are very focused in some certain product lines, our SBR products, our MOSFET products and our protection products. We think we want to get a very, very distinctive solid product line that we are going to focus on those areas. I would say, the application base is quite diverse. We are in lighting, we are in all of the inside chimes and bells and everything. So we are pretty diverse in where we are within the automotive market. But we consider it a pretty important product area for us going forward and we think our product is developing quite well for that market place.

Dr. Keh-Shew Lu

I don't know, do I mention to you before or not, but in last September, we actually officially formed automotive business unit to focus our people to drive the growth in automotive area because we believe that in the future, this is very important market segment for us. So you can see we gradually change our percentage from 3% to 4%. We start to pay attention and we will start to focus some of our effort in automotive business.

Vernon Essi - Needham & Company

Okay, and just remind me again, I apologize if you have already said this, are you getting most of the traction initially in the European market there or is this pretty much global to all the different geographies in automotive?

Mark King

Clearly, the European market, followed by the North American market and really hitting 4% was a very strong Europe and a weaker Asia. So it's going to take us a while to get that percentage rate towards 4% or 6% or 10%. So it could be back to 3% next quarter. Okay. It's not as fast growing and so as we start to ramp into the communication segments and the computer segments, again it may impact that. But our progress in that marketplace and our direction in that marketplace is very clear.

Vernon Essi - Needham & Company

Okay. That's hopeful. Thanks a lot, guys.

Dr. Keh-Shew Lu

Thank you.

Operator

Thank you. Our next question comes from the line of Vijay Rakesh from Sterne Agee. Your question, please?

Vijay Rakesh - Sterne Agee

Hi, guys. Nice look on the gross margin. I have a question. When you look at the BCD side, what are the fab utilizations in December and March quarter there? As you fill out the fab with equipment, where do you see BCD Fab 2 utilizations, let's say, exiting 2014?

Mark King

Hang on just a second. So Fab 1 was about in the 80% range and Fab 2 was a little less than full equipment utilization.

Vijay Rakesh - Sterne Agee

And this I am talking about BCD now. So what was the BCD utilization in March quarter and how do you see that as you start to fill that out exiting the year?

Mark King

This is just what I said. Fab 1 in BCD is about 80% and then Fab 2 was a little less than full equipment utilization.

Vijay Rakesh - Sterne Agee

Got it. Great. Okay. Going to the mix, obviously nice improvement of the mix there. It looks like industrial and comm mix went up nicely year-on-year. How do you see that mix as you exit the year? Obviously slower growth, but it looks like you guys are improving that pretty nicely and steadily. But how do you see that mix exiting 2014? Thanks.

Mark King

Well, the industrial going up in the first quarter was significant because of strong North American, European growth in the quarter. So as long as those marketplaces remain strong, our industrial will strong. But again, as we move in to the later part of the year with computer and computing. Excuse me. Computing and communications ramp, those percentages may suffer a little bit just based on size or scale. But I think we are strong. Again our product mix in our discrete side and in the analog side are growing for the industrial market and automotive market rapidly.

Vijay Rakesh - Sterne Agee

Okay. Great. Thanks.

Operator

Thank you. Our next question comes from the line of Shawn Harrison from Longbow Research. Your question, please?

Shawn Harrison - Longbow Research

With the increase in OpEx on a dollar basis into the June quarter, where will most of the fall into SG&A?

Rick White

Hand on just a second. Couple hundred thousand in R&D and the rest in SG&A.

Shawn Harrison - Longbow Research

Okay. Second, I wouldn't really expect probably cash flow generation to be strong in the second quarter as it was in the first but it still should be good. Where should we expect the cash to be deployed? More debt reduction or just let it build?

Rick White

No. We are going to be both. We think that the cash flow is going to be pretty good in the second quarter. We are going to continue with the CapEx limitations and we are going to pay down the debt. If the cash can get in the right place, we will pay down the debt.

Shawn Harrison - Longbow Research

Okay, and then finally just I think you have covered a lot of this, but the point-of-sale versus point-of-purchase dynamic during the March quarter, it diverged. Is it in line here during the second quarter, where you are seeing POS match POP so far?

Mark King

Yes.

Shawn Harrison - Longbow Research

Okay. Do you expect it to see any inventory build, Mark, as the quarter goes on or just continue in this similar fashion?

Mark King

I think we will see a little bit of build in this quarter in anticipation of next quarter. And I think that some, we had a pretty big reduction at the end of last year and our inventory was at very, very low point at the end of last year, but I think a few people feel a little bit short and see a lot of opportunity that's going to be made available for our competitors. So I think there is some people opportunistically building a little bit of inventory. So I think we will see some build and we expect further ramps in the third quarter in certain areas. So I think that you will see a little bit of build. I don't think it will be dramatic.

Shawn Harrison - Longbow Research

Okay. Thanks very much. Congrats on the quarter, guys.

Mark King

Thank you.

Operator

Thank you. Our next question comes from the line of Liwen Zhang from Blaylock. Your question, please.

Liwen Zhang - Blaylock

Thank you for taking our question. Congratulations on solid results. You haven't talked about your Chengdu facility for a while. Would you mind to give us some update and your plans on that Chengdu facility? Thank you.

Dr. Keh-Shew Lu

Okay. Chengdu facility, right now we are trying to connect to do the power. We already have the government approval and they going to start building the power to right point and then we will connect from the right point to our building. So right now we have been approved. We are working with the government for the building approval. Then after that, we will get people bid on it and then we will start the construction. But number one, the power. At the same time right now we have finalized our Murphy and we already approved the Murphy and finalized the spec for the Murphy. After that's finalized, we will start the construction, the Murphy, the clean room.

Rick White

Murphy is the acronym we use for clean room, air conditioning, those kinds of the manufacturing facilities related expenditures.

Dr. Keh-Shew Lu

And then after that, we will have the equipment on the order. So we are waiting for the equipment coming. So after the clean room is done, then we can put he equipment. We are hoping we can start production somewhere in August and September timeframe.

Liwen Zhang - Blaylock

Okay. Got it. And thank you for such details. Really helpful for me to understand. Another thing, just to clarify, Dr. Lu, I know when you answered the question about the integration asked by an analyst previously, you mentioned packaging constraints even though some packaging, BCD products is being approved by customer. Is that right?

Dr. Keh-Shew Lu

What I said is, first, we all call it, the one we want to move in, we will qualify. Now we do the PCM products into notice. Okay. And therefore, the major customer typically after the PCM you will need wait in for their approval. Now if its not a major customer, we separate into A, B, C, and A is a major customer, but not major customer, then you notify them. You can convert. And we are during in the process. Okay. But some of the limited packaging, some of them we do have a capacity issue because the market is getting stronger and equipment lead time and so we are not moving, most of them we are not moving inside Diodes facility yet. Okay.

Liwen Zhang - Blaylock

I see. Got it. And what is the lead time right now?

Dr. Keh-Shew Lu

What lead time?

Mark King

Product lead time?

Liwen Zhang - Blaylock

Yes. Product related lead time. Yes.

Dr. Keh-Shew Lu

No. I talk about equipment lead time. We are not talking about, lead time is the equipment lead time. Not our own product lead time.

Liwen Zhang - Blaylock

Okay, and how about your product lead times? Do some of your products get stretched because of the packaging capacity issue?

Mark King

Packages are always coming in and out. When you talk about capacity, we may within a month or within a month's period we might see a major upside where we need to make a slight adjustment on something. So it requires a little bit there. So we run up against certain points in our capacity at different times. I don't think we see, there is a stretching of the industry lead times and we are seeing a solid market. So the lead times maybe running on the longer end of the things, but I don't think anything dramatic is occurring at this point.

Liwen Zhang - Blaylock

Okay. Thank you. That's all I have.

Dr. Keh-Shew Lu

Thank you.

Operator

Thank you. This does conclude the question-and-answer session of today's program. I would like to hand the program to Dr. Keh-Shew Lu for closing comments.

Dr. Keh-Shew Lu

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

Operator

Thank you, ladies and gentlemen, for your participation in today's conference.

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Source: Diodes' (DIOD) CEO Dr. Keh-Shew Lu on Q1 2014 Results - Earnings Call Transcript
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