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Diodes Incorporated, (NASDAQ:DIOD)

Q4 2010 Earnings Call

February 9, 2011 5:00 p.m. ET

Executives

Leanne Sievers – IR, Shelton Group

Keh-Shew Lu – President and CEO

Rick White – CFO, Secretary and Treasurer

Mark King – SVP, Sales and Marketing

Laura Mehrl – Director of Investor Relations

Analysts

Ramesh Misra - Brigantine Advisors

Steve Smigey - Raymond James

John Venn - Collins Stewart

Shawn Harrison – Longbow Research

Gary Mobley – Benchmark Capital

Harsh Kumar – Morgan Keegan

Vijay Rakesh - Sterne Agee

Brian Piccioni – Capital Markets

Suji De Silva - ThinkEquity

Steven Chin - UBS

Operator

Good afternoon and welcome to the Diodes Inc. fourth quarter and fiscal 2010 financial results conference call. (Operator instructions) As a reminder this conference call is being recorded today, Wednesday, February 9, 2011. 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 fourth quarter and fiscal 2010 earnings conference call. I am Leanne Sievers, Executive Vice President of Shelton Group, Diodes' Investor Relations firm. With us today are Diodes' President and CEO, Dr. Keh-Shew Lu; Chief Financial Officer, 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 projection as to the company's future performance represent management's estimate as of today, February 9, 2011. 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 net income to non-GAAP adjusted net income, and GAAP net income EBITDA which provide additional details. Also, throughout the company's press release and management statements during this conference call, we refer you 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 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.

Ken Shew Lu

Thank you, Leanne. Welcome everyone, and thank you for joining us today. I'm pleased to once again report another historic quarter in the year of profitable growth of Diodes. We continued to experience strong demand for our products across all of our world-wide markets. Filled in by the continued ramp up of previous design wins and the customer acceptance of our new product portfolio in 2010, we achieved record results which underscore the successful execution of our profit and growth model as we emerged from the 2009 long term as stronger company. This accomplishment was further highlighted by our seventh consecutive quarter of sequential revenue growth and our 20th consecutive year of profitability.

The diversity of our end market and the geographic exposure provide us the flexibility to shift our focus to the product areas of all regions so we can maximize our growth and profits. For example, even though notebooks may be experiencing slow growth in the US, we also participate in the fast-growing tablets market. For we are achieving (inaudible) can grow and the market penetration. Additionally, all industry estimates indicate that US consumer and computing markets may be slowing, those end markets are experiencing higher growth rates in Asia which is a region where we have over 70% of our revenues.

Likewise, during the middle to late part of 2010, we were able to focus on European and North American markets to take advantage of the related strengths in those regions which contributed to our positive growth. I believe that it is this flexibility and the diversity of our business model that allows us to achieve better-than market growth rates and a richer product mix. This strategy has been consistently successful for Diodes and our shareholders. We plan to continue to execute on this strategy for years to come.

In regard to the fourth quarter, we generated a record gross margin of 38.3% primarily due to the benefit of our improved product mix, our aggressive cost reduction, as well as efficiency at our manufacturing facility. As I have stated in the past, our model rate continues to be in the 35% range, but we always strive to improve our gross margins in support of our profitable growth strategy. We will always seek ways to gain more profit dollars when and where we can without sacrificing revenue growth.

Our accomplishment in 2010 has established a strong foundation for continued growth momentum in 2011. We remain positive of our outlook due to our design win situations, highly successful new product initiatives and additional opportunity to capitalize on Zetex growth (inaudible) and synergy. Although typically a slow period, our current environment appears to be exceeded in stronger seasonal demand than in the previous first quarter. We are increasing assembly test equipment capacity in the first quarter, but our manufacturing output is being affected by reduced (inaudible) cost by China's labor shortage, fewer working days, and the Chinese New Year in February. As such, we are guiding revenue for the first quarter of 2011 to be flat to down 5 percentage point with fourth quarter 2010.

In closing, I would like to emphasize that our record result and consistent execution reflects Diodes' continued commitment to achieve growth rates that exceed our addressable market. Our future growth will be driven by securing greater market share in key launching additional products in new markets, and the leveraging of broader portfolio to maintain a high level of design wins, including an increasing contribution from our newly released stand (inaudible)products. With that, I will turn the call over to Rick to discuss our fourth quarter financial results and the first quarter guidance in more detail.

Rick White

Thanks, Dr. Lu and good afternoon, everyone. As Dr. Lu mentioned, revenue for 2010 was a record $612.9 million. A 41.1% increase over the $434l4 million in 2009. For the fourth quarter, revenue was $163.8 million, an increase of 25.8% over the $130.3 million in the fourth quarter of 2009, and a moderate sequential increase over the $163.1 million in the third quarter of 2010.

Gross profit for 2010 was a record $225 million, increasing $104 million or 86% from 2009. Gross margin increased 880 basis points over 2009 to 36.7% primarily due to benefits from our cost reduction initiatives, high operational performance, and utilization of our Wafer Fabs. Record output at our packaging facilities and favorable product mix related to our new product initiatives.

For the fourth quarter, gross profit was $62.6 million, or 38.3% of revenue, compared to $48.1 million, or 32.1% of revenue in the fourth quarter of 2009, and $61 million, or 37.4% of revenue in the third quarter of 2010. Gross margin was above our model rate of 35% due to our factory's running at maximum production and efficiency as well as continued improvements in product mix. Packaging capacity from our China facilities increased 3% sequentially in the fourth quarter to 6.3 billion units. We expect equipment capacity to increase approximately 4% in the first quarter, but total output will down approximately 9% due to reduced equipment utilization because of the recent China labor shortages in the coastal regions coupled with fewer working days and the Chinese New Year holiday in February.

Total operating expenses for the fourth quarter were $30.4 million, or 18.6% of revenue, an improvement from the 19.1% of revenue last quarter and in line with our expectations of a 50-100 basis point sequential decline. Looking specifically at selling, general, and administrative expenses for the fourth quarter, SG&A was approximately $23.1 million, or 14.1% of revenue, which is in line with the $22.8 million, or 14% last quarter.

Investment in research and development for the fourth quarter was $6.2 million, or 3.8% of revenue compared to $7.2 million, or 4.4% of revenue in the fourth quarter. Total other expense amounted to $1.1 million for the fourth quarter. Looking at interest income and expense, we had approximately $260,000 of interest income and approximate $900,000 of interest expense, primarily related to our convertible senior notes.

During the fourth quarter of 2010, we recorded approximately $1.9 million of non-cash amortization of debt discount related to the US GAAP requirement to separately account for a liability and equity component of our convertible senior notes. Also included in total other expense was approximately $1 million of income from forgiveness of debt from one of our Asian subsidiaries.

Income before income taxes and non-controlling interest in the fourth quarter, amounted to $31.1 million compared to income of $11.4 in the fourth quarter of 2009, and income of $27.4 million in the third quarter of 2010.

Turning to income taxes, our effective income tax rate in the fourth quarter was 19.7%, which was at the low end of our revised guidance range of 20-24%. GAAP net income for the full year of 2010 was $76.7 million, or $1.68 per diluted share, compared to $0.17 per diluted share last year, and, as Dr. Lu mentioned, represented our 20th consecutive year of profitability.

Non-GAAP adjusted net income for the year was $1.82 per diluted share. For the fourth quarter, GAAP net income was $24 million or $0.52 per diluted share, compared to fourth quarter of 2009 net income of $14.2 million, or $0.32 per diluted share, and third quarter of 2010 net income of $21.2 million, or $0.46 per diluted share. The share count used to compute GAAP diluted earnings per share for the fourth quarter was 45.9 million shares.

Fourth quarter non-GAAP adjusted net income was $25.3 million, or $0.55 per diluted share which excluded net of tax $1.5 million of non-cash interest expense related to the amortization of debt discount on the convertible senior notes, $900,000 of income from forgiveness of debt, and $800,000 of non-cash, acquisition-related, intangible asset amortization costs.

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 fourth quarter GAAP and non-GAAP adjusted net income was approximately $2.1 million, net of tax, of 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 from operations from the fourth quarter was $28 million, net cash flow was $7.1 million, and free cash flow was $5.5 million. For the year, cash flow from operations was $118 million, net cash flow was $28.9 million, and free cash flow was $29.2 million.

Turning to the balance sheet, at the end of the fourth quarter, we had $271 million in cash. Our working capital at quarter end was approximately $289 million. In the fourth quarter, our convertible senior notes, which are redeemable in October of 2011 were categorized on our balance sheet as a current liability and amount to approximately $128 million.

At the end of the fourth quarter, inventory was approximately $121 million, an increase of $8 million from the third quarter. This increase was due to a $2 million increase in raw materials, $4 million increase in work in progress, and a $2 million increase in finished goods. Inventory days were 104, compared to 95 days in the third quarter of 2010.

Accounts receivable was approximately $129 million and AR days were 69. Capital expenditures were $14.4 million during the fourth quarter, or 8.8% of revenue compared to 15.2% of revenue in the third quarter. For the full year 2010, CapEx totaled $86.6 million for 14.1% of revenue, which was above our model level of 12% due to reduced CapEx in 2009.

Our investments in capacity expansion at our packaging facilities allowed us to achieve record output during the year while also further supporting our growth in 2011. We expect CapEx for 2011 to be back to our targeted range of 10-12% of revenue. Depreciation and amortization expense for the fourth quarter was $14 million.

Turning to our outlook. In terms of first quarter guidance, we are increasing assembly test equipment capacity in first quarter but our manufacturing output is being affected by reduced equipment utilization caused by China labor shortages and fewer working days and the Chinese New Year holiday in February. As such, we expect revenue for the first quarter of 2011 to be flat to down 5 percentage points compared to fourth quarter 2010.

In addition to the impact on revenue, equipment utilization is also affecting our gross margin, which we expect to be 36.5% plus or minus 1 percentage point. Gross margin will also be influenced by our China wage increases and start-up costs associated with our new Chengdu assembly facility. Operating expenses are expected to be comparable to the fourth quarter levels on a percent-of-revenue basis. We expect our income tax rate to range between 17% and 23%. Shares used to calculate GAAP EPS for the first quarter are anticipated to be approximately 46.3 million shares. With that said, I will now turn the call over to Mark King.

Mark King

Thank you, Rick, and good afternoon. As Dr. Lu was mentioning, our record results in 2010 demonstrates the scalability and sustainability of our profitable growth model. Both Diodes and Zetex branded product reached record levels during the year as we continue to gain traction on both design wins and new product releases. From an industry's perspective, we believe the market has normalized and returned to typical seasonal trends with a healthy environment and long-term outlook.

Overall, we feel very positive about Diodes' position in the market, and our opportunities for continued growth in 2011. In terms of end market breakout, consumer represented 32% of revenue, computing 28%, industrial 20%, communications 17%, and automotive 3%. Asia represented 73% of total revenue, sales increased 2% sequentially led by consumer strength in consumer portables, smart phones, and tablets with notebooks, notebook adapters, and power supplies relatively flat. Similar to last quarter, LCD, LED TV, and panels decreased slightly during the quarter. Channel inventory rose to a traditional 3 months.

In North America, fourth quarter sales represented 13% of total revenue, sales decreased 27% sequentially as compared to a huge Q3, where distributors took advantage of Diodes' ability to ship while competitors struggled to deliver products. As a result, distributor POP declined 33% from the third quarter but Q3 and Q4 together averaged 22% higher than Q2. Distributor inventory is healthy and has decreased in the quarter. OEM sales declined at seasonal levels. For 2010, North American region increased 86% year over year and distributors of POS increased 73% and is positioned for continued growth in 2011.

To support internal wafer demand, we continue to reduce external foundry wafer sales, which decreased another 76% quarter over quarter and were down $7.5 million for the year. We have reached our goal to internalize our wafer production, and wafer revenue will not be immaterial going forward.

Sales in Europe accounted for 14% of total revenue and increased 27% sequentially despite typical seasonality. Sales were driven by 25% increase in the industrial customers, 22% in automotive, and 17% increase with consumer customers. Distributor POS gained traction and distributor inventory reached three months. Demand in the channel remains stable going into the first quarter.

Now turning to new products, it was a very active quarter for new product releases across all product lines. During the quarter we released 55 new discrete products across eight product families. There were three key product releases related to our MOSFET products. This includes the expansion of Diodes' IntelliFET portfolio, with the introduction of two single-channel and one dual-channel device. These self protected MOSFETs are well suited for automotive and industrial applications and ideal for switching inductive loads such as motors, relays, and lamps at low frequencies.

Secondly, the company's proprietary DIOFET process that integrates a power MOSFET and a Schottky diode into a single die has been strengthened with the introduction of two devices targeting DC to DC conversion circuits in notebooks. And thirdly, Diodes has introduced four MOSFETs packaged in the DF 10-006 which deliver higher performance in a low-profile package and our ideal are ideal for small consumer portables like smart phones, tablets, as well as media players.

Also within our discrete side, we released three bipolar transistor devices targeting back-lighting applications within the LED TV market as well as two high-performance devices, one a dedicated gate driver intended for the power supply market and the other for automotive HID lighting applications.

In terms of analog new product introductions, we released 74 new product devices across eight product families, including the expansion of our LED back-light drivers. During the quarter, we introduced a multi-topology LED driver designed to increase the performance of high brightness automotive industrial and commercial lighting systems. The ZXLD1374 LED driver is an integrated 60-volt power MOSFET switch that drives a maximum LED current of 1.5 amp. This driver is capable of delivering high current levels and tighter inner lamp luminescence matching required by higher brightness LED systems.

We also introduced the AL8400 linear LED driver controller, which is designed to tightly regulate LED current via an external transistor across a wide variation of high-brightness LEDs. This device has a very low current-sensing voltage, which reduces operating voltage overhead and increases efficiency compared with traditional solutions.

We also continue to make progress on further expanding our logic product line including the introduction of our CMOS Logic families in DFN packages. These low-power Logic devices draw less than 1 microamp of supply current, making them ideal for use in battery-powered products, including smartphones, tablets, notebooks, consumer portables, and other high-volume, key-end equipment. There continues to be a high level of interest from major customers for our single gate products as well as our future product road map.

In term of global design wins, we had another very strong quarter for design win activity across a broad range and end equipment. We saw three of our products, an SBR, a Schottky diode, and a voltage regulator adopted into power chargers for a major high-volume manufacturer of MP3 players and tablet PCs. These devices combine high-power efficiency with a very small form factor and reduced height, advantages that are highly valued in consumer charger applications.

In consumer products, we saw design wins for our Hall sensors into three different notebook PC platforms further increasing our share of the notebook open/close sensor socket. We had a very healthy growth in our USB power switch adoption across a variety of computing products, including wins in notebooks, notebook gateways, docking stations, and optical disc drives. In addition, we also saw our USB power switches pushing further into the consumer product space with wins in set-top box and LED TV applications.

In the industrial space, we saw further gains for our line of cost-competitive LED drivers with three new wins for MR16 applications including one multimillion unit- per-year opportunity. Our Diodes star product also continued to achieve strong design win momentum with industrial and telcom wins that allowed us to expand our customer reach to new accounts.

In summary, I believe that Diodes remains positioned for continued growth and will further benefit from the disciplined execution of our profitable growth strategy. This approach has allowed us to consistently grow faster than our addressable markets as we capitalize on driving revenue growth, benefiting from our operational efficiencies, and further improving our product mix. Our continued success on new product initiatives and high level of design win activity will be key growth drivers in 2011 and beyond. We are leveraging our broadened product portfolio to gain more share of customers by expanding our content within the same end equipment.

We enter 2011 with momentum across all business segments, and we look forward to reporting our future successes as we achieve new milestones in our business. With that, I'll open the floor to questions. Operator?

Question-and-Answer Session

(Operator instructions) Your first question is from the line of Ramesh Misra with Brigantine Advisors. Please proceed.

Ramesh Misra – Brigantine Advisors

Thank you. Good afternoon, everyone. My first question is related to your Logic product ramp. When does that become a meaningful portion of your revenues, and if you can provide some degree of the (inaudible) through 2011, that would be great.

Mark King

Yeah, I think we're pretty consistent on the path that we've been talking though, that we've started to see some reasonable revenues from that, or measurable revenues from that in the second half of 2011. The design activity is quite brisk, but the adoption takes a little time. Most of this will be done in new design wins and new sockets, so it takes a while for those things to get into production, but we feel pretty comfortable that we're making pretty good progress towards that goal.

Ken Shew Lu

Yeah, and Ramesh, when you start from zero (inaudible) even if you double every quarter, it still takes a long time to be significant to our revenue. But (inaudible) you said 2015?

Mark King

No. The second half of 2011.

Ken Shew Lu

Yeah, (inaudible) can have 2011, it really won't be a major effect to our revenue growth.

Ramesh Misra – Brigantine Advisors

Okay. Got it. In regards to the pricing environment, what are you seeing out there both at the end of Q4 and what do you see panning out for Q1 and if you're getting any greater visibility than...

Ken Shew Lu

I think that the price is still very stable. You know, you have seasonable slowdowns, and price erosion, but typically it is offset by our cost reduction. So if you see we still get in very high on our gross margin in the fourth quarter. Move forward to 1Q, we don't really see a major ASP declaration, we still see normal season patterns. And then you always try to offset by cost reductions. So we don't see any special difference from the past.

Ramesh Misra – Brigantine Advisors

Got it. In regards to the labor shortages, Dr. Lu, this is actually the first time I think you've ever brought this up. Are there any abnormal drivers for that, or is it mostly related to the New Year holidays? And do you expect the labor issues to be resolved by Q2?

Ken Shew Lu

Okay. Number one, to answer you, the problems should be resolved by Q2, yes. But the reason they're unusual than before is that China has just announced this twelfth five-year plan. The China government, every five years, they have this so called five-year plan. They just announced the twelfth five-year plan. This five-year plan started to put a lot of emphasis on the inland economic or the inland situation than the coast. So China wants to push the development inland faster than the coast such that their economy is much more balanced than before.

Before, China put a lot of emphasis in the coast, such that the coast didn't stand the way up, then caused this (inaudible) caused imbalance between the richer and poorest. So the government tried to stabilize the situation and tried to push the development in inland China. So therefore, you get more emphasis of money developed in the inland areas, and that coast (inaudible) instead of going to the coast to take a job, the (inaudible)starts to go back and don't come back. In addition to that, because of weather and the transportation problems, people go home for Chinese New Year sooner than before. And that is what's happened to us.

Ramesh Misra – Brigantine Advisors

Got it.

Ken Shew Lu

And so all of those things caused the labor shortage, but we (inaudible)in that and we believe in the second quarter - actually, we've started hiring more people, but don't forget that it takes 6-8 weeks of training before than they can be productive.

Ramesh Misra – Brigantine Advisors

Right. So just very quickly, I guess all this pushes you towards ramping up your Chengdu facility. When does Chengdu ramp up? What's the time line for production to become meaningful at Chengdu?

Ken Shew Lu

For the long-term, we just need to buy the land from the government, build the building, and then start o to ramp up the production. But temporarily, what we do is we lease a facility, and that facility we just finish there and then we install the equipment, and then the ramp. But there won't be a high volume until we have our land purchased, and build our own building. So I'm looking at, for the long-term biggest growth will probably be one year to 18 months. But we have rented out our leased facility to get people trained, to get engineering, to (inaudible) it, so we do have a so called initial production. Equipment will come in after Chinese New Year, so there is no equipment now. And probably one quarter form today, we can start to do some (inaudible) production.

Ramesh Misra – Brigantine Advisors

Okay, thanks very much, and congratulations.

Ken Shew Lu

Thank you.

Operator

Your next question is from the line of Steve Smigey with Raymond James. Please proceed.

Steve Smigey - Raymond James

Great, thank you. Congratulations on the nice results and the nice guidance. I was hoping you could talk a little bit about CapEx strategy for this year. You guys accelerated the capital spending last year, and I think that resulted in increasing significant share gains. It sounds like you're going back to your more normal CapEx plan. How does that fit in with continuing to capture market share? Could you maybe re-accelerate it later, or is there going to be plenty of capital added at this point?

Ken Shew Lu

Well, if you look at our [ph] CHEI in the past eight to 10 years, our [ph] CHEI is about 20-something percent, 23-25%, so if we want to keep that kind of rate. (inaudible)the reason last year that we spent 14% is that we actually underspent in 2009, so in 2010 we grew 41%. So to support that 41%, you really need to increase, and that's what happens. But moving forward, I think we'll be keeping to our previous model, which is 14%.

Rick White

12%.

Ken Shew Lu

No, 12%, 10-12%. Now, we would start to consider Chengdu and see how aggressive we want to grow up Chengdu. If we grow like our regular, then 10-12% can cover that, but at the beginning, we might need a bit more to cover the Chengdu staff.

Steve Smigey - Raymond James

Okay, great. And then I guess, similarly, you guys have done a couple of very successful acquisitions, Zetex and – more than a couple, several successful acquisitions, really ramped up your growth to give you some good cross (inaudible) opportunities. It's been a little while since the last major one. Does it make sense to start looking at another one here?

Ken Shew Lu

Yes, it always makes sense to do the M&A. And the only problem is that several parties want to buy – they're thinking my offer is too low. So if I can get to some kind of agreement, (inaudible) some M&A activity, but at this moment, I do not have that one I can talk about yet.

Steve Smigey - Raymond James

Okay.

Ken Shew Lu

(inaudible) strategy, and it's always in my consideration, and I always watch out for that opportunity.

Steve Smigey - Raymond James

The last question regards the gross margin. It sounds like you're getting some of the labor issues fixed up. I know your model is normally 35%. Right now it seems like pricing is a little bit more favorable than usual. As we start to look back to June, is it likely, getting to June and September,that that gross margin trends more back towards that 38%, or is that too aggressive?

Ken Shew Lu

Well it would probably be too aggressive. You know our strategy is always, if I can grow, then I choose to grow instead of (inaudible) to grow and try to improve the gross margin. But what I'm really talking about is GPM dollar. I think you know that. That's really as strong as GPM dollar, I don't care if it's coming from revenue or GMP percent. The reason we take the opportunity is due to not having enough equipment capacity. Even if we grow, we put 14% of CapEx in there, we still (inaudible) equipment capacity. And because of that, you take that opportunity since you can not produce more units, then you might take the opportunity by changing the product mix and get GPM percent higher to get more GPM dollar. Now, if I get the capacity, install it, and invest enough such that I can gain a market share and revenue instead of just growth and raise the GPM percent. So our strategy is always focused on GPM dollar. So when you play with the model, you can either play in revenue, but revenue targets the GPM dollar.

Steve Smigey - Raymond James

Right. Makes sense, okay thank you, guys.

Operator

Your next question is from the line of John Venn with Collins Stewart.

John Venn – Collins Stewart

Hi, thanks for taking my question. Just a followup question on the shortages. Obviously in your prepared commentaries, you talked about demand being better than seasonal, obviously your CapEx capacity continues to expand in Q1. If you didn't have the shortages, it sounds like revenues could have been up in Q1. Is there any way you guys can quantify what the demand trends look like in Q1 maybe in terms of either backlog or backlog coverage?

Ken Shew Lu

I don't if we can do that or not. The two guys here are shaking their heads, so I can't really talk about it, so we probably can't talk about it. But our market is better than traditional because typically in our 1Q, you should be down 5-10% and I think your own model, John, showed that too, right? . Even today we showed (inaudible) of 5%. We're still better than the seasonal down. But some of the reason was really due to man power shortage.

John Venn-Collins Stewart

I got it. And then my followup is, obviously on the labor shortage, this time of year you guys typically see quite a bit of turnover in China. Does your Chengdu facility give you some advantages in terms of – do you think you get a lower turnover rate in Chengdu versus Shanghai? And also on wages, can you give us a sense – is there a wage differential, do you get a cost benefit from shifting a little bit more capacity to Chengdu versus Shanghai.

Ken Shew Lu

I'm glad to answer that. Before I forget, don't forget our fourth quarter, which typically is 0-5% down, our fourth quarter actually is (inaudible), so that is why we believe we have continued getting the market share. So that just (inaudible). Sure, Chengdu, the level of cost is always going to be lower than Shanghai area. Because where our facility is is in Shanghai, and Shanghai is more expensive from (inaudible) cost point of view. So Chengdu is going to be reduced cost and from a stability point of view, yes, Chengdu is a big, dense city, and they can draw a lot of workers a lot around Sichuan province to walk in there. So Chengdu is going to be much easier to recruit people than Shanghai. Because Shanghai – most (inaudible) you're counting on the people coming from working in the Shanghai area. So if they don't come back, or they stay in their home town, then we're in trouble.

John Venn-Collins Stewart

Great, thank you. And my last question is, Mark, you talked a lot on this call about new LED driver products. Can you clarify, I think you mentioned TVs. Do you guys have a product that supports the LED drivers for TV? Do you have design wins at this point in time?

Ken Shew Lu

Are you talking about LED CTV?

John Venn-Collins Stewart

Yes.

Mark King

We have some drivers in small panel, okay, nothing in large panel. And so we focus on small panel presently and general illumination LED drivers. And we released our first AC/DC recently, and I can't frankly remember if that was in December or in January, our 99-10. So we continue to expand and we consider that a very exciting opportunity for us and a true growth driver going forward. So we're kind of moving in a lot of different directions in that product space.

Ken Shew Lu

Actually this is two different strategies. For the large TV, that is really back lighting strategy, and for the one AC to DC, that is more in general lighting driver strategy. They are completely different product families, product strategies.

John Venn-Collins Stewart

Great. Thank you.

Operator

Your next question here is from the line of Shawn Harrison with Longbow Research.

Shawn Harrison – Longbow Research

Hi, good evening everyone and congratulations.

Ken Shew Lu

Thank you, Shawn.

Shawn Harrison – Longbow Research

First question, I just wanted to follow up on more of the cost side of the capacity expansion in Chengdu. As you start to do some of the initial production, potentially in the June quarter, and at the back half of the year, is there going to be a step-up in cost ahead of revenues that maybe we should model some margin degradation as you bring that facility online?

Ken Shew Lu

Don't forget that that facility will start with very small quantity. So I think we probably don't need to.

Mark King

I think we have some in our start-up costs.

Rick White

In the first quarter we do because we're putting the facility together, we're hiring people, finance people, planning people, we've hired some direct labor operators for training. So we're going to have some expenses at least in the first quarter that aren't covered by any revenue.

Shawn Harrison – Longbow Research

Okay.

Ken Shew Lu

Other than that, the GPM should not be really affected that much.

Shawn Harrison – Longbow Research

Gotcha. In the first quarter, is it half a million dollars, is it less than that? Just trying to get an idea.

Rick White

It's probably in that neighborhood.

Shawn Harrison – Longbow Research

Okay. The second question I have is on North America with the adjustment that took place in the fourth quarter, particularly in terms of distribution. Do you think everything is normalized now going into 2011 or is there kind of any chance of further normalization during the first quarter?

Mark King

I think we're in pretty good shape. As I mentioned, this year's inventory is pretty healthy, and actually it went through last year very very clean. They just kind of got ahead of themselves a little bit in the third quarter, and actually we wanted that to happen because we wanted it to be our stock in place instead of other people's stock in place when they started canceling orders. So we got our stock in there, and it's allowed us to maintain our POS run rate, and I think we're well positioned to grow our POS from our position today in first quarter and beyond. I think we're in pretty good shape. I think the POP is still a little choppy on the (inaudible), as they don't really know – they do have a good inventory position across all their lines, and they're trying to decide whether they're going to be flat or they're going to be down 5% I the first quarter, or if they're going to be up 20% for the year. So I think that there's still a little hesitancy to reach out with great POP orders, but I think our inventory in first quarter will go down in the channel, but I think all in all, it should all just level into a good position.

Shawn Harrison – Longbow Research

And I guess the other side of that would be Europe, where you saw a very strong end demand. Is that continuing into the March quarter and also it looks like the fourth quarter you did see a little bit of inventory build, but it seems like the end markets in Europe are still very much your friend.

Mark King

The inventory build in Europe was very late, and the market is going on probably the strongest of all the markets we deal with. So we were really a little bit surprised by the POP, by the strength of the POP in December because European distributors have a tendency to turn off around the tenth. And they were aggressively trying to get product in, and first quarter looks pretty solid so far with POS, so I think that market is holding up better than we actually expected it going into the year.

Shawn Harrison – Longbow Research

Alright. Thank you very much.

Operator

Your next question is from the line of Gary Mobley with Benchmark.

Gary Mobley – Benchmark

Hi guys, I have a question for Rick to start out with. The R&D in the quarter was low compared to your recent run rate, and I'm assuming it's going to stay low in the first quarter, so I'm just hoping you can provide a better understanding of what's going on there in the R&D front?

Rick White

Yeah, on R&D it was basically a compensation reserve adjustment we made between the third and fourth quarter. So we made some accruals in the third quarter and we ultimately didn't spend that much money in the fourth quarter so the difference was about that amount.

Gary Mobley – Benchmark

Okay. Alright and...

Rick White

So you won't see that going forward because those are – we'll get back to the more normal 2011 status.

Gary Mobley – Benchmark

Normal, in the first quarter you're meaning.

Rick White

Yeah, normal means basically accruing and not reversing accruals.

Gary Mobley – Benchmark

Gotcha. And with the debt as being redeemable in October, you'll exit the year with what, roughly $75 million in net cash. Should we think of all of that being available for acquisition, or how much do you need for working capital requirements and then as well, how much is offshore?

Rick White

Well, we don't break down where the money is, but I will say that it's not all in the US, and we'll need to have some money in the US to pay off those convertible notes, but we've brought money back in the past, and we'll do it again if we need to. We will have to have some money for working capital. We're investing in Chengdu and we'll continue to invest in CapEx and grow the output capacity, so you could say maybe we need $100 million, somewhere around that for working capital to work with. And on top of that, the rest of it is available assuming Ken Shew doesn't do some M&A activity with it.

Ken Shew Lu

So you've ask me how much money is available for M&A, you can take that 270 and (inaudible)130 from the convertible bond, then say 100 for working capital, then we don't have that much money left for M&A. So if I look at some sizable M&A, then I might need to do some.

Gary Mobley – Benchmark

Okay. I know you won't be able to give me a precise number on this question, but for the 190 basis points sequential decline in gross margin for the first quarter, how much of that is attributable to lower fixed cost coverage, how much is attributable to chasing lower margin revenue, and then how much attributable to pay increase?

Ken Shew Lu

We cannot really break down that query, but number one, we do not have anything [ph] tracing or the lower margin. Like I said, if we don't not even have enough people to get the revenue we want to, we will not produce any product, which produce much lower margins. So I don't have anything to contribute into the lower margin part of revenue. And if you can look at it, our utilization actually went down to almost 9%, equipment utilization.

Rick White

No, 13%.

Ken Shew Lu

13%, yeah.

Rick White

In the past it's gone up 4% and (inaudible).

Ken Shew Lu

I'll put down 9%. So the utilization goes to 13%, and those kinds of utilization when you go down 13%, you're going to hurt quite a bit. And for us, 2% GPM, you're only talking about $3, $4 million dollars so that is why that GPM changes so much. It's because our revenue base is not big, so when you go just three or four million, (inaudible)2%.

Operator

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

Harsh Kumar – Morgan Keegan

Hey Dr. Lu and Mark, congratulations, very good guidance and quarter. A couple of questions, maybe Mark, you can help me with this. Usually March is always a tough, interesting quarter. I'm curious about your color as you see your markets for the four or five different end markets that you're in. Which you think will be strong, which you think will be weak, which you think will be normal or abnormal?

Mark King

Every quarter is a challenge. March is no exception to anything. Actually, I think, again, I think I mentioned in my speech that we just kind of see a healthy business environment. We're seeing some improvements in areas going into the year that have been soft for a period of time. We're starting to see some good action on LED and LTD TVs coming out of Asia. I think there's some improvement there. I think some notebooks look strong.

Ken Shew Lu

Notebooks actually have run into some problems because Intel have put a stop, because, you know their issue on that. But fortunately the tablets is the one offset and is not affected by Intel's stopped shipment (inaudible)Intel's problem. So therefore if you put the notebook and the tablets together, for us, it's actually, like he says, is up.

Mark King

So consumer portables look pretty solid, as well as smartphones. I think the automotive environment is quite healthy in European market and I think the industrial market continues to move forward. So I think when you come through the periods that have we've gone through over the last couple of years to be looking around the quarter in the first quarter and see a positive outlook and a healthy environment is good enough for me. I'm not so worried about the first quarter. I kind of worry about the next three quarters after first quarter. We're kind of already there. I think it's generally a healthy environment. We generally in the long run don't take – if the market grows in mid to low single digits, then generally we can perform pretty well as a company.

Harsh Kumar – Morgan Keegan

That's very helpful, Mark. Maybe I can rephrase the question a little bit differently. Are there any areas you think will be up sequentially in the March quarter, and what would those be?

Mark King

I would say consumer portables and tablets.

Ken Shew Lu

Yes.

Harsh Kumar – Morgan Keegan

Okay, that's pretty helpful. Okay, then a combative type question. A couple of the other companies have talked about issues in the industrial market, basically talking about inventory. I'm not suggesting that you have that issue. Your revenues were down slightly. Have you seen that issue, and if so, maybe talk about inventory in the industrial market specifically as you see it for Diodes?

Mark King

In the industrial market, I'm not seeing a great inventory problem. In the power supply market and in the areas we play in, adapters and so forth, we're starting to see reasonably good demand. Maybe it matches the end equipment that we play in from the consumer portables area and so forth. So I can't quote to that issue.

Harsh Kumar – Morgan Keegan

That's very helpful. Thanks guys and congratulations.

Mark King

Thank you.

Operator

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

Vijay Rakesh - Sterne Agee

Hi guys. You mentioned (inaudible)11 as a healthy environment but when you look at this year, what do you think would be the key drivers, where do you see (inaudible) among your markets? And also on the M&A side, what is it that you're looking to fill on your portfolio? Where do you see some areas that are lacking there?

Ken Shew Lu

When you talk about upside, are you talking about 1Q?

Vijay Rakesh - Sterne Agee

No, to the year, for the year.

Ken Shew Lu

Oh. For the year, I think we actually we are going to grow in almost every quarter. Our MOSFETs have come up very very strong, our transistor and our analog, so I cannot really tell you what area because in 2010 we've been gaining market share everywhere. We grew 41%, so obviously we are getting the market share, so we just don't see anything will slow us down because by looking at our design win activity, by looking at all our new products, we believe we will have another gaining market share years. So I don't really adjust in one area. We are able to take advantage of our product portfolio, our region, and move around the products such as that whatever area gives us the best GMP dollar, we move.

Vijay Rakesh - Sterne Agee

Okay.

Ken Shew Lu

Your other question?

Vijay Rakesh - Sterne Agee

On the M&A side, what portfolio are you looking to fill or you need to fill some products?

Ken Shew Lu

When I look at M&A, I have different region, different opportunities. So I don't have anything, say, I'm going to buy something because I need to get into this product area. In the past, I always say it depends on where the opportunity and then what kind of synergy they can give to us, and as long as the synergy is good, and we can acquire it right away or within 12 months and it gives me a good addition in something, then we'll do it. So I hardly say my M&As targeted at which area of the product family? I don't have that in my mind.

Vijay Rakesh - Sterne Agee

And lastly, this is a housekeeping question, is the tax rate still 20% for the year?

Ken Shew Lu

Yeah, I think we gave the guidance -

Rick White

Tax is 17-23 in the first quarter.

Vijay Rakesh - Sterne Agee

And for the year about the same?

Rick White

Approximately the same. We don't give guidance on the year, but you can look at 2010. It was about 20%.

Vijay Rakesh - Sterne Agee

Right. Okay, thanks a lot, guys.

Operator

Your next question is from the line of Brian Piccioni with Capital Markets. Please proceed.

Brian Piccioni – Capital Markets

Of course, congratulations on a very strong year and a great outlook. Of course, most of my questions have already been asked and answered. In prior calls, we've talked about your efforts to reduce costs with things like replacement of gold bonding with copper bonding and package reduction, size reduction, and stuff like that. Of course now we're talking about labor costs savings by shifting around. I was wondering if there were any other things that you were targeting to sort of sustain your ability to maintain good profit margins despite fairly significant pricing pressures in the market?

Ken Shew Lu

Number one, the gold to copper wire conversion. Gold is the highest cost today we've seen in our manufacturing, so we are not there yet. We still have a long way to continue to reduce our gold wire cost. So we are going to continue our cost reduction effort in the gold wire elimination and convert to copper wire. Then another area we are doing cost reduction in is when we grow up the revenue, our wafer usage will continue to increase, so if it's supportable internally, then we will continue to reduce our wafer cost, because the volume or the usage. But at the same time, now we are in the much better position to negotiate to get a low price of the wafer from our (inaudible). Therefore, we just continue our effort at cost reduction and I don't see anything will be slowed down so that we are no longer able to do any cost reduction, that's not the case. We will continue to be able to knock the cost down, and to offset the (inaudible) cost at the same time to offset ASP. Another way we can deduce ASP impact is by changing the product mix, aggressively driving the new products. You can see in 2010 that we have so many new products coming out and obviously the new products will give us a better GPM and then to(inaudible) or deduce the effect by the ASP reduction. So combined with the new products, combined with the wafer cost reduction, gold wire reduction, we have so many things going on to reduce the cost to offset the ASP declaration and offset the (inaudible) cost increase.

Brian Piccioni – Capital Markets

So in other words, you're not running out of runway here. You can see clear to keeping ahead of that curve, then. That's great. So you had a question earlier about cash usage and everything else. I'll just come out and ask directly: Has there been a decision made with respect to how you deal with the convertible debt, whether you'll simply pay it off or refinance it?

Ken Shew Lu

No decision has been made yet because it's still eight or nine months away from us. Number one, we get our money ready, so we do have our money ready, so if we need to pay it off, we pay it off. That's not an issue to us anymore. So just look at – if I a M&A target coming up, I need to do something to get more money, then we'll do it. But there's no target coming up. We have enough cash to pay for the convertible bond.

Brian Piccioni – Capital Markets

Okay, well that's my question, so thank you very much.

Ken Shew Lu

Thank you.

Operator

Your next question is from the line of Suji De Silva with ThinkEquity. Please proceed.

Suji De Silva – ThinkEquity

Hi guys, thanks for taking the questions. First of all, can you remind us of what 2Q's seasonality is and if the constraints in first quarter has it come off to provide a tail wind for the second quarter?

Rick White

Second quarter's seasonality. How does that compare to where we are in the first quarter?

Ken Shew Lu

I think we are now back to the normal semiconductor cycle. So I think you just look at how historically second quarter versus first quarter in the semiconductor cycle, then you can do an estimation over there.

Suji De Silva – ThinkEquity

Okay, then it's typically seasonal then. And then, what's your target inventory level versus (inaudible) just curious where you would like to keep inventory?

Ken Shew Lu

Are we back on?

Suji De Silva – ThinkEquity

I'm sorry, can you hear me?

Ken Shew Lu

Somebody is speaking in the background.

Suji De Silva – ThinkEquity

Sorry about that. Can you tell me where your target inventory levels are typically, versus where you are?

Rick White

Yeah, we're somewhere in the 90-100 days. If you look at where we've been historically, that's about where we are now and we build hub inventory for certain people and the increases are simply test capacity, we have to increase raw materials and (inaudible) so it will continue to go up as we continue to grow.

Suji De Silva – ThinkEquity

And then last question. It sounds like to a prior question you said ASPs are relatively stable. Do you still expect them to decline year over year in a 3-7% sort of basis or do you expect them to stay stable going forward?

Mark King

I think we're going to have some ASP declines. I don't – or we're going to have some pricing pressure. I don't think it's been clarified yet of what those are going to be. But pricing pressure is something that we go through. I've been here for 20 years and we go through the same pricing pressure pretty much. There are some periods that are a little stronger than others but in our product lines there's always going to be pricing pressure.

Ken Shew Lu

Yeah. All we need to do is put the pressure on the cost reduction and hope that the cost reduction can offset the ASP degradation and plus changing the product mix by doing the new products. So we know to do it, we just need to continue our efforts to do the same thing.

Suji De Silva – ThinkEquity

Okay, great. Thanks guys.

Ken Shew Lu

Okay.

Operator

Your next question is from the line of Steven Chin with UBS.

Steven Chin – UBS

Great, thank you for squeezing me in here at the end.

Ken Shew Lu

Yes, Steve.

Steven Chin – UBS

I wanted to ask about capacity. First (inaudible) in general for the industry, just given some of the supply (inaudible). as your competitors late last year and also given that I think in general a (inaudible) type for a number of different types of products, what is your expectation for overall industry supply growth this year for both discretes as well as analog products that you play in currently?

Mark King

Hi Steve, on the analog side in the products we played in last year, we didn't see a significant amount of shortage. We thought it was a really more normalized cycle in the commodity standard linear product area. From a discrete side, we think the shortage has eased off in Q4 based on most of our competitors and most of the industry being down in that period. But we do see some shortage opportunities going into this year, and I think that it's possible that discrete packaging stays relatively tight through the first half of the year, maybe a little bit of room in Q1 and I think maybe getting a little tighter and I think in Q3 there's a possibility that it could be relatively tight again. Especially in certain product lines.

Ken Shew Lu

Yeah, especially you don't really see that many people put in the capacity for the commodity product, for the standard product. Everyone puts in the capacity for the newer, more complicated device. So when you go to discrete, or even standard analog you just don't see that many people put in the CapEx in the packaging area that aggressively. We probably are one of the few companies that aggressively put in the capacity, you know, 14% CapEx to address this market.

Steven Chin – UBS

Okay, got it. And then the other question I had was just in terms of products that you sell into either that of mostly handset market as well as into consumer portables, can you talk about any opportunities for increased product contents, semiconductor dollar contents for the portfolio or maybe the ability to upsell higher-margin products into some of those sockets that may be drivers for those two target product areas that year?

Mark King

Yeah, I don't think I can get too specific, but I can tell you that our content in those product areas is growing everyday. We've had a lot of expansion in our MOSFET product lines that are specifically targeted in those areas. A lot of stuff in our bipolar arena. It's very consistent with our miniaturization strategy and so forth. So I think you can look at all of our key end equipment that we're continuing to try and add content in order to expand. That's a key part of our goal is to sell more products to the same customers.

Steven Chin – UBS

And may I just follow up there, is it more discrete content particularly or is it a combination of discrete and analog content?

Mark King

I think it's a content of both, and then throw in Logic. Single gate Logic solves all problems in design, so we think the positioning of our Logic product is very much in line with what we're trying to accomplish in those end equipments with our discrete and our analog. Clearly we can much faster in discrete because the design time for a new product is much shorter, but there is still opportunities for both.

Steven Chin – UBS

Okay, and if I can squeeze one more in. Just one more question on industrial market ,and perhaps Europe specifically, in terms of the drivers of the industrial business any thoughts as to how much longer that healthy demand will continue and what's underpinning that? I know it's very broad based, but is there potential for any (inaudible).

Mark King

Yeah, that's hard for me to say. The one thing I can say is that our product addressing that marketplace continues to grow every day. We're getting more and more products that we're going to make available to that marketplace with our SBR product line as well as our DIODESTAR product line and our MOSFET product line. A lot of the new product that we're coming out with are very very focused into those particular marketplace. We've got a lot of new solar parts in both in our SBR line and so on. I think that maybe the industrial market is not as good as we say it is, but we just have more product to sell to it.

Ken Shew Lu

Especially after the Zetex acquisition. We are gaining to the industrial and automotive application by (inaudible) products. So it's really a good opportunity for us.

Steven Chin – UBS

Okay, thanks, and congratulations on the solid results again.

Ken Shew Lu

Thank you.

Operator

Ladies and gentlemen, that's all the time we have for questions today. This concludes this portion of the call.

Ken Shew Lu

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

Operator

Ladies and gentlemen, thank you for your participation today. You may now disconnect your lines and everyone have a great day.

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