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Executives

Leanne Sievers – EVP of Shelton Group

Keh-Shew Lu – CEO and President

Richard D. White – CFO

Mark A. King – Sr. VP of Sales & Marketing

Laura Mehrl – Director of Investor Relations

Analysts

Steve Smigie – Raymond James

Harsh Kumar – Morgan Keegan

Suji De Silva – ThinkEquity

Gary Mobley – Benchmark

Ramesh Misra -- Brigantine Advisors

Steven Chin -- UBS

Tristan Gerra – Robert W. Baird

Brian Piccioni – BMO

Vijay Rakesh - Sterne Agee

Joe Whitten -- Longbow Research

Diodes Incorporated (DIOD) Q3 2011 Earnings Call November 8, 2011 5:00 PM ET

Operator

Good afternoon and welcome to Diodes Incorporated Third Quarter 2011 Financial Results Conference Call. At this time all participant are in a listen-only mode. (Operator Instructions) As a reminder, this conference call is being recorded today, Tuesday, November 8th, 2011.

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

Leanne Sievers

Good afternoon and welcome to Diodes’ third quarter 2011 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 who is joining us from Taiwan today, 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 estimates as of today, November 8th, 2011. Diodes assumes no obligation to update those 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 within financial information and 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 to EBITDA which provide additional details.

Also, throughout the company’s press release and management 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 web cast 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.

Keh-Shew Lu

Thank you, Leanne. Welcome everyone and thank you for joining us today. Revenue in the third quarter was $161 million, a decrease of 2% over the prior year and 5% sequentially. We continued to see broad weakness across globe market that became in May and accelerated throughout the third quarter especially in the consumer and computing market with the exception of tablets and the smartphones.

Despite this softness, we were still able to execute on our strategy of gaining market share by shifting our product mix to lower margin product to best yield our installed capacity. As has expected by the 10% growth in our year-to-date revenue above the prior year.

Gross margin in the third quarter was 28% of revenue. In addition to our shift in product mix, gross margin was also impacted by a weaker than normal price environment, as well as (inaudible) in the gold prices.

In response to the weaker market environment, we have implement cost reduction actions that including the day of capital investments improves, a reduction in factory over time as well as temporary reduction in (inaudible).

We did above $30 million of CapEx but still invested approximately $20 million during the quarter including $10 million for our Chengdu site expansion.

Our primary goal is to maintain manufacturing efficiency at the our packaging facility in order to avoid slow down on our ongoing productivity improvement. Even with the hurdling freeze, we continue to maximize dilation of all operators. During the quarter we used SS capacity to build finishing goods inventory and to prepare for a three day shutdown for the Chinese national holiday which occurred during the first week in October.

Looking beyond the current market environment we continue to increase our investment in R&D to further divest our new product initiatives, maintain designing momentum and additional tie up for additional market field gains in the future.

We have the additional capacity available to take advantage of upside potential and the return to our historical gross variable as the market improved. We then committed to our business motto and our focus on generating the long term return for our shareholders.

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

Richard White

Thanks Dr. Lu and good afternoon everyone. Revenue for the third quarter of 2011 was $160.6 million, a decrease of 2% over the $163.1 million in the third quarter 2010 and a decrease of 5% from the $169.8 million in the second quarter of 2011.

The decrease in revenue was due to the general market slowdown on a global basis causing larger than normal pricing degradation. Gross profit for the third quarter 2011 was $45.2 million or 28.1% of revenue compared to $61 million or 37.4% in the third quarter 2010 and $55.6 million or 32.8% of revenue in the second quarter of 2011.

The declining gross profit margin was due to primarily to pricing, a significant increase in gold prices and a shift in product mix to lower margin products in an effort to maintain full capacity utilization at our Shanghai packaging facilities. So, operating expenses for the third quarter were $31.8 million or 19.8% of revenue, which was slightly below our model of 20% revenue.

Looking specifically at selling, general and administrative expenses for the third quarter, SG&A was approximately $23.4 million or 14.6% of revenue, which was above the 14% revenue in the third quarter 2010 and the 13.3% of revenue last quarter.

Investment in research and development for the third quarter was $7.3 million or 4.5% of revenue, which was comparable to the $7.2 million or 4.4% of revenue in the previous year period and an increase compared to the $6.5 million or 3.8% of revenue last quarter.

Diodes continues to invest in R&D efforts to further advance new product development in design in order to capture additional market share in the future.

Total other expense amounted to $2.3 million for the third quarter. Looking at interest income and expense, we had approximately $316,000 of interest income on our cash balances and approximately $1 million of interest expense, primarily related to our convertible senior notes.

During the third quarter, we recorded approximately $2 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 a foreign currency gain of $460,000.

Also included in other expense was $1.2 million non-cash loss associated with the decreasing there value associated with the Eris stock investment. This investment is recorded based on the stock price of the underlying stock and on Taiwan to US dollar exchange rate since the investment was made in Taiwan dollars. During the quarter the Eris stock price decreased and the Taiwan dollar fell.

Income before income tax is a non-controlling interest in the third quarter amounted to $11.1 million compared to income of $27.4 million in the third quarter of 2010 and $23.4 million in the second quarter of 2011.

Turning to income taxes, our effective income tax rate in the third quarter was 3.2%, due mainly to a change in profitability by country it was within our updated guidance of 0% to 6%.

GAAP net income for the third quarter was $10 million or $0.21 per diluted share compared to GAAP net income of $21.2 million or $0.46 per diluted share in the third quarter of 2010 and GAAP net income of $18 million or $0.38 per diluted share in the second quarter of 2011.

The share count used to compute GAAP diluted EPS for third quarter was $47.1 million shares. Third quarter non-GAAP adjusted net income was $12.1 million or $0.26 per diluted share, which excluded net of tax $1.3 million of non cash interest expense related to the amortization of debt discount on the convertible senior notes 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 third quarter GAAP and non-GAAP adjusted net income was approximately $2.4 million net of tax of non-cash share-based compensation expense and $1.3 million loss net of tax in fair value associated with investment in Eris.

Excluding share based compensation expense, both GAAP and non-GAAP adjusted diluted EPS would have increased by an additional $0.05 per share and excluding the loss and fair value, both GAAP and non-GAAP adjusted diluted EPS would have increased by an additional $0.03 per share.

Turning to the balance sheet, at the end of the third quarter we had approximately $125 million in cash, which reflects the retention of $134 million of convertible senior notes. Working capital was approximately $311 million.

At the end of the third quarter, inventory was approximately $139 million, an increase of approximately $10 million then the second quarter. This increase was due to a $14 million increase in finished good and $1 million increase in raw materials, partially offsetting a $5 million decrease in working process.

Inventory days increased to 105 compared to 100 days in the second quarter of 2011. Accounts receivable was approximately $139 million and AR days were 81. Capital expenditures were $19.5 million during the third quarter, which included $9.6 million for our Chengdu site expansion. Excluding this amount, CapEx was 6.1 % of revenue compared to 18.4% in the second quarter.

We consider Chengdu to be a long term strategic project so we are continuing with our site development regardless of the short-term economic environment. We invested $10 million in the quarter and $15 million year-to-date.

As Dr. Lu mentioned last quarter for our production facilities, we delayed approximately 40% of our second half non-Chengdu CapEx due to market conditions. Year-to-date excluding Chengdu, we have invested a total of $59 million in CapEx, which represents about 12% of revenue. For the full year excluding Chengdu, we expect CapEx to be at the low end of our target range of 10% to 12%.

Depreciation and amortization expense for the third quarter was $16.1 million. Cash flow from operations for the third quarter was $17 million. Our cash balance decreased $166 million due primarily to $134 million used for the retirement of our convertible senior notes, $14 million used for the investment in Eris Technology Corporation and $20 million in capital expenditures including Chengdu. Free cash flow was a negative $7.8 million and includes $10 million in CapEx for the Chengdu infrastructure.

Turning now to our outlook. In terms of fourth quarter guidance, we expect revenue to range between $140 million and $150 million or down 7% to 13% sequentially. We expect gross margin to be 25% plus or minus 1.5%.

Operating expenses are expected to remain approximately flat with the third quarter on a dollar basis. We expect our income tax rate to range between 17% and 23% and shares used to calculate GAAP EPS for the fourth quarter are anticipated to be approximately 47.2 million.

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

Mark King

Thank you, Rick and good afternoon. Our revenue in the third quarter declined sequentially due primarily to weakness across our global markets particularly in Europe and North America. The global economic issue continued delay in markets and overall demand especially in the consumer and computing market resulting in larger than normal declines in pricing. However, as Dr. Lu mentioned, we continue to see strength in smartphones and tablets. Distributor POP was down 11% sequentially, as distributors began to reduce their stocking targets going into the fourth quarter. Distributor inventory was up 5% but should begin to decline in Q4. Global POS was down 3% in the quarter.

Although the current environment is causing customer and products to move slower into production, design win activity remains at high levels in all regions for both new and existing products. In terms of global sales, Asia represented 75% of revenue, Europe 13% and North America 12%. Our end market breakout consisted of consumer representing 34% of revenue, computing 27%, industrial 20%, communication 16% and automotive 3%.

Now, turning to new products, traction remains strong as we continue to execute on our new product initiatives. We’ve reached another record quarter for Synchronous MOSFET controllers as well as our USB power switches.

We also continue to gain momentum on our LED drivers, DC to DC converters, CMOS LDO as well as our standard linear product line. And although the demand is being constrained by current market environment, we continue to focus on new product introductions in order to expand transient at key customers and drive our future growth as the market improves.

Looking specifically at our discrete product line we continue to make solid progress in delivering value to our customer base in a wide range of applications. We introduced 66 products across nine product family. Diodes achieved another record quarter for our Synchronous MOSFET controllers as more customers are changing to Synchronous control to meet the latest standards from energy side.

We introduced two new Synchronous controllers, one targeting the notebook adapter market and another targeting set top boxes and power over Ethernet markets. Design wins continue to expand and we are engaging with an increasing number of potential customers on these products.

Also during the quarter, Diodes announced expansion of the Diode star product family targeted for LED Lighting Applications. We now have two versions available also low VF performance and very fast switching that allows to reduce power loss and higher efficiency.

These product releases were complimented by a number of other products that confirmed Diodes position as the leading provider of high volume performance devices. New design wins in the quarter for our discrete product line include major gains in portables, computing, industrial and automotive lighting market places.

We released the first new SVR Solar Bypass Diodes specially designed to simplify manufacturing concerns of solar panel makers producing the next generation PD modules.

The new product is highly efficient with a maximum package size of only 0.75 mm enabling it to be directly mounted within the solar panel and removing the need for separate junction boxes.

Now turning to analog we release 15 new devices across seven product family. New product highlights include the expansion of our Synchronous DC to DC converter product line with new 2 amp and 3 amp devices. These products are developed for consumer electronic applications that require ultra efficient voltage conversation such as LED TV, LCD monitors and set top boxes.

We also continue to expand our CMOS LDO portfolio with the addition of a full line of amp adjustable regulators as well as the family of low power, high-accuracy devices intended for battery operated consumer products.

Revenue in our power management segment also remains strong in which we set a new revenue record in our USB power switches. During the quarter we secured major design wins in output and debt hubs as well as LED TVs and Blu-ray DVD players.

Also during the quarter we released the industry’s smallest full featured single chip fan motor driver, it’s highly integrated device is designed for driving single coil brushless DC fan motors and is offered in the miniature low profile BFN package.

In the low powered DC fan market the demand for low noise and high performance provides an expanded opportunity for our recently watched integrated drivers. We have seen three-fourth increases in new sockets over the past few quarters.

We also continue to make advances in our standard linear product line with the release of ZXRD-O60, a dual adjustable shut regulator that operates excellent temperature stability. These devices were specifically developed to be compliant with the new high-speed serial thunderbolt interface with is an emerging scanner targeted at the consumer products market and is being backed by several major consumer electronic providers. In addition to several deigns wins from early adopters of thunderbolt, we secured major standard linear design win for both consumer and industrial applications.

Now turning to our logic products, we continue to expand our footprint in the logic market as we gain traction on our new Dual Gate devices introduced last quarter.

Design win activity and product introductions remain very solid even though some customer projects have been delayed due to the current environment. We still expect this product segment to be a huge contributor to our growth next year.

In summary, we continue to believe that Diodes is well positioned to manage to the current market environment as we proactively prepare for improving conditions and demands. We have innovational capacity of the LDO and also have a high level of new product and deign win activity that will enable us to catch traditional market share in the coming quarters. Traction remains strong on a large number of new products and we continue to have a solid position with our key customers.

With that I’ll open the floor to questions.

Question-and-Answer Session

Operator

(Operator Instructions) And the first question comes from the line of Steve Smigie of Raymond James.

Steve Smigie – Raymond James

Great, thanks a lot. My first question is just related to overall revenue, it’s seems like assuming two quarters you guys were down 15% I mean, between Q3 and Q4 versus some comps were down in more significantly, I’m going to attribute that you guys would be more aggressive on going out and chasing business, perhaps maybe little bit through price that’s the case and then what is that suggest for Q1. Q1 potentially be an up schedule quarter, thanks?

Keh-Shew Lu

We don’t really give the Q1 outlook at this moment and the Q1 really very uncertain or unclear for us, okay. You will hear from some people they said well its (inaudible). But some people talking about because a Chinese new year this year is coming from – it’s coming at the end of or day past January. And therefore some of the manufacturing do have a strong view out for Chinese new year in December, and so, January is specially the union Chinese new year. We don’t really know what would happen. Okay. So, and then the other Thailand slot, we don’t know what would be the effect so it’s very unclear for 1Q right now.

Steve Smigie – Raymond James

Okay. Thank you for the color I appreciate. Regarding the P down of the convert does that mean that going forward there is essentially no interest expense and no intangibles amortization?

Richard White

Yeah, that’s exactly right.

Steve Smigie – Raymond James

Hi, great. And just last question was just on with regard to overall CapEx, Dr. Lu you guys were, sort of the, one of the first to take the loss when things got worsened, when the first add stuff back and things got better last time. Sounds like you are still little bit cautious on CapEx although I wouldn’t say it does sound like you still going forward with the Chengdu investment, so you must be little bit short-term nerves but it’s seems like sort of immediate turns to feel pretty good that there is going to be a decent ramp in business?

Keh-Shew Lu

Well, because Chengdu investment is a long-term and it cannot be affect by the short-term market environment, if you know our strategy in the past, it’s a very short time to attend the equipment at the decent facility. Therefore, we are able to when the market is up we quickly add the capacity, when the market down, we quickly put that capital expansion on hold. But for Chengdu, we up putting the (inaudible) and then with we put in help these the facilities, the Murphy or need to be Imprime put it and then start to put in equipment. Therefore, after we finish this facility then we can go back to, when we put the comment we can control by the market environment. But, at this moment what we Diode in the facility, the Murphy, the dark portion you can also store down and that’s a long term project.

Steve Smigie – Raymond James

Okay. Great thanks a lot guys, I appreciate it.

Operator

Your next question comes on the line of Harsh Kumar, Morgan Keegan.

Harsh Kumar – Morgan Keegan

Good afternoon guys. Couple of questions, Dr. Lu is there a possibility or room for operating expense control beyond what you guided to which is flat from current level and then I’ve one more?

Keh-Shew Lu

Well, I don’t think there is that possibility but, I don’t see that’s the time we have taken that, okay. I think like the people go and put the R&D of all, but I don’t feel now is the time to do in that. We still with these short-term yes, we’ve (inaudible) but, from middle come next year we still go after for market share gain and we still go up and see again, therefore we don’t want cut down any R&D, okay and for the people, the headcount, I don’t think now it’s a time because we put a hide in freeze, but with the deed we can either put it and get through this long term which shall deduce that account. Other than attritions in a – no more attrition or take it that while we put it hide in freeze, but I don’t it I want to take any action yet.

Because, I think now is probably, I won’t know, but I think this is probably the worse but, like I say 1Q, we are not very clear but at these moment I don’t feel we need to do that.

Harsh Kumar – Morgan Keegan

That’s very helpful Dr. Lu and that’s actually consist with the couple of other companies. So, let me ask you in terms of inventory do you think this slow down on your revenues is inventory driven more or demand driven more, and if its inventory driven how much excess inventory do you think is left to be addressed?

Keh-Shew Lu

I don’t deem this inventory driven and more it is demand driven. The demand in general is soft.

Harsh Kumar – Morgan Keegan

Okay. Thanks Dr. Lu. Thank you.

Operator

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

Suji De Silva – ThinkEquity

Hi guys. Just want to ask for some visibility, what’s the turns implied in the guidance, how well are you equipped to that guidance?

Keh-Shew Lu

I am sorry.

Suji De Silva – ThinkEquity

How well are you booked to your guidance, what are the terms implied in the guidance?

Keh-Shew Lu

Mark, you want to answer this?

Mark King

Yeah. I think it’s pretty normal turns rate that we are at this point in the quarter. So, when we are making this guidance at this point, we are looking at where we are turning and what our expectations are.

Suji De Silva – ThinkEquity

Okay. And then for the pricing, can you talk about what maybe the decline was like for like and what kind of pricing pressure are you seeing in the bookings for next quarter as well?

Mark King

We are seeing – in the commodity product areas we are seeing significant amount of price decrease. I don’t think we don’t really give a specific quantity but more than normal. And possibly with some of the change in demand, it’s affected the mix a bit too. So, the ASP decline looks a little greater as we chase it with some of that commodity product that’s lower priced. And yes, it’s a competitive marketplace, but we are used to a competitive marketplace at any time that it gets slow, you are certainly going to see some makeup for the price decreases that did not occur over the last four quarter.

Suji De Silva – ThinkEquity

Okay and then last question, you held up revenue pretty well here. Can you talk about the dynamics in the lower margin business versus the higher margin business just demand wise looking at the fourth quarter? Thanks.

Mark King

Yeah, I think that there is the softness in demand that’s causing more people to react with better prices and so -- but I think the general demand in that product area is the same now. We might go after certain areas that we hadn’t participated in, in previous quarter. So, maybe that’s why that’s up for us relative to some of the other products.

Suji De Silva – ThinkEquity

Okay, thank you.

Keh-Shew Lu

Thank you.

Operator

Your next question comes from Gary Mobley of Benchmark.

Gary Mobley – Benchmark

Hi. I wanted to dig down into some of the market commentary about customer inventories and distributor inventories. Mark, could you help us reconcile the fact that distributor point of purchase you said was down 11% quarter-over-quarter, distributor inventory was up 5% quarter-over-quarter and global point of sale was down 3%. We didn’t you know, point --?

Mark King

Yeah, when you put all those together you get some timing issues. Okay, so if you look at it generally within the next month some of that correction gets, it gets corrected in the next month following the quarter. So, I think we’ve already seen some of that correction in October, so that those numbers don’t look so -- so they balance better. But clearly people were expecting a better period, so they built their inventories up. Now they are cutting their, they are not seeing the business base going into the late third quarter and early fourth quarter as they expected, so now they are changing their profile and cutting inventory drastically. So I think you will start to see the numbers probably, you will see the inventory going down further in the fourth quarter and the numbers will look different the other way in the fourth quarter. So, the channel is definitely rationalizing its inventories at this point. So, if there is any inventory correction it’s in the channel and not in end customer.

Gary Mobley – Benchmark

Okay and perhaps putting in terms that most of us are familiar with, could you talk about the weeks of inventory that both of your distributors and your end costumers maybe carrying now versus perhaps by the end of fourth quarter?

Mark King

We don’t really track our customer inventories because our customers generally do it, they expect us to deliver so they won’t care a lot. So Diode’s inventory is right at about 105 days and distributor inventory -- I know the Asia is running at about 3.4 months and probably North America and Europe is running at about 120 days, so maybe four months which is a literally -- it’s actually not that high. It’s to the old profiles, but they had gone, the industry had shifted to a little tighter inventory control and now they are little lot wax. So, they are about little bit out of wax, but I expect them to correct that this quarter.

Gary Mobley – Benchmark

Okay, and Rick could you go back over some of your comments regarding the Eris loss in the quarter, what was the exact EPS impact for the quarter?

Richard White

Yes, it was $1.3 million, basically we are treating that as a share value investment, so based on what the stock price does we either take a gain or a loss on them, plus the investment was made in Taiwan dollar, so we also are impacted by the exchanger changes and in the third quarter the stock price went down and the Taiwan dollar fell. It was about 50/50 of the 1.3 or stock price versus exchange rates.

Gary Mobley – Benchmark

Okay and what was the exact EPS impact?

Richard White

The EPS is about $3.0, right?

Gary Mobley – Benchmark

All right, very good. Thanks guys.

Operator

Your next question comes from Ramesh Misra of Brigantine Advisors.

Ramesh Misra -- Brigantine Advisors

Hi, good afternoon folks. In regards to inventories, so clearly you’re building _Diode bank inventory, built a fairly large amount to last quarter. Should we expect that to go down in the December quarter, is that the peak of inventory build or will you continue to focus on maximizing factory utilization?

Keh-Shew Lu

You were talking about the Diode Bank, the Welfare Bank inventory we actually slowed down the wafer output. Therefore, we expect the way for inventory should be reduced.

Ramesh Misra -- Brigantine Advisors

Okay and what about the total inventory Dr. Lu?

Keh-Shew Lu

For the total inventory, we already see some deduction and we’ll continue to control that. But finishing good and prepare for the Chinese New Year and prepare for the, we always have people don’t comeback at the Chinese New Year. And so, we buy excess capacity and probably continue to produce, as long as they don’t hire the people, as long as they don’t put excess overtime, (inaudible) because prepare for short month of February, Chinese New Year shutdown and we’re going to do -- some people don’t come. The manpower reduction due to the attrition during the Chinese New Year, I am prepare for those.

Ramesh Misra -- Brigantine Advisors

Okay, that actually feeds in to my next question the employee issues that you had earlier on in the year. How well do you think, do you perceive them to be resolved and do you expect any lingering issues?

Keh-Shew Lu

This already is resolved. I think by end of September I think our productivity due to the new walker is already recovered. Yeah, so 4Q we are now -- that’s why in my speech I said we do not want to cut down the output, okay because we want to continue that ongoing productivity improvement and that’s why I say if that improvement give me a more capacity I just go ahead deal with and prepare for Chinese New Year for the few months or for all days next year. And therefore I, you know, just go ahead. So I might have in the first quarter we have finished good could be higher a little bit, but I don’t want to slow down the productivity improvement.

Ramesh Misra -- Brigantine Advisors

And then, just a quick follow up on prior questions of debt our SG&A expenses. Clearly, revenues are coming down, so the ones to get a sense of what part of it is variable and what part is safe. So, I am little perplexed that you don’t have better flexibility in reducing the marketing SG&A expenses as your revenues come down?

Keh-Shew Lu

Well, let’s look at several fits, number one, R&D you know, there are two portions, one is manpower or fairly which is the fixed cost. Another one you can slow down is deduce the new product MOSFETs, and I don’t want to slow down in a new product development. So, that portion, I just keep constant okay don’t increase the people and I don’t want to slow down new product development. Okay. For SG&A you can deduce my, deduce the people, and I want to continue this design win because we had been very successful, the design we needed for us to gain a market share. And, we have been continue gaining market share and I think in all announcement we always say you know, quarter or year-to-date end of third quarter we actually grow 10% from last year.

So, you can see we continue gaining market share and therefore to do not slow down the design win, okay. So the way I’m doing now is -- other variable would be the accrue for the bonus and accrued, but I think in general people still doing good job, if the market involvement is not because people don’t do a good job. So we still need to accrue certain amount for the bonus. Okay, so those portion it just cannot or do not want, I just don’t want to deduce it. Okay, the only one I deduce now is encourage everybody taking a vacation and those is the portion (inaudible) that kind of thing we are doing. My point is we are not at a stage, we want to be a major force of reduction, work force reduction, I don’t think we are in that stage.

Ramesh Misra -- Brigantine Advisors

Okay, alright. Thanks Dr. Lu.

Operator

Your next comes from the line of Steven Chin with UBS.

Steven Chin -- UBS

Hi and thanks for taking my question. First one is for either Mark or Dr. Lu. Just in terms of how the -- I guess in your conversation customers wondering if the (NMN) booking orders that has stabilized yet or is that still deemed to (inaudible). That’s my first question.

Dr. Keh-Shew Lu

I think it’s stabilize, but Mark do you want to say?

Mark King

Yeah, I think I don’t think that they are really giving very much long term outlook first of all for customer stand point it’s not to their advantage to make us feel comparable because then we will be less aggressive with our price.

So but you know, I don’t, I think that it’s pretty much stabilizing we are starting to see the demand, but we are not really seeing much into, we are not really seeing much beyond this the net two months and everybody is little bit uncertain about where the demand will be around the Chinese New Year.

I mean I was concerned about product and they are concerned about slowing people down because then people won’t be prepared for it, but there is not a lot of visibility into that point.

Steven Chin -- UBS

Okay, that’s very helpful. And then just kind of relaying the comments earlier about what you doing with capacity utilization rate, it sounds like you are being upward on the backend that we study to maintain the activity level achievement. So, just depending on how this comes through, well any additional inventory build up that you have, is that assuming that basically an anticipation of a reasonable recovery going to next year and that we don’t have a repeat of like 2008 or 2009 that’s the way I think about, how you guys are positioning yourself?

Keh-Shew Lu

Well, let me just answer your question in the general terms. Okay, number one, since we put in hiding freeze major attritions. Still we now have capital equipment capacity more than manpower capacity. So, if the market turn, we have the room for putting more output. Number two, since we are cutting overtime, again from a market trend we can use the overtime to makeup the need. Therefore, when we see, when we say, we would yield at our capacity and more talking about fully year rate, our manpower capacity instead of equipment capacity and we have very demitted overtime right now to deduce our cost. But when the market turn, we are going to pay for the market turn and we still have the equipment capacity, the overtime weekend use. So, when the market turns, we are able to pickup the upside.

Steven Chin -- UBS

Thanks, that’s very helpful Dr. Lu. And last question is for Rick just on the gross margin side. Is it possible if you could split out some of the relative waiting of factors that led to the potential decline in gross margin in the higher gold class, the mix, and also the ASPs that would be helpful?

Richard White

Well, we don’t have -- we don’t normally give that kind of information. But just in general gold prices went up about 13% from the second quarter and we use a lot of gold from month-to-month. Prices were probably the biggest impactor of the whole thing. As Mark talked about the move to lower priced product that has a significant impact on GPM percent because it comes off the revenue and the GPM at the same rate. So, it was probably the biggest factor of the three.

Steven Chin -- UBS

Okay, thanks.

Operator

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

Tristan Gerra – Robert W. Baird

Hi. You talked about the inventories being in the channel, I know that end customers. What type of point of sale assumption are you making for Q4 sequentially that’s embedded in your guidance. And would you expect channel inventories to be back to normal level at the end of the year based on the trends that you are seeing or do you think that there could be a little more delivery chain taking place in Q1?

Richard White

Yeah, you know, I think, there could be, it could move into Q1 little bit but I think, that we are getting closer and closer I mean, we are cutting our POP targets this quarter quite a bit, and probably the actual POS I don’t have the exact figure of what where I expect our POS probably at the lower end of maybe the higher end of our guides. You know, I don’t really look at it from a POS perspective at this point. But I think, I can see the trend based on our ship rates and so fourth of inventory against POS improving already.

Tristan Gerra – Robert W. Baird

Okay, that’s useful. And then, what do you need to see to switch the mix back to higher end product, because you know, the mixed impact of the weakening demand really started to take affect for your last May, late May you know, do you need to see sustainable recovery trend or is there any other threshold that you are looking at in terms of moving back to mix up?

Richard White

Yeah, I think, it all goes. Okay, you want to tell one Dr. Lu.

Keh-Shew Lu

Okay. I think, when we switch is we actually are fully at our existing capacity. So, you know, we have install capacity and we are using that to support higher price mix product, and then when we have access capacity we go down the GPM to go after for the commodity you know, product. And so, if that capacity there, instead of their administrative item, well we go after for product mix, go after for the commodity. And that has been our strategy anyway so whenever we start to have you know, growth n the higher GMP product then we start to deduce number of the commodity product we sell. So, it just depends on the capacity yield.

Tristan Gerra – Robert W. Baird

Great, that’s very useful. Thank you.

Operator

Your next question comes from Brian Piccioni of BMO.

Brian Piccioni – BMO

Hi, couple of questions you mentioned that you don’t know the Thai flood impact for Q1 fiscal 2012. Do you have confidence that your outlook for the fourth quarter has that fully baked in at this time?

Keh-Shew Lu

I think so.

Brian Piccioni – BMO

Okay. Well that was quick.

Keh-Shew Lu

No.

Brian Piccioni – BMO

Sorry.

Keh-Shew Lu

No, because you know, when this Thai flood came in okay or happening, they still have inventory, they have the inventory in the PC manufactures. Okay so basically in the 4Q, you probably don’t see that much affect from our customer point of view, because they have inventory, okay but, you know, after ingoing to the 1Q how is the recovery I don’t think people are very clear. Okay therefore in 4Q I think we already affect in we are - we’re already pretty in and our customer is already pretty in.

Brian Piccioni – BMO

On follow-on basis somewhat unrelated note but, it’s been gone over earlier in the call, when I look at the gross margin I look for the fourth quarter. Given the revenue level its more or less in line with the gross margins itself is more or less in line with what you posted in the second quarter of fiscal ‘09 when revenue was considerably lower and when you had similar revenue levels in the second quarter of fiscal 10, you had much better gross profit margin and you know, I understand I guess what I am working towards is I am trying to figure out for a longer term model what we can do, and I understand you can’t forecast price of gold but, I thought that you are moving vigorously to copper and that sort of stuff so, how can we think of gross margins evolving with revenue levels?

Keh-Shew Lu

Okay. Yes we cohesively convert our copper and convert the gold onto the copper and they were stable factor, affect that conversions, number one, you know, the gold price in 2Q to 3Q actually dropped faster than our conversion rate, I think record will give you, you know, the gold price, dropped significantly from 2Q to 3Q and that is hurting us on the GPM 9 because our conversion rate cannot be that fast.

Number two is we still have you know, now that our major customer data won’t change the product during the motto year so, for the new product we have given the copper, they design in with the copper product no problem, but try to ask them to change the current model or current product and current model for using the gold, they are kind of resistant especially in this time of period when the demand is soft. We cannot you know force them to convert so we kind of did that major customer conversion, only to the new model, so from long term after the model down when they start the ramp of the new model they all will be in the copper. So from long term I think you can pray it will significantly deduce the gold product, whole lot of product.

Brian Piccioni – BMO

Okay, so I guess what it is, is you have converted the, you have done the process engineering but they are still a heavy mix towards gold and that’s going to take design cycles on behalf of your customers to offer that basically.

Keh-Shew Lu

Yes we do that, you know, we are already qualified number one, we already do the PCN for changing notes to all our customer for this T, for you now second tier is easier to say well you know, we need to convert, but for the major customer you need their approval to convert and typically the major customer features you know, our big volume one they typically hesitate to do the change during the meet of the model year, okay and so any new design yes we already give them the copper and then we need to convert. So it’s just takes time.

Brian Piccioni – BMO

Okay great, thank you.

Operator

Your next question comes from Harsh Kumar, Morgan Keegan

Harsh Kumar – Morgan Keegan

Dr. Lu, a quick simple follow up on taxes. Lot of the companies that have reported to the lower guidance have had much lower taxes I am wondering why yours shot up or you just trying to make up for the tax for the year? Or is there something else going on geographically in the mix?

Keh-Shew Lu

I think I will let Rick to answer this.

Rick White

Yeah, so basically what happened in the third quarter, the tax rate has been going down generally throughout the year, the issues is that you do your taxes based on year-to-date basis, so for instance in the first quarter you estimate your tax rate for the year and you accrue at that level, second quarter you do the same thing and you accrue for that on the year-to-date basis. The problem was then in the third quarter the tax rate dropped, but we had already accrued the first half of the year at a higher rate. And so, the third quarter dropped to 3.2% because we adjusted the accrual that we had in the first half and then in the fourth quarter you go back to your standard rate.

Harsh Kumar – Morgan Keegan

Got it, got it great. Thank you guys.

Keh-Shew Lu

Okay, thank you.

Operator

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

Vijay Rakesh - Sterne Agee

Yeah hi guys, just wondering on your sales, what’s the split between OEM and distribution and how much of selling versus sell through?

Mark King

It’s all sell in and it’s about 55%, 50, 45% OEM.

Vijay Rakesh - Sterne Agee

Got it, and second was I know Chengdu is long term project for you, but is the head count on Chengdu already done or is that you start to add head count on Chengdu in Q1?

Keh-Shew Lu

Our Chengdu in Q1 will finish the trail, so the building will be done in Q1. And then we’ll put in the Murphy, the equipment the power all those in the Q2 to Q3 and we’ll probably start to do the production in Q3 to Q4 timeframe.

Vijay Rakesh - Sterne Agee

Okay got it. Thanks a lot guys.

Operator

Your final question comes from Joe Whitten, Longbow Research.

Joe Whitten -- Longbow Research

Hi thanks. Most of my questions have been answered at this point, I’ll keep it brief. First off the Shanghai issue, the labor and yield issue, I guess that was impacting margins in the prior quarter? I think you said it had a 150 bips of improvement to come. I guess, my question is that 150 bips of gross margin improvement already either in the third quarter or already in the fourth quarter guidance?

Keh-Shew Lu

It’s already in the fourth quarter guidance.

Joe Whitten -- Longbow Research

Okay, thanks.

Keh-Shew Lu

And it’s the part of the majority is already in the third quarter because we finish, I think we the problem we’ve already have complete recover in September. Okay, so even the third quarter they already recovered a lot.

Joe Whitten -- Longbow Research

Okay, thanks Dr. Lu. And then this is a quick follow up Mark in your initial prepared comments when talking about the weaker sales environment. You started off by saying there is weakness especially in Europe and North America, I thought that was a little of surprising comment given you expect a lot of the weakness will be Asia with you guys. So could you clarify was that a comment saying that, your ultimate and sale of consumer electronic and computing to the North America and European markets will be weaker or how am I?

Mark King

To be honest with you our numbers were down more in North America and Europe because our POP was down further and since we are sell-in that affected us more in those areas.

Joe Whitten -- Longbow Research

Okay how about the inventory cuts in those regions versus in Asia, was it pretty similar or was it worse in the West as well?

Mark King

I think that they are tracking base proportionally.

Joe Whitten -- Longbow Research

Okay thanks guys.

Operator

Ladies and gentlemen that concludes the Q&A session, I would now like to turn the call back over to Dr. Lu for closing remarks.

Keh-Shew Lu

Well thank you for your participation today. Operator you may now disconnect.

Operator

Thank you. Ladies and gentlemen that concludes the presentation, thank you for your participation. You may now disconnect. Have a great day.

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