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Executives

Keh-Shew Lu - President and CEO

Analysts

[Sean Burke] - JPMorgan

Diodes Incorporated (DIOD) JPMorgan TMT Conference May 16, 2012 11:20 AM ET

Unidentified Analyst

Okay. Good morning everybody. My name is Sean Burke, I work here at – on the semiconductor research team at JPMorgan. For those of you guys who’ve sat through the previous two sessions, hopefully I am a little easier on than Chris was. With us today here now is the Diodes, and for those of you who are not just familiar with the Diodes, they’re the very company that’s continued to outgrow their end markets over the last 10 years, and really that’s driven by the man sitting next to me here, the CEO Dr. Keh-Shew Lu.

And before we get started into the questions, why don’t you kind of give a general introduction on the company and kind of the end markets you serve.

Keh-Shew Lu

Okay. Diodes is semiconductor company and we focus our products in standard -- application specific standard product in the area of discrete, analog and logic. We focus on the market, high growth and high volume market that can consume computer, communication, industrial and very limited in automotive. Those are the five area but the high volume, high growth area. And we’re using our packaging technology to drive in the market and to serve the customer to gain the market share.

So our history is the last 10 years, our CAGR is 21% and that actually if you compare 2008 or 2009 is a bad year but after about middle of 2010, we started setting record revenue and then even this time from third quarter, market started -- went south, and we already made announcement the worst is over and 1Q -- in a seasonally cyclically 1Q typically went down versus 4Q but we are able to announce 1% growth versus 4Q. And then we gave a guidance second quarter will be 10 percentage point growth versus 1Q. So we go back to this growth mode, and we have been able to consistently beat the market and give us a significant growth, and because our business model is like this. Our business model is we want a profitable growth as much as we can and then with that R&D growth the same as revenue growth.

But SG&A would then grow half of it. That way if our CAGR is 20% or 21%, our bottom line EPS should grow faster than 20%. That’s really our business model. And so we’re typically able to run about 35% GPM with operation costs about 20% R&D and SG&A. So we have flow-through of like 15%, then after tax, then we have a much better growth of the EPS. And that really is our business model.

Question-and-Answer Session

Unidentified Analyst

Thank you for that detailed introduction. I guess to dive deeper into the discrete space, obviously it’s a competitive space and you’ve kind of seen people come and go in and out of the market over the last 10 years or so. Yet you have continued to outgrow not only the overall discrete industry but most of the customers as well. What’s been your real differentiator versus some of the other players in the space?

Keh-Shew Lu

If you go back to discrete, discrete is like a 50 years, 60 years history, and you don’t see not many companies continue put the technology, continue spend the money, we’re talking about discrete. Today go to look at other semiconductor, you hardly hear. Most of the semiconductors are talking about high end IC integrated circuit and millions transistor integration, you don’t see that much of people talking about discrete. But different from that is we continue put innovation to our business. And like I said, we’re using packaging to win the market share and I will show, this kind of – you’re probably not able to see it. It will be great to show you but look at how small we are. Now our smallest one is like one circle of the fingerprint.

And actually if you go to look at the new smartphone, new tablets, all these kind of high end new products, they need smaller and smaller footprint. You cannot put too many of the components to build component into here. But they still need the discrete, and that’s where we can win in the market share is because our competitor is no longer putting R&D resource, they still produce the same product but we are able to put in innovation, put high tech into this area. And that’s what give us – able to participate and grow and gain market share.

Unidentified Analyst

So you mentioned the smartphone has been kind of the one of the bigger drivers of growth for you guys and you’ve got some nice content there with some of the larger phone OEMs. Can you kind of walk through what your design win momentum is like today and maybe more broadly what kind of opportunity it represents for you guys this year and going forward?

Keh-Shew Lu

Well, I think we already in our earnings conference call, 1Q earning conference call, we said typically seasonally 1Q should be going down 5% to 10% but because the ramp of some new application, especially smartphone, tablets and LED TV. Those are the ramping areas. The total TV may not grow but they move more to LED TV. The phone may not necessarily grow but the smartphones actually grow much faster than the other segments. Okay, and there you get the tablets, you get EPC, netbook pc, those are some areas which the new application needs small footprint of the component, give better power efficiency of the component which want to convert into the new technology, new product we have. And they have been helping us grow quite well, and this momentum is going to be continuing. And that’s why we are able to give the forecast of second quarter, we’re going to grow 10% versus 1Q. And the markets really continue doing well.

And we have more and more new products getting into those applications. So the content of our product is not just the volume increase, it’s the content of our product into those applications is getting better.

Unidentified Analyst

You also mentioned the tablets space as well, can you talk about maybe how some of the content in tablet would differ from the smartphone or is it similar type of application?

Keh-Shew Lu

Okay. The content of the tablets is too thin – it’s not just discrete or other logic or something, it’s just broad base of our product getting into there. And because they need low power and since we drive in power efficiency, and our low power, our power efficiency packaging has enabled us to get into those applications. And another thing is small footprint and you know, tablets, no matter which company comes up, even the Kindle Fire, if you put in that category, they are all asking thinner, smaller packaging, right? So we are able to get into those applications in big way.

Unidentified Analyst

Okay. I guess switching gears, let’s talk a little bit about your current quarter and you actually guided very strong for Q2 up 10%. And I know you gave a pretty strong indication that Q1 was the bottom. How much confidence do you that Q1 was the bottom and where do you feel like we are in the cycle?

Keh-Shew Lu

Well, actually January is the lowest month and the reason is because the Chinese New Year this year came up in January 23rd. So we only -- and couple day earlier than Chinese New Year, we still have started worker taking vacation. So January is probably only two-third of our production. So it’s coming very low. Then February is only 29 days, and our customers which they build in those and equipment, their workers didn’t come back on time. So their productivity actually went down quite a bit. So February again is very slow, low month for us.

So we said right after the Chinese year, we see the demand going up but the reason purchase from us is not there because February they don’t have enough workers. Then go to the March, we started to see their workers come back, they start to put in. And we said, well is it because just the shortage of January and February or this is real. And then we go to the April, we see continued strength and we see continued pull. That’s why we have confidence to say, okay, the worst is in 1Q and the demand is continuing and we’re putting the focus of 10% growth.

Unidentified Analyst

So it sounds like you had pretty nice March after the seasonally down February –

Keh-Shew Lu

Yes, correct.

Unidentified Analyst

In terms of inventory, it seems like you’ve done a really good job working down some of the finished goods in Q1 and also you’re planning on working some down in Q2 as well. Can you talk about where you are right now relative to where – how much you’d like to have and how much has been you’ve had historically?

Keh-Shew Lu

Okay. This separates into our own finished goods inventory to the distributor inventory. Finished goods inventory is actually in the fourth quarter, we know the demand is soft and instead of working sitting there idle, we go ahead build those low end commodity product. And the reason is because we hired the people you have to pay for – people going to be go home, take a vacation or loans, the people in 1Q, right after Chinese New Year. So in the December, November, October, we started hiring the people, can really get in 20 (ph). But instead of sitting there idle in December, we started to build some of the low end product.

Okay, then after Chinese New Year, we see that people really happened but we already see the productivity is all the way back. We are in no need to holding those units to support the shortage of the product. And then so we just shipped out all the finished goods. And that’s why we saw 20% of the finished goods that shipped off. Because we already see the capacity, capability or our productivity already came back and our people already come back and we should be able to support second quarter’s growth. We don’t need holding those inventories.

Then let’s talk about distributor inventory. Actually distributor inventory traditionally, 1Q is lowest one. If you go to look at 1Q is the lowest one. In second quarter, speeds just pick it up, we cannot ship them too much. Their inventories work down, third quarter going even further down. Then fourth quarter starts back it up, because it’s against our cycle. When we have excess capacity, we build for distri and when our cycle is high and we are tight, then we deduce inventory, for distributor inventory because we sell in, we’re POP, and since we sell in, we’re just using our capacity and our demand. So typically 1Q should be the lowest one but this time, because we don’t have that much capacity because our worker shortage in 1Q and therefore actually distributor inventory went down 3%. And we believe second quarter since we are going to grow, we believe second quarter they will continue going down.

Unidentified Analyst

Okay. So it sounds like they’re still kind of in a workdown phase, assuming demand starts picking up in the second half from some of these end markets, do you see the distributors kind of behaving in this kind of lower muted inventory environment? Or at some point, do you see them having to restock for the holiday and back to school seasons?

Keh-Shew Lu

When they restock is when we have enough capacity. So we kind of use distributor instead of its gates. So when we have enough capacity, we build it, we give to them. But during second and third quarters, since we believe we will be tight, then we are not going to give to them.

Unidentified Analyst

I guess one of the other leverage you’ve talked about is ASP. Obviously it’s been – the pricing has been a little – it’s been pressured over the last couple of quarters. What kind of confidence do you that ASPs have pretty much stabilized here?

Keh-Shew Lu

There is – then one more one we know the ASPs never go up. Okay, it’s only one direction. So traditionally we know we have certain percent of declaration every quarter. Okay, so we know that. Start from the third quarter last year, since market went soar all of a sudden, we have excess capacity, we have lesser on price and so we can keep gaining market share. So if you look at our revenue, do not really go down that much. Okay, and that’s our strategy, by drop the price, continue gaining market share, okay.

Then we know since now we have the capacity, now the demand is there, we now don’t need to drop the price. So we kind of no more drop price, so it’s controlled by us. Okay, so we are very aggressively gaining the market share. So when the demand is soft, we drop price to gain the market share. When the demand is turning on well, then no reason for us, so I am confident because ASP is controlled by me.

Unidentified Analyst

Great. Do we have any questions in the audience right now? Okay, I will keep going. Another one on the leverage you talked about was utilization. Obviously you took down utilization, I think it was Q1 and maybe a little bit in Q4 as well. How do you view offloading (ph) this quarter and kind of throughout the rest of the year?

Keh-Shew Lu

Front-loading typically is not a concern for us. Okay, because we buy some from outside, and when you buy some outside, or I should say, make you almost half of our product is – we have two fab, Kansas city and our fab but we still buy a lot of wafer from outside. And therefore if you buy from outside, you don’t worry too much about utilization, because you just don’t buy. The price is fixed. Okay, so that’s you don’t do that. Now assembly is where utilization is matter to us. And because we know the value of our product is not in the wafer. That’s unlike other semiconductor companies.

For us the value of the product is really in the assembly. That’s where we’re really making the money. And so utilization affects us and even today we’ve not fully utilized our back-end capacity yet. But during the conference call, I still put to say, we still continue putting capital because some of the capacity we are really tight especially for those new packaging, newly built, and those are the ones, those new equipment I mentioned, they need it and they ramp it up or they continue – we continue doing more design in and continue getting there. And therefore we still continue putting the capacity for those new products. But the tradition – the all capacity we have not fully utilized yet.

Unidentified Analyst

I guess that brings another – another key point here is on your back-end capacity, obviously you’ve put in – despite the downturn you have continued to invest and put in resources in place to grow the new Chengdu facility. Can you talk about what your ramp plans are there, and when you do expect it to start coming online?

Keh-Shew Lu

We originally slowed down the Chengdu, because last year in third quarter, it started soft, we don’t know how long. This softness will continue. Therefore we kind of slowed down and I think in March -- in third quarter conference call, I mentioned we slowed down our Chengdu facility development. But actually in this quarter conference call, I said we go back up. Okay, so basically what we would do is we’re going to finish our building by end of this quarter and then we start putting the power and to start the facility to build up the factory. Okay, that will be in the second half.

Then if the economy continues to grow, and then we will probably start to buy in the equipment and get installed in 1Q next year. And then we can go back to ramp, okay, either second quarter, depend on the customers’ acceptance, go to second quarter, or third quarter but we will start to ramp it next year for sure.

Unidentified Analyst

And moving on to the cost side, I think you guys have some challenges there, but some of the commodity costs, I know you talked about slowly transitioning from some of those gold lead frames and then wiring to copper. Can you talk about where you are on that front and how you expect that to ramp here?

Keh-Shew Lu

To affect our gross margin, GPM percent, actually there are four factors. One is ASP, and I already said ASPs have stabilized, so we have been going down and ASP now, get into second quarter, we no longer drop the price, stabilized. Okay. Second is the product mix and again, I mentioned since we have capacity idle, then you’re going to do is continue build the commodity, low GPM to utilize that capacity. And that again, since now the business is already done, we are no longer going further down. Okay. So product mix going to be gradually improving because those high end products, if they start to ramp more, and low end, since you are no longer going more, then you’re going to start to see an improvement. So that’s product mix going to be started changed other direction because when all those high GPM stuff, they start to ramp, and higher more advanced technology one, they’re going to start the ramp, and we are putting capacity. And so if you remember, I said we continue putting the capacity for those higher GPM stuff. And that will help us to change the mix but it’s gradually.

Okay, then the third one is the utilization. That utilization will be improved continuously when the market turns, because if the market start to gain more on this traditional standard product, if they start to buy more that we can start to use more. And that’s why in the second quarter we shall – we said from 23.3 in 1Q, we’re going to go to 26. That’s almost 300 or 270 basis point improvement in one quarter is because this product mix and the utilization. Couple wide conversion, it’s really not controlled by us, it’s controlled by our mix. The one we can convert is our major customer typically say wait until my next generation. Okay, and that portion we cannot but personally go is no longer going up. Go actually start to going slightly down. So they all now, those four factors are all in the right direction for us. So we should be continuing –

Unidentified Analyst

Any questions in the audience now? No, so you talked about mix getting possibly gradually improving throughout the year. Can you talk about – I guess digging into the end markets, your largest end market is consumers, it’s about a third of your revenue, it’s weighted towards the back half of the year. Do you expect some of those seasonal trends to play out this year even though first half was actually above seasonal?

Keh-Shew Lu

Well, in the past, this cyclicality is very clear because back to school and the Christmas sales, and now when this new tablets and 3G phone and high end phones, or even LED TV, then not really that much – they try to sink to that but whenever they are ready to announcing the next generation, everybody come out to buy. And what we typically is we will start to build some before they announce it, and then when they announce it, depend on market reaction, we ramp even higher. Okay, so yes the cyclicality is still there but it’s this them before.

But that’s why we still say second quarter is higher than first quarter because that build for back to school, okay, and then third quarter is better than second quarter because that’s almost Christmas build. And fourth quarter depend on how good that Christmas, you either build in up to end of November or you build to the mid of November. And so third quarter – fourth quarter either slightly down or slightly up, or it varies.

Unidentified Analyst

I guess consumers obviously are a little lumpy. You have designs coming and going. One of your more stable businesses is industrial and auto. It was actually pretty nice for you guys in Q1. What are you hearing from customers there and what’s the feedback from end markets?

Keh-Shew Lu

It’s actually getting very stable because automotive business cycle, they don’t really affect them much, okay. And industrial, and most of our industrial is go to like a house, like in the United States, dishwater, refrigerator and home security, and garage door opener, those kind of we have customer as industrial is really (indiscernible) instead in a home and because they cannot really build in Asia, ship to here. So we have more in that area and so last year is quite there but you already know the housing kind of stable, houses are doing – started doing turnaround, for our own sake complete but it’s better than before. So I think we see, that’s why we could get in 1Q and we continue to see that steady. So that really improved.

Unidentified Analyst

Thanks for the color there. I guess moving towards the PC end market, there were some headwinds, late last year with Thailand flood and everything. How has that balanced, since one number Intel announced a new platform and now there is momentum around ultra-books and things of that nature. How do you look at that market? What are you hearing from your customers there?

Keh-Shew Lu

I think actually 1Q is really low because hard disk drive problem, and so 1Q, virtually is on the other side, which we don’t classify as a computer but actually the tablets and netbook, those are the one come out to compensate for those slowing. Okay, and second quarter, yes we see a good ramp for notebook. But I don’t know can they continue on third quarter or just because the 1Q is too low, that’s why they are making up. That I don’t know. But we do see a good demand in second quarter. We don’t see in the third quarter yet. We do see a better demand but it could be because 1Q was low, we don’t know.

Unidentified Analyst

I guess we talked a little about the end markets. As far as the different geos go, I think the one that’s most uncertain now is Europe. What kind of color do you have and what kind of insight do you have there?

Keh-Shew Lu

Okay. Europe, to affect Europe, you need to look at from two directions. Okay, one is euro consumption. Actually euro consumption affects more in our Asia revenue than euro. Okay, because the building in Asia ship to Europe. That portion actually didn’t get better since we went down, it’s still bad because people still don’t have the money and they still cut it back their spends. So that portion really -- we don’t see it really turnaround but at the same time it’s not getting worse. The other one is the exchange rate. Euro exchange rate most people, including us, most of our European revenue is in euro, not in U.S. dollar. But when we consolidate, we translate that revenue in euro into U.S. dollar. And if you euro goes down 10%, automatically U.S. dollar wise goes down 10%.

Okay, and virtually for us is since with 77% from Asia, euro for us the revenue is only 10% to 12%. So even they go down 10%, they affect us 1%. So it’s not going to significantly affect us. And that’s why we are confident our revenue is going to continue to grow is because they have not really increased the consumption and they are not getting worse. But Europe could be changed, could be because all this unstable, people talking about euro exchange rate could be go down but they don’t affect us the much. Okay. On the other side, U.S. is actually in a much stable now and the consumption is actually going up. And that consumption going up, people are still buying smartphones, still buying tablets, still buying LED TVs, still – and those are the ones we are good at it and those are the ones continue helping us.

Unidentified Analyst

I guess we have time for one more question. Let’s talk real quick about you’re moving to the analog and logic space, and how the business (indiscernible) now looks versus five years ago?

Keh-Shew Lu

And you know, we stepped into analog, it’s about 5, 6 years ago, and we stepped into logic, it’s 2010, so it’s about two years ago. From analog point of view, they have been doing well for us. I still remember we spent 30 something million to buy almost $15 million revenue and that’s given us a jumpstart. And because of that, we continue grow quite well. We don’t separate that from – separate from discrete and analog because they share the same packaging capacity. But with our effort, that area we continue growing.

Logic, we just stepped into it two years ago, it took a while to be significant, okay. So today the way we get into it is we get to the bigger customer and use our discrete and analogy to carry our logic into those major customers. It’s a very difficult to just go into say, okay, use our discrete, our logic but what we do is since we build up that relationship with those major customers, we sell them since now we have those products, can use it. And we are now gradually get our major customer into use it. But the volume is still not there yet significant. But I think another two years, you will see a significant, because we start to see a pretty good ramp.

Unidentified Analyst

Great, thanks. I think we’re about out of time. Thank you very much again Dr. Lu for joining us today and I believe there is lunch outside. Thanks.

Keh-Shew Lu

Okay, thank you, Sean.

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