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Diodes Incorporated (NASDAQ:DIOD)

Q4 2007 Earnings Call

February 13, 2008 10:00 am ET

Executives

Leann Severs - Investor Relations

Dr. Keh-Shew Lu - President & CEO

Carl Wertz - Chief Financial Officer

Mark King, Senior Vice-President of Sales and Marketing

Richard White - VP Finance

Analysts

Harsh Kumar - Morgan Keegan & Company, Inc.

Shawn Harrison - Longbow Research

Kevin Rottinghaus - Cleveland Research Company

J. Steven Smigie - Raymond James

Chris Chaney - Stanford Group Company

Ramesh Misra - Collins Stewart, LLC

Christopher Longiaru - Sidoti & Company, LLC

Kevin Cassidy - Thomas Weisel Partners

Operator

At this time I would like to welcome everyone to Diodes Incorporated fourth quarter 2007 financial results conference call. (Operator Instructions) I would like to now turn over Miss Leann Severs of Shelton Group Investor Relations. Please go ahead, ma’am.

Leann Severs

Good morning and welcome to Diodes fourth quarter and fiscal 2007 earnings conference call. I’m Leanne Severs, 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, Carl Wertz, Senior Vice-President of Sales and Marketing, Mark King, and Senior Vice-President of Finance, Richard White.

Before I turn the call over to Dr. Lu, I’d like to remind our listeners that management 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 forward-looking statements that is contained in the Private Securities Litigations 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 filing with the Securities and Exchange Commission. In addition, any projections as to the company’s future performance represents management’s estimates as of today, February 13, 2008. Diodes assumes no obligation to update these projections in the future as market conditions may or may not change. For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 60 days at the Investors Relations section at Diodes’ website at www.Diodes.com. And now it is my pleasure to turn the session over to Diodes’ President and CEO, Dr. Keh-Shew Lu.

Dr. Keh-Shew Lu

Thank you, Leanne. Welcome everyone and thank you for showing up today. We are pleased to again report record financial results for the quarter end and the year. Our fourth quarter was highlighted by a sequential increase in gross margin by 110 basis points and an increase in revenue of 14% over the same period in 2006. Adjusted net income was also a record in the quarter growing to $18.6 million or $0.43 per share representing a 9% sequential increase. These quarterly results conclude another year of outstanding performance of Diodes and further demonstrates our consistent record of execution as well as strong growth and profitability. 2007 financial highlights were: revenues increased 17% to a record of $401 million. This 17% top line growth again far exceeded the semiconductor market growth of 3.2% according to WSTS figures. Gross profit increased 14.5% to $130 million. Capital income increased 22% to $65 million or $1.50 per share.

In terms of the biggest highlights, we achieved several key milestones during the year. We successfully consolidated analog manufacturing to our China facility for improved operation efficiency. We significantly expanded capacity and improved utilization at both of our manufacturing facilities, resulting in over 15 billion units produced in 2007. We invested to increase our fab capacity to reach 60,000 wafers per month with the planned expansion of a six inch SBR(NYSE:R) line. We accelerated the pace of new product introductions through an expanded research and development platform. We increased market share through our cross selling synergies between our analog and discrete segments. We integrated the APD acquisition resulting in the release of our successful SBR(R) product line and Diodes’ grew revenue in the Europe market by 50% in 2007. Diodes’ performance is a result of our ability to combine customer-focused innovation in the discrete and analog markets with state-of-the-art cost-efficient packaging. Our execution of this model has consistently delivered solid results for Diodes, our customers, and our shareholders over the long term.

And based on our historical performance, we believe 2008 will be another year of solid growth and profitability for Diodes that will once again substantially exceed the performance of the industry. As many of you know, the first quarter will be more challenging due to the overall weakening of the economy, and in particular, its potential effect on the consumer and computing market segments. Regarding profitability improvements, our business continues to benefit from operational and manufacturing efficiencies as we realize the full benefits from our manufacturing consolidation efforts in the coming quarters.

Most importantly, Diodes has delivered record top- and bottom-line results in the past 12 out of the last 16 quarters. We have successfully managed through challenging business environments in the past, and our proven track record of execution combined with our broadened product focus, aggressive new product introductions, and gains in our target markets will continue to deliver profitable results for shareholders.

Finally, I want to provide a brief update regarding our acquisition strategy, which is a key focus area. Over the past several months, we have continued to evaluate acquisition targets that we believe are synergistic to our business by offering complementary technologies, expanded market positions, and/or manufacturing capacity and efficiencies. Additionally, the acquisition must be accretive within 12 months. To date, we have made significant progress in our evaluation process while remaining very selective in order to achieve the maximum value for Diodes and our shareholders. Additionally, over the past year, we have taken the right steps internally to improve operational efficiencies and secure the adequate engineering staff to support our future expansion. We believe these efforts will help expedite the successful integration of a future acquisition into our organization, and we will provide updates to our shareholders as they become available.

With that, I'm going to turn the call over to Carl to discuss our financial results in more detail.

Carl Wertz

Thanks, Dr. Lu. Good morning, everyone. As Dr. Lu mentioned, Diodes again achieved record financial results in the fourth quarter and for the fiscal year 2007. Revenues for the fourth quarter were a record $107.6 million, an increase of 13.9% from the fourth quarter 2006 and up 2.2% on a sequential basis. New product sales accounted for 40% of revenues as compared to 33.5% just one year ago. Gross profit for the fourth quarter was $36 million or 33.5%, a 110 basis points sequential increase in margin. Gross margin was up primarily as a result of improved product mix and the realization for the benefits associated with internalizing our analog manufacturing. Selling general administrative expenses for the quarter were $14.8 million or 13.7% of revenue compared to 13.9% last quarter.

Included in the fourth quarter, SG&A was up $1.1 million in non-cash FAS 123R share-based compensation. In the earnings release we have included a table to reconcile the impact of the share-based compensation expense to our reported results. For the full year 2007, SG&A was within our expected range of 13.8% of revenues compared to 14% for 2006. Research and development investment in the quarter was $3.9 million or 3.6% of revenue. As expected, R&D investment percentage of revenue has increased throughout the year as our R&D and new product activities continue to increase in both the U.S and Asia. For the full year 2007, research and development was 3.4% of revenues.

Looking at the first quarter and 2008, we will continue to enhance to our R& D capabilities in order to support our broader market focus and new product introductions. Our business model going forward will be 3.5% of revenue plus or minus 0.5%. During the fourth quarter we had a one time credit in restructuring charges in the amount of $700,000. As you may recall we had originally taken a restructuring charge of $1.8 million in the second quarter 2007 as part of the consolidation in moving our Taiwan analog operations into our China manufacturing facilities. On completion of the integration, we were able to keep more of the equipment and ship it to our China facilities at much lower costs and fees than originally estimated.

Our effective income tax rate in the fourth quarter was 11.8% resulting in effective tax rate for the year of 13.2%. We have made good progress in our tax planning initiatives and we expect our effective tax rate to be in the mid teens for the full year 2008. Adjusted net income which excludes $1.3 million in FAS123R non-cash stock option expense and the $700,000 restructuring credit increased 18.1% over the prior year to a record $18.6 million or $0.43 per share up from $15.8 million or $0.37 per share in the fourth quarter 2006 and $0.40 per share in the third quarter 2007. Cash flow from operations for the quarter were $38.2 million up 54% quarter over quarter increase and $90.6 million for the year at 26 % increase.

Turning to the balance sheet at the end of the year we had $380 million in cash and short term investments, $452 million in working capital, and $237 million in long term debt including convertible bond. Inventories ended the fourth quarter are $53.2 million. Inventory returns at year end were 5.2 comparable to the same period last year.

Accounts receivable days were 75 in the fourth quarter compared to 77 days in the prior quarter. Capital expenditures for the current quarter were $11.3 million and for the full year, CapEx was $54.2 million. This represents 13.5% of revenue as we invested for our growth by capitalizing on opportunities to gain market share and included the addition of the 6-inch SBR(R) line at Diodes-FabTech as well as expansion of analog capacity in China.

Excluding the SBR(R) line, CapEx was 12.2% of revenue. For 2008 we expect capital expenditures to be in the model range of approximately 12% of revenue and will continue to monitor this plan throughout the year. Depreciation expense for the fourth quarter and for 2007 was $7.4 million and $26.2 million respectively.

Turning to our outlook, we currently expect revenue for the first quarter 2008 to be in the range of $95 billion to $101 billion. In terms of gross profit, we believe that our gross profit margin will be comparable to the fourth quarter. Our estimated first quarter performance reflects seasonality combined with the impact of the overall weakening economy. In particular, on key targeted end equipment in the consumer and computing markets as well as our foundry and subcontracting business, which is showing greater weakness than our core revenue drivers.

Over the longer term, we believe that Diodes’ history of execution in significantly outperforming the industry combined with our focus on customer-centric innovation and efficient manufacturing, will return us to our historical growth rates and will continue to deliver positive results for our shareholders.

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

Mark King

Thank you, Carl, and good morning. Let me begin with our segment breakup for the fourth quarter. Computing represented 37% of revenue, consumer 34%, communications 17%, industrial 10%, and automotive 2%. During the fourth quarter, we continued to make notable progress in our new product roadmap in discrete, analog, and hall sensor devices. We released 80 products from 15 different product families including 10 analog devices, 2 hall devices, 8 MOSFETs, and 12 SBR(R) devices. As Carl mentioned, new products grew to 40% of revenue, which was achieved with a corresponding increase in margin.

Our new product revenue was driven by our DSN product line, our low threshold MOSFET line, also increases in our SBR(R) product line. Also during the quarter, we recorded initial new product revenue from our recently announced medium power bipolar transistor line and we received our first orders from a tier-one handset manufacture for our omnipolar hall sensor devices. The release of our medium power transistors serves as an example of our effort to expand our product offering beyond small signal devices and to further position Diodes as a complete analog and discrete solution provider. During the quarter, we also announced the expansion of our standard linear product line to better serve the needs of our diversified customer base as a broad supplier. This initiative is a continuation of our strategy to focus our expansion on commodity analog products and leverage the synergy between our high volume packaging and our standard linear technology.

As I mentioned last quarter, we continue to make progress more towards focusing our analog line more towards mobility and portability which included the introduction of our first high efficiency charge pump white LED driver for small sized LCD display. Adding to this, we also announced the release of our first ultra-low dropout regulators which represented the first in a family of new power management devices that we will be releasing to target the portable and battery-powered electronic device segments. Further, we announced the release of a single channel smart load switch for use in notebooks, Bluetooth, headsets, smart phones, and GPS devices. Each of these product introductions furthers our progress towards penetrating the mobile and portable markets while also complementing our hall sensor and discrete product solutions. We are very excited about the opportunities in this segment and anticipate a meaningful contribution to revenues in the second half of 2008.

In terms of overall design activity, it was another strong quarter with multiple design wins in 65 accounts globally. Global design wins and in-process design activity is centered around new products including hall sensors for cell phones and notebooks where we had five significant wins including one Asian cell phone manufacturer and two notebook platforms. As I mentioned earlier, we secured a design win with a tier-one cell phone manufacturer for three of their current programs with initial orders booked during the quarter. SBR(R) s for end equipment ranging from cell phones to welding equipment, medium powered bipolar transistors in motherboards, cable modems, and set top boxes. Switching regulators and LDOs for set top boxes and LCD televisions as well as several industrial applications in North America and Europe, and DFN platform products for digital audio players, and mobile phones.

In terms of geographic breakout, Asia sales volume increased approximately 8% over the third quarter and represented 79% of total revenues. OEM sales were strong with solid demand in consumer and computing market for LCD TVs and panels as well as digital audio players, set top boxes and notebook computers. Additionally, we saw strong demand in DC fan and increasing demand for our SBR(R) products for the power supply and adaptor markets. Design activity in Asia was strong across all product lines including key wins in SBR(R), hall sensors, switching regulators and LDOs.

Now turning to North America, sales decreased 2% sequentially on generally soft demand and represented 21% of total revenue. Cable and satellite set top box business remained consistent, but there continues to be movement of manufacturing to Asia. We did experience some uptick in industrial accounts in a quarter, but it was not enough to offset the movement to Asia. Coming off a strong third quarter, wafer sales decreased 23% in Q4. Although trade wafers were down, our internal utilizations continued to increase. In total, we achieved 76 design wins in North America during the quarter. Seven of these were in analog, 65 were discrete, and 4 in SBR(R). We continue to make progress with our SBR(R) lines in industrial and communication accounts and also have design momentum in our PowerDItm, linear regulator, and omnipolar hall lines. Distributor point of sales was down 2% sequentially and inventory levels increased slightly.

Finally, sales in Europe accounted for 4% of revenue and decreased 12% over the third quarter due to weak distributor point of purchase. OEM sales were flat with distributor point of sales increasing 1% in the quarter due to stable demand from consumer and automotive customers. Our design win momentum in Europe continues to expand in the fourth quarter with 19 wins with 17 accounts including 4 hall sensors, 3 SBR(R)s, and 4 analog design wins. Additionally, we won expanded contracts with three customers during the quarter. Looking at Europe for the full year, sales increased 50% over 2006 and distributor point of sales grew 83%. We have an established plan for future growth and we continue to believe the European market will be a strong contributor to our results going forward.

In summary, we believe Diodes is taking all the right steps toward becoming a complete analog and discrete solution provider. Focusing on the right market at the right time, we are dedicated to product innovation and believe our pipeline of new products will further drive expanded market share. Additionally, we have made notable progress with focusing our analog business on mobility and portability which we expect to provide increased upside in the later part of the year. With that, I will open the floor to questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Harsh Kumar from Morgan Keegan. Please proceed.

Harsh Kumar - Morgan Keegan & Company, Inc.

I want to congratulate you. Despite the tough economy, I think your business model is pretty solid and you’re managing the business well. So congratulations on that. I just wanted to ask a couple of quick questions. You talked about general environment and that things are worse clearly in the U.S. Could you give us some more color? Is there any one area that is a little bit worse than the other within consumer or computing? Possibly also maybe talk a little about geography, high end versus low end. Anything you can help us with would be helpful.

Dr. Keh-Shew Lu

Thank you for the comment. I have Mark who will answer those questions.

Mark King

I would say we have a traditional seasonality in the Asian marketing in computing and consumer. I would say that the downturn is a little bit more severe this year and maybe just a little more unsure, people are being more cautious. In North America I think we see generally a soft market, a very conservative distributor network and so forth being very cautious about where the demand is going. But overall, we see that POS trend is relatively flat, people are more concerned with inventory reduction and making sure that they have a lot of flexibility in that area.

Harsh Kumar - Morgan Keegan & Company, Inc.

Got it, so you’re saying the end follow through is sort of pretty decent still.

Mark King

I think it’s reasonable, I don’t think there any significant fall off. I think that more in the POP area, and so forth. But, I think we have a little bit more exaggerated seasonality due to the economic climate and a lot of uncertainty and people being risk evasive.

Harsh Kumar - Morgan Keegan & Company, Inc.

Okay, fair. And just as a follow up to that, are you seeing any signs of return, possibly second quarter as better for you guys. Is there any encouragement that you’re seeing from the end markets about the length of this downturn or however you want to look at this soft spot?

Mark King

I think in North America and Europe it’s very hard to say which way it will go. We would expect some uptick in the Asian market, in the computer and the consumer market, but that’s still relatively uncertain based on back row economic conditions.

Dr. Keh-Shew Lu

But I will hold the view we are about to announce a new product, a new design win. We will wrap it up, the new models which are typical. It started in the second quarter, so we were affected by the maker. At the same time a new product design win during the last several quarters will help enough.

Harsh Kumar - Morgan Keegan & Company, Inc.

I appreciate the color and last question for me, margins of 33.5 are pretty good, is there any room from here on out as the year goes on and supposedly unless things get better can the margin ramp up or is this sort of the high we should be thinking about?

Dr. Keh-Shew Lu

Well, this is very difficult; we continue to do our best to improve our efficiency and our profitability. Unfortunately, a lot of times the product mix would change our efforts. Therefore, for us it is very difficult to predict in the future but we continue putting effort on manufacturing efficiency and through the year if we can reduce the cost, that is continued. It’s just a lot of time affected by the AP and the product mix.

Harsh Kumar - Morgan Keegan & Company, Inc.

Thank you, thank you for the color. I appreciate it, that’s all for me.

Dr. Keh-Shew Lu

Thank you.

Operator

Your next question comes from the line of Shawn Harrison from Longbow Research. Please proceed.

Shawn Harrison - Longbow Research

First question just has to deal with the weakness in the foundry and the subcontracting business. So if you could just remind me what percentage of sales those two pieces represent?

Mark King

We’ve never really published that percentage.

Dr. Keh-Shew Lu

We really never break it up but we profess to [inaudible] is produce the wafer for ourself, and at the same time we do [inaudible] for other people. Through the years, our objective is to gradually reduce that foundry business to internal usage and so, actually in just the fourth quarter I think that Mark is talking about to go around while we even have some growth in the fourth quarter, actually that foundry business went down, 23%. First quarter it went down significantly, it went down again, but our objective is always to try to, at the end, [inaudible] capacity for ourselves.

Shawn Harrison - Longbow Research

Okay. Maybe just on the foundry business from the subcontracting business, the margin profile, is that lower than the corporate average, in line with the corporate average, just trying to get an idea of gross margins holding steady here in the first quarter in light of a greater than expected revenue fall off, or is maybe something else that works such as an increase in contribution from the new product sales.

Dr. Keh-Shew Lu

Well, we didn’t disclose big numbers because this is a capital business and we just do the packaging for some of our customers and we really do not disclose the gross amount.

Shawn Harrison - Longbow Research

Okay, then just as a follow up, new products were 40% of sales this quarter, was it 32% last quarter, is that the correct number?

Mark King

I believe right in that, I think it was 34%. I don’t have that figure right here.

Carl Wertz

Yes 33.5% a year ago.

Dr. Keh-Shew Lu

33.5% a year ago.

Shawn Harrison - Longbow Research

Should we expect that number to increase further here in the March quarter and then in 2008 or kind of hold steady around this 40% range?

Mark King

I think you’ll start to see it drop some because some of the product is starting to age in groups. We don’t see any negative affected but we have long life cycles on our products and sometimes a long digestive period to get them into the line, so I think you might actually see that new product revenue percentage decrease but no major effect on the overall margin percentage on the thing. These are long-lasting products and some of them are just starting to mature at the time, and its big numbers, at the time they’re going to expire are basically classification.

Shawn Harrison - Longbow Research

Okay, and then two quick follow ups….

Dr. Keh-Shew Lu

Really the classification only, it really, for our [inaudible] the gross margin decrease is not very significant from new quarter versus old quarter, just the way we define it three years from the time we release it for production, within that three years, each quarter after three years [inaudible].

Shawn Harrison - Longbow Research

Okay and then two quick follow ups. ASP trends, have you seen any abnormal pricing pressure here in the first quarter and then also just how much, since we’re into this second week of February, how much backlog coverage do you have of the quarter, is essentially the quarter covered right now in the sense of what you’re seeing in the backlog?

Mark King

No, I think that there’s obviously in softer periods we’re going to have more than normal ASP pressure. I think we’re seeing more ASP pressure probably in North America right now than we see in Asia. But it will be more than a normal rate. Regarding backlog, it’s a very turns-orientated environment and actually it was a turns-oriented environment in the fourth quarter also. So, as people get more and more concerned about the economy, they are less willing to establish a long term position. So, this is a market place where everyone needs to be very aggressive and very attentive to capturing every order.

Shawn Harrison - Longbow Research

And what are the lead times right now and just a general range then for you?

Mark King

I think its very product dependent, but we’re very capable. We still maintain high utilization rates but we’re very capable of adjusting those utilization rates to capture business.

Dr. Keh-Shew Lu

I think I mentioned to several investors before the way we view our business, we view the valuement of it, view the finished wafer in packaging and that then can reduce the lead time because more lead time is coming from the wafer process instead of packaging and fortunately our wafer costs is much different relative to other companies’ product therefore we are able to build the wafer incrementally direct in assembly so that we can reduce our lead time and that’s the reason we have very detailed ability because we can turn the product very quickly, especially with our very big manufacturing packaging capacity. I mentioned to several investors before it’s easy for us to turn the product in a very short period of time to meet our customers demands, therefore, the very critical customers don’t give us a very long lead time orders. When they need it, they call us, we ship it.

Shawn Harrison - Longbow Research

Okay, thank you.

Operator

The next question comes from Kevin Rottinghaus from Cleveland Research. Please proceed.

Kevin Rottinghaus - Cleveland Research Company

Thanks. On utilization, is there any net change quarter per quarter or are you keeping it relatively flat?

Dr. Keh-Shew Lu

Relatively flat.

Kevin Rottinghaus - Cleveland Research Company

Okay, so what are your plans for internal inventory, do you plan to build in first half of the year then?

Dr. Keh-Shew Lu

Yeah, that’s the way we do when the business slow down, we keep our back orders by building that wafer for the wafer [inaudible] and when the wafer [inaudible] come in we are in a position to support our customers right away. So, that’s always our business model, you go back through history, 1Q particularly you will [inaudible].

Kevin Rottinghaus - Cleveland Research Company

Okay, and maybe from Mark, weakness that you mentioned from the macro environment, are you seeing actually any order cuts or changes to forecast, or is it just short visibility, increased customer caution, are you actually seeing any changes to forecast?

Mark King

Not really, we may have seen these forecasts coming, but there’s not a dramatic cancellation hitting our fax machine all day long.

Dr. Keh-Shew Lu

No.

Mark King

I think you’re seeing again the pipeline orders from distributors being cut back, you might see shorter windows on pipeline orders and so forth, but I don’t think we’re seeing any dramatic cutbacks. I think people are more cautious on the order end rather than what they’ve already got in place.

Dr. Keh-Shew Lu

When you’re talking about a very short lead time, typically people won’t give you a double order. We don’t have a double order form therefore we don’t see the cancellation problem. That’s one of the advantages of a very short lead time.

Kevin Rottinghaus - Cleveland Research Company

And Mark, I think you made a comment on channel inventories; maybe you give us any more color you have there?

Mark King

I think actually the channel inventory is pretty clean and I did mention that it upticked slightly in North America in Q4, but I think it’s negligible, I think Europe is very solid and I think our Asia position. Inventory I think always goes up at the end of Q4 because it goes down so dramatically in Q3 because the last two months of Q3 and the first month of Q4 are the hottest periods so we kind of squeeze everybody’s inventory down so it was natural for it to rise in Q4.

Kevin Rottinghaus - Cleveland Research Company

Okay. On the handset market, it sounds like you have initial orders into one customer and design ones at another. Are you getting orders across all three platforms at this point or is it just one and when do you expect the orders to start to come in for your new Asian customer there?

Mark King

I think we’re seeing some of the initial orders on some of these platforms. Some of these programs we have are on the newer platform so they haven’t ramped to full production and we’re a new supplier so we expect in the early stages to have minor shares but it’s been our history that we take minor shares and advance those into full shares over a period of time. So, I really can’t give a revenue flow on these yet, but these are very nice position wins for us for our long term development. So the orders initially have been quite small but we expect significant roll out as we approach the third and fourth quarter.

Kevin Rottinghaus - Cleveland Research Company

Okay, and last question on OpEx, could you kind of give us some direction on how we should expect OpEx for first quarter and if 3.5% for R&D is that on a quarterly basis or is that on an annual basis, how should we expect it to go for 1Q and then total OpEx for a full year?

Dr. Keh-Shew Lu

Yes, it’s 3.5% for 4Q is 6.3% and so 3.5 is an average, our 3Q is 3.4, but if you look at it, it’s not really significant in [inaudible] from a percentage point of view. Now with the 1Q, for our R&D expense either will be flat or it will size it down but because of revenue in the [inaudible] the percent will be in the [inaudible], but from the total amount point of view it will be either flat or sized down.

Kevin Rottinghaus - Cleveland Research Company

And how about SG&A?

Carl Wertz

SG&A should be fairly consistent with the fourth quarter.

Dr. Keh-Shew Lu

Yes.

Carl Wertz

With some pretty good controls in place.

Dr. Keh-Shew Lu

Our SG&A has been controlled quite fairly so it’s somewhere in the fourth quarter at 13.7%. You can see through the whole year it’s quite steady. Then again, we don’t see a major increase; we’ll probably see the same thing. [inaudible] fair increase typically in the 1Q some operations like in Taiwan and China they’re fairly increased so you might see some, other than you will not see any increase.

Carl Wertz

No, it’s not a significant change. We’ll probably be in the 13.7% and maybe 14% range due to the lower revenue in the first quarter.

Kevin Rottinghaus - Cleveland Research Company

Okay, great. Thank you.

Operator

Your next question comes from the line Steve Smigie of Raymond James. Please proceed.

J. Steven Smigie - Raymond James

Great, thanks, and the numbers you’re quoting on the last SG&A and R&D is that including or excluding op expense?

Carl Wertz

That’s including.

J. Steven Smigie - Raymond James

Including, okay. And you have a couple of large customers, if any one of those had somewhat mediocre performance in 2008 would you guys still be able to grow pretty healthily despite that, I’m curious about the impact of significant customers on you in ’08.

Carl Wertz

I think we should be able to continue to grow.

Dr. Keh-Shew Lu

Yes, our growth is longer in the new quarter, the new design win, new customers so, yeah some of the old customers will continue to grow but a lot of our growth is going to come from the new design win. Just like the PO sales phone, we will ramp it up in 2008 and this is just one of the examples, the new design win will be the one helping us.

Carl Wertz

And Steve we also don’t have a heavy concentration of one customer. We don’t have any one customer generating greater than 10% of revenues so it’s pretty diversified.

J. Steven Smigie - Raymond James

If you look at second quarter, I know you’re not giving guidance for it but can you give me any sense of, at this point, if there’s any reason why you wouldn’t have sort of a seasonal recovery going into Q2, is it unreasonable to think you would grow sequentially in Q2 or else is it Q1, given the lower Q1 number?

Mark King

My answer to that would be that it would be bold to make too many estimates about what’s going on around us but that we do expect normal seasonality shifts going into the second quarter. There’s nothing that has told us that that would not happen yet.

Dr. Keh-Shew Lu

Yes, nothing that tells us that that won’t happen yet, even in the best of times.

J. Steven Smigie - Raymond James

And looking at the gross margins in Q2, I see your revenues dropped here so I have to imagine that there might be some utilization impact unless you’re running more product at a lower margin, but as we go into Q2 it would also seem that gross margin would move up sequentially as well. Would that be the right way to think about that?

Carl Wertz

You know I think Steve we really don’t do quarter by quarter and we don’t really go out beyond the next quarter but for the whole year, we have a lot of opportunities, okay? We brought a lot of internalization of the analog in house, we’re doing more internalization of our wafer internally being packaged in China, we’re looking for all efficiency betterments, if the market holds solid, then we should continue to outperform the market.

Dr. Keh-Shew Lu

The key is really SP. If the market holds, but the forum is typically start to have the new model for a new model year for the consumer market and they can always negotiate the price and you need to make sure your cost reduction effort can [inaudible] the SP job then you’re okay, or the product mix give you growth market [inaudible] but at this moment, since there are so many factors going on and you know we are very conservative, we really don’t want to tell you anything one way or the other.

Carl Wertz

Steve, we’ve got a pretty solid track record in utilization of our expansion, we’ve given you some guidance for the year, we’ll continue to monitor that, we’ll try and do our best to keep utilization rates as high as we can, so like Dr. Lu says, if the market holds good, it’s all based on pricing, our cost reduction should stay ahead or equal to the curve in the SP, so all indications are we should be able to squeeze a little bit by the end of the year.

J. Steven Smigie - Raymond James

So the last question is that sometimes things slow down a little bit, you guys will be a little bit more proactive about going in and getting some extra business, maybe you just take in a better environment, but have you done any of that in Q1 guidance or is that something that you might do throughout the quarter that maybe might help revenue a little bit?

Mark King

We take all strategies into consideration.

J. Steven Smigie - Raymond James

Okay.

Mark King

We constantly are managing the requirements of our revenue versus our utilization and our customer opportunities.

Carl Wertz

Remember Steve, we’re focused on gross profit dollar improvement and if we have to sacrifice a little margin percent, we’ll do that if we’re getting additional gross profit.

J. Steven Smigie - Raymond James

All right, thank you.

Carl Wertz

You’re welcome.

Operator

The next question comes from the line of Chris Chaney from Stanford Group. Please proceed.

Chris Chaney - Stanford Group Company

Thank you, nice quarter guys for Q4.

Mark King

Thanks, Chris.

Dr. Keh-Shew Lu

Thank you.

Chris Chaney - Stanford Group Company

Sure, I have a couple of questions here. First could you remind us on how you define new product and these devices introduced in the past year or two?

Mark King

Three years from release.

Chris Chaney - Stanford Group Company

Okay, and when I look at your R&D, or your R&D budget for 2008 versus 2007, based on what portion of R&D do you allocate to the development of new products, a third, two thirds, any idea there?

Dr. Keh-Shew Lu

Well, actually, if you go to look at it, the R&D has three portions, one is R&D for wafer, then it’s R&D for packaging, and then R&D for product and that product you separate into discrete and obviously wafer will take bigger R&D money from the [inaudible] point of view than discrete and the majority of the R&D money is in the product. Now because I’ve mentioned that to some investors before, to do the R&D for the packaging, it will not take that much money because it was done in China and so, the cost is still fairly easy to control. Now we spent a lot the money for process because that’s not where our competition is therefore most R&D money will be in the product design, in the product area.

Chris Chaney - Stanford Group Company

Okay, great, I understand. Now I had a question about utilization both in the fab and in the packaging facility, what would your utilization be in those two?

Dr. Keh-Shew Lu

Our fab capacity is somewhere around 89%.

Carl Wertz

We’re in the high 80’s.

Dr. Keh-Shew Lu

Yes.

Carl Wertz

We’re in the high 80’s for percent for fab and…

Dr. Keh-Shew Lu

And the package is typical; we ship very, very full. I think we mentioned that before. We are very careful to add in the capacity in the packaging because the installation, you don’t have to put a big chunk, you can put a small 9x9 and therefore you can increase that capacity whenever you see you need, okay? And since we continue to grow, if you continue to grow, then whatever you put in is going to be fully utilized. Then we predict how much we need it for next quarter then we decide the [inaudible] not that long either, and therefore we want to get into that capacity issue for the packaging.

Chris Chaney - Stanford Group Company

Got it. Okay, now, you produced about 15 billion units in 2007, so that’s about what, 1.25 billion per month, I think earlier in the year you said your goal by year end would be around 1.2 billion, so you’ve slightly exceeded that. I’m wondering do you have a goal for mid or year end ’08 in terms of units per month, run rate and how will that be affected if you do an acquisition? Can you effectively or quickly put on new capacity in that packaging facility to sort of take advantage of that?

Dr. Keh-Shew Lu

Okay, number 1, all our function we don’t put into the capacity assumption or acquisition because until we really nail down to the one we really nail down, we’re stuck, okay? Now, after we announce the acquisition then the capital we’ll need time to expand that capacity won’t be that long. We will have enough time to react.

Chris Chaney - Stanford Group Company

Okay.

Dr. Keh-Shew Lu

And so typically we don’t really need to worry about the capacity to support our M&M targets until we get agreement and make announcement and then you give me two or three months, or three or four months to install the capacity and what kind of capacity is needed to support it. Okay?

Chris Chaney - Stanford Group Company

Got you. Okay, well, execution has been great so far so thanks so much and that’s all I have.

Dr. Keh-Shew Lu

And well, you’re asking by end of year? Our target is somewhere around 1.7 billion units.

Chris Chaney - Stanford Group Company

1.7, wow, okay.

Carl Wertz

That’s the run rate at the end of the year.

Dr. Keh-Shew Lu

Yes, that’s at the end of the year, through the whole year, the total year will be that, end of year is 1.7 billion units. Yeah, remember, I kept telling everybody the value of our company and the very competition of our company is the packaging and that even we’re able to gain the market share is we have a very, very big capacity and very, very easy, flexible, can turn around to support a customer and we don’t put the customer on occasion because we are not trying to disappoint, we want to please.

Chris Chaney - Stanford Group Company

Got you.

Carl Wertz

Chris we did mention that we expect to have about 12% of Cap Ex of revenue and that’s pretty much in line with what we did in ’07 as well. So, we try to do that to show you where we’ll be.

Chris Chaney - Stanford Group Company

Very good, thank you.

Dr. Keh-Shew Lu

If we do get an acquisition it will be a different story, because then we’ll need to look at additional needs and input additional money in there.

Chris Chaney - Stanford Group Company

All right. Thanks.

Operator

Your next question comes from the line of Ramesh Misra of Collins Stewart, please proceed.

Ramesh Misra - Collins Stewart, LLC

Hello, good morning gentlemen. My first question was in regard to the acquisitions. Can you give us an indication of what size of acquisitions are you're looking for, are you looking for multiple small acquisitions or maybe just one larger acquisition?

Dr. Keh-Shew Lu

Well, I don’t know how you define large or small, but I think somewhere, I tell everybody I’m looking at somewhere about $100 million to $400 million, probably $300 million maybe. We don’t want to look at anything bigger than our revenues, but we really don’t want to look at $20 million or $30 million, that’s too small. So if you want to look at it at somewhere around $100 million to $300 million, yeah.

Mark King

Definitely sizeable.

Dr. Keh-Shew Lu

Sizeable, okay and that’s what we’re looking at.

Ramesh Misra - Collins Stewart, LLC

Got it. If you were to acquire [inaudible] Dr. Lu, that was you were able to get away with one time sales of probably even less than one time sales, just looking at the analog portion of it…

Dr. Keh-Shew Lu

You still remember that number? Good.

Ramesh Misra - Collins Stewart, LLC

Now, are valuations in the market out there today comparable to where they were at that point, or do you think you might have to pay a little premium for that?

Carl Wertz

Yes, Ramesh, that was a good deal for Diodes, I’m not sure that valuations are reflecting one than one times revenue, so there would definitely be a little bit of a premium paid and…

Dr. Keh-Shew Lu

Well, it depends on the company. The reason we [inaudible] we are able to do that is don’t forget that company they pay us for a month before we negotiated it, they actually lose some money. Now, after we take over, we put in a lot effort, turned around the company and make them profit, but before we take over the past twelve months of that company was actually negative.

Carl Wertz

We brought a lot of synergies to that company that they couldn’t have gotten on their own.

Dr. Keh-Shew Lu

That’s right, so now depending on the company we buy, if that company is making a profit then I don’t think you can put that investment there, in their revenue, to buy it, you need to probably pay higher depending on the company. If they are making more profit…

Carl Wertz

The key again Ramesh, Dr. Lu’s statement, whatever we do it must be accretive earnings within 12 months.

Dr. Keh-Shew Lu

It needs to be that and so that requirement makes me a little tough to find the right target to go with, we do have an acquisition criteria I think I mentioned I shared those with you before and those criteria make our acquisition tough, but we want to make sure it’s really the best benefit for our shareholders, so…

Ramesh Misra - Collins Stewart, LLC

Okay.

Dr. Keh-Shew Lu

So, you can rest easy, I’m not going to spend the money just for acquisition, just because we have money so we want to do an acquisition, just spend it, I watch it, make sure it’s accretive in 12 months.

Ramesh Misra - Collins Stewart, LLC

Okay, in terms of your China facilities, especially the one in Shanghai, if I remember correctly, are you running out of physical space over there, do you…

Dr. Keh-Shew Lu

You are right, but our lender is going to build the next building next to our building and even put a bridge between those two buildings. So you have a good memory, Ramesh.

Carl Wertz

That’s all part of our Cap Ex too, as we need more space, we’ll go out and lease more buildings and while we’re ordering equipment, they’re building the building.

Dr. Keh-Shew Lu

Yeah, you remember why I said we’re [inaudible 3:35] number 19, after the floor and we go next to floor and virtually we only used the last floor, so now our lenders are already in agreement, we already have agreement with them, we’re going to construct the next building just next to the one we have in Shanghai, the one and actually going to be much bigger.

Ramesh Misra - Collins Stewart, LLC

Right.

Dr. Keh-Shew Lu

We’re talking about four, six floors and two extra sites and then we’re even going to build a bridge between these two buildings so people can walk between the buildings without going up the floor.

Carl Wertz

The decade we’ve been expanding over there, additional buildings, additional equipment has not been an issue.

Ramesh Misra - Collins Stewart, LLC

Okay.

Dr. Keh-Shew Lu

The same angle.

Ramesh Misra - Collins Stewart, LLC

Okay, great and Carl, in regards to the tax rate I know that there’s some plans underway to actually start grading taxes in China, but I think you then have some benefits of tax holidays, are there any concerns about being able to maintain the current tax rates for the foreseeable future?

Carl Wertz

I think we indicated that we expect the 2008 tax rate to be in the mid teens which is a little bit higher than our current 2007 tax rate.

Ramesh Misra - Collins Stewart, LLC

Okay.

Carl Wertz

And I think our actual tax rate in the fourth quarter is 10.2% or 10.8%, I may have said 11% when I was talking earlier, but overall we did put a little cushion in there that we do feel that there is greater potential for taxes in China, that’s a given. They are restructuring, we probably won’t see the same type of tax holidays and benefits we’ve had in the past. However, we are doing tax planning initiatives worldwide, so we’ll do our best to keep that number as low as we can possibly do.

Dr. Keh-Shew Lu

In 2008, not expired in 2008.

Ramesh Misra - Collins Stewart, LLC

I’m sorry, say that again Dr. Lu?

Dr. Keh-Shew Lu

I said in 2008 our tax holiday has not expired.

Carl Wertz

Yes, it’s grandfathered in as far as we know.

Ramesh Misra - Collins Stewart, LLC

Got it. In regards to tax rate in Europe, I presume that would be that significantly higher than what you have out in China or maybe in the…

Carl Wertz

Europe is definitely greater than Asia, the China tax rate in particular.

Ramesh Misra - Collins Stewart, LLC

Okay.

Carl Wertz

I think we just need to take a look at the mid teen range and you’ve known us for years and that’s always the most difficult one to forecast for us.

Ramesh Misra - Collins Stewart, LLC

Right, okay. And my final question was in regards to some of these integrated devices, Mark, this may be for you, you’ve talked in the past about potentially introducing integrated, almost system and packaged kind of devices which include analog and discrete devices on the same package, can you give us an idea about what your current thoughts are as to when that starts happening and what’s the gross profile margin over there and…

Mark King

We do that regularly on the discrete side by mixing multiple technologies into certain packages to create circuits and we’ve actually recently had some opportunities to work in that with say mixing op amps with discretes and various things so I think it’s just the idea is just starting to mature with the customer and we’re seeing more opportunity. We’ve integrated the units so now the discrete side is working closer with the analog side to work on these issues, so I think that we’ll see more and more opportunities on that going forward as the year goes forward and as the time goes on. They’re very selective, where you’re basically looking for high volume repeatable circuits and convincing people in those areas to isolate themselves down to one vendor sometimes takes a longer period, but we see a lot of opportunity in that area.

Ramesh Misra - Collins Stewart, LLC

Okay, great. Thanks very much guys.

Carl Wertz

You’re welcome.

Operator

The next question comes from the line of Christopher Longiaru from Sidoti & Company. Please proceed.

Christopher Longiaru - Sidoti & Company, LLC

Hi guys, congratulations on the quarter.

Mark King

Thank you.

Dr. Keh-Shew Lu

Thank you.

Christopher Longiaru - Sidoti & Company, LLC

What I kind of wanted to just get some color on here is it seems like despite the first quarter sales are coming down you’re gross margins are staying the same. Now what that leads me to believe is that your analog business is becoming more of an ingrained part of your business even though it’s a new business it seems like as far as product mix, you know whether you’re sales are going up or down, that’s staying relatively consistent as a percentage of sales, is that correct?

Dr. Keh-Shew Lu

We don’t separate, I don’t know. We don’t separate.

Carl Wertz

That sounds pretty logical. Our focus is on analog, we are saying comparable margins, we’ve improved our mix, we put in more into design and R&D into analog end products.

Mark King

It could be a balance between the wafers being down and certain things being up too. You know it’s a very complex; our margin profile is very complex, so we have to work through it, but I would also say there are good improvements in some of the discrete areas, too, some of the newer SBR(R)s, small profile SBR(R) devices are also adding to our margin profile. Obviously when we introduce a new product, we’re focusing on changing the margin profile of our product line, so I think there’s a lot of contributors to the consistent change.

Christopher Longiaru - Sidoti & Company, LLC

What would be the difference between your average, we’ll just talk about new products here, between your average analog and your average discrete component with respect to your gross margins, what’s the difference in the sense of just basis points and gross margin?

Mark King

I don’t really think we want to isolate that but you’re assumption can’t be that the analog gross margin will always be higher than the discrete margin. The problem with the discrete margin is it might fall faster, okay?

Christopher Longiaru - Sidoti & Company, LLC

Okay.

Mark King

In certain cases, and certain dye stuff, our margins on discrete could be much higher than a new product in analog, it depends on the ASP, it depends on the package, it depends on the market, it depends on a lot of different things, really I think I’d be misleading you by trying to profile that for you.

Christopher Longiaru - Sidoti & Company, LLC

All right, thank you. The only other thing I really had in my head, did you give a share count, Carl?

Carl Wertz

Share is, one second and we’ll get you the exact number, about 42.7 on a GAAP basis.

Christopher Longiaru - Sidoti & Company, LLC

Right, okay, thank you guys.

Carl Wertz

You’re welcome.

Dr. Keh-Shew Lu

Thank you.

Operator

Due to time constraints, we only have time for one question and your next question comes from the line of Kevin Cassidy from Thomas Weisel Partners, please proceed.

Kevin Cassidy - Thomas Weisel Partners

Thank you, speaking of your acquisitions, are there any technologies in particular that you see as a whole in your product lineup that you might be considering?

Dr. Keh-Shew Lu

Now remember I mentioned that in our condition, we’re really looking for synergy, so if some of its synergy, then that’s one company that I’m not really particularly looking for one technology to buy. No, we look at a company typically have discrete, have analog because that’s our product line and use it to build product using our packaging capabilities, so it’s very important because the value is in the packaging and so therefore the majority of their product needs to be able to [inaudible] our packaging capabilities and then helping the channel, helping the sales, those are the synergies. So we take all of those synergy into consideration and then try to make sure that it is accretive within a year and that’s our acquisition strategy.

Kevin Cassidy - Thomas Weisel Partners

Okay, thank you.

Carl Wertz

You’re welcome, Kevin.

Dr. Keh-Shew Lu

Okay.

Kevin Cassidy - Thomas Weisel Partners

Okay, if I could ask another question. You had mentioned strength and power supplies and adapters in Asia were those mostly due to your new products or was it just the strong market for the power supplies and adapters.

Mark King

Yes, no definitely because of our new product and this is a new segment for us and really if you look at our segments, we’ve always been relatively weak in the industrial area. The SP air product line really focuses, it’s a power product, so we should see expansion over the coming years in our industrial product range based on our focus into our SBR(R) product line, so our share or our numbers in those markets grew, I can’t profess as to what those markets, we have a very small share in those products because these are newer products for us, or a newer focus for us and so this is our expansion and new revenue in those markets for us.

Kevin Cassidy - Thomas Weisel Partners

Okay, great, thank you.

Operator

At this time, I’m showing we have no further questions. I would now like to turn the call over to management for closing remarks.

Dr. Keh-Shew Lu

Well, thank you for everybody for participating in this conference call. We had a great 2007 and we believe 2008 is going to be a rather great year for us and we are committed and we want to focus on our execution and get another outstanding year in 2008. And you know our target is always 2x, more than 2x of market goal and that’s our challenge and we always accomplish that goal, for the past several years, and we will continue using that as our target and we believe we will be there and thank you for everybody that joined the call.

Carl Wertz

Look forward to the same conference 90 days from now. Take care.

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Source: Diodes Incorporated Q4 2007 Earnings Call Transcript
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