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Diodes, Inc. (NASDAQ:DIOD)

Q2 2008 Earnings Call Transcript

August 7, 2008 11:00 am ET

Executives

Leanne Sievers – IR, Shelton Group

Dr. Keh-Shew Lu – President and CEO

Carl Wertz – CFO, Secretary and Treasurer

Mark King – SVP, Sales and Marketing

Analysts

Shawn Harrison – Longbow Research

Ramesh Misra – Collins Stewart, LLC

Steve Smigie – Raymond James

Vijay Rakesh – Think Panmure

Dennis Reed – Cleveland Research Company

Operator

Good morning and welcome to the Diodes Incorporated second quarter 2008 financial results conference call. At this time, all participants are in a listen only mode. At the conclusion of today’s conference call, instructions will be given for the question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded today, Thursday, August 7, 2008.

I'd now like to turn the call over to Shelton Group, the Investor Relations agent for Diodes Incorporated. Leanne, please go ahead.

Leanne Sievers

Good morning, and welcome to Diodes' second quarter 2008 earnings conference call. I am Leanne Sievers, Executive Vice President of Shelton Group, Diodes' Investor Relations firm.

With us today are Diodes' President and CEO, Dr. Keh-Shew Lu; Chief Financial Officer, 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'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 filing with the Securities and Exchange Commission. In addition, any projection as to the company's future performance represents management's estimates as of today, August 7, 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 Investor Relations section of Diodes' website at www.diodes.com.

And now we’ll turn the call over to Diodes' President and CEO, Dr. Keh-Shew Lu.

Dr. Keh-Shew Lu

Thank you, Leanne.

Welcome, everyone, and thank you for joining us today. I am pleased to report another strong quarter for Diodes in which we reported record revenue at the high end of our guidance range and a gross profit that increased 24% over the first quarter exceeding the high end of our guidance. As previously announced, our second quarter results include one month of financial results from our June acquisitions of Zetex.

As we have stated previously, the acquisition of Zetex offers substantial synergies that we believe will further enhance Diodes’ global leadership in this quick and airlocked [ph] semiconductor solutions. We have been analyzing Zetex business model for several years prior to announcing the acquisition. So, we are prepared to capture the synergies of the combined companies which we expect to realize over the next several quarters. To note, Zetex was accretive on an operational basis for the month of June.

In terms of timing, this acquisition occurred at a time of strength in Diodes’ development and growth and will only enhance what we have accomplished today. As all of our shareholders know, we have consistently achieved growth rate that has exceeded those of the industry in addition to delivering profitable results quarter after quarter. Although the overall market economy is weak, we believe that our continuous efforts will be complemented by the addition of Zetex to our business by enhancing Diodes’ market position, expanding our product portfolio and increasing exposure to the automotive and industrial markets, as well as broaden our presence in Europe.

Since crossing June, we have made significant progress in aligning and integrating the sale and the distribution channels across all geographies which Mark King will discuss with you in great detail. And although we will continue to analyze the cost, manufacturing and operational synergies, between our two companies in the coming quarters. Our immediate focus is on capturing the revenues and the growth synergy that are offered through these acquisitions.

We have a very experienced management team that has a proven track record of quickly and effectively integrating companies for maximum returns for our shareholders. And I look forward to report to you our progress in the coming quarters.

With that I would turn the call over to Carl to discuss our second quarter financial results in more detail.

Carl Wertz

Thanks, Dr. Lu. Good morning, everyone.

As Dr. Lu mentioned, our second quarter financials include one month of results from the Zetex acquisition. Revenue for the second quarter was 116 million which was at the high end of our increased guidance range representing an increase of 21% both sequentially and over the prior year period and set an all time record for the company. New product sales accounted for 30% of revenue and does not include the one-month of Zetex.

Gross profit for the second quarter of 2008 was 39.6 million, an improvement of 24% sequentially and 29% over the same period last year. Gross margin improved 70 basis points sequentially to 34.1% of revenue and 220 basis points from the year ago quarter. Our gross profit results were above our increased guidance range and was driven by solid average selling prices, continued operational efficiencies and improved product mix.

Selling and general administrative expenses for the quarter were 17.1 million or 14.8% of revenue which was an improvement from the first quarter on a percent of revenue basis. Absolute dollar increases were primarily due to Zetex operations. Included in the second quarter SG&A was $1.1 million of noncash FAS 123-R share based compensation. In the earnings release, we have included a table to reconcile the impact of share based compensation expenses.

Looking at the third quarter and with the full quarter of Zetex results, we expect SG&A to range between 15% and 15.5% of revenues. Research and development investment in the quarter was $5 million or 4.3% of revenue. The increase as a percentage of revenue reflects Zetex greater focus on wafer process technology as well as their depth of engineering resources as we have stated previously.

Looking at the third quarter, we believe that the R&D will be approximately 5% to 5.5% of revenue as Zetex is fully factored into our quarterly results. Other expense amounted to approximately $900,000 for the quarter, consisting of $2.6 million of interest income primarily related to our auction rate security investments offset by $1.9 million of interest expenses primarily related to our convertible bonds and a noncash loss of $1.5 million related to a foreign currency hedge required by the Zetex acquisition.

Although that hedge was an expense related to Zetex acquisition purchase price, US GAAP does not permit this hedged to be booked in the purchase price accounting, thus a P&L loss was recorded. However, even when considering the one time charge, our operational performance was strong enough to cover the hedge loss.

Net other expense for the third quarter is expected to range between $2 million to $2.8 million. Our effective income tax rate in the second quarter was 16.8% which was slightly higher than our expected range due to the earnings contribution from Zetex. For the full year of 2008, we expect the tax rate to range between 16% and 17% which takes into consideration Zetex combined with our operations in lower tax rate jurisdictions as well as our preferential tax treatment in Asia.

Adjusted net income was $15 million or $0.35 per share. Fully diluted shares used to calculate adjusted earnings per share were $43.4 million shares. In the third quarter, we expect the fully diluted share count for GAAP earnings to be 43 million to 43.4 million shares.

Adjusted net income for the second quarter excludes $1.2 million of noncash stock option expenses as well as the one time noncash hedge loss related to the Zetex acquisition. Cash flow from operations for the quarter was $13 million and $23 million year to date.

Turning to the balance sheet, as of June 30, we had $86 million in cash and short-term investments with $197 million in working capital. Long term debt including convertible bonds and the loan related to Zetex acquisition was $400 million. As discussed last quarter, we had $320 million invested in auction rate securities as part of our cash management program. The securities are currently evaluated using a third party valuation methodology and are classified under our balance sheet as a non current long term investment in the amount of $295 million.

We review impairments in accordance with FAS 115 as well as related guidance issued by FASB and SEC in order to determine the classification of impairment as temporary or other than temporary. Revaluating the ARS portfolio, we classified the 8% decline in value as temporary and recorded unrealized loss in our other comprehensive loss on the balance sheet. As we have stated previously, we considered the liquidity issue to be temporary and currently intend to hold the securities until recovery of the auction process. We believe our cash flow should be sufficient for all our operational requirements. We will continue to monitor the auction rate market and evaluate the securities at each quarter end to determine the valuation required.

Inventory increased during the second quarter to $102 million primarily as a result of the $30 million of Zetex inventory acquired. Without Zetex, inventory days increased slightly to 91 from 88 last quarter. Accounts receivable increased to $112 million with the inclusion of $18 million acquired from Zetex. Without Zetex, AR days improved from 82 to 80. Capital expenditures were $12 million for the quarter and $26 million year to date. The majority of the investment was for manufacturing equipment in China as well as a $5 million-land purchase for our Dallas headquarters. Going forward, as part of our wafer fab review plan, approximately $6.5 million of capital is authorized for Zetex to expand its 6 inch line and we are also qualifying the 4 inch bipolar process in our 6 inch line at Diodes’ FabTech in order to capacity and reduce costs. For the year, we continue to expect to invest 10% to 12% of our revenues in CapEx. Depreciation for the quarter was $9 million and $16.5 million for the year.

Turning to our outlook, as we look at the third quarter of ’08, we expect revenue to increases to between $134 million and $142 million. Included in the total revenue guidance is expectation of approximately $27 million to $33 million of revenues associated with the Zetex acquisition. Additionally, we expect the overall gross profit to grow 13% to 20% from the second quarter.

Because of the one-month contribution of acquisition of Zetex in the second quarter, we are providing a more detailed guidance for the third quarter only. The table is included in the earnings release. Any future guidance will not include the same level of detail or break out of the Zetex results since its operation will become an integrated part of our business. We are in the process of obtaining third party evaluation as per FAS 141 for many of Zetex assets and liabilities require and as such the fair market value adjustments and corresponding depreciation and amortization expenses are not provided in today’s guidance. These purchase accounting rules should have no impact on the ongoing free cash flow values but will affect US GAAP gross margin and net income in the future periods.

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

Mark King

Thank you, Carl, and good morning.

As Dr. Lu mentioned, we made significant progress during the quarter in aligning and integrating the sales and distribution channels across all geographies. Our marketing units have been combined and consolidated and we are in the process of consolidating our rep organizations and cross training on both product lines. And although the distribution channel and integration requirements vary with each region, we have taken the appropriate steps to fortify many areas of the business in order to quickly combine our two organizations into one cohesive operation.

From an overall business perspective, I believe that Zetex infrastructure combined with its process knowledge, strong applications team and solid technology would greatly benefit our company. Additionally, Zetex brings analog and application centric exposure in categories where Diodes does not currently participate in areas of power management and LED lighting. With limited portfolio overlap, we believe in the coming quarters we will be able to fully capitalize on the established sales organizations cross-selling synergies and expanded product offering provided by the combined companies.

Since Zetex was only one month of revenue, let me begin the discussion with a segment breakout for Diodes only. Computing represented 37% of revenue, consumer 34%, communications 15%, industrial 12%, and automotive 2%. In terms of segment breakout, we expect the Zetex impact – with the Zetex impact an increase in the industrial and automotive segment which will add more balance to our industry distribution.

Let’s move on to new products. During the second quarter, we released 53 new products, including 6 analog, 13 discrete, 2 Hall, 22 MOFSET and 10 SBR devices. As Carl mentioned, new products accounted for 30% of revenue. Our new product revenue was driven by our continued expansion of our MOSFET product offering and particularly our newly released MOSFET used for load switches, DC-to-DC switching and inverter application for notebook PC, GPS, digital camera, inverter and DC fans.

Additionally during the quarter, we released a customers rated product for an automotive key list entry system and a custom 3 amp SBR DFN device that is being used in the DC-to-DC converter for ultra thin LCD TVs. Both of these products resulted in design wins in the quarter.

Also during the quarter, we released our first SBR product in our patent pending TO-220 S package and further expanded our omni polar Hall sensor line with our 24-millimeter slim body package targeting cell phones and portable devices. In terms of overall design activity, it was another strong quarter with broad based design wins across all regions at over a 100 accounts globally. Design wins and in process design activities were highlighted by AP22 AV [ph] load switch wins in digital camera and digital picture frames, omni polar Hall sensor wins in cell phones and multiple notebook platforms including our recently announced AH1822; LDO wins for our AP7217 in DVD read-write and our AP7173 in set-top box. We won our first two design wins in our recently announced SBR product for a solar panel application as well as in the notebook platform and multiple MOSFET wins in portable GPS, blue tooth headsets, notebook computers and battery packs.

In regards to geographic breakouts, Asia sales increased approximately 10% over the prior quarter and represented 80% of total revenue. After a weak first quarter, we experienced a seasonal recovery in the computer and consumer industry, specifically in end equipments of notebooks, set-top box, LCD TV and DC fan coupled with improvements and increased demand in our sub contract packaging business. OEM sales were up 16% while distributor point of purchase was down 3% and distributor point of sales were up 7% over the first quarter. Distributor inventory was down in the quarter. And to turn to design activity in Asia, we had a strong quarter with a 128 design wins at 57 customers including 38 wins in analog, 47 in SBR and 43 in discrete.

Now turning to North America, discrete and analog sales remained flat compared to the prior quarter and represented 15% of total sales. Direct sales were up slightly due to continued strength in set-top box and small increases in the industrial market. Distributor point of purchase decrease 1% and distributor inventory was up slightly. Distributors continued to have a very conservative outlook on the economy. Distributor point of sale was down 4% sequentially. In total, we achieved 59 design win in North America during the quarter at 18 customers, 12 of these were for analog, 4 discrete, and 3 in SBR. In terms of wafer sales, we were off 6% in the second quarter.

Sales in Europe were done 12% over the record first quarter as European demand softened and in total accounted for 5% of revenue. Distributor point of sales decreased 3% in the quarter. Our design win momentum in Europe continued to expand in the second quarter with 36 wins at 31 accounts including 31 discrete and 5 analog design wins. Specifically our high-powered SBR products received strong interest from the European customer base and we believe these products have the potential to become major contributor for our future growth in this region.

Zetex worldwide sales performance trended positively in the quarter with strong design win momentum. Regarding the Zetex integration efforts, we have consolidated the combined sales organizations globally. In North America, we realigned the direct network and trained 80% of them. We’ve also added the Zetex line into Arrow and Avent who have signed and placed initial stocking orders. This is a major step for the Zetex product line as it really expands the product reach. We estimate that better than 60% of the North American distributor serviceable market for semiconductors goes to Arrow and Avnet.

In Europe, combining resource of the direct sales team supplemented by a rep organization in the outer regions has generally – has greatly expanded the reach of the combined company. Moving forward, we will combine the lines in the distributor network by moving Zetex line into Avent and retrialing, and Diodes product into some strong regional distributor. We expect to complete the remaining consolidation by the beginning of the fourth quarter. In Asia, Zetex has the least distributor overlap with Diodes, so we expect the consolidation consolidate the channel over the next three to six months.

In summary, we believe Diodes is taking all the right steps toward becoming a global leading provider of complete analog and discrete solutions and the acquisition of Zetex is an important component of that process. We continue to execute on our growth objectives and we are well positioned to accelerate our growth through the extensive synergies of the combined company. Our primary focus in the coming quarters will be on expanding sales, while capitalizing on the cost savings and other operational synergies provided through this acquisition.

With that, we will open the floor to questions.

Question-and-Answer Session

Operator

(Operator instructions) The first question comes from the line of Shawn Harrison representing Longbow Research. Please proceed.

Shawn Harrison – Longbow Research

Hi, good morning. Just a number of modeling questions, first. Carl, I missed the CapEx in the quarter?

Carl Wertz

It was $12 million.

Shawn Harrison – Longbow Research

Okay. And then getting back to the operating expenses what do you expect options expense to be in the third quarter? And then just have following on that, what should we see in terms of operating expense dollars move kind of going forward as you take cost out of the Zetex model?

Carl Wertz

The SG&A expenses, op expense, we expect to range between 15% and 15.5%, and then the R&D percent also is 5% to 5.5%.

Shawn Harrison – Longbow Research

And options are included in that 15% to 15.5% – or stock based compensation, correct?

Carl Wertz

Correct.

Shawn Harrison – Longbow Research

And how much would you expect that to be?

Carl Wertz

Very similar to this quarter, maybe slightly more.

Shawn Harrison – Longbow Research

Okay. And I guess looking at the operating expenses of 15% to 15.5% of sales, slightly greater than I expected and probably most Street models had included, so how should we expect that to trend over time on both the dollar and a percentage basis?

Dr. Keh-Shew Lu

Okay, maybe this is tough to do, let me answer. The reason we acquired Zetex is we know they have very good results over there. Their engineering is very strong and they are very good in resources. So, our plan is not really to trim down or reduce the R&D and SG&A, okay. Our strategy is very simple, we want to be grow the revenue either by cross selling, by bringing each other (inaudible). By our past history, we are able to grow CAGR above 20% a year if the market is reasonable. Now we don’t know what would be market next year, but assume the market is reasonable, then we should be able to grow above 20% CAGR. So, if you look at – if we grow the revenue by 20%, just an assumption, then SG&A – currently where we focus, we focus third quarter 15% to 15.5%. It’s probably very reasonable if you said no increase, the head count, no increase, the expenses, but just that the revenue growth 20%, then you can very reasonably think then should we go back to our model or even better than our model. And if you look at R&D and we use the same approach, we should be able to grow 20% because if the revenue grow 20%. So, then you go back to our old model. So, today our model by integrating Zetex which we all know at the beginning when we purchased this company, we know their R&D is very high, and their SG&A is high, but consolidated two companies together gives us 12 months of the growth, I think we should be able to bring that model back to Diodes’ old model.

Shawn Harrison – Longbow Research

Okay. So I guess the key takeaway is you think you can deliver substantial revenue upside with essentially the same cost structures at Zetex?

Dr. Keh-Shew Lu

That’s what I said.

Shawn Harrison – Longbow Research

Okay. And then just –

Dr. Keh-Shew Lu

If the market is reasonable, we really don’t know what will the market be next year, but if the market is reasonable, then we should be able to do it.

Shawn Harrison – Longbow Research

Okay, then just a quick follow-up, the Zetex revenue contribution in the second quarter, was that about $12 million?

Dr. Keh-Shew Lu

We don’t separate it, but we give the guidance, end of last quarter, we said $10 million to $13 million. So, you can take somewhere there.

Shawn Harrison – Longbow Research

And then Mark maybe just a little bit of commentary on what you are seeing in the legacy businesses as we move into the third quarter, distribution seems like it is weak in a few geographies for you, or what maybe you are seeing by end market?

Mark King

Yes. I mean I think we are seeing pretty much everything what everybody else is seeing out there, so pretty short term market. North America is remaining relatively flat, Europe is softening somewhat, Asia’s growth pattern in the third quarter but maybe not as robust as it’s been in previous years, so I think it’s a pretty quite cautious in all market areas.

Dr. Keh-Shew Lu

But by our past history, our growth is not just coming on the market growth. Our growth should be more than the market growth, and so if I look at our number that we focused, the revenue growth 15% to 22%, some of that was due to one month to one quarter of Zetex numbers, but it still can be on our own organic growth too.

Shawn Harrison – Longbow Research

Okay, thank you very much and congratulations on closing the acquisition.

Dr. Keh-Shew Lu

Thank you.

Operator

The next question comes for the line of Ramesh Misra representing Collins Stewart. Please proceed.

Ramesh Misra – Collins Stewart

Good morning, gentlemen. My first question was in regards to the gross margin improvement sequentially of 70 basis points, since this is the last time that you will be talking a little more about Zetex separately. Can you give us a sense of how much of that was organic and how much was Zetex contribution?

Dr. Keh-Shew Lu

Right now we really do not separate and it will be difficult for us to separate in the future because we are going to sell each other and we are starting to qualify, we are starting to qualify Zetex for us to our HK site [ph] and then we transfer the product from the some of that wafer capacity from Zetex fab to our Kansas fab. At the same time, we expanding Zetex 6 inch line. We have a lot of working between the Diode and Zetex working together. For example they have people now from Zetex today is in our case of CT to help to transfer some of their 4 inch by product technology into our fab, and so I really don’t like to separate the – we like to treat them as one company and we help each other to improve the gross margin bring therefore to our assembly side and bring their 4 inch line, some of their product to our FabTech, expand 6 inch line, maybe we will bring some of our 6 inch product to their line. And we will have the same going, try to make it into one company instead of two separate companies. So I really don’t like to – don’t prefer to separate the gross margin differently from one company to the other. All I would say is their product margin from the – we are very comfortable to each other, okay. We are comfortable to each other, their ASP is higher but unfortunately their manufacturing cost is higher and our ASP is lower but our manufacturing cost is lower, so I think the gross margin is not that far away from each other. Therefore, there is no meaning for me to separate those two.

Ramesh Misra – Collins Stewart

All right, that makes sense. Now Dr. Lu, as you bring in some of the manufacturing efficiencies and operating efficiencies that Diodes has developed, do you expect a meaningful improvement on the margin side at the former Zetex operations?

Dr. Keh-Shew Lu

Yes, it will be, but don’t forget these kind of things won’t be quickly resolved, okay. Especially their market is in the industrial and automotive. Their customers typically do not want to change their sourcing quickly. They are more slow to adapt sourcing change. Some we are not really counting on that portion, we really count on is this, cross selling the new product to each other, get their growth, revenue growth quickly such that you load in the fab, and when you load in the fab, you bring the costs down. I am more looking at that direction instead of just taking their product from their subcon to our SKE, do this, move the fab into FabTech, that is not what I am looking it, especially from short term point of view, okay. Short term is growth revenue as fast as we can hoping if we can grow 20% or more then R&D as a percent go down, SG&A as a percent go down to (inaudible), it is then time to loading their fab would be increased and the loading in our fab would be increased too and that will happen so much and that is synergy I have been talking about.

Ramesh Misra – Collins Stewart

Okay, got it. Then a final question in terms of again Zetex revenue in the month of June and your expectation of it in the September quarter, it seems that that number will be going down and I want to get an understating of that is that because Europe’s slows down in the September quarter or are there other factors?

Dr. Keh-Shew Lu

I will put it is two factors. One is yes, the third quarter typically the July and August is very slow month and the biggest problem is how to kick it up in September, but another reason is they are very uneven. Typically when you run a semiconductor, the rain is not coming out evenly. We have April and May typically which is slow and then June, end of month, end of quarter, you pick it up strong. And that always the case because even your customers spends less, they don’t ship it linearly. And so just by looking at one month of June, in Zetex it’s much bigger than their three-month average, but that is just that. It is not really the business, it is up or down so much.

Ramesh Misra – Collins Stewart

Okay, all right.

Dr. Keh-Shew Lu

I hope I answered your question.

Ramesh Misra – Collins Stewart

Yes, that does. So, I will stop there an let others get on, thank you.

Dr. Keh-Shew Lu

Thank you.

Operator

The next question comes from the line of Steve Smigie representing Raymond James, please proceed.

Steve Smigie – Raymond James

Great. Thank you, just as a follow on to that last call, so what might the Zetex revenue look like as we enter the December quarter, I mean does that –

Dr. Keh-Shew Lu

Well, I don’t – we don’t look at the forecast on the fourth quarter right now. It is easy to get on the third quarter, so I am sorry, we don’t really give the guidance on the fourth quarter but –

Carl Wertz

Steve, it is going to take us a little time to run their cycles and learn their consistency of the thing and the way their distributors work and so forth, I just don’t think we have that nailed down yet.

Dr. Keh-Shew Lu

Yes, and because the – they are more – and they are very strong in Europe, and you know Europe cycle is different from Asia cycle. Now we typically very strong third quarter from Diodes point of view, but they are a little weak in the third quarter

Steve Smigie – Raymond James

Okay, so it is not inconceivable to think that you could potentially have a stronger fourth quarter out of Zetex than the third quarter?

Carl Wertz

We are certainly hoping that we will get some synergies from the cross-selling and so forth going into the fourth quarter and into next year. So, we hope to have had an opportunity to build some momentum when we kind of close this deal right in the middle of summer, so in summer, some of the excitement is like, we are trying to get people together and so forth, but there is the vacation piece and everything else. So we think we can really be rolling and all over the customers starting the beginning of September in say the European market and so forth, but we’ve done an enormous amount of work to be prepared to make that happen.

Steve Smigie – Raymond James

Was there any currency impact translating euros generated back to dollars, anything that might have made Zetex revenue look lower in terms of what you are projecting for Q3, anything like that or is it –

Carl Wertz

Steve, I don’t think there is anything significant in the currency other than the hedge loss that we took. I think it is the one time where we kind of hedged the whole $160-some-odd-million and the dollar strengthened against the British pound.

Dr. Keh-Shew Lu

And this was hedged for purchase of Zetex is really – sometimes we cannot really predict. When we buy Zetex, we announced we are going to pay certain US dollar, so we are announcing US dollars. For a change UK government said you need to put all the money in pounds, okay, and at the time, when you announced the acquisition, so we need to go ahead, hedge at that time. One way or the other, you know the exchange rates are going to be changing one way or the other. You just need to convert into pounds, so when we do acquisition we are turning pounds to pounds. Unfortunately US GAAP states, well, if you convert it at that time, but you don’t really give them the money as the time comes, then whatever the exchange rate is (inaudible) you can say we buy cheaper US dollar but in pound we buy in the cent, and that’s cheaper both regional and US dollar is showing into our P&L, and that’s what we are talking about the hedge loss which is not really impact to us from the operation point of view. We expect to spend X dollars for it and that’s the X dollars.

Steve Smigie – Raymond James

Okay. Just looking at the other expenses line, $2 million to $2.8 million, if I just take your convert and multiply it through and your interest income from the ARS debt, other expense line for Q3 looks somewhat higher than I might expect, I am just curious if there is just like some one-time thing in there, is that sort of the level we’d expect roughly to run through your models going forward?

Dr. Keh-Shew Lu

The key thing is the expenses for borrowed money from UBS to purchase Zetex. That never really happened, that don’t have it until June 9 or something on closing. So if you look at it, now we will pay in three months interest payment to UBS for borrowing the money to purchase Zetex.

Steve Smigie – Raymond James

Okay, at some point I guess if the auction rate market starts up, you just pay that off of cash, the rates will go back down then?

Dr. Keh-Shew Lu

Yes, exactly. Whenever we get some additional cash, we will try to pay off, so either from operations (inaudible) or if we get some relief from the ARS, we will pay it off immediately.

Steve Smigie – Raymond James

Okay. I’ll let somebody else ask questions, thank you.

Operator

The next question will come from the line of Vijay Rakesh representing Think Panmure. Please proceed.

Vijay Rakesh – Think Panmure

Hi, guys. Dr. Lu, just going back to your questions on better margins with – trying to get better margins with your fab absorption at Zetex, how do see your gross margins going forward as you start to get more leverage out of Zetex?

Dr. Keh-Shew Lu

I think from gross margin percent improvement point of view, it will be gradual, it won’t be a big increase over – in a very short period of time. If you look at our expense on the Anachip integration, it takes about more than one year. And as you would remember, we acquired Anachip in January 2006, the real impact of which show up in September, in the third quarter of 2007, and fourth quarter of 2008. Those two quarters will show the major impacts, okay. And the Zetex will be the similar way and maybe even take longer because like I said their customers won’t be quickly changing that much. But the one we really want to get all the synergy is like I mentioned we want to be a aggressively grow the revenue by cross selling, by bringing the product to all the different distributors, their distributors use our product, our distributors using their product and aggressively in Asia for their product, aggressively in Europe for our product, they have a lot of cross selling activity going to happen. And from there, you are going to be in a sense you are holding R&D and SG&A, correct, then you are to significantly reduce – improve the bottom line, okay. And that’s what we – we committed it would be accretive within 12 months. Today it’s already showing in June, we already told you it is accretive from operations, and we are accretive from operational actually in third quarter, but with expenses of paying those interest, but we are going to be within 12 months, we should be able to generate enough line bottom line savings to pay for.

Vijay Rakesh – Think Panmure

Got it, and here Dr. Lu on your core business, Diodes business and the Zetex business, as you look at your guidance here for the second half, how is that visibility and what does your backlog look like for the two – for your and Zetex businesses separately?

Dr. Keh-Shew Lu

Well, I’ll ask Mark King to answer it.

Mark King

And I think our backlog is probably around our traditional pretty much level, the same as it was in the second quarter. There is still lot of turns business that had to occur, I think we went into the quarter about 60% loaded. Their backlog is a little stronger than the Diodes, traditionally stronger than the Diodes, because they’ve had traditionally longer lead times, but I think we are pretty much right where we always are.

Vijay Rakesh – Think Panmure

And here as you look at your ASPs within the two segments, within Diodes and Zetex for the quarter, and as you look out, pretty flattish or where are you seeing?

Carl Wertz

You know what, actually you are going to see a big shock to the ASP next quarter because their ASPs are quite a bit higher than our ASPs, but their units are much lower, so we will probably have to retrack it. If you look at the Diodes’ ASPs, they were down pretty consistently and traditionally in the second quarter, but with that one month overall, our ASPs were up about 8%. So there is going to – we are going to kind of have to readjust the whole ASP situation when we get a full quarter in.

Vijay Rakesh – Think Panmure

And one last question here on the tax rate, looks like it crept up a little bit, is that just Europe or what’s happening there?

Dr. Keh-Shew Lu

Well, yes, because, all the Zetex revenue or their profit is 100% through Europe tax rate, and that’s why (inaudible). Now we are looking on, but it would take a while to start to get the product direct shipped (inaudible) but today 100% of their profit would flow through Europe and European tax rate.

Vijay Rakesh – Think Panmure

So, should it be about the 16.5% range through for the next couple of quarters, 17% virtually?

Dr. Keh-Shew Lu

Again you are right, you should use that.

Vijay Rakesh – Think Panmure

Okay, thanks guys.

Dr. Keh-Shew Lu

Until we start to have some action to direct ship orders.

Vijay Rakesh – Think Panmure

Okay, thanks.

Operator

The next question will come from the line of Kevin Rottinghaus representing Cleveland Research. Please proceed.

Dennis Reed – Cleveland Research Company

Hi, this is Dennis reed for Kevin. Just wanted to dig in a little bit on the pricing environment, you’d mentioned kind of the core pricing was down in a traditional level and you had a boost from the Zetex acquisition, if you look at your competitors, how did they behave on the pricing side?

Carl Wertz

I think we always live in a very competitive price environment and I think if you look at this environment, it’s probably is competitive as I guess, so I think there is significant amount of price pressure, nothing that we’d never experienced before and so forth. But obviously when the demand is less than traditional in a period, people are going to be more aggressive. So, in our product line, we see the competitors positioning themselves aggressively.

Dennis Reed – Cleveland Research Company

Okay. Looking at the Zetex ASPs, what type of cost saving could you drive by moving some of their outsourced assembly and test into you facilities?

Dr. Keh-Shew Lu

As I mentioned, saving would be good. By doing their subcon assembly packaging from their subcon to our assembly side, saving would be good. But we that I mention is not just moving and then go because Zetex customer base is very, very restricted of this sourcing change, and nobody likes – all our customers don’t like us change, because the saving money for us is good for them, right. So, my plan is not just pulling out and putting our assembly side and then saving the money, that’s not the plan. Our plan is qualify their product in our own SKE and then move those product to the new customers, not existing Zetex customers. If new customers or Diodes customers who have the confidence on our packaging site. Most of our customers always get product from our SKE site, they share confidence on our packaging side, so we are going to be tell them that Zetex product used in our own packaging site to our customers and that is the one you are going to see (inaudible) instead of their Zetex customer who really don’t familiar with our own SKE site. And that is the way – but again, our synergy going to be quickly accomplished by cross selling, by bringing up the revenue as fast as we can, holding the (inaudible) which is R&D and SG&A as a constant (inaudible), holding at a constant dollar, then we are going to see a much greater (inaudible).

Dennis Reed – Cleveland Research Company

Sorry to jump around here, in terms of the cell phone, I think you mentioned couple of design wins in that market, could your provide any color I guess in terms of what percent of revenue it has become and where you ultimately see it going?

Dr. Keh-Shew Lu

How about that Mark can answer it?

Mark King

Traditionally the cell phone marketplace has been really negligible in our overall number and I think we are still in that level. We’ve seen more and more – wining more and more design wins with our Hall product, we see some more opportunities with some of our analog products, Zetex product line, and some of their current monitors. There are some opportunity and we are starting to do some more work in discrete. So, I think it can become more significant for us going forward, but at the present time it is not. The timing of that depends on market and other things, so I don’t really want to get too much into when can see it much different at this point.

Dennis Reed – Cleveland Research Company

Okay, and then one just last from me, if you look out at your customers base, whether a distributor or a drop down, just any through or commentary on inventory in the supply chain?

Mark King

Frankly, our customers for our products, I can say they are not over inventoried. And they keep very low inventory and I can’t say the overall chain, but our distributor inventory for Diodes product is quite clean. The pressure is overall inventory in those distributors and so that puts pressure on us because it is not that they are not buying Diodes product, they are just not buying anything. Okay and basically they are trying to, they are all focusing on cash and keeping things in cash rather than inventory. So until I think that the sentiment changes a little bit about the direction, I think we are going to be up against that from a distributor standpoint on a POP basis. Now I think from the OEM side, I think they are very cautious with inventory also. Really we’ve never experiment an inventory problem at our customer base on our product line, but I think their buying cycles are shorter now, and they are being more conservative about planning long term.

Dennis Reed – Cleveland Research Company

All right, thank you very much

Operator

The next question will come as a follow up from the line of Steve Smigie representing Raymond James. Please proceed.

Steve Smigie – Raymond James

Great, thank you. Just as a follow up, could you say how much of Zetex revenue is outsourced to the subcon versus done in house?

Dr. Keh-Shew Lu

I will probably say 60% is outsourcing and 40% is produced themselves. And then when we say produced themselves, they have two sites, one is a JV [ph] and JV in the Chendu, which they only own one-third. Then they 100% own is in the Neuhaus in East Germany. So, that is the about that.

Steve Smigie – Raymond James

Okay, and then I know the major part of your plan, it sound like it is not to move that stuff in house because customers don’t like that, but is there any of that 60% outsourced that you will be able to move over to your packaging shop in Shanghai?

Dr. Keh-Shew Lu

Long time

Steve Smigie – Raymond James

Take a long time.

Dr. Keh-Shew Lu

Yes, like I said, our objective is not really aggressive move those into of our own assembly. Our objective is to qualify the part which we are doing right now, sell to our own Diodes’ customers, Diodes’ existing customers, new opportunity, new customers and that is really our objective.

Steve Smigie – Raymond James

Right, okay, thank you.

Operator

Ladies and gentlemen, this concludes our question and answer session, I would now like to turn the call back to Dr. Keh-Shew Lu for closing remarks.

Dr. Keh-Shew Lu

Well, thank you for your participation today. We appreciate your time and the consideration, and I will see you three months from now. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your presentation, you may now disconnect. Good day.

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Source: Diodes, Inc. Q2 2008 Earnings Call Transcript
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