Diodes Inc (DIOD) 2013 Q3 法說會逐字稿

Good afternoon, and welcome to Diodes Incorporated third-quarter 2013 financial results conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded today, Tuesday, November 12, 2013. I would now like to turn the call over to Leanne Sievers of Shelton Group Investor Relations. Leanne, please go ahead.

Good afternoon, and welcome to Diodes' third-quarter 2013 financial results conference call. I'm Leanne Sievers, Executive Vice President of Shelton Group, Diodes Investor Relations firm. With us today are Diodes' President and CEO, Dr. Keh-Shew Lu; Chief Financial Officer, Rick White; Senior Vice President of Sales and Marketing, Mark King; and Director of Investor Relations, Laura Mehrl.

Before I turn the call over to Dr. Lu, I would like to remind our listeners that management's prepared remarks contain forward-looking statements which are subject to risks and uncertainties, and management may make additional forward-looking statements in response to your questions. Therefore, the Company claims the protection of the Safe Harbor for forward-looking statements, which is contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today, and therefore we refer you to a more detailed discussion of the risks and uncertainties in the Company's filings with the Securities and Exchange Commission. In addition, any projections as to the Company's future performance represent management's estimates as of today, November 12, 2013. Diodes assumes no obligation to update these projections in the future, as market conditions may or may not change.

Additionally, the Company's press release and management statements during this conference call will include discussions of certain measures and financial information in GAAP and non-GAAP terms. Included in the Company's press release are definitions and reconciliation of GAAP to non-GAAP items, which provides additional detail. Also throughout the Company's press release and management's statements during this conference call, we refer to net income attributable to common stockholders as GAAP net income.

For those of you unable to listen to the entire call at this time, a recording will be available via webcast for 60 days in the Investor Relations Diodes website at www.diodes.com. Now, I will turn the call over to Diodes' President and CEO, Dr. Keh-Shew Lu. Dr. Lu, please go ahead.

Thank you, Leanne. Welcome everyone, and thank you for joining us today. I'm pleased to report another quarter of record revenue, increased market share gain, and a solid operational performance across our business. Our past design win momentum and the strength in the TV market and at certain major OEMs, we were able to offset the continued weakness in the PC market.

Also during the quarter, we further improved gross margins through our cost reduction efforts and improved BCD wafer fab loading. Additionally, we reduced our operation expense on a dollar basis and as a percentage of the revenue, demonstrating further progress toward achieving our target model of 20% of the revenue.

These achievements are even more notable when considering the weakness of the US dollar relative to most currencies where we have operations, especially the British pound and the euro. Our improved operational efficiency and the cost reductions were able to mostly offset this currency impact and allow us to exceed our operational expectation for the quarter.

As we look to the fourth quarter, it is shaping up to be weaker than our normal seasonality, due to a broad-based market weakness, especially the continued weakness in the PC market. However, we believe we are well positioned to benefit from ongoing operational improvement as we leverage our broadened product portfolio and additional cost saving from transforming BCD product into our packaging facility by the end of the year.

And then eventually offloading our analog foundry wafer loading into BCD wafer fabs. With that, I will now turn the call over to Rick to discuss our third-quarter financial results in more detail, as well as fourth quarter guidance.

Thanks Dr. Lu, and good afternoon everyone. Revenue for the third quarter 2013 was $224.5 million, an increase of 4.7% over the $214.4 million in the second quarter and an increase of 34.7% from the $166.6 million in the third quarter of 2012. The sequential increase in revenue was primarily due to of our past design win momentum and strength at certain major OEMs.

Gross profit was $69.6 million, or 31% of revenue, compared to $61.3 million, or 28.6% of revenue, in the second quarter 2013, which included $3.7 million of an inventory valuation adjustment related to our BCD acquisition and $43.6 million, or 26.2% of revenue, in the third quarter 2012. Gross profit margin improved as a result of our cost reduction efforts and improved BCD wafer fab loadings.

GAAP operating expenses for the third quarter were $49.3 million, or 22% of revenue, which included approximately $1.9 million of amortization of acquisition intangibles and approximate $800,000 of acquisition-related employee retention accruals, compared to $51.1 million, or 23.8% of revenue, in the second quarter 2013, and $36.1 million, or 21.7% of revenue, in the third quarter 2012. Even with the addition of BCD, we were able to sequentially reduce our operating expenses on a dollar basis and as a percentage of revenue, putting us closer to our target model of 20% of revenue.

Excluding amortization of acquisition intangibles, and acquisition-related employee retention accruals, operating expenses on a non-GAAP basis for the third quarter 2013 were $46.6 million, or 20.8% of revenue, compared to $46.2 million, or 21.5% of revenue, in the second quarter 2013, and $34.9 million, or 20.9% of revenue, in the third quarter 2012. Looking specifically at selling, general, and administrative expenses for the third quarter, GAAP SG&A was approximately $33.8 million, or 15.1% of revenue, compared to $35.1 million, or 16.4% of revenue, in the second quarter 2013,and $25.8 million, or 15.5%, in the third quarter 2012.

Excluding acquisition-related employee retention accruals, non-GAAP SG&A was $33 million, or 14.7% of revenue, compared to $34.1 million, or 15.8% of revenue, in the second quarter and $25.8 million, or 15.5%, in the third quarter 2012. Investment in research and development for the third quarter was approximately $13.6 million, or 6.1% of revenue, on a GAAP basis. This compares to second quarter 2013 R&D expense of $12.1 million, or 5.6% of revenue, and $9.1 million, or 5.5% of revenue, in the prior-year quarter.

Total other expense amounted to $2.8 million for the third quarter. We had approximately $1.6 million of interest expense and approximately $600,000 of interest income. In addition, we sustained approximately $2.5 million of currency losses due the weaker US dollar relative to the British pound, down by 6%-plus, and the euro, down by 4%. Our favorable operation results mostly offset this currency impact on net income and earnings per share.

Income before taxes and noncontrolling interest in the third quarter was $17.5 million on a GAAP basis. This compares to income of $10.5 million in the second quarter 2013 and $9.4 million in the third quarter of 2012. Turning to income taxes for the third quarter, our tax rate was 20.5%, which was within our estimated range of 18% to 24%, reflecting the increased amount and movement of profit between various taxing jurisdictions with different tax rates.

GAAP net income for the third quarter was $13.6 million, or $0.28 per diluted share, compared to GAAP net income of $8.6 million, or $0.18 per diluted share in the second quarter and GAAP net income of $8.6 million, or $0.18 per diluted share, in the prior year quarter. Third quarter non-GAAP adjusted net income was $15.8 million, or $0.33 per diluted share, which excluded net of tax $1.5 million of non-cash amortization of intangible asset costs and approximately $700,000 of acquisition-related employee retention accruals.

The fully diluted share count used to compute GAAP and non-GAAP earnings per share for the third quarter was 48 million shares. We've included in our earnings release a reconciliation of GAAP net income to non-GAAP adjusted net income, which provides additional details.

Included in third quarter GAAP and non-GAAP adjusted net income was approximately $2.3 million net of tax of non-cash share-based compensation expense. Excluding share-based compensation expense, both GAAP and non-GAAP adjusted diluted EPS would have improved by $0.05 per share.

Cash flow generated from operations was $16.7 million, and free cash flow was $9.6 million for the third quarter. Net cash flow was a negative $9.3 million for the third quarter. Two specific items reducing our net cash flow were a $7 million payment to reduce our revolver and the purchase of $22 million in short-term investments. For more details about our cash flow statement, please see our Form 10-Q.

Turning now to the balance sheet. At the end of the third quarter we had approximately $204 million in cash and cash equivalents and $22 million of short-term cash investments. Working capital was approximately $489 million.

At the end of the third quarter, inventory was approximately $194 million compared to $187 million last quarter. Inventory days were 113 in the third quarter, compared to 110 days last quarter. Inventory in the quarter reflects a $2 million decrease in finished goods, and a $7 million increase in raw materials, and a $2 million increase in work in process.

At the end of the third quarter, accounts receivable was approximately $192 million, and AR days were 77, compared to 75 last quarter. Capital expenditures for the third quarter were $12.4 million, or 5.5% of revenue. This compares to 3.8% of revenue in the second quarter.

We expect capital expenditures to remain between 5% and 8% of revenue for the full year, which includes both BCD and Chengdu. Depreciation and amortization expense for the third quarter was $18.5 million.

Now turning to our outlook. For the fourth quarter 2013, we expect revenue to range between $205 million and $220 million, or down 2% to 9% sequentially. We expect GAAP gross margin to be 28%, plus or minus 2%. GAAP operating expenses are expected to be approximately 22.7%, plus or minus 1%.

We expect our income tax rate to range between 18% and 24%, and shares used to calculate GAAP EPS for the fourth quarter are anticipated to be approximately 48.2 million. For more detail on the outlook, please see our press release. With that said, I will now turn the call over to Mark King.

Thank you Rick, and good afternoon. Our record third quarter revenue was driven by growth in all regions, with strong increases in North America and Europe after a relatively flat second quarter in these regions. We also achieved record sale in China local market, where we are making great progress.

In the communications end market, our solid position with smartphone manufacturers continues to be a key driver of sales as a result of our growing new design win revenue. Computing grew slightly in the quarter, primarily due to increased sales for our products used in tablets, partially offset by weakness in notebook and mother board.

The auto and industrial markets were also up in the quarter on the strength in both North America and Europe. OEM sales were up 2% and distributor POS was up 8.6%. Distributor inventory rose 6%, and global inventory remained in line and under three months.

In terms of global sales, Asia represented 82% of revenue, North America and Europe each represented 9%. Our end market breakout consisted of consumer representing 32% of revenue, computing and communication each 23%, industrial, 19%, and automotive, 3%.

Beginning last quarter we realigned our market product classifications according to the guidelines of the world semiconductor trade statistics. As a reminder, smartphones and cellphones are now classified under communication, tablets and computing and lighting now falls within industrial.

In terms of design wins, activity once again remained very strong across all regions, as well as end equipment and markets. We have a solid pipeline of designs as a result of our expanded customer engagements. There continues to be significant cross-selling opportunities with the BCD products.

In fact, we achieved another record quarter for BCD's AC-to-DC line. In addition, we achieved record quarterly revenue on DC-to-DC converters, CMOS cell diodes, LED drivers, and MOSFET products.

We also had strong revenue quarter on hall sensors, SDR, and logic products across broad-based markets and end equipment. In fact, our logic products had another record quarter and continues to remain on a positive trend.

On our discrete product, introductions totaled 63 new products across 14 product families aimed at diverse range of markets and applications. Once again, several new products were launched for the high volume portable devices, such as smartphones, tablets, and energy efficient power adapters.

Other product developments were aimed at applications such as LED lighting, touch screens, USB, HDMI, and other industrial applications. Several products were launched specifically for the high growth automotive electronic market, where ruggedness, reliability, and quality are key attributes.

During the quarter, Diodes launched additional product based on its performance-leading Trench SBR technology. These new products are aimed at the thermally demanding small form factor portable adapter market, and enable power supply designers to meet efficiency and temperature targets.

We also launched the first Trench SBR products for the LED lighting market that offer reduced power consumption and improved efficiency in higher temperature operation, resulting in better thermal stability. As I have mentioned in the past, miniature packaging remains a core strength for Diodes, and building upon this expertise we introduced new chip scale packaged products for the portable applications.

These SBR CSPs occupy less board space and have 50% [cnu] off-board profile. Also new in the third quarter were high voltage technologies to complement our MOS and diodes ranges.

300-volt MOS sets were released based on the new mid-range Trench MOS platform. This innovate process platform allows Diodes to offer up to 300-volt MOSFETs with low [RVSI] in a small package.

In addition, new switching diode products feature a proprietary industry-leading 400-volt technology and are suitable for many new applications employing high voltage, including capacitor touch screens and LED lighting circuits. Diodes also added to our performance TVS portfolio with the release of a wide range of devices suitable for USB 2.0, HDMI, and USB 3.0 applications.

Now turning to analog products. We released 21 new products across four product families during the quarter. New product highlights include the significant expansion of Diodes' low voltage, high performance qualified products with the addition of a family of omni-polar and unipolar switches. This product family offers a range of medium and high sensitivity devices, as well as a programmable sensitivity device for enhanced system flexibility.

Additional new releases during the quarter include two new offerings in our growing family of AC-to-DC power devices. We released a high performance power supply controller with excellent standby power performance.

In addition, we introduced a secondary side synchronized rectifier who's fast response to secondary side voltage can effectively improve transient performance in a system's primary regulation. Both devices are targeted at high efficiency chargers and set-top box market.

Also during the quarter we released two high performance LED drivers that offer protection features to further enhance system performance and cost effectiveness. The first is an AC-to-DC power factor correction controller that provides accurate, constant current regulation while eliminating the need for an opto-coupler and secondary control circuit feed at the system level. The other new product is a primary side PFC controller for dimmable LED driver application.

In terms of design wins for our analog products, Diodes continued to gain traction for our hall sensor product with significant wins in the smartphone and gaming markets. During the quarter we secured a large win for our AC-to-DC devices in the set-top box market, as well as continued traction for our AC-to-DC products in smartphone chargers.

Our USB power switches also continued to receive excellent market acceptance with multiple wins across essentially all major notebook manufacturers. We also secured a number of wins for our DC-to-DC converters across a broad range of applications, including white goods and communication data cards, as well as continued expansion in LED TV, Wi-Fi modules, and set-top box applications.

We also obtained two significant new design wins in the European set-top box market for our low voltage DC-to-DC converters that we acquired from Pam. Also from Pam, our audio amplifiers were awarded sockets in flat panel TV and monitor markets.

In summary, we are very pleased with the operational achievements we made in the quarter, as evidenced by our solid results. We also continue to aggressively expand our new product introductions, which has been a key driver of our design win momentum and market share gains.

Going forward, we remain focused on leveraging our expanded product portfolio with the addition of the BCD products and capitalizing on cross-selling opportunities in order to fuel our future growth. With that, I'll open the floor to questions. Operator?

(Operator Instructions)

Your first question comes from the line of Gary Mobley of Benchmark.

Hi, guys. Thanks for taking the question. If I look at the midpoint of your guidance for the fourth quarter for revenue, it calls for about a 5.5% sequential decline. And in your third quarter I think you grew 5% sequentially, which was in line with peers, but your fourth quarter revenue guides below the peer group, which is guiding for about a 1% to 3% sequential decline. So I'm just wondering, where is that Diodes that historically has taken market share, and should we read anything sinister into that sequential comp?

Well, Gary, I don't think the peer -- I don't know where you get the peer is at 2% down. I think when we look at our peer company, we feel it's somewhere around 8% down.

So that maybe different company you use, but the key thing really, you need to compare is the third quarter we actually grew and then fourth quarter we're down. And then you need to -- if you compare with third quarter and fourth quarter, then you might come up different numbers, okay?

But in general -- what we see is a general market slowdown, especially is in the PC market. And you can see that the PC market continue weakness, continued weak. And at the same time, some of our OEM company they are not as strong as the third quarter.

So overall, that's why we guided 5.5%. It's strong -- it's worse than our normal seasonality, somewhere around 0% to 5% down. That's normal seasonality. It's worse than that. But I think really majority was due to the weak PC market and the general market weakness.

Okay.

But we still believe -- we don't know yet, but we still believe in the fourth quarter we may still can gain the market share.

Okay. If I look at the midpoint of your gross margin guidance, it calls for about a 300 basis point sequential decline. Could you give us sort of a relative ranking of what the impacting factors are there? Whether it be a lower manufacturing load, currency, so on and so forth.

Okay. It's majority is really is the manufacturing under-loaded, and especially this time was you have some impact by the packaging, but the majority are impact is really by the wafer fab. If you look at our -- from the first -- 1Q, wafer inventory to end of 3Q wafer inventory, we are up almost $10 million.

And the reason we started loading the wafer fab is we think when we -- 1Q, we look at 2Q going to be strong, and 3Q going to be strong, and so we started loading wafer fab. But now if I look at it, leading forward, 4Q we know is weak, and we think and traditionally 1Q will be a weak quarter too.

Therefore, we take this time, try to reduce the output of a wafer fab and such that we can hopefully reduce our wafer fab inventory to align with our regular plan for 4Q and 1Q. So if the packaging under-load has some impact, but the majority of the impact coming from BCD fab, our Oldham fab, and especially our Kansas City fab.

Okay. Let me ask a follow-up, and it's somewhat of a hypothetical situation. Let's assume your inventory was flat sequentially in the third quarter, and your revenue for the fourth quarter was expected to be sequentially flat with the third. Would your gross margins stay the same or increase?

Well, if you make that assumption, if the revenue the same and wafer fab loading is the same, and then you're obviously the GPM will be flat on 31%, yet your costs might going up, but our cost reduction effort will be able to balance that. So this time we look at it is pure due to the loading factor of the making functions.

That's it from me. Thanks, guys.

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

Great. Thanks a lot. Doctor, obviously a soft environment out there. If I look at maybe perfect comp, but maybe a semiconductor, they guided down about 8%. They did have a lot of computing exposure there.

Still, it seems like there's a lot of that computing weakness out there. I was just curious if you could talk a little bit about how you see that, maybe even the next year generically, not necessarily an estimate, but it seems like that's a little bit soft.

Should we think about that as you're diversifying, you've got other categories growing while that's coming down a little bit? Or is there even the potential that because you guys gained share, and you have new products coming out that it might be down a little bit next year, but not as bad as you might think?

I think you know we originally heavy in the PC market, and if you notice under the notebook age it went down quite a bit, even the desktop and the mother board kind of flat or slightly down. PCs, the notebook is the major softness.

But fortunately we are working our way to the tablets and that kind of market. So that will help to reduce some of the burden of the PC century. But at the same time, we have another design win, cellphone, and other applications and that's why we can still continue gaining the market share so far.

If I could add on the PC side, we do see some significant opportunities for us to balance out the decline with new products, and we're looking into that. We're moving in that direction for next year. So we see some ways that we can mitigate the softness in that market either way.

Okay. Great. That's very helpful. And how should we think about Q1? That sounds like Q1 is probably a little bit soft for everybody out there. Again, computing probably continues to roll off.

You've got some seasonality in stuff like handsets, typically. So is it fair to say that you guys would likely be similar to other folks where you'd probably have a soft seasonal Q1, followed by, in a typical pattern, like a strong Q2, Q3? Because you guys have always done well there, plus BCD's always had very strong Q2, Q3 period as well.

Well, actually, it's too early to call about 1Q. Right now, the visibility is very short. If three months ago you asked me, what will be the 4Q look like, I won't say it will be so soft.

So obviously now to look at 1Q, I really don't know. Even this 4Q is worse than seasonality. So 1Q, yes, seasonally go down, but since 4Q is so soft, I don't know. 1Q will be better or will be the same. Really very hard for me to see.

Okay. Great. And I was hoping for a little bit of commentary around operating expenses and currency impacts. I'm not sure if I'm doing the math right.

The OpEx seems a little bit higher in Q4 dollar-wise than I would have thought. And so is there going to be some cost control potentially coming in on some of that going forward post-Q4? And then just on the currency stuff, is that sort of one-time in nature, or would we potentially see some more impacts going forward as well?

You're talking about the currency exchange impact is actually in 3Q, and the 3Q is just because our currency, US currency against euro and against the pound, English pound, is significant low, okay? Against renminbi, that's about -- it's still going down but it's in the range.

You can -- normal going down type of performance. But euro and the pound, English pound, is the one significant change.

So I don't think that will be repeated because if the US dollar starts getting stronger, then you reverse. These are just -- it will be automatically balanced. If you go down, then you go up, they will cancel each other.

So basically the issue with the guidance is that there are no currency impacts in the guidance. We just assumed the same currency going forward that we closed the third quarter with.

So there's no significant currency up or down in the guidance numbers. So from an Op-expense standpoint, we were slightly over $49 million in third quarter at 22%.

And if you just take the midpoint of our guidance, it's a little bit over $48 million, but because the revenue goes down, it ends up being 22.7% from a GAAP perspective. So the dollars did not increase. They're going to go down.

Okay. Yeah, I may be looking at GAAP versus non-GAAP, might be a little bit of my issue. Great. Thank you very much.

Okay.

Your next question comes from the line of Christopher Longiaru of Sidoti & Company.

Hello, can you hear me?

Yes, we can hear you.

Hello, guys. How are you? My question has to do with just the supply chain in general. I know that you're manufacturing's in China, but in terms of the situation in the Philippines, are there any parts that are in the food chain of customers that your parts are in the food chain that you might see delays on because they can't get product, at least in the short term. from their Filippino suppliers?

No, I'm aware of it.

I don't think we have a significant customer base in the Philippines, and we don't have any raw material base in the Philippines. So we haven't seen any impact as of yet.

Okay, And then just in terms of the utilization rate that you're assuming for the fourth quarter guide, can you just give us what the number was in September, and kind of what you're expecting for December?

From a wafer fab perspective, we were -- it really depends on the wafer fab, but we were around 85% in most of them, except for our K fab, which is the Kansas City fab and it was a little bit lower. We basically conclude that 85% is fully loaded for the wafer fab. From a fourth quarter perspective, two of them are in the 80% range and one of them is below 70%.

Okay. Just in terms of the packaging and test facility, because you moved BCD in there. So you had a lot of capacity there. Can you just give us an update on where you are as you moved BCD into the packaging facility? Or you're saying that it's going to take some time, but just in terms of where you are?

It's about 85%, 86% in the third quarter, and it's about that in the fourth quarter.

I'll jump back. Thank you, guys.

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

Hi. Good afternoon. Could you give us an update on the manufacturing transition at BCD to Fab-2? How that's going?

It sounds like the BCD utilization rates are higher than they've been in the past, but how loaded or unloaded is Fab-1? And if we assume normal demand, what will be the utilization rate outlook for BCD a year from now, when we look at both fabs?

Okay. Actually, what we try to do now is move from Fab-1, which is O-fab, some of the product to the Fab-2, which is new one. So basically the Fab-2 is ramping up and so it is 100% loaded all the time. But don't forget it's ramping up.

So basically we try to keep Fab-2 while they ramp it, then fully loaded. Therefore, the Fab-1 going to be in the 4Q, going to be going down.

So is the expectation that in the future you will still be using Fab-1, or is that a fab that eventually you plan on using for certain -- just some lower products, lower end products?

Okay. For the Fab-1, what we intend to do will be move the diodes currently outside wafer into the BCD Fab-1. Currently Diodes analog wafer, majority of them, is using foundry.

And that is one we plan to do, is move inside the BCD Fab-1, while BCD Fab-1 moved their loading to their Fab-2 for the high end product. We eventually will be fill up the Fab-1 by Diodes products, too.

That's very useful. And then in PCs, you mentioned the opportunity to offset declines with new opportunities. Industry-wide do you think that there is credence to some that have thinking that the notebooks units could rebound next year?

Yeah, I think the industrial segment for us specifically with our MOSFET products and our SBR (technical difficulties) is quite strong. I don't think we've seen a significant weakness movement in the industrial market.

I think it's kind of been up to flattish over the last couple of quarters. So we don't see any declines. So we see continued upside with new product additions that we're adding.

Okay. Thank you.

Your next question comes from the line of Harsh Kumar of Stephens.

Hello, Dr. Lu. Couple of questions. Are you seeing anything strange in the end markets at this point for your seasonality to be worse than historical, let's say, even some of the industry players in your category? Is it a inventory of chips issue, or is it an inventory of finished goods, or is it just a slower market?

Well, what I see is the general slowing market. If you look at, let's say Europe. Typically third quarter Europe is vacation quarter and fourth quarter will recover.

This year for some reason, Europe third quarter is strong, and then fourth quarter is relative to third quarter is weak. So this is a normal situation.

Then you go to the PC. We already know PC is really slow down, and especially notebook. And then you go to the general China market. Again, general China market, we're supposed to see a very hot in 4Q, but we do not see that.

So it's just a normal from a typical year, but the key thing really now, I don't know how to define typical year because since 2011 every year looks like it's different. So I don't know now what is a typical year. But it's different from my past 20 years of experience.

Okay. That's helpful, Dr. Lu. And then you have actually tablets in your computing business, and my understanding is that tablets should continue to build through December, maybe towards the midpoint of the December quarter. Or is the build in tablets not strong enough to offset some of the PC weakness in notebooks?

Probably not strong enough to offset the weakness in PC and notebook.

Okay. And then last question from me. Mark, maybe you can answer this. But as you look across your four or five end markets, which will be the best faring and which will fare the worst?

I think probably computer is going to fare the worst.

Okay. Any more color on which, like any kind of industrial versus -- or com versus consumer, more color on that?

To be honest with you, I think that the auto and industrial will be relatively flat. The impacts that we see in regions or some downs might be POP versus POS.

I think POS is remaining relatively stable, but the channel might be a little bit less interested in investing over the fourth quarter. I think it's a choppy market in general, and there's bright spots and there's weak spots, and we just have to navigate through them. I don't think it's such a clear pattern.

Thanks, guys. Thanks, Dr. Lu, Rick, and Mark.

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

Just looking at your -- look at the last four years your March quarter top line has been flat to up. When you look at your disty inventories, do you see -- for the March quarter, do you see your fab loadings improve into the March quarter?

I mean, I think our disty inventory's been pretty good. If the market's going forward then we should have a good position to load.

We're not over-inventoried in our channel. We're very, very happy with our channel position right now. It's relatively clean. Again, if there's any feeling that the market's going to grow in 2014, then we'll see a stronger loading in that period.

Okay. And when you look at your gross margins, obviously Dr. Lu mentioned two things. You've done some cost reduction efforts, and on the BCD side, some loading.

When you look at the cost structure side and the product mix, what is a sustainable gross margin that you guys can hit? Obviously margins came down a little bit here, it looks like fab loading. As you look at next year, given your cost reduction and the mix, what is a sustainable margin level that you can achieve?

I think I need to make some correction. When I said wafer fab loading down, I'm not just saying BCD wafer fab loading down.

I say in general, especially one of the fab, which is the biggest fab, that loading down because we had too much of wafer inventory. So I'm not saying BCD is the only wafer loading down, okay?

And you are talking about what will be the GPM we can sustain? We measure our GPM percent, the actual versus underloaded numbers. The fully loaded number versus underloaded number, and I think we still able to maintain or go up to our business model.

Our business model is 35% GPM, and we believe we can hit there. It's just because the underloaded factor going to affect that GPM percent.

If you look at third quarter, we already up to 31%, and that, again, is not fully loaded yet. Our wafer fab is kind of there. but the assembly is not there yet. So if we can assume all the fab is loaded up to 85%, all the assembly loaded up above 95%, then I think we should be have very good chance to get our business model of 35%.

Got it. So when you look at your 35% business model and assembly and fab loading, what is -- is that like a midterm time line which you're looking at to get to those kind of levels on the gross margin side? And that's the last question. Thanks.

Exactly what do you mean by midterm? What does that mean?

Are you looking at, given -- are you looking at improving that assembly loading for the next couple of quarters based on keeping the capacity there flattish and improving the loading on the assembly side? How do you envision getting to those gross margin?

Well, number one, if your revenue, let's say if our revenue go back to $225 million like the third quarter or above that, our wafer fab will be kind of equal to about 85% loading.

That's in our third quarter, we are doing that, and BCD should be, if their business continue grow, they will continue growing and we can put move our wafer fab loading next year from our foundry into the BCD. Then the fab will be there. So then we can back to like a third quarter number, 31% or above.

Got you.

Then you look at the packaging, and the packaging we have been have problem loaded up. And so if we can get another 10% or more loading up, then that will be -- that will give us the -- another several point of the GPM improvement.

Now, another key factor, which we probably talking about, is we start to cut down our capital investment. If you remember our business model in the past is 10% to 12% of revenue. And now we are cutting down our expense.

This year we said 5% to 8%, and our business model going to -- we were going to talking about 5% to 8% or 5% to 9%. So basically we cut down our capital from 11% midpoint of our revenue to 7% midpoint of our revenue, and if we continue to do that, 4% capital reductions, then several years later, that automatically improves your GPM 4%.

Yep.

This is what we try to do to improve our GPM from long-term point of view. Our model said 35%. Obviously, we are not happy from long-term point of view, using 35% as the model.

One is to design more new product with more differentiated type of new products to get a better GPM. But the other thing is, we reduce our capital investment, our target now is reduce 4%. And if we are able to reduce 4% continuously for four, five years, then our GPM will be automatically improved 4%, 5% and that will be make it better than our business model.

Got it. Thank you very much.

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

Hi. Evening, everybody.

Hi, Shawn.

I don't think I heard this specifically asked, but of the gross margin decline sequentially for the December quarter, how much of that is related to the inventory you want to take out of your system in terms of the finished goods? So is that inventory decline 100 basis points of the 300 basis points? Just trying to get a triangulation of that figure.

We didn't talking about take the finished good out of the inventory number. We talking about reduced wafer fab. The wafer inventory, okay, what I'm talking about is if you look at our wafer inventory from 1Q to end of 3Q, our wafer inventory up about $10 million.

And that is quite a bit, and that is because we predict second quarter and third quarter going to be, and we think in fourth quarter going to be a good quarter too. And you know my strategy always, wafer, you build up the wafer and then we put in different package because the lead time for packaging is short, and that way you can easily to support the customer and take advantage of the short lead time.

And then when the market turn, you can take advantage of the support customer and gain the market share. That really is the strategy.

I make that strategy, and had been working fine but now since we start see fourth quarter and 1Q going to be slow quarter, then we try to say, okay, basically reduce our wafer inventory. And so we significantly cutting the wafer fab. And if you said how much PPM point, how much base point you affect? I will say probably 2 to 3. I said we talking about probably 2.5 basis -- 250 basis points.

Yeah, something like that. 200 basis points.

200 basis points, just by the wafer fab is 200 basis points.

Okay. That's extremely helpful. The other thing I just wanted to clarify, I think last quarter it was mentioned that there was a power outage that affected your business. And I was just wondering kind of what the cost drag on the September quarter was related to that power outage?

That power outage, I think at that time we -- I don't know, I don't remember talking about how much or not. But I remember we said about $0.5 million impact. I don't remember.

I don't know. I don't remember whether I tell you or not. At the end, we do write-off the inventory, and it's less than that, it's less than that number. Okay.

The capacity loss is not a major issue because wafer fab is not fully loaded, but we did have some WIP in the line. It end up to be small, and I don't remember what, if I say something but right now we have the number is less than $0.5 million.

About $0.5,

About $0.5 million. That's why we are able to get 31%.

Okay. Perfect. And then, Mark, I guess a question for you on distribution. Of this revenue decline for the December quarter, is there any abnormal destocking activity occurring at distribution?

Is there any risk of that heading into the March quarter? It doesn't sound like there is, but I just want to be 100% clear on that.

Certainly they're not robustly placing inventory orders. So they're definitely being careful. And so I think that it is putting a little bit of drag, and it could put a little drag on this quarter and next quarter.

But if the POP -- if the POS holds up, then we should remain a little consistent. But again, distributors towards the end of the year are very habit-based at not placing stocking orders or restocking in that period. So, yeah, I definitely think that they're being conservative.

If I'm correct, it sounded as if your point of purchase for the third quarter distribution was higher than the point of sale, is that correct?

Not correct.

I guess would the sell-in match sell-through, or was sell-in below sell-through?

It always kind of matches in that area. I think we did have some inventory increase because they were expecting maybe slightly better than they expected, but our POS was up 8.6% in the quarter. So I think it was -- I think that was all healthy.

Got you. Thanks so much everybody.

Your next question comes from the line of Lena Zhang of Blaylock Robert Van.

Hi. Thank you for taking my question. Can you talk about ASP erosion in Q3, and also give us general weakness in the market? How about ASP you are seeing right now for the current quarter? Thank you.

I think I've been talking about our typical ASP going to be -- go down almost every quarter. That is our business and typically we said it's normal, typically it's like go down 1.5% to 2% a quarter,

And third quarter it turn out to be mixed independent, look like go down slightly worse than seasonal, or typical. We define typical about 1.5% to 2% down each quarter, and third quarter is worse than typical.

How about the current quarter?

Current quarter, I don't know. Because we don't have the number yet.

A lot of moving targets.

Yeah.

Okay. Thank you.

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

Hi, guys. I'm curious, on the BCD and analog side, are you seeing design wins accelerate there as you bring the BCD products into your Company in terms of the merger synergies there?

Yeah. To be honest with you, we're really, really, really happy with what we're seeing in the customer base and the interest at the customers. North America and Europe has a whole new energy toward analog, and frankly I think that they're pretty excited about being able to walk in to every customer in North America and Europe where they couldn't before.

So I think there's a significant amount of opportunity for us to develop these design wins over the next year and beyond. Again, an analog design win takes a little longer to get to production than some of the discrete design wins, but the progress is quite good and the activity is very, very strong.

When you look at the top of the revenue, and so and almost double the number of the product, you make the sales more exciting. Our sales team, very exciting.

Okay. And then my other question, should we still think of your phone exposure as more high end, or are you making progress in the low end smartphone market? and also, (inaudible) can you talk about the momentum in the charger market? I know that's an area of strength the last few quarters.

I think that you would probably say that we're driven by the higher end of the smartphone market, but we have a lot of interest and a lot of activity in the mid-size, maybe the larger Chinese and moving forward on there. And the charger progress continues, both on the Diodes side as well on the BCD side. So there was some pretty good synergies between our two companies in that area.

Okay. Great. Thanks, guys.

This ends today's question-and-answer session. I would like to hand the call back to management for closing remarks.

Well, thank you everyone for join us today. Operator, you now can disconnect.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a wonderful day.