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International Rectifier Corporation (NYSE:IRF)

F1Q14 Earnings Call

October 30, 2013 5:00 PM ET

Executives

Chris Toth – Executive Director, IR

Ilan Daskal – EVP and CFO

Oleg Khaykin – President and CEO

Analysts

Terence Whalen – Citi

Steve Smigie – Raymond James

David Wong – Wells Fargo

Micheal Wu – JMP Securities

Christopher Rolland – FBR

Operator

Good afternoon. My name is Natalia, and I will be your conference operator today. At this time, I would like to welcome everyone to the International Rectifier First Quarter Fiscal Year 2014 Results Conference Call. All lines have been placed on mute to prevent any background noise.

Thank you, I would now turn the call over to Mr. Chris Toth, Investor Relations. You may begin sir.

Chris Toth

Thank you, operator. Hello, and good afternoon. We all welcome you to the International Rectifier conference call. On the call today are Chief Executive Officer, Oleg Khaykin, and Chief Financial Officer, Ilan Daskal. I trust you’ve all seen copies of our press release, which was published about an hour ago. If not, the press release can be found on our website at investor. irf.com, in the Investor Relations section.

Before we begin, I would like to remind you that except for historical information, the matters that we’ll be describing this afternoon will be forward-looking statements that are dependent upon certain risks and uncertainties, including factors such as orders shipped and received during the quarter, level of bookings, the timing and introduction of new technologies and products, general semiconductor industry conditions, and the overall economy and financial markets.

In addition to these risks, we refer you to the risk factors included in our press release, and in our most recent SEC filings.

I would also like to mention that in addition to reporting our GAAP financial results, we present supplemental non-GAAP financial data. A reconciliation of the non-GAAP to GAAP measures set out in our press release and in discussion today can be found in our press release and on our website. We believe providing our non-GAAP measures, combined with our GAAP results, provides a more meaningful representation regarding the Company’s operational performance.

Our non-GAAP presentation and EPS calculation exclude certain items such as accelerated depreciation, restructuring and severance charges, amortization of acquisition-related intangibles, and certain discrete tax items, among others. Lastly I would like to highlight the following upcoming events.

On Tuesday November 12, we’ll be attending the Wells Fargo Technology Media and Telecom Conference in New York and on Tuesday November 19th we’ll be attending the UBS Global Technology Conference in the San Francisco Bay Area. And on December 3rd we’ll be attending the Credit Suisse Technology Conference in Scottsdale Arizona.

Now, Ilan will discuss our most recent financials. Ilan?

Ilan Daskal

Thank you, Chris. Good afternoon and thank you all for joining us. For the first quarter of fiscal 2014 which was the customary 13 weeks IR reported the revenue of $269.8 million a 2.4% decrease from the prior quarter which was 14 week quarter and a 7% increase from the first quarter of fiscal year 2013.

Revenue in the September quarter when compared with a normalized 13 week June quarter increased 5% sequentially. GAAP gross margin increased to 35.3% in the quarter which exceeded the high end of our guidance. The gross margin increased from the prior quarter was primarily due to higher utilization an operational efficiencies.

Non-GAAP gross margin was 35.5% and excluded $427,000 of accelerated depreciation associated with the resizing of our new product Newport, Wales fab. Overall, GAAP net income was $8.7 million or $0.12 per share for the quarter. This compares with GAAP net loss of $6.1 million, or $0.09 per share in the prior quarter, and GAAP net loss of $28.8 million, or $0.40 per share in the prior-year quarter.

Non-GAAP net income was $15.1 million or $0.21 per share for the quarter. Non-GAAP net loss excluded accelerated depreciation of $427,000, asset impairments, restructuring and other charges of $1.4 million, amortization of intangibles of $1.6 million, and the net tax charge of $3 million. This compares with a non-GAAP net loss of $1.2 million or $0.02 per share in the June quarter, and the non-GAAP net loss of $13.9 million or $0.20 per share in the September quarter of last year.

Moving on to operating expenses. R&D expenses were $32.2 million and represented 12% of revenue. R&D expenses included addition on ins associated with engineering deals to qualify new product for the upcoming Grantley server launch and other advanced technologies including GaN and Next Generation IGBT products.

SG&A expenses were $43.8 million and represented 16% of revenue. Amortization of acquisition related intangibles was $1.6 million. During the quarter we reported $1.4 million in asset impairments restructuring and other charges. Excluding the accelerated depreciation asset impairment restructuring and other charges and amortization of intangibles operating income was $19.8 million or 7.3% of revenue.

Other expense net for the quarter was $762,000. GAAP tax for the quarter was $6.9 million expense. Non-GAAP tax expense for the quarter was $3.9 million and excluded discrete tax items and net tax effects on onetime items.

We ended the quarter with $479 million of total cash, cash equivalence and investments which is an increase of about $23.5 million. During the quarter inventory increased by about $11 million to $244 million which is a one week increase to about 18 weeks.

The increase in inventory was primarily a result of planned inventory deals to support the targeted customer service levels. In the September quarter we generated $24.8 million in cash from operating activities. Cash capital expenditures for the quarter were $11.9 million or 4.4% of revenue.

Free-cash flow was $12.9 million. Depreciation and amortization expense was $22.1 million and stock based compensation was $6.9 million. Total shares outstanding increased 1% in the quarter to 71.1 million shares primarily due to the exercise of expiring employee stock options and the issuance of restricted stock units to employees.

Now moving on to our outlook. We currently expect revenue for the December quarter to be between $260 million and $270 million. For this projected revenue range we currently estimate non-GAAP gross margin to be between 34.5% and 35.5%. GAAP gross margin in the December quarter is estimated to be between 34.3% and 35.3%.

During the December quarter to allowing supply with the current demand we expect some reduction in our overall factory loadings. We expect R&D expenses to be about $31 million and $32 million. SG&A expenses are expected to be between $44 million and $45 million. Amortization of acquisition related intangibles is expected to be about $1.6 million. For the December quarter we expect approximately $1 million to $1.5 million in restructuring and other charges resulting from the resizing of our manufacturing facilities.

Other expense net is expected to be about $1 million. Non-GAAP tax expense for the quarter is expected to be about $3.5 million and $4.5 million mainly due to foreign tax accruals. And finally for the December quarter we expect our cash capital expenditures to be about $19 million.

Our targeted CapEx for the 2014 fiscal year remains 7% of revenue or lower. Now Oleg will give you the latest updates on our business. Oleg?

Oleg Khaykin

Thank you, Ilan. For the September quarter we grew revenue about 5% compared with a normalized 13-week June quarter. Revenue exceeded the high end of our guidance due to a greater level in terms of business. Profit also improved nicely as our non-GAAP operating profits margin increased to 7% of revenue and non-GAAP net income grew to about $15 million or $0.21 a share. As we move into the December quarter we are seeing some seasonal weakness in bookings and backlog.

That said order, push outs and cancelations remains low and demand remains significantly stronger versus a year ago. Despite an expected slight decline in our December revenue we are optimistic that business conditions will continue to improve in 2014 as the economic recovery continues in Europe and Asia.

Geographically on a normalized 13-week basis, Japan exhibited strong revenue growth in both the industrial and automotive end markets. North America and Europe increased nicely led by automotive and industrial and Asia was about flat as we saw strength across the automotive and industrial end markets offset by weakness in the computing and appliance end markets.

Moving on to our business units. The enterprise business unit revenue increased to $32.2 million. The increase was mainly due to a strong Tier 1 gaming platform ramp. We also saw a steady demand from server and communications infrastructure markets. For the December quarter we expect Enterprise Power to remain flat as all of our end markets including service and computing remain stable. We remain well positioned on the graphics, server platform as customers adopt our digital Power Management solutions.

Design win activity has been strong and we continue to remain confident in significant share gains when Grantley ramps in the September quarter of 2014. Our management devices business unit revenue was $102 million about flat compared with a normalized 13-week June quarter. Strength in the industrial and power supply market was offset by weakness in the consumer and computing end markets. Overall lead times from offset continue to slowly trend upwards and pricing pressure remains minimal.

For the December quarter distribution sell through is expected to remain stable. However, distributors are continuing to manage down their inventories ahead of the year-end and as a result we expect TMD to modestly decline.

Our energy saving products business unit revenue was $50.5 million up about 4% compared with a normalized 13-week June quarter. We continue to see strength in the industrial end market that was offset by some weakness in the appliance end markets. Design wins with our new micro modules that target lower power motors continue to progress nicely in both the industrial and appliance end markets.

We expect micro modules to be one of our fastest growing segments in the coming year. For the December quarter we see ESP revenue modestly down as customers reduce their year-end inventories and prepare for a new-year model launches in the first half of 2014.

Our automotive products business unit revenue increased to a record $36.5 million growth was driven by both market strength and continued new product ramps. The automotive end market continues to remain strong for us and our design win activity is robust particularly in the new hybrid and electric vehicles as that are expected to go into production over the next couple of years.

Recently Tesla motors awarded IR the Excellent Development Partner Award in recognition for our leading IGBT technology for it electric vehicles.

In December we expect automotive to be slightly down due to the year-end customer inventory management. Lastly our HiRel business unit revenue was $48.3 million. Revenue was up about 4% compared to the normalized 13-week June quarter. Satellite and commercial aviation remains the predominant end markets for this business.

Military business is small and we do not anticipate any impact associated with the U.S. government budget reduction.

Overall our bookings and backlog remains stable in all of our HiRel markets and we continue to see steady long-term growth in our business. Now an update on channel inventory. During the September quarter sell-through increased 9% compared with a normalized 13-week June quarter. Distributors continued to reduce their inventory and overall weeks were reduced to about 10 weeks.

Lead times continue to remain normal and pricing remains firm. Tax utilization increased into the upper 80% range and inventory levels rose by about one week. During the quarter we saw a greater level of churns business and customer expedite, coupled with a lower channel inventory weeks we remained comfortable with a slightly higher than normal inventory level. That said we are vigilantly tracking end market demands and adjusting wafer starts accordingly.

As a result in the December quarter we are currently planning to slightly lower factory loading. Now I’d like to provide a few updates on some of our ongoing initiatives. Our six-inch fab resizing in Newport is on track and currently scheduled for completion by the middle of calendar 2015.

In addition we are making good progress in qualifying products at our new ultra think wafer processing facility in Singapore. We are planning to start initial production in this facility in the March quarter with a ramp in the June quarter.

Our operational wafer once operational wafers from both foundry and internal fabs will go to our Singapore facility for final wafer and die processing before being sent off for final assembly and testing.

Now I would like to discuss technology development. Over the next year, over the last year we have prioritized our R&D to focus on core technology platforms with Tier 1 OEMs that provide significant growth opportunities.

We have been highly successful in securing design wins in our core markets and are in process of releasing new technologies including digital Power Management solutions for server and high performance computing segments where we expect to significantly increase our share. High voltage IGBTs and modules for products in the automotive industrial and appliance end markets next generation low voltage MOSFETs IRS currently the market leader in MOSFETs and we continue to invest to maintain our leadership.

And lastly Gallium Nitride, we continue to see strong interest in our Gallium Nitride technology from top tier customers and expect to launch high voltage commercial products within the next several months. We are currently in discussions with customers on a broad range of applications in the industrial, appliance and power supply markets.

In closing, over the past several quarters we have been very encouraged by numerous successful design wins with our digital power management solutions, advanced IGBT technology and module products. As a result we have strong confidence in program ramps starting in the middle of 2014. In addition to these areas Gallium Nitride remains a significant long-term driver for our business and we are optimistic in its success.

We believe we are making the appropriate investments in these areas to execute on our technology strategy and provide high value solutions to our customers.

This concludes our prepared remarks and I would like now to open to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line of Terence Whalen with Citi.

Terence Whalen – Citi

Great, thanks for taking my question. This question relates to a comment all of that you made about sort of vigilantly watching demand given there some signs of swelling set against having increased inventory slightly. I just would like to understand your perspectives out over the next three months. What are sort of the expectations on the sort of the tax per month to month basis that you are looking at I guess up until Chinese New Year what would cause you to either adjust your wafer starts down or up? Do you expect restacking to begin at distributors again once the New Year starts? Thanks.

Oleg Khaykin

Thank you, Terence. Well certainly one thing is what was different about last quarter is we had much greater level of what I call churns business essentially customers coming in on a very short notice and asking hey I need this product if you have it I will take it this quarter.

And that leads me to believe that everybody is being very cautious I mean last couple of years have been quite volatile. And we saw in combination with these increased terms and expedite business we also saw a number of weeks in inventory held by distribution go down.

So we felt comfortable to slightly increase our internal inventory so we can accommodate this type of churns business. During this quarter we are seeing also some of the same behavior. So that said you plan your production based on what you get as your fixed bookings but you also try to be flexible to see if situation changes during the quarter and the demand remains healthy. You can restart some wafers to replenish the inventory. So what we are doing is we are clearly consuming the buffer stock and to the extent this trains business persist we’ll place the replacement orders to the extent it comes in lower we obviously are going to hold off on loading our fabs with new wafers to maintain current inventory levels.

So from that perspective on one hand we want to able to be take advantage of the opportunistic opportunities on the other hand we don’t want our inventory to get out of hands. So it’s a very balancing act and when I say about reducing utilization it’s a very small level of utilization that we are expecting in terms of reduction this quarter.

Terence Whalen – Citi

Okay great that’s very helpful. My follow up question is switching gears looking at the acquisition of Volterra by Maxim and just how do you think that affects digital power management market and if you could remind us sort of specifically where you typically would intersect with Volterra? Thank you.

Oleg Khaykin

Well I mean clearly Volterra was one of the three major competitors in the server space. They were a big winner in the current Romley generation but also one of the bigger losers on the next generation. And I mean clearly they had a very good exit from the market I mean they were facing quite a few challenges going forward. Now that said Volterra had some very good technology and being a small company they really could only focus on one or two vertical markets given the level of application support if needed.

I would imagine Maxim given their broad application footprint we’ll probably find other applications of that technology and their diverse end markets. But I do not see, I do not expect much movement at this stage as far as their portion go in the server market.

Terence Whalen – Citi

Okay. Very helpful, appreciate the perspective, thanks.

Operator

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

Steve Smigie – Raymond James

Hey thanks a lot and congratulations Oleg on nice performance here and guide level of focus been what’s more challenged just as we look here into the start of the next calendar year typically your air conditioner business is up pretty strongly. Is that enough to drive the first quarter up or what are the puts and takes to make the first quarter up sequentially?

Oleg Khaykin

Well I think you bring up very good point. So clearly December quarter is the area we get headwinds in the air conditioning markets. As everybody tries to deplete their inventories before they switch over to the next year’s model. In about few years we’ve seen stronger demands especially beginning of the year for air conditioners. We expect the same kind of cyclicality right so clearly we expect our industrial and appliance market to be stronger in the March quarter.

To make the whole March quarter stronger while it’s early to tell it really will depend at what degree the consumer and computing market will drop off in the first quarter from the December quarter because we feel other business units such as automotive and industrial should be pretty good.

But if all things being equal I mean in general I think 2014 will be a very strong year I mean I just finished kind of my visits with number of our major customers and I haven’t seen that kind of bullish optimism about the upcoming year in the past two years.

So either everybody is went out from being beaten down over last two years and they feel good about next year. I actually tend to believe that they are all seeing gradual recovery in the infrastructure and capital goods markets which they think is going to drive recovery for them next year.

Steve Smigie – Raymond James

Okay, great thanks. And if I could just follow up on the Volterra question. One of the things that Maxim said that they could add was that they were bringing in near strong sales and may be that was what you were talking in terms of application support so maybe they can be stronger in other areas outside of server. But within the server itself you’ve seen so much skeptical and their ability to really major headwind at least in the short term.

Is it just extra sales people help that opportunity or is it just basically winning more just on technology in order to take few sales people that win there anyway?

Oleg Khaykin

Well when you don’t have the product and technology at the time right now when all the designs are finalized I don’t see what a sales guide can do I mean he can only buy too many launches if you don’t have the product to win business.

Steve Smigie – Raymond James

Okay, great. Thank you very much.

Oleg Khaykin

Thank you.

Operator

Your next question is from the line of David Wong with Wells Fargo.

David Wong – Wells Fargo

Thank you very much. Does your December guidance assume distributors will continue to reduce inventory in the December quarter?

Oleg Khaykin

Well I think every December quarter David it seems like most of them have their fiscal end year is in December. And a lot of them one of their key metrics they are judge by their investors if they are kind of finished end year inventory on that basis they calculate inventory return.

So we always see the very cautious kind of inventory reduction taking place in December quarter and then more aggressive reordering starting in January.

And also not only distributors automotive suppliers do the same thing they are very careful about deciding how much inventory they pull in at the end of the year in terms of showing what their total end year inventory looks like.

Ilan Daskal

And that’s part of the behavior the increased term business that we continue to see.

David Wong – Wells Fargo

Okay great. And does it shift from Sandy Bridge to IB Bridge on the Romley platform do you have any incremental content in service and what content you expect to get for Grantley platform within a year’s time?

Oleg Khaykin

Well I mean the current shift currently it does have some positive impact but not that much. Really the Grantley is the big platform that meaningfully moves the needle. Just purely looking at the volumes of servers and the content for blade.

David Wong – Wells Fargo

Okay great. And what’s your utilization currently running at? Do you expect utilization will rise in the March quarter from what you can see at the moment?

Ilan Daskal

So we ended up David September in the high 80s we did reduce the utilization into the December quarter and March we haven’t determined yet how is it going to shape up it depends what the visibility will look like in terms of revenue and seasonality but we’ll have to wait and see.

David Wong – Wells Fargo

Also the June quarter outlook is usually a primary driver of your March quarter utilization?

Oleg Khaykin

Right.

David Wong – Wells Fargo

Okay thanks very much.

Oleg Khaykin

Thanks, David.

Operator

Your next question is from the line of Alex Gauna with JMP Securities.

Micheal Wu – JMP Securities

Hi guys, this is Micheal Wu for Alex congratulations and thank you for taking my question. I was just wondering about the guidance a lot of companies have been missing on the guide for the December and you guys have seems to be guiding better. Where do you think we are in terms of cyclicality for the entire for the overall industry and what is different for our international rectifier in the December quarter?

Oleg Khaykin

Well, I think you got to look at the individual companies exposure to have various vertical markets. I mean last year for example wireless segments were unusually strong in the second half of the year this year many of our competitors and peers who plan the space seeing weaker demand. We play very much in a power space that kind of higher power space. So in last two years those segments been fairly anemic given the general recessionary pressures.

So I think what we are seeing now is really a combination of just gradual recovery in those markets but then there are also specific IR factors such as the ramp of some of the new platforms in automotive and enterprise products business units there are helping us move the needle in the positive direction.

Micheal Wu – JMP Securities

Okay, great. And as a follow up on the guidance for gross margin is slightly lower at the midpoint is that mostly due to the lower loading that you are expecting for next quarter or is there something else that also in there like mix or pricing effect?

Oleg Khaykin

So you are right I mean for the most part is the absorption and the lower utilization that drives kind of the slightly lower margin into the December quarter.

Micheal Wu – JMP Securities

Okay, great. Thank you very much.

Operator

Your next question is from the line of Chris Rolland with FBR.

Christopher Rolland – FBR

Hey guys thank you for taking my question. So I guess the first is sort of housekeeping question. So accounts receivable is up does that tell us anything about linearity there, and also on the inventory side you guys talked about targeted customer service levels so could you expand a little bit on that and what are we talking about? Thank you.

Ilan Daskal

So first question you had about accounts receivables?

Christopher Rolland – FBR

Yes does that tell us anything about linearity in the quarter they were up?

Ilan Daskal

Yeah I mean this is which is if you recall the June quarter had a 14-weeks quarter so there was kind of the cut off was a little bit different than a traditional quarter but overall it’s in line with the revenue.

Christopher Rolland – FBR

Okay. And on the inventory side you guys talked about customer targeted customer service level so could you talk a little bit more about that what we are talking about?

Oleg Khaykin

Yeah several major customers that contractually require us to have certain amount of inventory on the shelf. And to guarantee the service level and more friendly making sure that there is enough product to hit certain upside in demand. And we just had to get up to some contractual obligations.

Ilan Daskal

To some of them as an example for example you can see the automotive product line with a VMI the vendor management inventory that is a problem that we run with several our end customer so they drive the inventory levels we have to keep.

Oleg Khaykin

And some of the enterprise our customers also.

Christopher Rolland – FBR

Okay great. And then also if you could remind us what typical seasonality for the company looks like overall and if by segment do you think there is any sort of meaningful deviations there just from typical seasonality?

Oleg Khaykin

Well I’d like to have a typical seasonality in the last five years and fortunately every year has been different. But generally on our industrial products like energy saving products we see much stronger, greatest trends in the March quarter and then greater weakness in December quarter. And now enterprise far conversely the biggest headwinds you get is in the March quarter with this in December and the greatest strength they get in the June and September quarter.

Automotive first half of the calendar year is always stronger than the second half of calendar year and PMD is pretty much goes more with the overall semiconductor cycle. So I mean we don’t have any one business unit that’s kind of defines the overall company. See if I take all five of them together generally we have a much greater strength in the June and September quarter. December is usually our weakest quarter with a greatest headwinds and March is slightly up.

But generally our June and September are our strongest growth quarters and December the weakest and March is somewhere in between.

Christopher Rolland – FBR

Great thanks guys.

Operator

(Operator Instructions) There are no further questions I will now turn the call back over to International Rectifier Corporation for closing remarks.

Oleg Khaykin

Thank you for joining us today and we look going forward speaking with you in person over the next several weeks.

Operator

This concludes today’s conference call. You may now disconnect.

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