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Executives

Chris Toth – Investor Relations

Ilan Daskal – CFO, EVP

Oleg Khaykin – President, CEO, Director

Analysts

Steve Smigie – Raymond James

Bill Ong – Merriman Curhan Ford

Gabriela Borges – Goldman Sachs

Terence Whalen – Citi

Craig Berger – FBR Capital Markets

Ramesh Misra – Brigantine Advisors

Brian Piccioni – BMO Capital Markets

Stephen Chin – UBS

Alex Gauna – JMP Securities

International Rectifier Corporation (IRF) F1Q12 Earnings Call November 3, 2011 5:00 PM ET

Operator

Good afternoon. My name is David and I will be your conference operator today. At this time I would like to welcome everyone to the International Rectifier fiscal year 2012 First Quarter Conference Call. (Operator Instructions) I would now like to turn the call over to Mr. Chris Toth. Sir, you may begin your conference.

Chris Toth

Thank you David, and good afternoon. If you have not already read through our press release issued earlier today, it can be found on our website at investor.irf.com in the Investor Relations section. Our quarterly report on Form 10-Q is expected to be filed with the SEC tomorrow Friday November 4, 2011 and can be accessed using the same web address.

This call is being broadcast over the internet and can also be accessed through the same IR web address. A conference call replay will be available through November 10, 2011. After our prepared comments, we will open the line for questions.

Our discussion today will include some forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. We caution that such statements are subject to a number of uncertainties and actual results may differ materially. Risk factors that could affect the company's actual results are included in our press release issued today and the company's filings with the SEC, including the most recent forms 10-K and 10-Q.

Before we begin, I would like to mention the following upcoming events. On Tuesday November 15, we will be attending the UBS Global Technology and Services Conference in New York City and on Tuesday November 29 we will be attending the Credit Suisse Annual 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 2012, IR reported a revenue of $302.7 million, which was a 4.6% decline from the prior quarter and a 7.8% increase from the first quarter of fiscal year 2011. Quarter-over-quarter revenue declined as end market demands softened and customers reduced inventory.

Our power management devices business unit posted the largest percentage revenue decrease among our end market segments. Gross margin for the September quarter were 37.9%, 0.7 percentage point higher than the prior quarter as we benefited from the higher factory utilization in the June quarter.

We reported a net income $22 million or $0.31 per fully diluted share compared with $39.6 million or $0.55 per fully diluted share in the June quarter. The June quarter results included a $12.4 million gross tax benefit that benefited fully diluted earnings per share by $0.18.

R&D expenses was $33 million compared with $32.5 million in the prior quarter. R&D expense represented 10.9% of revenue for the quarter. SG&A expenses were $49 million down about $3 million from the prior quarter primarily due to lower variable G&A cost. SG&A expenses represented 16.2% of revenue for the quarter. Amortization of acquisition-related intangibles was $2.6 million. Operating income was $30.2 million and represented 10% of sales for the quarter.

Other expenses net was $2.2 million in the September quarter primarily due to negative foreign currency rate volatility. Interest income net was $200,000 primarily due to low interest rates on our cash, cash equivalents and investments.

The income tax for the September quarter was a $6.2 million expense primarily due to tax accruals in our foreign jurisdictions. The total cash, cash equivalents and investments at the end of the quarter was $443.7 million which included $2.1 million of restricted cash.

During the quarter, inventory increased $32.8 million to $282.9 million. Weeks of inventory increased 3.3 weeks to 19.6 weeks. The increase included some safety stops that we had prebuilt to mitigate the potential risk associated with the switch over to our new ERP system.

We are lowering FX utilization and working to reduce our inventory level in the December quarter. Cash from operating activities in the quarter was $16.6 million and free cash flow was a negative $28.6 million. Cash capital expenditures for the quarter were $45.2 million and represented about 14.9% of revenue. Of the $45.2 million about $10.7 million was related to our ERP implementation. Depreciation and amortization expense was $19.5 million and stock based compensation was $3.7 million.

During the quarter we purchased about 1.1 million shares of our stock at a total cost of $23.6 million. We are now down to about 69 million shares outstanding at the end of the September quarter. Before I discuss guidance I would like to make a few a comments regarding our new ERP system.

As you know the implementation has been taking place over the past 18 months. I am happy to report that we successfully went live with the new global system at the beginning of the months of October with no major technical issues to-date. However, as with any system change of this magnitude it will take several quarters for everyone to get comfortable with our new business processes and certain operational impacts may arise in the short term. We expect to realize a multitude of benefits that the new system will bring, and so significantly improve our operating efficiencies over time.

Moving on to our outlook. We currently expect revenue for the December quarter to be between $240 million and $270 million. For this projected revenue range we currently estimate gross margin in the December quarter to be between 34%and 36% primarily due to lower client sector utilization in the December quarter.

As we have stated in the past our current quarter utilization typically has a one quarter leg effect on our gross margin. Therefore, even though it is too early to guide for the March quarter, the effect from lower plant utilization in the December quarter may result in 1 to 2 percentage point impact to the March quarter gross margin.

We expect R&D expenses to be flat at about $33 million and SG&A expenses to increase to $52 million. The expected increase in our SG&A is a result of depreciation and initial support for the new year PC standard that went live in the beginning of October. As a result of the European stimulation we expect our SG&A expenses to peak out at about $53 million to $54 million in the March quarter and then go down to the $50 million level or below at the end of the June quarter or at the beginning of the September quarter in calendar 2012.

For the December quarter, amortization of acquisition related intangibles is expected to be about $2 million. Other expense net is expected to be about $5 million and interest income net is expected to be about $200,000 due to low interest rates.

For tax, due to lower profitability resulting from the cyclical downturn we now expect to realize some of the evaluation allowance benefits into our 2013 fiscal year. Therefore we now expect a tax rate of approximately 20% for both the December and the March quarters.

In the June quarter we expect a significantly lower rate as we release reserves. For the full 2012 fiscal year we expect the effective rate to be below 10%. For the 2013 fiscal year we expect our tax rates to normalize in the mid 20s. And finally, for the December quarter we expect our cash capital expenditures to be about $40 million. For the full 2012 fiscal year we expect capital expenditures to be in the range of approximately $140million to $170 million. For the 2013 fiscal year we would expect capital expenditures to run below 10% of revenue.

Now Oleg will give you the latest update on our business. Oleg?

Oleg Khaykin

Thank you Ilan, in the September quarter our industry faced a rapidly deteriorating demand situation. Most of our market segments were impacted to one degree or another. The typical seasonal strength associated with the September quarter did not materialize. The consumer and computing end markets led the decline and were followed by decrease in demand in the industrial appliance and automotive end market towards the end of the quarter.

The two bright spots were the high performance computing including servers and our High Reliability products. Both experienced modest growth. Geographically for the quarter we saw a growing weakness in Europe, automotive declined as a result of seasonal trends and industrial saw slowing in market demand towards the end of the quarter during the economic uncertainty and inventory adjustments. Asia was down modestly as we saw software demands and the consumer computing and industrial and markets. The Americas were about flat as the industrial and appliance markets slowed and Japan exhibited modest growth particularly in the automotive market.

Moving out to our business units, the enterprise part of business unit revenue increased about 4% from the prior quarter driven by high performance computing and server shipments. During the quarter, we continued to see a nice ramp in our digital power product and remain well positioned for future growth as our tier one customers accelerates the adoption of digital power.

Design win traction in the next generation servers, high performance computing and graphics segments continues to strengthen as well. Our fire management devices business unit revenue decreased about 11% from the prior quarter, this drop was due to customer inventory reduction and weakening end market demand across the consumer computing and industrial end markets.

The majority of our PMV products are sold for distribution and POS softened significantly.

Our energy saving product business unit the revenue decreased 2% compared to the June quarter. While overall demand was muted particularly in the Americas, designing activities remain strong for our motion control and high voltage products. Our automotive product business unit revenue decreased about 9% from the prior quarter mainly due to seasonality in Europe, however we did see growth in Japan and the rest of Asia as we continue to gain traction in these markets.

As I consistently said in the past, we continue to see automotive as one of our long term growth drivers as they are, and our design activity and product introductions remain robust. Just yesterday I was in Las Vegas at the SEMA Automotive trade show where we unveiled a complete end to end electric power plug for electric and hybrid vehicles.

Lastly, our HiRel business unit increased 4% compared with the June quarter. The HiRel business segment continues to see steady demand for high reliability power management product particularly in the commercial aviation and space end markets. We continue to see strength in bookings for our HiRel products and our position remains strong.

Now, an update on channel inventory. During the September quarter, as a result of slowdown in POS channel inventory increased and we ended the quarter on September 25th with above 12 weeks of inventory. Lead times are currently below normal for the majority of our products. Overall, factory utilization came down to about 90% during the quarter from the high 90s in June.

In the December quarter we have planned a further reduction in factory utilizations. In the December quarter we expect our HiRel business unit to be flat to slightly up and automotive to be about flat. For enterprise power revenue is expected to be down as inventory burn in high performance computing more than offset initial product (inaudible) and graphics cards. And as your saving product is also expected to be down due to slow down in China and continued inventory reduction by our industrial customers.

And lastly, we expect our PMD business unit to significantly decline as OEMs and distributors continue to burn off of their inventories. In summary, we expect the industry conditions to remain challenging in this coming quarter. However, we see this latest inventory correction as an opportunity to improve IR’s operating efficiencies and extend the IR’s technology leadership in order to position IR to outperform the industry during the next semiconductor cycle.

To this extend we have launched several notable companywide initiatives this quarter that will drive our medium and long term performance. The most notable initiatives include, first we have launched ERP system last month. The automation and unification of key business process is expected to enable IR to derive significant operating leverage throughout the company.

Second, we have taken advantage of the lower fab utilization to accelerate the development and introduction of the new high voltage ICs and IGBTs, as well as next generation of low and mid voltage MOSFETs to drive growth during the next semiconductor up cycle.

Third, we sampled 600 volt GaN rectifier to tier I customers as a first step in releasing high voltage GaN products early next year. The launch of 600 volt GaN devices will significantly expand IR’s available market in high voltage discreet products beyond the IGBT products today. And lastly, yesterday IR launched an Evera (ph) hybrid and electrical vehicle platform targeting industrial, commercial, and military applications. Evera platform delivers a broad range of breakthrough innovations in the electrical motor drive, battery, and battery management technology that’s solely broad range of technical and application problems faced by industrial, commercial, and military customers.

In closing, our goal during this market downturn is to continue to strengthen IR’s technical leadership and position the company for future growth. This concludes our prepared remarks. We will now open the lines for your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question is from the line of Steve Smigie of Raymond James.

Steve Smigie – Raymond James

Thank you. You did down about 5% sequentially in September and then December is down roughly 15 at the midpoint. So, December is down quite a bit, but if I take the two quarters down about 20% across the two quarters. To me that seems pretty similar to comps, is that how I should be taking that or is there something more significant going on the December quarter for you guys?

Oleg Khaykin

No, I think you are calling it exactly right. I mean the reason we are giving a broader range is I think it is – obviously clearly a lot of uncertainties from the macroeconomic environment I mean with all the chaos going in Europe today. So we are just feeling that it’s probably prudent to be a bit more cautious. Also, there is a lot of – I think you might have been listening to some of our peers. There is occasional discussion of ASP erosion, and from my perspective it’s really just driven more by a few players who would try to take an opportunity to grab some revenue by killing their pricing. By taking a broad range gives us flexibility to walk away from business that we find unattractive given – since there is absolutely no price demand elasticity in the market and by taking business at a significant discount today all you are doing is stuffing channel with under priced product which will take you longer next year to fix.

So, we are just taking a more prudent approach to make sure that we maintain price discipline and safeguard against any potential macroeconomic events.

Steve Smigie – Raymond James

And one of your peers mentioned their call they had seen impact from some Itona (ph) stuff, they also have a pretty – in their more defense HiRel type businesses, is that something that’s impacting you as well?

Oleg Khaykin

Well, not really. I mean we have a very small exposure to truly what they call military defense segment. Most of our HiRel is in the commercial aviation and space, and these programs have been funded well in advance, especially in space, right? So, as such we don’t see any issues at least in the near term. Clearly defense budgets gets cut back significantly and obviously a lot of our space prog is going to a so-called a black boxes that have government designation. It may in the future have some decrease in business, but this is – I don’t see that happening in the near term because all of these products have a concrete launch date and the bottom line is once you decide and buy a launch window you don’t cancel the project.

Ilan Daskal

So Steve, overall we are ITAR compliant. So we have no reason to believe that there is any concerns.

Oleg Khaykin

Yeah, so I think as long as you don’t violate U.S. government regulations, and we have a very strict IR compliance program. You don’t lose business due to ITAR if you do not violate ITAR. Let's put it that way.

Steve Smigie – Raymond James

Okay, great thanks guys, appreciate it.

Operator

And your next question is from the line Bill Ong of Merriman Curhan Ford.

Bill Ong – Merriman Curhan Ford

Hi, good afternoon gentlemen. Just a follow-up on the earlier question. If you look at the distributors results, the (inaudible) they also came down about 20% from June to December similar to your guidance. Does that mean that the channel inventory levels going to the second quarter will be about the same, or is there some relative space in the OEM that will actually bring down the channel inventory level in the fourth quarter.

Oleg Khaykin

Well, I don’t know what their mix is, right. So I think we are monitoring very closely the pool of product from the channel by the OEMs. We know that OEM inventories and contract manufacturer inventories have been burning off pretty nicely. But my bet is, the whole channel – when the channel is trying to work out the inventory it starts from the end, right, from the retail and to the OEMs, the contract manufactures, then distributors, and then to us. So I think we may be seeing kind of a parallel burn off of inventories, but remember when they talk about weeks, right, of inventory you can have the same number of weeks, but a smaller amount of revenue. Because it’s all coming down – weeks of inventory is calculated based on the weekly burn rates, right, for the quarter.

So, I mean I don’t know exactly how it’s going to work out for us, but we are prepared to work down the inventories. And that’s why we sort of is prudent to give a broader guidance.

Ilan Daskal

So Bill, just to add to that. You know, week on the quarter on September 25th and we did see that the week after the quarter closed, the central definitely outpaced the setting for about more than $10 million actually. So it could be that the channel decided to build a little bit inventory due to our notification of going glide with the European connotation, but again overall as we stated in the past, we prefer to keep the inventory in-house and not in the channel. So it could be also partially associated with some timing issue after quarter close, coupled obviously with the European connotation.

Bill Ong – Merriman Curhan Ford

Okay, that’s helpful. So 12 weeks is probably, how you would get maybe a little bit more but could get less than that.

Oleg Khaykin

Yeah. I mean you got to look at it, I said, when you say 12 weeks it’s a function of your revenue and the inventory, right? If your inventory – if your revenue drops and your inventory drops, but if one drops more than the other you may actually see an increase in weeks, but you’ll have a lower absolute dollar amount altogether.

Bill Ong – Merriman Curhan Ford

Understood, appreciate that math clarification. 1and then my last question is the breakeven point. So is it fair to say, just given the guidance, break even will be about $240 million to $250 million just given you higher OpEx in the near term.

Ilan Daskal

Could be right, could be also with lower revenue than that. It depends obviously on the mix and the gross margin. I mean the OpEx side is pretty stable based on the guidance, but it depends on the mix, the range of this revenue but potential so with lower revenue we can break even.

Bill Ong – Merriman Curhan Ford

Great, that’s helpful, thank you so much gentlemen.

Operator

And your next question is from the line of James Schneider of Goldman Sachs.

Gabriela Borges – Goldman Sachs

Thanks for taking my question. This is Gabriela Borges on behalf of Jim. I just have questions on service, it seems to be an area of strands and tricky, but then guided down in full Q on the inventory correction. A few data points from OEMs just so the demand might be weaker than expected, can you talk a little more about what you are seeing here?

Oleg Khaykin

Let me just make sure I understand your question. You are talking about the server inventory, is that what you are saying?

Gabriela Borges – Goldman Sachs

What are you saying in terms of server demand?

Oleg Khaykin

Server demand, okay. Well, we are now finding ourselves in the same situation as we found ourselves with servers in the December quarter of 2008. This quarter and next quarter, the two transition quarters where the manufacturers go from the previous generation of servers to the next generation of servers. So, as such, what they are – it kind of becomes a crossover. The shipments from Romley are now starting off at a very low base and manufacturers are very busily burning off whatever inventories they have in the prior generation of servers.

December quarter is a big quarter when they do the inventory purge, there is a lot of discounts. If you want to buy from servers this will be a perfect quarter to buy. If you want to buy the current generation servers, and then towards the end of the March quarter we expect – the next generation starts to pick up steam and by summer time it will almost be entirely the next generation servers, and by then most of the inventory of the older generation servers should work itself out.

Gabriela Borges – Goldman Sachs

That’s helpful thank you and if I could ask a follow up, you mentioned walking away from business that would require discounted pricing. Can you provide any more detail on the sort of pricing pressure you are seeing across your segments and are there any products that are seeing more pressure than others. Thank you.

Oleg Khaykin

Yes, so I think clearly the commodity products like Discrete, we are seeing some competitors taking what I think is a very irrational approach by giving these discounts to move the product. I mean in the end in the market where you have no elasticity of demand, you could drop all the prices you want, all you end up doing is delaying the recovery for yourself in the next year, and weakening your pricing position.

We prefer to compete on performance rather than purely on price. If we do however see an opportunity where the product actually moves and it’s an OEM taking a product to put into production, that’s a different story, you can consider that. But we are not taking a position where we would just drop the price at any cost to move the revenue. Because all you are doing is you are cannibalizing your next year’s business and just destroying your ASP structure.

Gabriela Borges – Goldman Sachs

That make lot of sense thank you.

Operator

Your next question is from the line Terence Whalen of Citi

Terence Whalen – Citi

Thanks for taking the question. This first one relates to that comment that Ilan made about the March quarter gross margin being down about 1 to 2 points. I was wondering what sort of a utilization assumption does that incorporates in the December quarter? I think you mentioned utilization with about 90% in the September thanks.

Ilan Daskal

So, the utilization for December would be much-much lower, would be in the range of about 70% or even lower. It depends on what would see the demand and how we could shape up during the quarter. With that said, we got into gross margin. Obviously, partial of this reduction of utilization rate from September to December, as he mentioned will impact (inaudible) of the March quarter. However, since we take down the utilizations so drastically some of it will impact the December quarter directly so will not be postponed to March. So if the combination…

Oleg Khaykin

And it's already has reflected in our guidance.

Ilan Daskal

It's already embedded in the guidance.

Terence Whalen – Citi

Okay, terrific. And then I guess this is a follow-up. You say March revenue were flat based on where inventory is and where you want it to be, made the comment that you don’t mind holding it on your balance sheet versus distribution. Then, could we expect that that gross margin in March could be a bottom and that utilization in December would be a bottom?

Ilan Daskal

Most likely.

Oleg Khaykin

Yeah, so you are assuming that by June quarter the market starts to recover, that will be correct.

Terence Whalen – Citi

Okay, great. And then one other question I had is, given that you guided CapEx out for about $40 million in December, it seems to me like the range of CapEx that you have talked about for fiscal ’12. I think you mentioned 140 to 170, that still leaves a fairly wide range for CapEx in the second half. I was wondering why such a wide range, what are the leading indicators you are looking at? Is that for extension or retrofit or why such a wide range for a second half spending?

Oleg Khaykin

Well, I mean the lower range is obviously something that we have already ordered and this equipment is coming in, right? Then there is also an opportunity – if the situation continues to be slow we can push some CapEx out so it could reduce the amount that we are going to consume. On the other hand if we see the market picking up there are certain areas where we need to add CapEx because we are currently – even though for some products we have a excess capacity for a number of other products we are living still today hand to mouth, and that’s mainly for our high voltage and ultrathin wafer product. And that’s where the CapEx is intended for.

Ilan Daskal

Basically, you know, a product is something that you invest for the med and long term. At these points of time we are not trying to change any of our plans, and one or two quarters that the recent inventory correction out there that’s still our baseline. If we see the – and later in the year that the situation is different based on the macroeconomic situation, definitely will help to react accordingly.

Oleg Khaykin

Yeah, absolutely. I mean we can always change our long term CapEx strategy if it’s not purely a cyclical correction and if it becomes more prolonged speaking on the downturn.

Terence Whalen – Citi

Okay, that makes sense. And then my last question is regarding the buyback. I mean that’s a big positive that we saw this quarter. You essentially bought back this quarter a similar amount of stock that you had bought back in prior fiscal years alone. What's the stance on buyback here given the environment we are in? What's your philosophy to approaching buyback and how you communicate that to investors given that you have a sizeable cash balance that I think investor should probably be viewed better being buying back stock here than making acquisition. Thanks.

Ilan Daskal

So Terence, generally speaking, we always try to be opportunistic in the market place. And I think if you look at the program to-date which we purchased about a $105 million so far, the average buyback price is very, let's say even attractive (inaudible). And then – but with that said, in the current macro economic situation definitely we have to further balance it with the overall capital allocation model that I presented last year in our analyst day. And we may need to be a little bit more prudent in terms of – to preserve some of this cash and we monitor the situation. I mean if we feel that – again it is a one or two quarters of some minor correction then we will continue with this strategy.

You could see that it's another WR there. We will probably be more conservative.

Oleg Khaykin

And Terrence, although at the university I’ve always been drilled into my head that markets are efficient. I mean I find it anything but because – we all know this industry has been cyclical for the last 30 to 40 years, yet we always find ourselves with these massive swings. So, even though we don’t claim to know the bottom of the market or the top of the market we generally know when we are in the lower part of the market or the higher part of the market. And every single cycle that stocks tend to – semiconductor stock tend to move in uniform wildly. So, clearly from our point of view we are committed to be buying stock back, but we prefer to get the biggest bank for the box.

Terence Whalen – Citi

Okay, I appreciate the color, best of luck guys.

Operator

Your next question is from Craig Berger of Friedman Billings Ramsey.

Craig Berger – FBR Capital Markets

Hey guys, thanks for taking my question. I guess on channel inventories of 12 weeks, can you just remind us what was low there at or where did they come from and how long do you think it takes to before they get back to optimal levels?

Ilan Daskal

So, again Craig you are asking how long it's going to get us to brand this inventory or historically where we are at?

Craig Berger – FBR Capital Markets

What you are thinking for this cycle?

Ilan Daskal

Generally we prefer that it would be at about 9.5 to 10 weeks. You saw a slightly elevated number of weeks this quarter, and as I mentioned earlier it’s probably a combination of some build up. Probably we just get – in anticipation of the new ERP system, but also it could be associated with some timing issue because we did see in the first week of this quarter that sell through was much higher than sell-in.

Oleg Khaykin

We finished one quarter before the distributors, I mean one week before distributors.

Craig Berger – FBR Capital Markets

Okay. Thanks for that color. I want to ask about free cash flow which over the last year has been about flat. I think that’s probably not as good as some peers. I know you guys are investing some now. If you think about the changes you’re making to the company, you know, the past year has been pretty good in the semi-conductor industry. As you think about the changes you’re making, how do you think about cash flow generation and moving back towards your margin model as we move forward?

Craig Berger – FBR Capital Markets

So Craig, you know, free cash flow is a relative concept, right? I mean when you have a business that’s dying, you have a lot of free cash flow. When you have a business that’s not growing, you also have a lot of free cash flow. However, if your business is growing and you’re investing in growth; you’ll have negative cash flow, right? So I think if I look at our operating cash flows, obviously we had a very nice cash flow, and we have chosen to invest it in building for future growth. And cycle on cycle we grew by 50%. We obviously hope to repeat the performance in the next cycle, and that takes investment.

A lot of the peers you are talking about with the free cash flow, I mean they really are about the same level where they were in September, December of 2008. So, yeah, on that basis if you are not growing, you should be generating a lot of free cash flow. So I think it really comes down to what is the goal and investment strategy of the company. If you are planning on growth, you will require investment. If you are planning on harvesting the business and kind of cashing out, then clearly you will generate a lot of free cash flow.

Craig Berger – FBR Capital Markets

That’s helpful. Let me ask you one more which is just a natural follow on to that. Can you just revisit what’s your gross and operating margin model, at what revenues, what’s your taxes and how long do you think it takes you to get there?

Ilan Daskal

So, again, we have not updated Craig the perfect model that we presented already last year. So, obviously we are still at $1.25 billion in revenue. We still target the low 40s and to get to the high (inaudible) of the operating income. With that said, we have to obviously go through several consecutive, sustainable quarters in order to get to this model. We had the two kind of cyclical down quarters last year of the semi-cycle. These two quarters right now, I’m not sure that it is directly associated with the semi-cycle, it’s more associated with the macroeconomic situation. And therefore, you know, we had to wait and get to those five to six quarters in order to kind of substantiate this target model. From there with the new – also European project that we have as we grow we will get to that target model.

Craig Berger – FBR Capital Markets

On taxes, I think …

Ilan Daskal

Yeah. The tax – so this fiscal year over all it's going to be below 10%. This quarter and next quarter is going to be 20% but in the first fiscal quarter which is the June quarter will have a much lower rate. So even if you look for the fiscal year it's going to be below 10% and then it’s going to normalize as of 2013 in the mid 20s.

Craig Berger – FBR Capital Markets

So in the June quarter you need like a minus 30%?

Ilan Daskal

Right, either these or if we can benefit from a lot of reversal of (inaudible) allowances.

Craig Berger – FBR Capital Markets

I see. Okay, thanks for the detail guys, I appreciate it.

Operator

Your next question is from the line of Ramesh Misra of Brigantine Advisors.

Ramesh Misra – Brigantine Advisors

Hi, good afternoon folks. With the low factor utilization, any updates on your factory consolidation plans?

Oleg Khaykin

Hi Ramesh, this is Oleg. So I think from my point of view, we expect it to be kind of a two-quarter phenomena in terms of the inventory correction in view of the lower demand expectation by the market. On that basis you don’t make any radical operational changes per se. However, if this turns into a much more prolonged downturn, obviously that’s something we’ll revisit. But at this point in time, we have no plans.

Ramesh Misra – Brigantine Advisors

Okay. So basically you’re continuing to maintain your window fabs.

Oleg Khaykin

Correct, because I think what we are looking at right now is a – right now the scenario under which we are operating is that it's a kind of say 2¼ correction and then the growth returning thereafter. Obviously if the situation changes we’ll revisit it.

Ramesh Misra – Brigantine Advisors

Got it. In regards to the ERP roll-out, with the system finally in place, do you anticipate shifting over formally to a sell-through recognition model?

Unidentified Company Representative

So, Ramesh, originally I had a plant to a sell through. But right now there is a draft exposure of potentially new accounting rules that basically will not support a sell-through revenue recognition any longer. It’s still a draft but I don’t think it’s going to be prudent if I switch right now, and then in a few months it will take into effect and then I will have to switch back to sell-in. So I am watching the progress on this draft exposure and if it doesn’t go through obviously, we’ll consider again to move to sell throughout definitely.

Ramesh Misra – Brigantine Advisors

And then a final questions on your automotive business, Oleg. So well congratulations on the formal announcement. But when do you see hybrid and plug-in hybrids or other electric transmissions become a consequential portion of your business?

Oleg Khaykin

Well, so I think, typically we’re not targeting consumer segment with our product. What we are looking at is at commercial-industrial segments where you retro-fit Class VIII or Class VII trucks for kind of go in a certain loop, closed-loop operations like in ports, supermarket chains and things like that. There’s a lot of regulatory requirements to eliminate diesel fuels in many of these worksites. So that’s really the type of market we are targeting and that’s mainly industrial, military, kind of commercial type of applications.

We expect, we just rolled out the platform, obviously it’s – we are in conversations with multiple parties but I would imagine it probably would be – we may see some initial revenue next year and hopefully it will become much bigger component for us two years down the road.

Ramesh Misra – Brigantine Advisors

Okay, thanks gentlemen.

Oleg Khaykin

We’re going after opportunities that are self-funded on the basis of economics rather than regulation only.

Operator

Your next question is from Brian Piccioni of BMO Capital Markets

Brian Piccioni – BMO Capital Markets

Hi, I was wondering – I believe you mentioned in the press release that there was a risk factor associated with the Thai flooding. But certainly you have to have some direct and indirect exposure there. Do you – can you quantify that in terms of what that exposure might be or is it still too early?

Oleg Khaykin

No, one of our major suppliers is literally under water. But one of the things, part of the strategy we’ve done in the last three years is to maintain several very strong suppliers and cross-qualify them accordingly. So no one of them can shut us down. So even through one of our suppliers got flooded, we were able to extract all our die from that supplier, even using boats, believe it or not, to get the product out. However, and with that said, most of our products we have found new home ahead of time for those products and we cross-qualified what we are doing. There are however, a small number of products with medium-type volume where we currently need to requalify them. So, there is a risk to that revenue. But it’s a fairly – from revenue point of view it’s not a very big risk. So it’s not material enough to impact this quarter.

Brian Piccioni – BMO Capital Markets

So that’s on the supply side, but what about the customer side?

Oleg Khaykin

Oh, the customer side. Well, that one is a little bit more difficult. On the customer side it’s really – Japanese are the biggest kind of manufacturers in that area of Thailand. So, from my perspective I don’t think we will be that hard hit because we don’t have much business with them to start with. But I would imagine it may impact a number of Japanese competitors. But that side is – you never know what the second, third the order of fact might be from one thing or the other of not being there. But it is a big problem in Thailand.

Brian Piccioni – BMO Capital Markets

Okay, great. Sorry I couldn’t help, but check on the thought of sending in a rescue mission to pick up some dye.

Oleg Khaykin

I mean, I tell you I feel that – especially with some of our Japanese peers they have been hit by practically every biblical disaster. The earthquake, the flooding, and I mean next thing I'm waiting is locust and fire, you know.

Brian Piccioni – BMO Capital Markets

In the cash flow statement I notice that there is fairly significant, what looks like an inventory reevaluation, is that baked into the cost of goods sold for the quarter, and if so I guess it would have pulled down the gross margins accordingly.

Unidentified Company Representative

So there was a higher, there was an increase in ENO reserve in the impact of the gross margin. ENO doubled from the range of about $2 million to $4 million for the quarter.

Unidentified Company Representative

But it's purely driven by – because of the drop in the revenue level – revenues snaps backup when we have a reversal.

Unidentified Company Representative

The reversal depends on the overall inventory levels of the few and ended forecast and what is the outlook for the remainder of the year?

Brian Piccioni – BMO Capital Markets

Okay, that’s it from me, thank you.

Operator

(Operator Instructions) Your next question is from Stephen Chin of UBS.

Stephen Chin – UBS

Good afternoon, thanks for taking my question. First question I had was on the trends coming into the current quarter. I guess Ilan, you mentioned earlier that the current sell through is greater than selling in the first week of quarter. Any more comments that you can make about how that has continued throughout the quarter and also in terms of orders has that stabilized or has that declined currently?

Ilan Daskal

So, again Steve, this is still a volatile quarter and I think it's – we will have to wait and see. I mean even last quarter every day and every few days we saw addition of push outs. On one hand you can look at it from a seasonality standpoint of view for both the December and March quarter, but on the other hand it's not kind of an inventory correction at the end that is associated with a semi cycle. So we are all dependent on all those other daily macroeconomic events that we all kind of hear about every day. So, again, you are right, I mean as I mentioned earlier in the first week we did see the sell-through outpace the selling.

Stephen Chin – UBS

That’s related to also – has the December quarter been a big period for new product launches, and if so have you seen customers push out or reduce the volumes associated with those new product launches.

Oleg Khaykin

Which particular customers are you thinking, like servers or?

Stephen Chin – UBS

Yes, the servers and also maybe in terms of automotive I guess if there is – there may be some new products that are ramping, I’m just wondering if a typical – the seasonal bounce back you see in Q4 is – that is being reduced because of unit volume push outs or lower cost.

Oleg Khaykin

Yeah. I don’t think we have any major customers that are like ramping new product line. I think the only area where we see it is in servers. I think Romley is finally starting to ramp and we’ve seen some small shipments this quarter, but my bet is they are going to look to burn off all the inventory on the previous platform and probably we will see really the volumes pick up towards the end of the March quarter. It's kind of mimicking the 2008-2009 transition.

Stephen Chin – UBS

And lastly, on the gross margin side, if I recall I think your – in terms of your manufacturing capacity you were about 30% outsourced, and I'm just wondering given where your utilization rates are going, is that the plan that you are maintaining your outsourced capacity at similar rates (inaudible) quarters, and if so why is that?

Oleg Khaykin

Well, we are at 70-30. However, our outsourced utilization has – I mean at least the capacity that we have been using has been hit much stronger because a much bigger share of consumer and computing products is running through the foundries. And since those are the two segments that have been hit the most that’s where most of the reductions and demand have taken place. Today, more of the kind of industrial automotive product is running inside IR and the decreases in those areas has been less.

Ilan Daskal

So the entire flexible strategy, Steve, that Oleg laid already three years ago and built over those three years. You know, it plays out excellent here right now. Because from the 70-30 we are down to a mix of about 75-25. We target to be also at about 80-20 in the next quarter. So we definitely take advantage of the flexibility that we have right now in the manufacturing footprint.

Oleg Khaykin

Yeah. And I think by having more volatile products on the outside it shields our internal assets from very high volatility.

Operator

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

Alex Gauna – JMP Securities

Hi guys, thanks for taking my call. This is Matt actually calling in for Alex. I was wondering if you could shed some light on your exposure into the emerging markets and what kind of trends you guys are seeing there.

Oleg Khaykin

By emerging markets any particular markets you have in mind?

Alex Gauna - JMP Securities

Not specifically.

Oleg Khaykin

Well, I think China – I mean it’s not a really emerging it’s a huge market now, but we are seeing slow down in China. We have seen a number of our major customers, actually twice in the last several months guided down their next year’s revenue projections and thereby volume projection. So there is the fact that Chinese government been trying to achieve in slowing down the inflation seems to be working by slowing down some of the demand.

Alex Gauna - JMP Securities

Okay, great. And I didn’t know, just as a follow up, I didn’t know if you guys had any expectations into the seasonality in the March quarter, but if you did is there any – like key puts and takes, if you could shed some light on there?

Oleg Khaykin

Well, you know, there is one segment in our business that’s seasonally strong in March quarter that’s the air conditioners. And it’s too early to tell how it’s going to play out, because generally you buy all the products and bill them ahead. Also industrial segment is generally stronger in the March quarter. So I think to the extent that seasonality repeats it will be very nice. But I’ve also seen in the past when you had very weak summer quarters, like September and December, you actually find the computing and consumer can surprise you. Because –a lot of the seasonality is going to be more of the depleted inventory where you have the order start coming in.

So, I think March quarter – I think if demand – kind of the consumer demand does not drop significantly could end up being a positive for the industry. It could be a positive surprise. Now, obviously if the economic situations turns down for the worse and is – obviously your guess is as good as mine then obviously March quarter could be a disappointment. But, if things stay as they are now my thinking March quarter could be a positive surprise for the industry.

Operator

And there are no additional questions in queue. Sir, are there any closing comments?

Oleg Khaykin

Yes, thank you for joining us today. We look forward to speaking with you in the coming months.

Operator

Ladies and gentlemen this does conclude today’s call. Thank you for your participation you may now disconnect.

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