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International Rectifier Corporation (NYSE:IRF)

F2Q12 Earnings Call

February 2, 2012 5:00 PM ET

Executives

Chris Toth – Executive Director, IR

Ilan Daskal – EVP and CFO

Oleg Khaykin – President and CEO

Analysts

Gabriela Borges – Goldman Sachs

Brian Piccioni – BMO Capital Markets

Terence Whalen – Citi

Stephen Chin – UBS

Craig Berger – FBR Capital Markets

Ramesh Misra – Brigantine Advisors

Steve Smigie – Raymond James

Operator

My name is Kerry and I will be your conference operator today. At this time, I would like to welcome everyone to the International Rectifier second quarter fiscal year 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to Mr. Chris Toth with International Rectifier. Thank you Mr. Toth, you may begin your conference.

Chris Toth

Thank you Kerry 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, February 3rd, 2012 and can be accessed using the same web address. A conference call replay will also be available through February 9th, 2012.

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, February 7th, we will be attending the Stifel, Nicolaus 2012 Technology and Telecom conference in Dana Point California. Then on February 15th, we’ll be attending the Goldman Sachs Technology Conference in San Francisco, and on Tuesday February 28th, we’ll be attending the UBS one-on-one Symposium in Boston.

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 second quarter of fiscal 2012, IR reported revenue of $230.1 million which was a 24% decrease from the prior quarter and an 18.3% decrease from the second quarter of fiscal year 2011.

Revenue over the last quarter significantly decreased due to economic uncertainty and macroeconomic concerns that resulted in broad market inventory reductions across nearly all of our end markets.

Further, we reduced our channel inventory as our shipments to distributors were well below their self achievement. The largest percentage revenue decrease among our end market segments within our power management devices business unit, which felt the most impact from the channel inventory reduction.

During the December quarter, our IP segment revenue decreased to a negative $900,000, the negative royalty revenue was due to a $1.5 million over reporting and overpayment in prior periods by our largest licensee. Excluding these effects are IP revenue would have been a positive $500,000.

Gross margin for the December quarter was 35.4%, down 2.5 percentage points from the prior quarter, mainly due to lower factory utilization during the quarter. We reported a net loss of $6.3 million or $0.09 per fully diluted share for the quarter. Excluding the effect of the prior period royalty revenue over reporting and overpayment of $1.5 million and an investment impairment charge of $1.5 million, net loss would have been $3.3 million or $0.05 per share.

This compares with a net income of $22 million or $0.31 per fully diluted share in the September quarter. Our R&D expenses were $32.2 million compared with $33 million in the prior quarter. R&D expenses represent at 14% of revenue for the quarter.

SG&A expenses were $50.6 million, up from $49 million in the prior quarter due to ERP implementation cost primarily depreciation of about $2 million. SG&A expenses represented 22% of revenue for the quarter. Amortization of acquisition related intangibles was $1.9 million.

Operating loss was $3.3 million for the quarter. Other expense net was $2 million in the December quarter, primarily due to an investment impairment charge of $1.5 million. Income tax for the December quarter was at $1.1 million expense primarily due to tax accruals in our foreign jurisdictions.

The total cash, cash equivalence and investments at the end of this quarter was $398.6 million which included $1.4 million of restricted cash. During the quarter, inventory increased $26 million, to $308.9 million. Weeks of inventory increased eight weeks to 27 weeks. We used $19.4 million in cash from operating activities in the quarter, mainly due to changes in working capital. Cash capital expenditures for the quarter were $26.6 million and represented about 11.6% of revenue.

Depreciation and amortization expense was $20.7 million, and stock-based compensation was $4.3 million. During the quarter, we did not purchase any shares of our stock. We’re at about 69 million shares outstanding at the end of the December quarter.

Moving onto our outlook. We currently expect revenue for the March quarter to be between $230 million and $250 million. For this projected revenue range, we currently estimate gross margin in the March quarter to be between 31% to 32% primarily due to lower planned lower factory utilization. Going forward, we’re working to balance utilization and inventory reduction, but overall expect that our gross margin will likely drop in the March quarter through this cycle.

We expect R&D expenses to be about $33 million and SG&A expenses to be about $53 million. For the March quarter, amortization of acquisition related intangibles is expected to be about $2 million. Other expense net is expected to be about $1 million and interest income net is expected to be negligible.

For tax, we expect an expense of about $3 million, due to foreign jurisdictions tax accruals. In the June quarter, we anticipate a net tax benefit as we believe we will be able to release reserves.

And finally, for the March quarter, we expect our cash capital expenditures to be about $30 million. For the full 2012 fiscal year, we expect capital expenditures to be between $110 million and $120 million.

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

Oleg Khaykin

Thanks, Ilan. December quarter revenue came in much weaker than expected. The core progressed, we observed weakening demand driven by a broad end market inventory reduction, capital slow down in several end markets particularly appliances in Asia and industrial in Europe.

Geographically for the quarter, Asia was down sharply as distributors reduced inventory in the appliance and marketing. China, weaken dramatically. The Americas and Europe also came in weaker than expected as customers were to reduce inventories. In particular, we saw significant weakness in industrial demand in Europe. On the positive side, we saw modest growth in Japan as recovery from the Japanese earthquake continues.

Moving out to our business units. The Enterprise Power business unit revenue decreased 15% from the prior quarter mainly due to weakness in the computing end market as a result of vicious flooding in Thailand. Server shipments were flat as the industry slowly shifts the new Romley platform, also as a result of the slow ramp, we continue to see persistent demand for prior generation platform product in the near-term.

We continue to be well-positioned for the future as future growth of Tier 1 customers accelerate adoption of our digital power management solutions. Our latest generation product deliver industry-leading performance and efficiency, thermals, and density while offering compelling cost performance value proposition.

Customer activity is robust and we believe we are well-positioned for the future growth in next generation servers, ultra books, and other computing platforms. Due to normal seasonal weakness, particularly in computing, we expect March quarter revenue to be flat to slightly up.

Our Power Management Devices business unit business decreased 35% from the prior quarter. This drop was mainly driven by customer inventory reduction and weaker computing sales due to the Thailand floods.

The majority of our PMD products are sold through distribution and we significantly under-shipped POS during the quarter. For March, we are starting to see customers beginning to replenish inventory and we expect our PMD business unit to grow modestly.

Our Energy Saving Products business unit revenue decreased 23% compared to the September quarter. Overall demand was weak in the industrial and appliance end markets. China was particularly hard-hit as overall industrial production fell towards the end of the year.

Initial projections for the March quarter indicated revenue trending flat to slightly up, as customer demand is expecting to recover. Our automotive product business unit revenue decreased 15% from the prior quarter mainly due to how they shut down from timing of shipments.

As a result, we expect to see automotive bounce back to the $28 million to $30 million run rate level in March, we continued to see automotive as one of our long-term growth drivers at IR and our design activity and product introductions remain robust.

Lastly, our HiRel business unit decreased 9% compared to the September quarter. The decrease was due to manufacturing delays as a result of tax acceptance criteria and a weather related fab closure at the end of October. For March, we expect revenue to be between $48 million to $50 million. Bookings in our overall backlog continue to be strong in our HiRel market segments.

Now an update on channel inventories. During the December quarter, even though our total company revenues declined 24%, we saw our POS decline only in single digits percentage points compared to the prior quarter. As a result, we significantly undershipped at the market demand and reduced our channel inventory to be below 11 weeks.

During the December quarter, internal inventory increased to 27 weeks. Several factors drove the increase. First our expectations of seasonally strong September and December quarters did not materialize as customers aggressively reduced their inventories. Thus our pre-build earlier in the year ended up contributing to the inventory. Secondly, we made the decision not to pursue highly discounted stock market business during the quarter.

Clearly 27 weeks of internal inventory is too much. However we are comfortable that we will be able to unwind the inventory throughout the year on our terms rather than taking deeply discounted stock market opportunities today. Lead times remain below normal for the majority of our products and overall factory utilization came down from 90% in September to 70s in the December quarter.

In summary despite weak industry conditions and in the last two quarters our design win activity remains robust and we are starting to see some improvements in orders as customers demand returns. We remain committed to our strategy and our long-term growth objectives. In the December quarter we also launched our new ERP system. The new system promises to deliver automation to many of our business processes and we fully intend to capture these productivity gains.

As a result we have started to review our SG&A structure and over the next two quarters we expect to begin benefiting from the automation delivered by our new ERP system. Our goal remains to reduce SG&A expenses down to about $50 million level by the end of June quarter or early in the September quarter. We believe we are on track to realize this goal.

In R&D we continue to take advantage of the lower fab utilization to accelerate the development and introduction of new products. Last cycle we maintained our R&D investments during the downturn and as a result captured significant market share during the upturn. As the company continues to grow, we expect to maintain our quarterly R&D expenses in the 33 $34 million range.

Finally, we continue to make good progress in our GaN products and we remain on track to make initials shipments to customer during 2012 calendar year. We are approaching completion of 100-volt rated devices and have sampled several key customers. In addition we have developed high-voltage GaN power devices and sampled 600-volt GaN rectifier and switch prototypes to Tier 1 customers. The feedback on both has been very positive.

Next week at the APEC trade show Orlando Florida we are planning to present three demonstrations showing superior GaN performance and efficiency and density from 20-volts to 600-volts. The launch of 600-volt GaN devices will significantly expand IRs available market in high-voltage power management products beyond the IGBTs products today and we remain confident in the opportunities for them to choose by GaN.

In closing, the market continues to show promising signs that our bottom has formed and the demand is starting to recover. As demand returns, we believe we are well positioned with new products and capacity for the future.

This continues – this concludes our prepared remarks, we’ll now open the lines to your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from James Schneider with Goldman Sachs.

Gabriela Borges – Goldman Sachs

Hi and thank you for taking the question. This is Gabriela Borges on behalf of Jim. I understand that it’s only been a week since Chinese New Year but any insight into whether ordering patterns have picked up in PCN consumer since that time?

Chris Toth

Last week, well, you know, I mean, it’s not even last week, we only had I’ll say three days. So I mean, clearly the Chinese New Year just ended on Sunday and we’ve seen some orders coming in. But at this point, it’s hard to discern whether these orders are just catch up for the two weeks or snap back, but nevertheless we’ve seen order activity to pick up.

Gabriela Borges – Goldman Sachs

That’s helpful. Thank you. And as a follow-up if I may, you mentioned your expectations for gross margins to trail from the March quarter. With the guide up in sales in March, could you provide any color on how high you think March quarter utilization will be versus the December quarter? Thank you.

Chris Toth

So, I believe its little bit too early to tell what the exact utilization or even a range that I can point out. At the end of the day it’s going to be a combination of the utilization rate and the level of inventory that we will end up the quarter at that time. So due to the higher than normal inventory that we have right now it will be a mix of both of those factors.

Gabriela Borges – Goldman Sachs

That’s helpful. Thank you very much.

Operator

Your next question comes from Brian Piccioni with BMO Capital Markets.

Brian Piccioni – BMO Capital Markets

Well, okay, so a couple of questions, actually I have a whole bunch of questions, but there was some signs at the Chinese appliance market was slowing down, if I recall from your preannouncement comment and I was wondering whether there was any sense that that was some sort of an inventory rebalancing or some sort of a longer-term type impact?

Chris Toth

Well, Brian, actually, if you remember in the summer of last year, Chinese government was getting very nervous about the rapidly escalating inflation so they slammed hard on all the lending and available liquidity in the markets. The – these measures had a desired effect.

And probably more so than they expected and by about October timeframe, we laterally saw all the orders get pushed out or get canceled from the appliance manufacturers as they found themselves in a very tight liquidity crunch. And also, I guess it is kind of perpetrated all the way through the Chinese supply chain, all the way down to the consumers into couldn’t get any liquidity.

From my understanding is the in early December the Chinese government reopened all this tickets and the funding began to flow and now we are seeing return towards consumption and orders. So, really, I don’t think there was so much of the inventory correction in this thing maybe there was excess inventory the finish goods level that the manufacturers were expecting to sell, but it clearly put big brakes on the new builds.

Brian Piccioni – BMO Capital Markets

Okay. And as – I will drop back into the queue to ask my GaN question but with respect to the comments regarding the commodity type devices, is that, in your mind representative to let’s say strategic discounting by a small number of players or it is reflective of a significant supply demand imbalance in the industry?

Chris Toth

Well, I think I wouldn’t say it’s a small number player. As you know, the stupidity does not come small portions in this industry. It’s been broader, but the way we look at it is if it was purely an inventory correction, if you do a discount and you get into the right customers are commodity products it’s great, because then you still move the product.

Judging where we were seeing last quarter, it didn’t matter how much you discount, your end customers do not want the product because they were trying to reduce their own inventories. So, most likely where your products would end up is with the speculative broker segment, which always going to do is going to take the air out of your sales.

Later through the year as those products pop up all over the world through gray market channels and undermine your pricing in various segments. So we consciously decided not to play this game because clearly discounting gives you increased market share and displaces somebody at the point of consumption, it’s great then you’re actually at the stock market share but by doing discounting all you’re doing is you are placing it into a gray market channel or some broker speculative channel and then you are really just hurting your future quarters. We felt that the December quarter was more of the latter.

Brian Piccioni – BMO Capital Markets

Okay. Great. So I’ll go back into the queue, then. Thank you.

Operator

Your next question comes from Terence Whalen with Citi.

Terence Whalen – Citi

Good afternoon. Thanks for taking the question. This one relates to a comment or one that you made about the decision to hold inventory on your balance sheet versus in the channel. In terms of your experience over the past couple of years coming out of the recession, what have you learned that you might change differently? In other words are we going to see a structural change in between the balance of what you hold in the channel and what you hold on hand? And the reason I ask that is, I am trying to understand how and you and Ilan think about balancing, improving utilization in gross margin with working down inventory to an acceptable level, thank you.

Chris Toth

Okay, well let me kind of address it from a couple of points, right. So I mean as I said, it’s okay to give customers a discount if you pick up market share, right? However we got to be very careful and you say, am I actually going to – is it actually going to create the demand, is there a – elasticity of demand.

Well we felt the last quarter there was really no elasticity of demand in the end market. Just like all of our customers were also under orders from their CEOs to reduce inventory so it’s the hold up your procurement guy who was buying more product even though with some discount and increasing his inventories, right? So we’ve seen clearly that channel shop for us, so we didn’t feel that doing any kind of discount would move the product in the right direction.

Secondly, it is always more preferable for me to keep inventory on my shelf than put it into a particular distributor because when demand recovers, maybe the distributor A will not see demand for their product but distributor B will see it, and if all the products are sitting at distributor A all you’re doing is – the product is not moving from the channel.

But if it’s sitting on my shelf, I can more efficiently reallocate the product to where the demand appears first. And lastly, you got to think of inventory of cash. I mean, and from my perspective, if you have so many dollars on deposit, and you decide to move it and you take a loss on it, well you just reduced your return on your cash, right, so you take cash, you build the product and when you sell it you get return on cash. If you dump it at a significant discount, you take a very low return.

My view was, given the current situation is that by unwinding the signature over the next several quarters, we’re getting a heck of a lot better return on a cash then we would be just by dumping it into the channel, especially since all it’s going to do is sit out there and cannibalize my revenue in the coming quarters.

And lastly, doing this kind of deep discounts you can destroy your pricing strategy in one quarter that may have taken you eight quarters to create. And it is just playing stupid. And you look at any industry, outside of semiconductor industry, they seem to understand pricing. But in this industry we still have very unsophisticated view of inventory and elasticity of demand.

Ilan Daskal

And Terence, I would add also to that that if you recall our strategy of internal utilization versus the external of 70% versus 30%. When you look at the inventory, a lot of the incremental inventory was manufactured through the foundries and not internally. And that’s part of the overall consideration.

So, if it’s a time shift then the foundries will suffer probably more than the internal utilization, but at the end of the day it will be the same balancing effect for everyone because the demand is at the same – demand over the context of a few more – a few additional quarters.

Terence Whalen – Citi

Okay, very helpful points. And then as my follow-up, this follow-up relates specifically to the PC Power Management. Just want to gauge your overall ambition there. Given that Ivy Bridge is a process changed to sync at 22 nanometer, but the following platform as well, actually have accurate architectural shift in D-Core power management. To what degree does this process and then this architectural shift create a window of opening to increase your market share in the core controllers? Thank you.

Ilan Daskal

That is a very good question. I mean as you probably seen in my script, I had some language indirectly addressing it, but it’s actually very, very good news for us, because effectively all these new technology platforms, ranging from ultrabooks they’re going to be benefiting from these advanced notes. They are all pretty much adopting universally power control. And with our old digital power control and integrated power stages solution we are extremely well positioned and we are getting very strong traction in the market for these new applications.

Terence Whalen – Citi

Great. Thank you very much.

Chris Toth

It’s actually represent a significant market expansion for our enterprise power business unit. These are the areas where we have not played before and we are seeing very strong traction there.

Operator

Your next question comes from Stephen Chin with UBS.

Stephen Chin – UBS

Hi. Good afternoon. Thanks for taking my question. First when I had was related to your European industrial exposure. I guess if you could first please help us better understand what some of your European customers might be seeing out there right now in terms of demand? Is it all largely macro related concerns that they are leading to a relatively low order rates or are you seeing some improvement based on some pickup in certain areas of European markets?

Chris Toth

Okay. Well, let me talk about Europe itself in part of the semi conductors. You can read through it very simply, it’s predominantly Germany with a sprinkle of France and Northern Italy. So, that’s pretty much the European extent of the power semiconductor where most of the market is.

And what we saw in Europe is – I guess the drop in demand was driven by two things. One, is there was a big continued concern over the European economy and as a result, we saw a lot of customers from OEMs to distributors working hard to reduce their inventories.

But furthermore, we also saw a lower level of consumption, not only inventory reduction but also due to build and part of it is December is a big holiday month in Europe, so clearly, it was a shorter quarter.

But also, remember a lot of European capital goods and industrial goods are exported into Asia and with China being particularly slow in the December quarter, a lot of these orders got either delayed, pushed out or canceled. So that’s further exacerbated the European demand.

And lastly, when you think about industrial, industrial has always been a very slow growth market. The last few years it has been seen as a new growth market, mainly driven by solar and wind power deployment.

Some of those deployments or rates of deployments have slowed down, especially in Europe where they – appearance of government incentives and credits clearly the dynamics have changed somewhat. So, that’s kind of our view where we see Europe today.

Stephen Chin – UBS

Okay great. That’s very helpful. The other question I had was on gross margins. I’m guessing that a good portion of your gross margin recovery going into next quarter, or sorry, into like Q2 period was based on some appreciable recovery in your capacity utilization rates. I guess to whatever the degree that you can peak at this point, like how much of an effect do you think lower pricing and also may be mix would have an effect on gross margin recovery? Thanks.

Chris Toth

So, Steve, you referred to the mix versus utilization?

Stephen Chin – UBS

Right. So basically in terms of – as we look forward beyond March quarter as how your gross margins might trend, understanding that capacity utilization rates will probably be a very big factor in driving margin improvements...

Chris Toth

Right.

Stephen Chin – UBS

...how about other factors such as pricing and also mix?

Chris Toth

So, I believe for the shorter term, when gross margin will start to recovery it will be more utilization driven than mix. But then, it’s going to be a combination of both. But if you look at the June and the September quarter, it will be more utilization driven.

Ilan Daskal

Especially as PMD in the later quarters gets back to its run rate level. There you’re going to see more of a mixed factor because it’s a below company average market segments. But in the early quarters, clearly, utilization will drive the leverage in the model.

Stephen Chin – UBS

Perfect. Thank you.

Chris Toth

Thank you.

Operator

Your next question comes from Craig Berger with FBR Capital Markets.

Craig Berger – FBR Capital Markets

Hi, guys. Thanks for taking my question. I guess one question I have is when you look at sort of your peak revenues over the last cycle, 317 and your trough revenues now of 230-ish, where do you think true consumption is? And when you look at your design win funnel over the next year, where do you think revenues can recover to?

Chris Toth

Well, I think if we go back to kind of business as usual a steady state, I think we’re probably – the demand was kind of more than 290 type of thing. I think with the Japanese earthquake and some expectations of a strong September demand, we get push to maybe over $300 million and they will probably get some over consumption by the channel. But I’d say 290 was the rate. I don’t know how much – how lasting affect is going to be from the economic weakening at the end of year, what it’s going to be. But I’d expect as things recovery needs to go back at least to that level.

In terms of the peak and trough, I don’t actually think about it the same way. You are correct. I think the right ways to look at it is the trough to trough and peak to peak, because how you do in any one quarter dropped from peak to trough, really comes down to how you choose to play the channel game.

I could have gotten a higher revenue last quarter, but I would have done some significant discounting and taken a lower margin. And then my peak to trough would have been smaller, but it also would have implied that the next few quarters my recovery would be also shallower. They probably would have stopped the channel. So – but I think if you really the best way to look at it is the way I look at it, I look at a much longer term. I look at it cycle-over-cycle.

Our previous peak was 212, our latest peak was 317, so we grew about 100 million, it’s about 50% increase peak on peak. And our previous trough was 133 and our current trough was – current trough 230 and that is over 70% increase. So to me that is a more relevant comparison, because how you manage the drop off over one or two quarters is really a function of how you want to operate the channel inventory game.

Craig Berger – FBR Capital Markets

Oleg, these cycles are always good for some self reflection, is there anything you would have done differently over the last cycle and as part of that, can you guys still do 41% gross margins at 12.50 a year, and what you need to do in order to get there? Thanks so much.

Oleg Khaykin

So, I think, I would say in the retrospect, everything is 2020. I mean, had I known that the economy would be so heavily in the September, December quarter clearly in the retrospect us pre-building some inventory in the first half of last year was not the best decision, but let’s look at it this way. Nine out of ten times over the last 50 years, it would have been a pretty good back.

So had I been sitting again, I mean, would I do it in the future, I think I probably would be more cautious as to how much I would grow, but still I think it’s a good idea to take advantage of available capacity in the expectation of strong September quarter to do a little bit of the build ahead. We probably got a little bit ahead of ourselves.

In terms of the gross margin at 250, I think given that the current mix and significantly greater pro rata presence of our PMD business today, probably 40% of 250 is not a viable model unless really the other business units recover quickly and PMD stays lower then obviously the mix will give you the 40% margin, but I think really that as things recover you’ll grow more towards the mix we were running at the 290 level, which really kind of puts us in a high 30 gross margin.

Chris Toth

Thank, Craig. Next caller?

Operator

Your next question comes from Ramesh Misra with Brigantine Advisors.

Ramesh Misra – Brigantine Advisors

Thanks, guys, good afternoon. First, some book keeping, in regards to inventory, Ilan, do you anticipate any write-downs and also what was the utilization level last quarter?

Ilan Daskal

So there was about 3.1 million write-down in the last quarter. And it was in the 70s.

Ramesh Misra – Brigantine Advisors

Okay. And do you anticipate any further or major inventory write-downs with the large inventory last quarter

Ilan Daskal

So far, obviously, write-downs depends on two factors. The immediate kind of forecast that we have and an analysis of the overall inventory, since the inventory, the incremental inventory is a recent one, it still has a pretty long life shelf unless towards the entire macroeconomic situation would change and the focus cannot substantiate, to keep the inventory which for now we don’t see it.

Chris Toth

Well, the other thing, what we have done is when we get to prevail – last year we picked the high volume runners and those things have very long life cycles. So at least from my perspective I see very little risk that a lot of this inventory we are getting at.

Ramesh Misra – Brigantine Advisors

In regards to CapEx, so clearly that has come down very sharply and you will be running at fairly low levels, at least for the next few quarters. What is happening over there or is it basically you’ve got the production capability that you needed and now you are kind of done for some time?

Chris Toth

So, on the CapEx, Ramesh, first the ERP is alive so maybe as a comparable, it’s smaller but we tried that kind of stick to our strategy of having the CapEx between 10 to 12% of revenue and its pretty much we have seen out to the strategy.

Ramesh Misra – Brigantine Advisors

Okay. On the SG&A side, you said that you plan to get us below the 15 million mark by the June quarter or September quarter, well, looking back just last year, you were well below the 15 million mark while your revenues were around the 280, 290 kind of level, so – I mean do you view this as kind of the new SG&A run rate or do you anticipate being able to come down to below prior levels with the ERP system implementation?

Ilan Daskal

Well, one of the things you got to remember is when we say 50 million that includes actually $2 million depreciation that we are now including on SAP, right? So when we’re saying to going back down it means effectively offsetting that $2 million increase in SAP. The other thing is that over the last few quarters, even though most of the SAP implementation was capitalized, we are still going through a learning curve and there are as you can imagine receiving pains with all these programming. So we continue to rely a lot on additional incurred additional expense and developing new applications and doing some to stabilize the system. As the system becomes stable, that’s where we’re going to look to take advantage of the productivity it offers and start taking cost out of the SG&A to more offset or more than offset the increased due to SAP.

Chris Toth

And Ramesh I will add to that, that you know, the 50’s that kind of we guided for we’ll be able to support a much higher revenue level. I mean it easily can support 350 level at the quarter, it’s not even higher and if its higher then you know the scalability is going to be or incremental SG&A is going to be much lower than what it used to be. That’s obviously due to all the efficiencies that we will be able to gain, here.

Ramesh Misra – Brigantine Advisors

Okay. Thanks. And just a final one if I may. On the industrial side, at least in North America, with ISM data looking actually pretty good in recent months, what is your talks in terms of the normal cyclicality or seasonality in the industrial side? Do you see that coming back up nicely in the first two quarters of this year or do you think it will be somewhat subdued? Thanks.

Chris Toth

You’re talking about in North America specifically or?

Ramesh Misra – Brigantine Advisors

Yes, industrial especially in North America?

Chris Toth

Yes, I think, I mean, the North American industrial, I mean, clearly there is a little bit of lag between the attitude and the actual orders being placed. That said the U.S. did undergo inventory correction last quarter. I think it’s too early to see how strong it’s going to bounce back. But all that said, industrial is not a very big number for us in North America. Now, military and space, now some people put military space and industrial that’s segment that we track separately in our heir and that segment remains to be very strong for us and we’ve seen expended bookings and very strong demand profile there.

Ramesh Misra – Brigantine Advisors

Okay. Thanks very much guys.

Chris Toth

Thanks, Ramesh.

Operator

Your next question comes from Steve Smigie with Raymond James.

Steve Smigie – Raymond James

Great. Thank you. I just wanted to follow-up on the issue here with the SG&A expense and they’re coming off. I think you mentioned there is 2 million of amortization and we’ve been seeing a couple of million over the last couple quarters. So is that already the amortization in there or should I be backing an extra 2 million per quarter out of whatever SG&A? So if I was trying to do a pro forma number backing out amortization would it be like a $48 million number in either June or September or is it still?

Ilan Daskal

So on a net basis, Steve, it’s a bit lower than that. For the new ERP system its about 2 million, but there was some old system residual depreciation that we no longer depreciate. So on a net basis it’s a bit less than 2 million.

Chris Toth

And also we started depreciating SAP only in December, so September did not have SAP in it.

Steve Smigie – Raymond James

In the December quarter?

Chris Toth

Just in December quarter. December is the first quarter where we are carrying SAP.

Steve Smigie – Raymond James

Okay. And Oleg, R&D has been relatively high over the past couple of quarters, as the revenue has fallen off and you indicated that was to run some additional R&D wafers. I was wondering if you could talk a little bit about when we’ll see the benefit of that investment and does it show up again or does it show up in other product categories?

Oleg Khaykin

It’s actually going to show up across the board, I mean, clearly GaN is one of them, but a new generation of IGBTs, the new generation of MOSFETs. Our new high-voltage IC processes are coming online and probably one of the bigger elements of it was the digital power controller development that we will start seeing benefits as early as this summer as these new products start ramping up in the computing and server space.

Steve Smigie – Raymond James

Okay. And if I, so if look at PMD given investments you’ve made there, let’s say 2012 is a 10% growth year for the industry as a whole. How much faster do you think you would grow given your investment would be 12%?

Chris Toth

I mean, 12% for the discrete is expected growth in 2012.

Steve Smigie – Raymond James

Yes I am just wondering do you get an extra 20% bump above the market for your investment do you think?

Chris Toth

Well, I think in generally in the discrete I mean we put a target to grow 50% faster than the market so if market grows let’s say 12 then we want to be 18, if the market grows 5 we want to be 7.5%, things like that. So it’s kind of how we look at it.

Steve Smigie – Raymond James

Okay, great. Thank you very much.

Chris Toth

Thank you.

Operator

Your next question comes from Brian Piccioni with BMO Capital Markets

Brian Piccioni – BMO Capital Markets

Okay, so, on the GaN product offering, do you expect the same sort of let’s say delay in customer interest or whichever in the higher voltage parts because there was some hesitancy as you introduced the new technology amongst customers they wanted to make sure that it worked okay and that it was stable and all the rest of it. Does the same – will the same apply with the higher voltage parts?

Chris Toth

I don’t believe so. There is a little bit difference in the lower voltage part you’re dealing with a lot of the standards like motherboards or server architectures and in those architecture the frequency at which you are switching is pretty much set by the standard, right or by the – whatever the prevailing rules of thumb that manufactures are using. So really in the lower voltage again the main value proposition is a higher frequency. So you have to change the way you design the product to use a higher frequency. And higher voltage we effectively do a swap and effectively the way we are also approaching is a little bit differently than a low voltage.

We are approaching it with the way we can just swap an existing product with footprint compatible or from the point of view of the user, they can just put a GaN switch from outside and it’s going to look just like a regular muskrat but it will give you better performance because of the high-voltage at that time or volume again is the lower – not only faster switching but also much lower resistance.

So, actually, again in the high voltage application, it does not require rethinking the network topology and things like that. All you are getting is immediately a much higher efficiency part by swapping conventional muskrat with a GaN. So in fact we believe the adoption will be much faster.

Brian Piccioni – BMO Capital Markets

Okay. When you hope that over time the customers would design for both the – all the improved – all the benefits of GaN higher frequency and lower resistance and so on and so forth?

Chris Toth

Absolutely. In fact we are trying to help them think through it, but what we’ve learnt is it’s a heck a lot easier to drive adoption when they initially just plug it into existing circuit and immediately get percentages worth of improved efficiency over the best solution out there and then of course if they want to go even further, and shrink the form factors, shrink the footprint of the design then they can take advantage of the higher frequency.

Brian Piccioni – BMO Capital Markets

Okay, great. Thank you.

Chris Toth

Because I mean, I think what we want to do is be able to plug the part into existing designs and not wait for the full new development cycle.

Operator

At this time there are no further questions. Gentlemen, are there any closing remarks?

Chris Toth

I would like to thank everybody for joining us today and we look forward to speaking with you in the coming months. Thank you.

Operator

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

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