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International Rectifier Corporation (NYSE:IRF)

Q4 2012 Earnings Call

August 22, 2012, 05:00 pm ET

Executives

Chris Toth – IR

Ilan Daskal – CFO

Oleg Khaykin – CEO, President

Analysts

Terence Whalen – Citigroup

Alex Gauna – JMP Securities

Craig Berger – Friedman, Billings and Ramsey

David Huang – Wells Fargo

Steve Smigie – Raymond James

Gabriela Borges – Goldman Sachs

Ramesh Misra – National Security

Stephen Chin - UBS

Operator

Good afternoon. My name is (Shamaria) and I will be your conference operator today. At this time, I would like to welcome everyone to the International Rectifier fourth quarter and fiscal year 2012 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) Thank you. I would now like to turn the conference over to Mr. Chris Toth, Investor Relationsr International Rectifier. Sir, you may begin your call.

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 al 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 received and shipped during the quarter, 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 issued today and our filings with the SEC, including the most recent forms 10-K and 10-Q.

Before I hand the call off to Ilan, I would like to mention that starting in the September quarter in addition to reporting our GAAP financial results, we will begin presenting supplemental non-GAAP financial data.

Our non-GAAP presentation and EPS calculations are expected to include certain items such as restructuring and severance charges, amortization of acquisition-related intangibles and certain discrete tax items.

Our non-GAAP presentation and EPS calculation will include stock-based compensation expense. However, we plan to publish a table in our future press releases that includes our total stock-based compensation as allocated to our cost of sales, R&D and SG&A.

For those that work with and rely on Thompson, First Call, Fact Set, Capital IQ and other financial service platform non-GAAP estimates, we ask that starting with the September quarter of 2012 you exclude any restructuring and severance charges and amortization of acquisition related intangibles from your non-GAAP estimates.

As always, we'll continue to publish and maintain our primary focus on GAAP financial results.

Lastly, I would like to highlight the following upcoming events. On Wednesday, September 5th, we will be attending the 2012 Citi Global Technology conference in New York and on Wednesday, September 12th, we will be attending the 2012 Deutsche Bank Technology conference in Las Vegas.

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 fourth quarter of fiscal 2012, IR reported a revenue of $269.7 million, which was an 8.7% increase from the prior quarter and a 15% decrease from the fourth quarter of fiscal year 2011.

Gross margin was 25.9%, lower than our guidance mainly due to an asset impairment and inventory write-off associated with our El Segundo fab closure that impacted gross margin by 1.6 percentage points.

Mix also impacted gross margin PMD revenue increased sharply and HiRel gross margin increased due to a change in mix within the June quarter.

We reported a net loss of $68.2 million or $0.88 per fully diluted share for the quarter. Excluding an asset impairment and inventory write-off associated with the El Segundo fab closure of $4.4 million, $1.7 million in severance payments, amortization of intangibles of $1.7 million, a goodwill impairment of $69.4 million and a discrete tax benefit of $21.2 million, net loss would have been $12.2 million or $0.18 per share.

For the June quarter, R&D expense were $35.1 million which represented 13% of revenue. SG&A expenses were $51.3 million which represented 19% of revenue. Excluding $1.7 million in severance payments associated with the reduction of our fixed cost structure, SG&A expenses were $49.6 million. Amortization of acquisition related intangibles was $1.7 million.

In the June quarter, we reported a goodwill impairment charge of $69.4 million within the Enterprise Power business unit. This charge was based upon the recent trading value of our stock coupled with a higher computing mix within the Enterprise Power business unit that resulted in the write-down of goodwill, including the goodwill from the CHiL acquisition. We continue to see CHiL as an integral part of our success in the transition to digital power management in the server and computing end market segments.

Operating loss for the quarter was $87.7 million. Income tax for the June quarter was a $19.6 million benefit due primarily to a net release of tax reserves and deferred assets and other discrete items totaling $21.2 million. This was partially offset by $1.6 million in foreign tax accruals.

Total cash, cash equivalents and investments increased $19.7 million to $385.9 million at the end of the fourth quarter, which included $1.5 million of restricted cash.

During the quarter, inventory decreased by $12.6 million to $294.7 million. Weeks of inventory decreased to 19.2 weeks.

In the June quarter, we generated $58.3 million in cash from operating activities, mainly due to improved working capital. Cash capital expenditures for the quarter were $31.6 million.

Free cash flow was $26.8 million. Depreciation and amortization expense was $22.9 million. And stock-based compensation was $4 million.

During the quarter, we purchased about 168,000 shares of our stock that totaled a cost of $3.1 million. We are now down to about 69 million shares outstanding.

Before I move on to our outlook, I would like to discuss the reporting of our future results on a non-GAAP basis.

Starting in the December quarter, we will begin presenting non-GAAP financial data. We currently use non-GAAP measures to evaluate certain portions of our core business. Since we find these measures useful, we believe that investors will also benefit from seeing non-GAAP financial measures to supplement our GAAP results.

When we report our September quarter results, we will provide full GAAP to non-GAAP reconciliation.

Now, moving on to our outlook, we currently expect revenue for the September quarter to be between $235 million and $250 million. For this projected revenue range, we currently estimate gross margin in the September quarter to be about 28%.

We expect R&D expenses to be about $34 million. SG&A expenses are expected to be about $47 million. Amortization of acquisition related intangibles is expected to be about $1.7 million.

For the September quarter, we expect approximately $8 million to $9 million in severance charges. These charges will appear in the asset impairment restructuring and other charges line item on the income statement.

Other income – other expense net is expected to be about $1 million. Foreign tax accruals for the September quarter are expected to be about $3 million. Long term, we still expect our tax rate to normalize in the mid 20s.

And finally for the September quarter, we expect our cash capital expenditure to be about $34 million. Capital expenditures to upgrade manufacturing capabilities are expected to remain elevated in the next two to three quarters for equipment that was already approved.

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

Oleg Khaykin

Thank you, Ilan. As June quarter progressed, industry demand weakened and the near-term level of uncertainty increased. As a result, we saw OEMs focused on burning off inventory and distributors hesitant to restart.

Although we increased our revenue by about 9% during the quarter, orders began slowing during the month of June and have continued to remain weak throughout the summer. This has put significant pressure on our revenue margins and factory loadings.

We expect this environment to persist for several quarters and, as such, we are using this slowdown as a catalyst to resume the operational transformation of the company that we started in 2009. I will discuss this in more detail following a brief overview of our end markets in the June quarter.

Geographically, demand was up in Asia in both computing and automotive. However, that strength was tempered by significant weakness in the appliance and industrial end markets as customers continue to work down their finished goods inventory in the face of lower end market demand.

The Americas increased modestly as we saw some sign of stabilization and inventory replenishment. Europe stabilized but is still running well below normal levels due to weak industrial demand.

And finally, Japan decreased modestly as increases in automotive were offset by significant decreases in the appliance end market on products that ultimately get sold into China.

Moving on to our business units, the Enterprise Power business unit increased 4% in lien with our expectations for modest growth. Our latest generation of DC-to-DC conversion solutions that incorporate digital power control and power stage products continues to grow and experience strong design wins.

We remain well positioned on the next generation server platform side (inaudible) and ultra book designs based on the (Hazel) processor.

During the quarter, we launched a digital power controller with an optimized single and dual phase power stage solution for ultra books that reduces the footprint of more than 50% compared to the leading monolithic solutions and offers a 40% smaller footprint compared to an alternative reference design.

OEMs are rapidly adopting digital power in their designs and, as a result, our addressable market and potential content continue to expand. Last year's ChiL acquisition is a critical factor in our recent success in the server, computing and ultra book markets.

In addition, we are exploring opportunities to bring digital power control technology to other end markets served by IR.

For the September quarter we expect solid growth in Enterprise Power revenue in what we expect to be the seasonally strongest quarter for the year. Our measurement devices business unit significantly increased 28% from the prior quarter. The increase was mainly due to the inventory replenishment during the first quarter of the year – sorry, during the first half of the year.

However, as the quarter progressed, bookings slowed down and that trend has carried into September quarter. We currently expect September revenue to be down from the June quarter.

Our energy saving products business unit revenue decreased 11% compared to the March quarter. Overall demand continues to remain very weak mainly as a result of high level of finished goods inventories and slow consumer demand in the appliance end markets, particularly in China.

For the September quarter, our revenue is expected to continue to decline. We expect China demand to bottom out in the second half of the year and start to recover in early calendar 2013, boosted by depletion of inventories and seasonal strength in appliance builds.

Energy saving products design win momentum remains strong and we are starting to see the initial ramp of our new micromodule targeting low power motors that expands our addressable markets.

We believe the secular trend towards energy efficient variable speed motors is here to stay and, as such, believe our investment pieces in this market remains intact.

But attrition rates of this product throughout the world remain low and once inventory levels of finished goods inventory stabilize, we expect resumption of growth.

Our automotive product business unit revenue increased 8% from the prior quarter mainly due to broad market strength and share gains in Asian. Design win activity remains robust particularly with our latest automotive IGBT platform of products and modules that deliver industry benchmark performance.

We are seeing design wins in hybrid and electric vehicles where our technology is used in electric power drive power train components.

For the September quarter, we expect automotive to decline in line with normal seasonality.

Lastly, our HiRel business unit increased 3% compared to the March quarter. Gross margins for HiRel, however, decreased about seven percentage points. The decrease was mainly due to product mix.

For September, we expect revenue to decline several million dollars as a result of timing of product shipments but the gross margin is expected to return back to the 50 plus percent area. Bookings and our overall backlog continue to be strong in all of our HiRel markets.

I'll update on CHiL inventories. During the June quarter, (POF) increased 15% compared to the March quarter. Sell-in versus sell through during the June quarter was about an equilibrium and our channel inventory remained at slightly below (technical difficulty). Our target range for channel inventory is about nine to 10 weeks.

During the June quarter, internal inventory decreased to about 19 weeks. While our level of inventory remains high, we continue to balance utilization and inventory reduction to minimize the impact to gross margins and disruptions to our operations. Near term, we will continue to work down our inventory to normalize levels.

Lead times remain below normal for the majority of our products. Overall factory utilization increased to 80 percentage points during the June quarter, however we have subsequently decreased the utilization in the September quarter in response to the slower sales outlook.

As I mentioned earlier, in view of the continued weak demand environment, we have initiated operational restructuring activities to align our manufacturing footprint and operating expenses with the current business conditions.

Our goal is to lower our fixed cost to increase operating leverage in our business model. Overall, we expect to reduce our operating expenses by about six percentage points and the reductions in operating expenses are expected to save about $20 million on an annualized basis starting in the December quarter of this year.

We will continue to review our operating expense structure and will take additional measures as necessary.

In manufacturing, we will be closing our El Segundo fab and consolidating its production into Temecula fab. The majority of our products are already qualified in Temecula and we do not anticipate any major disruptions with our customers or product supply.

We expect to close the fab by the end of March quarter in 2013. The closure of this fab is expected to save approximately $10 million per year when completed.

Also, we are planning to resize our Newport Wales manufacturing site in several phases through the middle of calendar 2015. Pending the successful qualification of existing products and technologies into other facilities, we may be able to accelerate the resizing activities to an earlier date.

We are in process of finalizing our operational restructuring plan and will update you on the expected annualized savings on the Newport resizing and expected costs associated with all of our restructuring activities on our next earnings call.

However, as Ilan mentioned, our immediate actions are expected to result in about $8 million to $9 million in severance charges in the September quarter.

In the past four years, our manufacturing model targeted 30% external sourcing on the front end and 60% on assembly and test. With the operational restructuring, our model will now target up to 50% external sourcing on the front end and 70% on the assembly and test.

Doing so will allow us to more effectively scale the business to reduce volatility in the down cycle and expand our margins.

In conclusion, while current end market conditions are presenting many challenges, they also present opportunities. The current environment is a catalyst for us to resume our operational transformation in line with our long-term strategy and drive higher future profitability.

We continue to focus on our R&D efforts, design wins with industry leaders and on other factors that we can control while reducing costs and boosting operating efficiencies. We are well positioned to manage through the cycle given our strong balance sheet and our objective is to emerge as a stronger, more profitable company as market recovers.

This concludes our prepared remarks and we will now open the session to your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Terence Whalen – Citigroup.

Terence Whalen – Citigroup

This question is on the magnitude of the expense reductions. Oleg, I was just thinking we would hear your insight on why is $10 million on the cost line and I believe you said $20 million on the OpEx line, why is that the correct magnitude (inaudible) given that even after that your operating margins will be below (inaudible).

Ilan Daskal

So Terence, I will star here. The $10 million is just for the El Segundo fab and we will continue to update on the savings from the Newport fab and we are still compiling kind of the data.

And as Oleg mentioned in his prepared remarks, we will provide you the next running score. The savings in the (cost) for Newport and we see it probably will be north of $10 million just for Newport.

Oleg Khaykin

At this point in time, we don't have the numbers finalized yet.

Terence Whalen - Citigroup

And then the follow up that I had was regarding gross margin. Can you help me understand the mix dynamics and also what's going on with utilization so that you can have gross margin holding relatively intact despite the 10% revenue reductions?

Oleg Khaykin

Yes, so I think we are trying to manage two levers. One is the utilization and one is the inventory reduction. So as a result, our factories are running somewhat underutilized but not to the point where they become operationally not sustainable. So this underutilization clearly puts a burden on the gross margin as you factor it in.

The second part is we've seen significant reduction in our industrial and appliance demand, which was generally a higher margin business for us and we've seen some strong recovery in our discrete business unit in the June quarter, which is generally lower margin.

So mix clearly further pushed the gross margins below the 30% margin. So clearly mix is still a major element here but also the sustaining underutilization over next several quarters will have a further drag on our margins.

So that's why we say 28% is where we believe that mix of the managing the inventory reduction and underutilization and the mix will be coming out in the September quarter.

Ilan Daskal

And Terence, also the $4.4 million I said in inventory write-off that is associated with the closure of the El Segundo fab had a headwind of about 2% of the gross margin.

Operator

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

Alex Gauna – JMP Securities

I was wondering with the closure of the El Segundo fab, what does that mean about the headquarters thinking in general and can you give us an idea about in rough percentage terms what kind of employee headcount reduction you're targeting over the next few quarters?

Oleg Khaykin

So the El Segundo fab has no impact on the headquarters. It's a separate facility from the headquarters. So we have not published the actual employees. I think there is a – are you talking about the operators or SG&A and R&D?

We've basically – pardon me?

Alex Gauna – JMP Securities

All of it together, rough ballpark kind of headcount reduction you might be thinking of in the range? I know it's not finalized.

Oleg Khaykin

Let's just stay with the dollars reduction as we have not disclosed the actual headcount, give a number of regulatory and since we have not executed some of those measures as of this date. I mean, I think the dollar count pretty much captures the target reductions.

Alex Gauna – JMP Securities

And then I was wondering in terms of – in the past you've talked about some pricing competition that you've refused to follow down. In your down guidance, is this pretty much volume driven or are you now starting to give in on some of the pricing levers to try to keep utilization up?

Oleg Khaykin

Well, it is widely volume driven. In fact, we saw a very strong upswing from our distribution partners in the June quarter and they all anticipated strong summer quarter and into September.

But as you can imagine, starting in June they really did not see September quarter firming up or looking strong. They pulled back and probably in some respect (inaudible) and discrete part of the market we have several distributors who are taking a more aggressive posture in taking product in the June quarter and consequently they are some of the biggest ones who have scaled back in the September quarter.

But really, if you even normalize the PMD, it's fairly I would say – if you had taken a six month view, it's generally I would say flat would have been to slightly up if you added more (linearized).

The area where we've seen significant deterioration of demand – and that's purely volume and there the prices are fixed and multiyear agreements – was our energy savings products business unit where we've seen significant deterioration of demand for IGBT modules, the motor controllers and things like that. And that is purely driven by end-market demand. I think really does not play much overall here.

Alex Gauna – JMP Securities

On more (till) in your digital control, how big has that become as a percentage of your Enterprise Power management? Is that sizeable at this point or is that more on the (come) with the next generation platforms and also if you could kind of give a ballpark around the opportunity in the new ultra mobile digital design wins?

Oleg Khaykin

Sure, so the – it's just now starting to ramp. It's mainly newer platforms that are using digital power management. So the last quarter growth and this quarter growth in EPBU is driven by combined solution that leverages the digital power controller together with IR power stages.

So but just so that you understand, when you think about revenue content, you get about $1 – for every $1 of digital power controller, you get about $6 to $10 of the power silicone and it depends on whether it's a small server or big server or a – one of those mainframes.

In terms of the ultra book, the area where we see this technology playing into – and that's just so you know, we are not in those markets today, so for us it's a new market – is mainly on the (Hazel) base processor design, which are expected to be 100% digital power management and more on the higher performance computers because I think the lower performance computers are going to leverage more of a solution that is more in line with the tablet computers, mobile tablets versus the high power laptops.

So I would say where we see strong traction for us is the business higher performance laptops based on the (Hazel) processor.

Operator

Your next question comes from the line of Craig Berger – Friedman, Billings and Ramsey.

Craig Berger – Friedman, Billings and Ramsey

I just wanted to ask on the operating expenses, your peer on is at 23% of sales, Fairchild's 26% of sales and you guys are guiding to 34% of sales next quarter with the cuts. So I guess I'm wondering why do you think it's OK to be so far above your peers and so far outside of your targeted model margins?

Oleg Khaykin

Well, I mean, it's a good question, Craig. I mean, clearly, we don't expect our revenue levels to be – to remain at those levels. If they do and the end market continues to be weak, obviously we've got to proceed and take further action.

Also, at the same time, you have to keep in mind there is a certain amount cost required to support a global footprint and we still have some elevating costs associated with our implementation of ERP system such as the application development.

These costs over the next several quarters pair down. WE intend to take our SG&A further down and obviously we're also reviewing some of our R&D programs where we can stretch them out or reduce the cost further.

At this point, I think the initial cut we feel is prudent and we obviously take further view where else we can take the costs going forward.

Craig Berger – Friedman, Billings and Ramsey

And so you said you would reassess if things don't change. How long into the future would it take for revenues remaining weak in order to take additional actions and can you just give us updated thoughts on maybe what a more realistic gross and operating margin business model is for IR and at what revenue levels?

Oleg Khaykin

Well, I think the – with our operational restructuring and on the assumption that the business does come back and I think we are going to be actually sitting in a much better gross margin environment where we are today.

I mean, taking out restructuring – shutting down the fab three and El Segundo and scaling down our Newport operation and increasing the leverage of the foundries and outsource assembly and test is expected to give us several percentage gross margin expansion on ou operating model.

So if you take the level of operating model where we were running in the high 30s gross margin, that would comfortably put us into the low 40% gross margin.

Now further pruning of the SG&A and as we implement our ERP, taking advantage of the productivity and optimizing our SG&A structure and further streamlining our R&D, we feel we can – we are going to stay with our long-term model, which is our low 40% gross margin and mid to high teens operating income.

Ilan Daskal

Craig, we believe we can hold the line of the dollar value on the OpEx.

Craig Berger – Friedman, Billings and Ramsey

Last one, you said you don't expect revenues to be at these levels forever. What are the signs that suggest your module business could grow or your PMD business could grow back towards historical levels?

Oleg Khaykin

Well, I mean, I think PMD level we actually don't have much concern. With just a reasonable expectation of recovery, we've topped over $100 million. If you remember, our peak revenue in that business unit was around $123 million about a year ago.

And the area, if I look at our Enterprise Power business unit, we are now getting into territory where we have the highest revenue yet per quarter on that business. On automotive, we are now at running close to the highest revenue per quarter that business has been at.

And HiRel is running comfortably between $46 million to $50 million. The area where we really see a significant degradation is Enterprise – sorry, energy saving products where we went from the peak level of revenue, about $78 million, to $50 million and now into the 40s.

So when we assess it, I don't think the demand for air conditioners and appliances is going to go away, especially as more and more societies achieve higher living standards.

What we are seeing today is a significant uncertainty and when you see significant market uncertainty, the first thing that consumers cut back on is durables. And as the demand for durables come back and as the economy improves – I guess it depends whether you believe the economy will ever improve; we tend to believe that it will – we feel we have very strong design win position and market presence in that space.

And in fact, with our new generation products, we have even better position that we were before. So as that business bounces up, it'll – as much as it's providing a strong headwind for us today, it'll provide significant tailwind as that segment recovers.

Operator

Your next question comes from the line of David Huang – Wells Fargo.

David Huang – Wells Fargo

Can you run through in terms of your cost savings, what your highest priorities for R&D are and what areas are most susceptible to cuts?

Oleg Khaykin

So when you think about R&D, there's a couple of things in there. So the first one is the actual product development. And the second one is platform development. And platform development includes silicone technologies, the gallium nitrite and packaging technology development.

What we are looking at among the cuts is one of the things we've done is during the past few quarters we've taken advantage of weaker loadings in the fab to accelerate engineering loss and accelerate some new products to market.

So clearly as these products come out, get launched, we will have reduced demand for a lot of the engineering builds, the mask layers and things like that, so that constitutes kind of the first level of reduction in R&D spending.

The other thing we've done is as we've developed new platforms and they now come online, the level of resources to sustain them and optimize them is reduced and we will take some of those resources down.

And one area we will continue to invest in at the same levels is our gallium nitrite technology where we are planning to launch first family of commercial products and customer revenue by the end of this calendar year.

David Huang – Wells Fargo

And when you look at the types of – the manufacturing facilities that you are shutting down, that there are certain things that you wouldn't have otherwise closed had you not gone into this downturn period.

So when you come back up with a lower cost basis, is there an opportunity for you to actually do better than your long-term target model in gross margin?

Oleg Khaykin

I mean, several years ago we have already outlined those facilities that we are now shutting down for – shut down. These are mainly older fabs, kind of five and six inch technologies and as the market rebounded we did not have enough opportunity to transfer technologies to other facilities or to the foundries.

And as a result, the only way we could meet customer demand is to maintain high level of loadings on those existing facilities. In the last three years, we have made significant progress by bringing up IR technologies at foundries and other facilities within IR.

So at this point in time, as the business has weakened, it has given us an opportunity to shift production into those facilities and potentially push out older products where we have qualified foundries to run them on our behalf.

At this point in time, we actually see a significant slowdown as giving us an opportunity to execute on something that we were preparing for for the last three to four years.

Operator

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

Steve Smigie – Raymond James

So my first question is sort of a follow up from the R&D one earlier. You guys took the opportunity as things have been a little soft here to run some extra wafers, R&D wafers through your facilities.

And that's been going on for a few quarters now and I'm just curious when would you be able to exploit that extra investment? So how long is it from when you started that process to when you can get the benefit of that investment and what categories are you particularly investing in there?

Oleg Khaykin

So where we are – what we've done is really the products that we've been releasing in the last six months are the products that have benefitted from being accelerated to market by anywhere three to six months.

So as the designs with these products start ramping up over the next three to nine months, that's where we're going to see the benefit. And a lot of the products that mainly benefit from it are some of our power devices on our new voltage and mid voltage (inaudible) platform and our new IGBTs in both automotive and industrial space.

So those are really the four platforms that we have accelerated to market. And the area in terms of our ICs on digital controllers, there have been all along at the foundries, so that did not really benefit so much from the internal underutilization.

But that said, also your foundry partners are putting more engineering resources and helping us to accelerate technology transfers and qualifications when their factories are less busy than when they are running full production because every time we transfer a process you have to build certain number of lots and certain number of units and put them through a qualification which requires engineering resources both internally as well as at our subcontractors.

And as you can imagine, they always prefer to earn revenue but when the economy slows down they're always more eager to win more business and we get a lot more traction and support during the down cycle, which allows us to accelerate technology transfers and restructuring of our operational footprint.

Steve Smigie – Raymond James

And then with regard to the multiphase products focused at the server market, I think there were at least two new entrances to that market that I know of that are trying to come into the market with (inaudible) solution.

And I was just curious if you've seen new players entering that market and just your sort of updated thoughts on how important it is to have a fully integrated solution versus sort of optimizing discrete solutions for the whole multiple power stages there.

Oleg Khaykin

Well, I think the people we see at all the big server players there are all the usual suspects. So I think really we have not seen any new players to that extent coming. And remember, there's a lot of feature – especially if you want to play in a server, it takes you – when somebody is on a fourth, fifth generation of the controller that encompasses all the features and somebody coming in, there is a significant learning curve.

In terms of the implementation, what we are seeing is there is actually a broad range of implementations. On the lower end, the customers are very much still preferring kind of discrete, standardized solution on the power side plus the digital controller.

On the immediate higher end, what we're seeing is really a combination of a controller and a power stage. And power stage in that case is a highly integrated driver with (inaudible) with one or two phases.

So we are seeing a lot of traction where we are penetrating into is where traditionally we did not have is the integrated power stage solution. So it could be basically controller plus power stages rather than just create drivers and just create (inaudible).

But as you go into the lower end, especially in China and Taiwan, they still have a preference for fully discrete solution so they can mix and match different components.

But we are seeing as the complexity of servers gets more and more complex, most players want to have one supplier provide both power stages and the controller to avoid finger pointing and basically have one party accountable for the bring up of the platform.

Operator

Your next question comes from the line of James Schneider – Goldman Sachs.

Gabriela Borges – Goldman Sachs

I know you mentioned the slowdown of orders in the June quarter. I was hoping you could talk a little more about the linearity of order patterns into September so far and perhaps the visibility you have into order trends over the next few months broadly.

Oleg Khaykin

Well, I think you always start a quarter, you kind of have some initial bookings. And generally there is – sort of there is an initial bookings for the quarter. We start tracking them about 90 days before the quarter starts, so one quarter ahead.

And generally there is some trajectory and as you enter the quarter you expect a certain amount of the trends business. So what we saw is in the June quarter, the trajectory that started for the September quarter was moving pretty normal in the early June quarter.

But then as June progressed and the summer entered, it's kind of flattened out and it largely failed to – I mean, when you think about trends business, it normally comes into the quarter. The trends business is either flat or fairly anemic.

So that's what has kind of given us an outlook for our September quarter. In terms of beyond September, it's too early to tell because we also know that many of our distributors are sitting on fairly lean level of inventories and their position is wait and see because they're not getting any visibility from their customers into December and as such they're pretty hesitant to place orders.

Plus we do have a – we are in a situation where we are somewhat, we have an inflated inventory and they know that we are able to respond a number of SKUs if the demand does pop in.

Ilan Daskal

So basically it will be based more and more on terms I mean most likely going into the next three months.

Gabriela Borges – Goldman Sachs

And then as a follow-up, if I may, I was hoping to get a sense of how much capacity might be taken offline with the fab restructuring you announced today. I think you had previously talked about 100% utilization supporting about $290 million in revenues. What do you think that number might look like post El Segundo fab closure and then maybe longer term with the Newport resizing as well?

Oleg Khaykin

Our internal capacity after all the restructuring will be able to – we're about $0.25 million internally. But you've got to look at the mix of product. It's like front end and back end. Let's say if we recover to about $300 million run rate, we are looking to go from kind of 30/70 split where we do 70% wafers in-house, 30% external to 50/50 split.

On the back end manufacturing, we're already at the 60/40 split, 40% internal, 60% external, and we are looking to take it to 70/30 split.

Operator

Your next question comes from the line of Ramesh Misra – National Security.

Ramesh Misra – National Security

In regards to the El Segundo production, do you anticipate most of it going to outside foundry partners or will some of it go to Newport? I know a few quarters ago you were preparing to transfer most to Newport but has your thinking changed in that regard?

Oleg Khaykin

Ramesh, sorry, the El Segundo fab, it's mainly a high voltage IT fab and these processors are currently qualified to make – so 100% Temecula – sorry of the El Segundo fab production will go to Temecula.

It's not the technology that's available externally nor is it technology that's currently qualified in Newport. That said, the Newport IT capacity for us today is completely full. So we are in our (inaudible), so there is really no opportunity – there is good (inaudible) expand capacity there to be able to accommodate Temecula – to accommodate El Segundo fab.

However, we have a lot more flexibility with Temecula where we can push out some of the older technologies to the foundries and replace them with the high voltage Its that are currently lining in our El Segundo fab.

Ramesh Misra – National Security

In regards to CapEx, still running at pretty elevated levels. Is this all related to new product areas or is it also in preparation for this kind of stuff, El Segundo to Temecula transfer?

Oleg Khaykin

No, our CapEx is intended – it's really to – it's not a capacity expansion. It's capability operate to build the new technologies that we're introducing mainly for the – actually 100% for the (inaudible) equipment.

So as we consolidate it and the two fabs – actually the two do not have any relationship because our goal is longer term. We have new technologies coming online. We build them internally and then gradually bring them up externally.

In a way, we're looking to push out more older technologies to the foundries and the (inaudible) and upgrade internal capacity, take advantage of the new technologies as well as take advantage of the foundry capacity that we install.

Ramesh Misra – National Security

Your factory utilization number at 80% was a little higher than I would have thought at this revenue level. Were you building some bridge inventory ahead of the El Segundo shutdown or is something going on underneath?

Oleg Khaykin

Well, when we were seeing kind of if you take March quarter and you look into the June quarter, we saw very strong demand. So we thought, OK, well, it's – we're seeing strong recovery. And if you kind of see your inventory bleed out, we started some wafers in the fabs.

Most of them came out during the June quarters. As we saw in the June quarter, things weakening, we reversed it and we have taken down wafer starts significantly. So as a result, the June quarter had a slightly elevated utilization and the September quarter will drop right back down.

There's about a one quarter lag between the utilization you see in the fab and the decisions that were made.

Ramesh Misra – National Security

Well, I guess the silver lining with the slowdown is you have more time to focus on your long-term products. So can you update us on your thoughts or your targets on how much – how quickly could these new product areas account for overall revenues, I don't know, two years down the line, three years down the line?

Oleg Khaykin

Well, so if I look at the – it varies by the business units. So Enterprise Power business unit, most of their products run on two, 2.5 year cycles, so everything you do today you are in full production, full swing within 12 months.

So this is one area where we are obviously keeping investment at a healthy level to make sure we don’t miss any cycles. The automotive products obviously takes a bit longer and what we are seeing is all the technology we are launching today we are seeing a lot of design activity, a lot of design win activity but revenues probably, I would say, a lot of what we are winning today is about 1.5 years wait from now.

However, we are also now seeing the designs that we won 1.5 years, two years ago are now starting to ramp in production, so we are benefitting from the products we launched one to two years ago. And as a result, if you look at our automotive business unit, it's actually the only business unit that fiscal year and fiscal year showed – well, although 1% growth but it actually grew whereas all other business units have seen a decline in demand.

The energy saving product, there whatever products they introduce they're generally in production within 12 months. But also all these products have very long lives. So if you win a design, it generally runs for five years and so every new product introduced generally ramps up into production within 12 months.

But and then it stays in – has a life of about five years. So you don't have a big change over all portfolio every couple years. And power management devices is probably one of the fastest time to revenue especially in the consumer and computing markets where you are generally seeing production in the six to nine months of the product launch.

So as you can imagine, products that go to production the fastest is the area where we are pushing more aggressively. The products that take longer time to go to production and where customers have long product cycles, this is an area where we can take – pull back a bit and reduce burn rate.

Ramesh Misra – National Security

Ilan, of the $69 million goodwill write-down, can you say how much of it came from CHiL?

Ilan Daskal

So about two-thirds came from CHiL. The rest of was the Enterprise Power business unit kind of legacy group on the books.

Operator

Your next question comes from the line of Stephen Chin – UBS.

Stephen Chin – UBS

Oleg, first one is sort of a follow up on an answer you gave on the previous question on tier one customer design wins that are now just starting to reach revenue ramps, some of which from the past year, 1.5 years.

I was wondering if those customer wins, are they still ramping to the same volumes as you expected one year, 1.5 years ago or are there other lower volumes given the macro environment?

Oleg Khaykin

I think the – as I said earlier, the tier one, that's where they really go fast mainly in the computing and service space. So what we're seeing – I'll say three areas where we are seeing ramp up. One is the Enterprise Power.

But as you can imagine, the outlook for a lot of computing customers a year ago was somewhat higher than what they're actually buying. That said, since most of these areas for other new areas, new markets where we did not play, we are feeling it's still accretive to the overall growth of the business unit.

And if you look at – one thing I told you guys earlier is on the (Romney) platform, we had some market share loss. So I mean, given that this business unit is actually greater than it was even a year ago, our design wins in the computing space have more than made up the drop in revenue on the server side.

That said, as the next generation servers based on all digital power control going to production, it will be an additional boost to our revenue growth on top of what we are currently experiencing.

So next to your question, the computing is the area where we're seeing some of the strongest growth coming from new products. Probably not as strong as the volume expectations were a year ago in that space but still very healthy.

The next area is the energy saving products. Even though the existing products are down significantly, one area we have just entered with our micro modules is going after 3M Motors, which is by far the biggest segment in the market and that's a segment where IR historically didn't have any revenue or products.

So now these products are ramping up but they are not ramping up to the quarterly run rate levels the customers were forecasting even six months ago. But it's largely due to the weak end market demand in industrial motors, pumps and appliances.

So as this market recovers we feel very comfortable that these – the demand for these parts will spike up. And the last one is automotive.

Even though there is some slowdown in some sectors, we feel very good about our automotive revenue growth as newer products are starting to kick in. And more significantly, with our new automotive IGBT platform, we are seeing very strong traction not only with European but also with Japanese customers where historically it's been a big challenge to penetrate.

Stephen Chin - UBS

The last question I had was with regards to the revised higher outsourcing percentages that you mentioned for your front end and back end services. I'm just kind of curious if you can provide some more color on if there is any meaningfully revised terms to the timeframe of when you can revise orders so on and so forth because if I recall correctly, one of the reasons why your inventory levels continue to grow as demand starts falling down about a year ago was because of the foundry arrangements and how quickly you respond to the changing demand levels. So any color on the foundry service terms would be helpful.

Oleg Khaykin

Sorry, what do you mean by foundry service terms?

Stephen Chin - UBS

Yes, just in terms of how the timeframe that you can revise your rolling forecast for wafers or backend services if the increased percentage of outsourcing effects differ from your previous arrangements.

Oleg Khaykin

Well, when you do foundry services, there is always a window over which you can not meaningfully change forecasts and it's usually a month or so and then you can take the forecast down.

So I think as we are reconfiguring our manufacturing strategy we are also addressing some of the terms. But I think the area probably which – some of it is not necessarily foundry. Some of it was self inflicted. I mean, we thought it would be a traditional reshaped recovery inventory adjustment and snapback. So we've gone ahead and taken advantage of some lower pricing to build inventory.

I think in retrospect we probably should not have done it and looking forward we're going to take a much more conservative attitude than a down market. So I wouldn't so much blame it on the foundry terms.

I mean, they are fairly standard for the industry. I think there was more of our demand expectation that the market was going to behave that caused us to give them bigger orders and, as a result, it took us longer to take those orders down.

In terms of the – I think you mentioned earlier the benefit it'll do. Clearly the – we expect from our new manufacturing strategy at kind of the peak of the cycle to kick in about 2% to 3% additional gross margin but by far the biggest benefit of it comes at the lower part of the cycle where you have significantly lower fixed costs and you're able – you're going to have much more resilience in the overall gross margin and will experience lower swing, smaller swing fro the peak to the trough as you reduce your fixed cost.

That's really kind of the strategy we have foreseen.

Operator

Your next question comes from the line of Craig Berger – Friedman, Billings and Ramsey.

Craig Berger – Friedman, Billings and Ramsey

I just wanted to ask on the capital expenditures we've seen to be at elevated levels relative to revenues. Can you help us explain why you need to spend so much money on capital, what's wrong with the tools that you have, what's new with the tools your buying and what do you view your normal capital expenditure levels at?

Oleg Khaykin

So I mean, about a year ago we have approved a certain upgrade to our capabilities and it's mainly – it's less on the lithography and kind of traditional front-end processing. It's really to take – to be able to do the power device optimization that requires ultra thin wafers, metallization, other types of specialized processing which makes a power device like IGBT or (inaudible) very high performance.

So this is the type of capability that's required going forward on advanced power devices. The older devices generally did not require it or required very little of it. So that's the capability upgrade that we have approved to extend the life of our assets and provide the capability to kind of turn over the portfolio to the new product or the businesses.

The CapEx we are spending money on does not include the front-end traditional fab equipment like lithography and other type of equipment. So once you decide to do this upgrade, you cannot stop midpoint because you either have the capability or you don't.

And that's why we said over the next two, three quarters we obviously stretch some of the CapEx for it to come in maybe push out by a quarter if it comes in. But that's a capability that we need to finalize and after that we expect our CapEx to drop significantly actually below what you would consider to be the normal CapEx run rate for our business. Ilan?

Ilan Daskal

So for the next two to three quarters it's going to remain elevated at a range of between $33 million to $35 million per quarter. But then our plan right now is of the fourth fiscal new quarter, meaning June '13. It will drop significantly to a single digit to (inaudible).

Craig Berger – Friedman, Billings and Ramsey

Then lastly can you just remind us about your priorities with regards to cash? I believe you still have about $5.5 million this year of cash. What are your priorities there?

Oleg Khaykin

First one is obviously kind of work as much of inventory into cash as possible as quickly while balancing against the underutilization or the operational effectiveness of the factories.

The second one, as we continue to be opportunistic with a stock buyback, we still have about $43 million left in our approved buyback and as opportunities arrive we are going to exercise it. And the remainder is just to complete the capability upgrade that we have initiated about a year ago.

Ilan Daskal

Overall, the cost allocation models have not changed and we generated cash new mainly due to improved (boarding) capital in the last quarter. And that's part of the upside that we get from sale of the current inventory levels that we are in.

And as you know, we do have about $42 million left in our buyback plan out of the $150 million that we started with and historically during periods that the stock had some weakness we have been committed to making some opportunistic purchases and we plan to continue to show some of those examples of being opportunistic in the market.

Operator

And at this time, there are no further questions. I would now like to turn it over to Oleg Khaykin, Ilan Daskal and Chris Toth for any closing remarks.

Chris Toth

Thank you. Thank you all for joining us today and we look forward to speaking with you in person over the next several quarters.

Operator

Ladies and gentlemen, thank you for your participation in today's conference call. You may now disconnect.

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