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International Rectifier Corporation (NYSE:IRF)

Citi Technology Conference Call

September 5, 2012 11:15 am ET

Executives

Oleg Khaykin – President and Chief Executive Officer

Unidentified Analyst

Just for a comment on the format, we are going to do a 40-minute session here, and 20 minutes of Q&A initially and then I will turn it over to questions for the audience, so I will give you your chance in a little bit, but we would like to kick things off. So I guess, Oleg, maybe starting from a high level question, how you’ve seen demand change here in the second half versus the first half and how are you responding to that?

Oleg Khaykin

Well, in the first half we saw a kind of first drop in December quarter and then as people reassess their needs, we saw nice recovery into the March. And early into the June quarter, there was a lot of enthusiasm going into the summer and feeling that September will be a strong quarter and a recovery here we come. But as the June quarter progressed, the mood had changed and exiting the June quarter, the mood was largely negative in the September quarter.

So for us, we saw a nice recovery in revenue from the trough in December quarter and we have nice growth going from 230 to 270 between December quarter and June quarter. But then going into September quarter, we saw softening as the mood for the September quarter has shifted, and is largely persistent. What we are seeing today is a lot of kind of just in time orders, very fast kind of short cycle behavior. It tells me a lot of our distributors OEMs, ODMs really don't know what’s the demand is and it comes in and they expect the fulfillment to be very quick. Right now it's fairly easy, because we have still the inventory and we can respond relatively quickly.

Our Discrete business, which is one of the businesses, it can respond to quickest because of the shortest lead time. We saw a big pop in the June quarter, because the feeling was, the mood shifted that things are getting better and it opt, the mood shifted for the September quarter, the demand dropped. But going into the September quarter, we just reported about a week ago, and we are seeing lower quarter than the June quarter mainly, we have a big exposure to industrial and appliance space, that’s where we are seeing the biggest weakness between Europe and China.

And the Discrete business, which because has a short lead times, it has some of the biggest upsides, people don't forecast, but it's generally becoming in weaker for September. Up for December, I tell you, I mean, what I am seeing right now is still a lot of very cautious attitude, people just kind of waiting to see kind of between now and the end of September, the December orders are going to start rolling in to the contract manufacturers and to the OEMs, and they are kind of taking wait-and-see attitude before they placed hard orders.

One area where we are seeing some increased enthusiasm is more on the kind of server side, but it's mainly driven by end of the year push to meet the annual numbers of the big server manufacturers as they try to meet their annual sales calls.

Unidentified Analyst

Okay and terrific.

Oleg Khaykin

And it's generally typical every year, December quarter, they try to get as much business as they can.

Unidentified Analyst

Okay, okay. I think what I’d like to do before digging into each of the specific product lines that maybe take a step back here and talk about, since you and [Alan] joined International Rectifier, can you just recount some of the changes you made to the organization and sort of where you are with regard to milestones of progress towards this initial changes that you’ve made?

Oleg Khaykin

Well, when we joined, we identified several major problems, one was the company after divesting $300 million business to be shared with top scale with the infrastructure and footprint that goes significantly bigger than it’s a scaled wood warrant. So the other thing was, there was a significant defocusing from Tier 1 customers to Tier 2 smaller customers, which obviously shrunk your volumes and markets. And the third one, there was growing product and technology gap that would fall needed to be filled especially in the MOSFETs and IGBT technology front.

So when we joined one strategy, I had three key elements, first one was to reengage with Tier 1 customers and win with them, that’s kind of volume drives, it drives volume win with the winners also so to say. The second one is to accelerate product development to close the product gap and technology gap. And the third one was the operational transformation, changing footprint of the company and bring greater level of external manufacturing versus internal.

I would say, the first two things have done very well and the company, we group kind of cycle and cycle about 50%. We’ve done very well in that respect. We have reengaged with all the Tier 1’s, we’ve got very nice attractive design win traction. The area where we’ve paused on was the operational transformation because of the market going back from 2009, pretty soon everything was riding on allocation. And to restructure your footprint, you need to transfer lot of technologies and it requires engineering resource at that foundries, as well as engineering resource internally and you need to have external capacity already in place before you shutdown your internal assets.

So that is one area that’s kind of get delayed and we put on hold. Now that we see, I think, we’re into a more prolonged downturn, or the weaker demand, which is prudent and it’s something we can move very quickly on to move forward with the operational transformation. And we announced in our earnings recently that we’re going to look to shutdown two fabs, one, very quickly within the next kind of three to six months, and the other one within the kind of 18 to 24 months period.

Unidentified Analyst

Okay. And can you just recall quickly for us. I think your expectation for cost savings for the El Segundo fab, is that about a point of gross margin, is that right?

Oleg Khaykin

About $10 million is roughly equates, it’s a $2.5 million a quarter, so roughly equates to 1% gross margin.

Unidentified Analyst

Okay. And then what’s your expectation for the Newport Fab?

Oleg Khaykin

It’s anywhere going to be between 1.5 to 2X of the, El Segundo has a much bigger site. But it’s also takes longer, because it does some of the processes that need to be transferred to the foundries before we can bring the productions down.

Unidentified Analyst

Okay.

Unidentified Company Representative

The El Segundo project is the process that will take us about six to eight months.

Unidentified Analyst

Okay.

Unidentified Company Representative

The Newport Fab will take us two to three years into different phases. So, obviously when we look right now at the savings, so the El Segundo is more visible to us. The Newport will take us…

Unidentified Analyst

Yeah.

Unidentified Company Representative

The few more weeks to finalize kind of the cost savings here and the overhead as you can see there. That is going to be way north of the $10 million of El Segundo savings.

Oleg Khaykin

So, the El Segundo was a much easier project, because it controls both fabs that are connected in El Segundo. So we actually over the last three years moved to the technologies, because we had both control of internal engineering resources and the capacity. So as a result we are able to move very quickly, because we have pretty much mere image both fabs in the second location.

Unidentified Analyst

Okay, terrific. And then are these costs just cash costs, or are there going to be other operational cost that…

Oleg Khaykin

Well, this is our cash cost savings clearly. So I mean, yeah, that’s a real operating cost of goods reduction.

Unidentified Analyst

So, it’s not a depreciation shift, it’s just a cash savings.

Oleg Khaykin

It’s a cash savings.

Unidentified Analyst

And then for Newport, is that also going to be COGS mainly, or is there also OpEx savings in that as well?

Unidentified Company Representative

So, it’s mainly COGS, I mean, on the Newport…

Oleg Khaykin

Yeah. So our expectations is when we completed, we’re going to see, depending where you are in the cycle, when you are fully loaded, we’re going to see up to 2% to 3% expansion in the gross margin. So that puts us kind of from the high 30s and their last cycle to kind of 40%, 41%, 42% range, that’s our expectation today. And but the bigger impact is that the bottom of the cycle of the market demand drops, since you're going to have a much more fixed costs footprint, we expect 5% to 7% gross margin expansion on the gross margin during the down part of the cycle.

Unidentified Analyst

During the down part. Okay, understood. And then you’ve talked about COGS, what about some OpEx considerations as you are thinking through restructuring and adjusting to the winter demand environment?

Oleg Khaykin

Well, we started in the first half of the year, calendar year, so we are initially focusing on SG&A, so we’ve started implementing the number of changes. So we’ve reduced our SG&A during the first half of the year and we are going to see some benefits already this quarter too. We continue to do restructuring and reductions throughout the second part of the year and we’re looking to get it down to about $47 million exiting this calendar.

So overall, we probably take about 10% SG&A reduction over the last eight months. Furthermore going forward, we continue to extract efficiencies out of our ERP implementation and we intend to keep that SG&A level, those levels, even as revenue starts to recover and we have to pay greater commissions, shipping costs, bonuses and so on as we extract further efficiencies out of our SG&A structure.

Unidentified Analyst

Okay.

Unidentified Company Representative

And the new reduced level of SG&A and OpEx in general, I mean, it’s still under the basis that, the market really cover, and we’ll get back to the $310 million and $320 million per quarter, and we can serve with the same level of OpEx, that higher level of revenue.

Oleg Khaykin

And we have taken down R&D down by 10% from $35 million to $32 million a quarter, partially by leveraging, we had to do a lot of a catch up, so as a lot of the new platforms got launched. Our level of burn rate is going to decrease and we are redeploying new resources and reducing some resources in various areas.

Unidentified Analyst

Okay, great. So it sounds like a lot of operating margin leverage once revenue begin moving or...

Oleg Khaykin

Correct.

Unidentified Analyst

Now, I think you mentioned the 50%ish revenue growth in the ‘09 timeframe, you had a very strong cycle-to-cycle growth into 2010 as well. I think a lot of that was driven by applications related to short production as we are benefiting from a pretty strong ISM in PMI environment.

Now, we’re in a different sort of an environment more driven by mobile application growth and less by industrial growth. Can you just comment on sort of the bifurcation you are seeing and where the growth is coming from in the semiconductor market and talk a little bit about how you are thinking about aligning towards that growth?

Oleg Khaykin

Well, I think if I look at where we are in the kind of power semiconductor, there is the bifurcation here happens really between the something that’s top 20 volt power silicon, that’s really what goes into the mobile devices and about 20 volts, right.

And it’s also looking at the power kind of 3 amperes and below, or about 3 amperes. IRF has historically been very strong on the upper half and that's mainly kind of starting from the laptops and going up into the servers, routers, and then industrial, pumps, motors, infrastructure, that’s still the area where we are very strong, and we are actually now one, the big area of growth in that core segment is the automotive, because as you’re getting more and more power silicon, electrification in the car, the electric drive, hybrid drive, it’s consuming an exuberant amount of power silicon. And it’s, usually the silicon of the highest quality exactly the kind of business you want to be in.

So in that respect, if I look at also the fragmentation in this market, I mean some of the biggest players barely over 10%. So, you can say, while, so clearly a mobile has been the great market right, but you got to set yourself, how quickly you want to get into the mobile and do you have what it takes, would you be the 30th, or 50th company in that space with very little capability, or you better off going so-called so say, go north and take greater share in your core segment.

From where I sit today, I actually think we have lesser path of resistance to taking share in our core power silicon market, where a lot of our competitors are all now chasing the magic kind of wireless factor. And it's great, I mean it’s a lot easier for me to steal $10 million, $20 million of existing power silicon market, while everybody is looking the other way than go and develop a whole new platform into mobile space.

That said, we do have capabilities to work our way towards the, maybe not quite the mobile phones by the mobile computing, or the Ultrabook. And the area where we’re going to leverage, technology that we have today is digital power management. We acquired a company called CHiL about a year and a half ago. It’s a digital power controller and what we’re seeing is, wholesale migration to digital power management initially started with servers, but it’s very rapidly now being adopted in the desktops, laptops, and ultra books.

And we see getting into that kind of lower level of power from our perspective as kind of higher edge of the mobile electronics like Ultrabook type applications and maybe even tablets with a more integrated digital power controller.

So that’s probably the area that we would first target from the mobile computing perspective.

Unidentified Analyst

Okay, that's very helpful. And then maybe, if we dig into some of the other larger business segments, energy saving products, enterprise power, if you were to sort of orderly rank what you think offers the strongest growth prospect, how would you do that?

Oleg Khaykin

Well, so I’ll look at it, let’s just have a look at our last three years. One of our biggest wins in our sales has been our energy savings products. We went from the mid $30 million per quarter revenue run rate in the March quarter of 2009 to about $75 million, $77 million run rate last June quarter. So it was a great, while it was growing very rapidly. Well unfortunately, in the last three quarters, it’s been the biggest headwind for us as the industrial production plummeted in Europe and consumer wide goods and appliances slowed down significantly in Asia, because that business unit mainly focuses on the higher power like 600 volts and 1,200 volts applications that go into the industrial power.

So the typical customer spend are the lot of European machine tool manufacturers kind of infrastructure manufacturer OEMs. And guess what? They sell most of those products to China, they go mainly into infrastructure. So as China slowdown and pulls back on their build out, they got hurt. At the same time, the China slowdown, the consumer confidence got hurt. So the first thing is people cut are the consumer durables. So the wide good sales has come down significantly and given that they had fairly high growth rate, lot of the OEMs have overbuilt and finished goods inventory and they’ve been largely in the last three quarters working their way out of that inventory.

So I would say in the last three quarters of it, business unit has gotten the most of their headwinds for our business units, but just as it was suffering the most and last three quarters that business has to recover, it may actually be one of the businesses that’s going to do well for us. And the other businesses, they are doing very well for us is the Enterprise Power actually this quarter, they are looking at their best quarter ever, and that is mainly computing, servers, routers, communication equipment and they are a lot of the business practice driven by high performance power silicon, as well as the digital power controllers.

Unidentified Analyst

Okay, great. And then if you could help us understand just the differences between the base power businesses in terms of PMD?

Oleg Khaykin

Well, PMD, it’s fundamentally a discrete business. We sell low voltage MOSFETs and mid voltage MOSFETs. So they go anywhere from computing, consumer electronics to a power tools and industrial, battery, power supply market, right. And this business unit has the shortest lead time, because making a MOSFET, it’s a one of the shortest production processes in the semiconductor value chain.

So if you are a OEM, or a distributor, and you have uncertainty about the near-term demand, while the first thing you want to do is, reduce your inventories and convert as much as possible to cash. So when you have to make a decision, which product you want to reduce the inventories on first, you are not going to reduce inventories on long lead time MAC ASICs, where you have 12 to 14-week lead times. You would rather take something like MOSFETs where you have six to eight weeks, or even two weeks if I have dye band.

So the first thing they do is, they absolutely, if their (inaudible), they zero out orders in the next quarter, because they feel like even if they make a mistake, the worse they are going to hurt is maybe six to eight weeks. Rather if you cancel inventory on ASICs, you are pretty much out for a quarter. So from our perspective that business is very volatile, it’s a first business where that you get slammed when the demand slows down or uncertainty increases, but it’s also the first business that snaps back when things become bright. So it’s kind of, it’s a proverbial canary in the mine shaft.

Unidentified Analyst

Okay. Now, if we talk about longer-term growth rate across the ESP and Enterprise Power and PMD and Automotive, how would I rank over the next three years?

Oleg Khaykin

Over the next three years, I think, given that ESP is right now, it’s fairly dropped to a fairly a low base, I mean they will naturally have a nice strong recovery. I think the Enterprise Power is going to be the second business in terms of growth expectation, just from the all the design win traction they are getting into next generation servers, so that business coverts to the more digital controls servers. They will get a nice pop, as well as some of the computing wins they have had. Automotive is going to come in pretty strong, and I think we’ll continue to grow our PMD business unit, so kind of in that order.

Unidentified Analyst

Okay.

Oleg Khaykin

And the high rail, it’s a high rail, it goes up and down with the GDP, so it doesn’t really go down, but it also doesn’t really snapback, or grow crazy…

Unidentified Analyst

Okay.

Oleg Khaykin

On a given time.

Unidentified Analyst

Understood. I want to see if I could switch gears for a second and talk a little bit about the target profitability model [Alan] and I think Oleg referred earlier to a 42% gross margin target. Can you remind us, is that your official gross margin target range and also what you think in terms of target operating margin as well?

Unidentified Company Representative

So, yeah, this model is still kind of our target model having kind of the low 40s in the gross margin, high teens, mid to high teens on the operating margins. If you think about the first half of calendar year 2011, when we started to hit kind of the up cycle, which based on the microeconomic was not sustainable, but when you think about the tradition of six quarters kind of up semi-cycle, we did get to a high-30s on the gross margin, with the operational and transformation that Oleg just described, we believe that we definitely can gain the additional margin to get to the low-40s.

In terms of the OpEx, we do target to hold the line on the $47 million on the SG&A and about $32 million, $33 million on the R&D. So overall, it does imply additional savings even in the up market, and with that steady state of about $80 million per quarter, it will get us through the mid to high teens on the operating margin.

Unidentified Analyst

Okay. And if we look at where we are with gross margin today, getting to your target range implies a pretty significant improvement, how do we think about the drivers behind that, especially considering that inventories high and utilization fairly low right now?

Unidentified Company Representative

Right. So in the first, two or three quarters, in the next two, three quarters, we’ll continue to balance between the elevated inventory levels that we carry and the utilization rates in our manufacturing footprint. So it will take us probably another two to three quarters to continue to burn that inventory to a more normalized level. And then, we'll definitely get the leverage on the gross margin from there on from the high utilization rates. And then obviously, the mix also with the new technologies will get us back to that targeted gross margin.

Unidentified Analyst

And can you remind us where you stand in terms of manufacturing internally versus externally and what you're doing in terms of balancing your supplier relationships while also doing what's in your best interest to reduce inventory?

Oleg Khaykin

So, I mean, about three years, four years ago when we started this process 98% of our wafers came from internal factories. We have set an aggressive goal to increase our external sourcing up to 30% over the cycle, and it's kind of the peak cycle we got close to 30%. And that was pretty good achievement, going within three years from 0% up to 30%.

As we reduced the internal footprint, first step would be just, we can get back to that ratio and then take it on to up to 50%, 50-50 mix on a front-end and 70-30 mix on a back-end. So we are already at 60% external, 40% internal, and we look to probably take it further to 70%ish external to 30% internal on the back-end manufacturers assembly and test.

My view is whenever you have hard times, you have to make two decisions, one thing as you can really reduce inventory very quickly by just shutting down all the productions, the problem is you don't have inventory in every single product. If you shutdown your factories and take down production, you'll actually going to end up disappointing lot of your customers, and memories are long, and it’s going to cost you goodwill and the market share today.

So you cannot really shutdown the factories and besides in semiconductor manufacturing once you shutdown the factory, it takes you several quarters to bring it back up, because a lot of your employees leave, they don’t come back and then you're going to have a lot of quality and start-up issues. So that’s one thing, the other one, it’s okay, well, I’m just continue running my factories at higher utilization and I'm going to have better margins, I'm going to be profitable, but I'm going to start moving cash from balance sheet into inventory and that’s a very dangerous scenario turned up as well.

So the balance we are trying to strike is as I’m sitting right now, there is a lot of uncertainty in the next couple of quarters, right, and say, well, what do I do with my private business? Well, I would want to grow cash from my balance sheet. So what we are doing is yeah, maybe we are underutilizing our factories, but they are still running at basic level of efficiency, but it’s maybe costing me in the gross margin, but at the same time I am reducing inventory and converting into the cash. So in fact, last quarter even though we are a negative operating income, our cash flow went up by $20 million on our balance sheet.

So these are the levers you are trying to balance. For me, cash was king whenever you are in an uncertain environment and yeah, I’ll have lower utilization, I have lower gross margin, but to me extracting cash out of working capital is more important that strategy to line item pursuing. Now, it will take maybe a one to two quarters longer to workout the inventory, but once it does our utilization will come up, because even at current revenue levels once the inventory has gone, we will be running just to maintain current revenue levels, we will be running at fairly high utilization and the margin will expand up to the mid-30s, and we actually will be break-even as low as what 260% and 30% gross margin.

Unidentified Analyst

Okay. And just a follow-up on that question right now where is your utilization then internally on the front-end?

Oleg Khaykin

This quarter it’s dropped down quite a bit. I mean last quarter we, when you think about utilization, you got to always look at the quarter before.

Unidentified Analyst

Right.

Oleg Khaykin

Because whatever utilization you have this quarter is based on the decisions we did last quarter. So last quarter our utilization pops to about 80%, because the end of the March quarter we saw a very strong demand going into the selling a lot of optimism about the fall, so there more wafer started as the move deteriorated in the June quarter we took the wafer starts down significantly, but the utilization came in higher, because of the wafer that’s going through the fab.

Now, this quarter we are going to see a significant drop in utilization does, the wafer that’s drop that started in the June quarter peculates through the supply chain into this quarter. And we continue to maintain this quarter much lower level of wafer starts to be able to flush out all the excess inventory.

Unidentified Analyst

And what’s your expectation heading into next quarter than whether you would?

Oleg Khaykin

I think over the next two quarters, we expect our inventory to come into the levels where we are comfortable with it.

Unidentified Analyst

And so with regard to utilization does that mean.

Oleg Khaykin

Probably around, to maintain – we are close to about 70%, a little bit, but lower.

Unidentified Analyst

Okay.

Oleg Khaykin

Most of the consolidation of the El Segundo fab will lower (inaudible) that will serve another kind of tailwind to the user….

Unidentified Company Representative

They are shutting down fixed assets actually reduced to some of the strap from the under utilization.

Unidentified Analyst

Okay, great. I wanted to give an opportunity for some of the audience to ask questions. If they had questions for International Rectifier.

Question-and-Answer Session

Unidentified Analyst

Okay, maybe I got a couple of more questions one of them is on your thoughts around buyback that stock is pull back, you guys have a very adequate cash level, what’s your thinking on keep that level of cash on the balance sheet as opposed to deploying it either in a buyback or a longer term in a dividend.

Oleg Khaykin

Yeah, so you know we already laid out kind of our capital allocation model, three years ago, which we continued to operate under the same capital allocation model, which closed for about 40% kind of operational needs ongoing working capital maintenance of our manufacturing footprint.

And other 40% is investments upgrading some of our manufacturing capabilities from 6 inch to 8 inch investing in some IP and the CHiL acquisition that we did last year and with the remaining balance, originally we kind of discussing whether we should kind of initiate any dividend or buyback that we decided that it will be why more suitable with cyclicality in the semis and power end markets to compliment it with the buyback, the board approved $150 million buyback plan, and so far we have purchased about $105 million, $108 million out of the $150 million, in the last three, four years the average buying price was about $18.5 which overall we try to be opportunistic.

So we only buy in the open market and we try to see when do we believe there is some weakness out there with the share price and these are the times that we try to be a little bit more aggressive.

Unidentified Company Representative

One thing you can be assured in semiconductor space there is always going to be a down cycle?

Oleg Khaykin

Yeah there will be a down cycle.

Unidentified Company Representative

As much there is always going to be an up cycle.

Oleg Khaykin

Yeah, so you the same strategy we’ll continuing on, now we believe that’s its kind of a weakness in, we will continue to operate in the same fashion that to be more opportunistic order.

Unidentified Analyst

Okay, terrific. A couple of other questions I had just okay.

Oleg Khaykin

So we had no debt and it was $385 million cash, cash and investment portfolio kind of short term mainly.

Unidentified Analyst

(inaudible).

Oleg Khaykins

Well, there is a very low.

Unidentified Analyst

So I just want to repeat the question, the question was on the inventory and if you are able to produce your inventory levels?

Oleg Khaykins

Many of it perishable.

Unidentified Analyst

Yeah, okay.

Oleg Khaykins

So, I think one thing to understand about our business, it’s not a, you’ve got to look at by business units right. So enterprise business unit your whole product portfolio turns every 2.5 years, because it’s followed very closely internal architecture right, so and it’s actually one business units where we have almost [two in the ferry], so there is very low risk factor, all the other business units your product life cycles are five to seven years. So the risk of perishability is very low on those products, so if I don’t tell it today, I will tell it tomorrow most likely. There are some components here, and they are about think they been already fully reserved.

Unidentified Analyst

(inaudible).

Oleg Khaykins

There is a – you could see some degradation but generally it’s not inapt that it’s full below your production costs that you have write things off.

Unidentified Analyst

And so maybe another way to ask the question as well as, how will you evaluate your own approach to dealing with distributor in managing channel inventory because I know coming into the company four years ago, that was one of the areas where you really want to improve versus prior management, how would you could seek yourself in terms of your success in doing…

Oleg Khaykins

Well, I think we’ve done a very good job, I mean one of the things that kind of perennial problem in semiconductor industry is the channel staffing, because you have a sales plan and even there is no demand, people would drop the price, the given sense is just to move product into the channel, while you are doing you’re just selling next quarter’s revenue right, you’re destroying your pricing in the market. We take a much more prudent approach, we see a lot of crazy behavior going in the market, we generally do not participate and because it did see kind of one-off by deal, all you’re going to do is destroy your pricing, that takes you so long to build, and generally you even really gain much sustainable advantage by dumping a product, but what you’ve done is, you have created expectations, then it becomes very difficult to work where we are.

So I think we’ve and actually what I find out, a lot of your distributors don’t like it either because it kills their margins, right and then. What do really happens when you do these aggressive pricing and trying to move inventories, your end customer don’t really buy because they don’t want it, they don’t want it. Tell me, how many procurement guys will take a 5% discount and increase their inventory, they are still going to cut their head off, if they increase inventory. They are trying to work that inventory down.

So, who picks up this product? Usually brokers. And where do brokers down this product, they will go and find the markets where you are making your highest margin in Europe, South America, and North America and before you know it, that product is popping up two quarters later in the markets where you’re dividing your biggest profit and all you've done is cut off your juggler, right, kind of cut off your nose to spite your face. So when we look at it, we’ll look at very specifically if there is a weak market, and we are not idiots, we will realize the, you’ve got to get some discount to incentivize customers, because there is many offers.

If we look at the some contract manufacturers, and if we see a concrete sale that they’re going to consume and we don’t have that business anyway, we may give a one-off type of incentive rebase, but it has to be shown that it goes to the ultimate consumption and the product is out of the channel.

We will never give the incentives where all it does is moves from one warehouse into another warehouse and then pops up in the grey markets all over the place. And actually it has won us a lot of loyalty from distributors, because think about right. They generate demand and they get the registration and they get commissions on that. If somebody comes into their territory and undercuts them with exactly the same product, they get pretty ticked off and they don’t push your product after a while.

Unidentified Analyst

And so as a result, the pricing trends you are seeing today …

Oleg Khaykin

I think this is much more casino, if you look at the semiconductor cycle, generally you've got six quarters of upside demand and then two quarters downside. You don’t do stupid things in two quarters that will jeopardize your six quarters.

Unidentified Analyst

Okay. And then my last question is, in terms of leading indicators that you are looking at now in terms of what you are seeing from China demand in terms of what you are seeing in broad order rates? How are you thinking about demand heading into the fourth quarter?

Oleg Khaykin

I think I mean, it’s too early to tell. But I mean, I'll see what, after everybody kind of reviews their inventory, because inventories in the channel are pretty limited. And I know the OEMs and ODMs don't hold inventory now. So as they get an order, it’s like travels faster than the speed a life to get the request, do you have any products on hand, right. So but I think overall, I don’t expect much to change in China. I think it’s going to be anemic for the next couple of quarters. I think it looks like, we’re not going to make any decisions until they have the change of the government.

I think North America, independent who wins, you've got six to nine months of inactivity from the government. And Europe, I think it’s still going to be a basket case a year from now what it is today. So I think if anything it looks like you are going to be relying on the organic recovery in the market. I think supply and demand comes slowly into balance. That’s the scenario under which I am operating this slide. So the good time to really do a major reorganization of the factory.

Unidentified Analyst

Right, okay. And so just to complete that thought on China demand, do you see additional downside risk, or are you seeing any signs it all of green chutes appearing?

Oleg Khaykin

Well, I should never say, never. But I think at this point, most of the downside risk is fairly transparent and has been kind of worked itself out.

Unidentified Analyst

Okay, okay, terrific. I think that approaches our time limit. Thank you, Oleg. Thank you Alan. Thanks.

Oleg Khaykin

Thank you.

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