Q3 2013 Earnings Call Transcript
Transcript Call Date 04/29/2013

Operator: Good afternoon. My name is Samantha, and I'll be your conference operator today. At this time, I would like to welcome everyone to the International Rectifier Third Quarter Fiscal year 2013 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. Thank you.

I would now turn the call over to our host Mr. Chris Toth, Investor Relations. Sir, you may begin your conference.

Chris Toth - Executive Director, IR: Thank you, Samantha. Hello and good afternoon. We all welcome you to the International Rectifier Conference Call. On the call today are Chief Executive Officer, Oleg Khaykin; and Chief Financial Officer, Ilan Daskal. I trust you've all seen copies of our press release which was published about an hour ago. If not, the press release can be found on our website at in the Investor Relations section.

Before we begin, I would like to remind you that except for historical information the matters that we will 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, level of bookings, the timing and introduction of new technologies and products, general semiconductor industry conditions and the overall economy in financial markets. In addition to these risks we refer you to the risk factors included in our press release that we issued about an hour ago and in our most recent SEC filings.

I would also like to mention that in addition to reporting our GAAP financial results, we're presenting supplemental non-GAAP financial data. A reconciliation of the non-GAAP to GAAP measures set out in our release and discussion today can be found in our press release and our website.

We believe providing non-GAAP measures combined with our GAAP results provides a more meaningful representation regarding the Company's operational performance. Our non-GAAP presentation and EPS calculations exclude certain items, such as restructuring and severance charges, amortization of acquisition-related intangibles and certain discrete tax items among others.

Lastly, I would like to highlight the following upcoming events on Tuesday, May 14th; we will be attending JMP Securities Research Conference in San Francisco.

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

Ilan Daskal - CFO: Thank you, Chris. Good afternoon and thank you all for joining us. For the first quarter of fiscal 2013, IR reported a revenue of $224.3 million, which was about flat compared to the prior quarter and 9.6% decrease from the year ago quarter. Gross margin was 24.3%. The gross margin increase from the prior quarter was primarily due to better mix and manufacturing efficiencies.

Overall, GAAP net loss was $21.2 million or $0.31 per share for the quarter. This compares with a GAAP net loss of $32.7 million or $0.47 per share in the prior quarter and the GAAP net loss of $2.5 million or $0.04 per share in the prior year quarter.

Non-GAAP net loss was $19.8 million or $0.29 per share for the quarter and non-GAAP net loss excluded $900,000 of asset impairment restructuring and other charges, amortization of intangibles of $1.7 million, and the net tax benefit of $1.1 million. This compares with a non-GAAP net loss of $30.3 million, or $0.44 per share in the December quarter, and a non-GAAP net loss of $14.9 million or $0.22 per share in the March quarter of last year.

Moving on to operating expenses; for the March quarter, R&D expenses declined to $28.9 million, which represented 12.9% of revenue. SG&A expenses declined to $43 million and represented 19.2% of revenue.

Amortization of acquisition related intangibles was $1.7 million. During the quarter, we recorded $900,000 in asset impairment, restructuring and other charges.

GAAP tax for the quarter was $1.6 million expense, excluding a net tax benefit of $1.1 million, mainly due to a one-time release of tax reserves and adjusting for net tax effects on one-time items, our non-GAAP tax expense for the quarter was $2.7 million.

Turning to the balance sheet, total cash, cash equivalents, and investments increased $20 million to $403.4 million at the end of the third quarter, which included $1.4 million of restricted cash.

During the quarter, we decreased inventory by about $29 million from the prior quarter to $231.7 million. Weeks of inventory decreased to 17.7.

In the March quarter, we generated $33.2 million in cash from operating activities, mainly due to improved working capital.

Cash capital expenditures for the quarter were $12.9 million or about 5.7% of revenue. Free cash flow was $20.3 million.

Depreciation and amortization expense was $22.8 million, and stock-based compensation was $5.3 million.

Now moving on to our outlook; I would like to point out that there is 14-weeks in our June quarter this year as part of our fiscal calendar. We currently expect revenue for the June quarter to be between $255 million and $265 million. On a 13-week normalized basis, this translates to a revenue range of $237 million to $246 million or 6% to 10% increase from the prior quarter.

We currently estimate gross margin for the June quarter to be between 28% and 30%. Utilization and mix improvement are driving gross margin expansion. We expect R&D expenses to be about $32 million. SG&A expenses are expected to be about $47 million. OpEx of $79 million is a result of the 14-week June quarter. On a 13-weeks basis we are on target with our goal of about $75 million.

Amortization of acquisition-related intangible is expected to be about $1.7 million. For the June quarter, we expect approximately $1 million to $2 million in restructuring and other charges resulting from the reciting of our manufacturing facilities and other cost reduction efforts. Other expense net is expected to be about $1 million. Tax for the June quarter is expected to be about $4 million expensed, mainly due to foreign tax accruals. And finally we expect our cash capital expenditures to be about $15 million.

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

Oleg Khaykin - President and CEO: Thank you, Ilan. During the March quarter, we managed to significantly reduce our inventory, continued to execute on cost reduction initiatives and increased our cash balance by $20 million. During the quarter all of business and markets saw significant improvement in booking trends, both our three and six months bookings continue to trend higher at the same time last quarter, giving us optimism that we are seeing a steady rebound in business demand.

Geographically, for the March quarter, Europe increased significantly as we saw encouraging signs of stabilization and inventory replenishment, particularly in the automotive and industrial. Both Americas and Japan remain steady and Asia declined modestly mainly impacted by seasonal weakness in computing and consumer demand and that offset increases automotive, industrial and appliance end markets.

Moving onto our business unit, as expected the Enterprise Power business unit revenue decreased significantly to $20.5 million, mainly due to weakness in the computing end market. That said, we expect Enterprise Power revenue to rebound significantly in the June quarter. We have secured strong design wins on the Haswell platform and in Romley server programs that are expected to start ramping in the June quarter. In the second half of 2013 design wins in gaming and on the Brickland server platform are also expected to contribute.

For calendar 2014, we remain well-positioned on the Grantley server platform as Tier 1 customers adopt their digital power management solutions. Design win activity to-date has been strong and we expect to increase our share relative to Romley. Our Power Management Devices business unit revenue increased 2% from the prior quarter. The increase was mainly due to a pickup in industrial and power supply demand that offset weakness in computing and consumer end markets.

Our MOSFET inventory is lower and we are starting to see initial signs of lead time expansion in certain product lines. We currently expect revenue in the June quarter to grow significantly, driven by seasonality and market recovery.

Our Energy Savings Products business unit revenue increased 21% compared to the December quarter, buoyed by a recovery in orders in both the industrial and appliance end markets, particularly in China. The past six quarter notwithstanding, we believe the secular trends towards energy efficient variable speed motors is here to stay and as such, believe our investment thesis in this market is as strong as ever.

Penetration rates of these products throughout the world remain low, and in many cases, our products enabled the cost of variable speed motor to be equal to a single speed motor while offering a significant improvement in energy efficiency. For June, we expect another significant quarter of growth, OEM inventory levels particularly in industrial and appliances have come down significantly and we believe our current shipments are more in line with the end market demand.

Our Automotive Products business unit revenue increased 9% compared to the prior quarter, mainly due to broad market strength and new product ramps. The Automotive end market continues to remain strong for us, and our design win activity continues to exceed historical levels. We continue to see Automotive as one of our strongest and long-term growth drivers at IR, and for June, we expect Automotive to increases as revenue is projected to reach record levels.

Lastly, our HiRel business unit revenue decreased 7% compared to the December quarter. The decline in revenue and gross margin was primarily due to production issues associated with a fab transfer. We are working to complete fab transfer and product re-qualifications and we expect June revenue to increase back to the high 40s level. We expect gross margins to recover to historical levels over the next several quarters.

Overall, booking and backlog continue to be strong in all of our HiRel markets and we continue to see steady long-term growth in our business.

Now an update on channel inventories. During the March quarter sell-through increased to 7% compared with the December quarter. Sell-through outpaced sell-in last quarter as a result and of the results, we decreased channel inventory in absolute dollars and reduced overall weeks to 11.

During the March quarter, we continue to prioritize inventory reduction at the expense of gross margin. As such over the past two quarters we actively reduced inventory levels by $53 million. Now with the business conditions trying to improve we are increasing utilization to production levels that are in line with product shipments.

Combined with our Fab footprint resizing manufacturing efficiencies and improving product mix our gross margin recovery is striking ahead of earlier expectations. Now I'd like to provide a few updates to some of our ongoing initiatives.

Over the past several quarters, we took a number of strategic actions to reduce our manufacturing footprint and optimize our supply chain. Our El Segundo facility is now closed and our Newport resizing remains on track. With these restructuring actions our internal capacity is expected to scale to about 850 million per year depending on mix.

We also started to look at areas where we could further increase efficiencies in our manufacturing. This includes accelerating our long-term manufacturing plant to target up to 50% external manufacturing on the front end and up to about 70% on the assembly and test. At the end of the March quarter, we were slightly – we have slightly exceeded our target on the assembly and test.

We believe this actions will allows us to more effectively scale the business, manage inventories, reduce volatility in the down cycle and expand our margins. In the March quarter, we made further progress in reducing our OpEx. Our goal is to maintain OpEx at about $75 million quarterly level as we grow revenue to about $300 million to $315 million per quarter.

In conclusion, our design win traction continues to gain momentum and long-term business drivers such as automotive electrification, adoption of variable speed motors, digital power management and gallium nitride are strong. We have significantly reduced our fixed cost and remain confident in our strategy that we're starting to see the positive results from the actions we have taken.

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

Transcript Call Date 04/29/2013

Operator: Terence Whalen, Citi.

Atif Malik - Citi: This is Atif Malik for Terence. Can you provide the utilization levels for the March quarter and what are your expectations for the June and then to the September quarter?

Ilan Daskal - CFO: So, the utilization for March was in the 70s, we don't guide for the utilization going forward, but it's going to be higher than that.

Atif Malik - Citi: Then as a follow-up, is the management thinking about moving to a more flexible or variable compensation structure given lower operating margins versus some of your peers?

Ilan Daskal - CFO: I'm not sure understand, what's your mean by variable compensation structure?

Atif Malik - Citi: Basically, I'm trying to ask the long-term model for the Company given the resizing of the manufacturing facilities, like what's your long-term gross margin, operating margin target?

Ilan Daskal - CFO: So, what is your question, I really don't understand what you're asking?

Atif Malik - Citi: The long-term growth margin, operating margin target for the Company.

Oleg Khaykin - President and CEO: So, basically our long-term stays intact of the $1.25 billion in revenue and gross margin, high 30s to the low 40s as we progress with resizing our manufacturing footprint and we are trying to keep our – that's our goal to keep the OpEx at $75 million a quarter and that will get you to the operating level of mid-teens to the high-teens.

Atif Malik - Citi: Then, with respect to your bookings into the summer, I mean, historically in the last four years, we've seen bookings kind of moderate or come down in the summer, what are your expectations for bookings trajectory into the summer and why would things be any different this year versus last four years.

Oleg Khaykin - President and CEO: I don't know where you're taking the numbers from. Traditionally summer quarter is one of our stronger quarters for our business. So, I don't know where you're taking the data that summer is weaker. It's been actually opposite.

Ilan Daskal - CFO: We did indicate last time that we have a better visibility into the outlook of the bookings, I mean, do you know, it extended from the traditional last year – at least the 3 months to the 6 months. With that said, we do not guide and it's very difficult to assess how the second half of the year will shape up there, but definitely if the gradual recovery will continue, we believe that the bookings will shape up the same and seasonality reacts a little bit different this time and it's also defined by the end market.

Oleg Khaykin - President and CEO: Historically, summer quarter has been the stronger quarter for IR.

Operator: Jim Schneider, Goldman Sachs.

James Schneider - Goldman Sachs: If you look into your gross margin guidance for the June quarter can you give us any kind of sense about how much of the increase is being driven by mix and how much by utilization?

Ilan Daskal - CFO: So, Jim we don't really split the abnormal level that we were prior to March definitely contributes a lot to the improvement of the margin, but definitely the fact that we see more on the industrial end market you know an increase on the revenue there, helped a lot also this quarter specifically in the overall gross margin improvement. When you think about June definitely the continuation of having the better absorption doe help the utilization more than the rest of the components there.

Oleg Khaykin - President and CEO: So, I mean Jim also I would add I mean if you look as far as June quarter is concerned mix probably plays a little bit greater role than anything because remember lower utilization in June quarter is much stronger. You're still a caring of bulk of lower utilization from the March quarter in your P&L. So, actually the result of strong June quarter utilization will be more pronounced into the September quarter. So as far as the June quarter comes along the clearly better mix and higher utilization both play meaningfully, but probably I'd say mix gives you a bit better – more – takes a bit more credit that he normally would in the typical quarter.

James Schneider - Goldman Sachs: Then if you look at the pricing environment you're currently seeing certainly there's been pricing pressure for a while as we've been bouncing along the bottom of the cycle. Are you seeing any kind of changes in the pricing environment from competitors and specifically are you seeing any changes from your Japanese competitors, given the depreciation of the yen?

Oleg Khaykin - President and CEO: So actually Jim for the March quarter pricing pressure was not, again they almost not there. I mean it was the regular even below the normal price erosion that we are accustomed to. So, specifically for March, it's definitely different than what you've described that what we have seen kind of last year and before then.

Ilan Daskal - CFO: In fact, I would actually go further to say that we are seeing pricing is firming up as a lead times and inventories have been pretty much depleted, and a lot of distributors are sitting on very lean inventories and at least, I don't see anybody offering big discounts and with extending lead times and lower inventories, if anything we've seen people placing orders at the current book pricing. So, I think the aggressive tactical pricing is pretty much behind us at this time, who knows maybe somebody will come out surprise me. But at this point in time, we're not seeing any irrational behavior.

James Schneider - Goldman Sachs: And then just a final housekeeping question for me, which is in the quarter your gross margins in Enterprise Power segment went up significantly despite the 29% sales decline sequentially. So, can you explain what happened there?

Ilan Daskal - CFO: Well, I think in this particular it's really mix because we had a big revenue drop mainly a lot of the computing business one away. And Enterprise Power actually sources quite a bit of its manufacturing services externally. So, as a result, there is less of the underutilization burden on the Enterprise Power from our internal factories. Conversely, business units like Power Management Devices, Automotive and especially Energy Saving Products carry a greater underabsorption burden within our manufacturing facilities.

Ilan Daskal - CFO: The Enterprise Power, Jim, revenue actually is – it's just pushed out, as we said already in June, it's going to be up very nicely.

Operator: Alex Gauna, JMP Securities.

Alex Gauna - JMP Securities: Oleg, you touched on this a bit, I know you said that, the September quarter is historically or your strongest, last couple of years that turned out not to be the case. Can you maybe give us an idea in that six month backlog that's improving, what's working and what may be still on more shaky ground so we can think about what would drive it up versus a flat or down sequential in September in your view?

Oleg Khaykin - President and CEO: Sorry, I think it came out a little bit unclear. I said, our June quarter historically is our strongest and you're right, in the last two years, a lot of share was really – there was a lot of cancellations in May, June; and September came in weaker, but generally when the economy is solid, I think our September quarter and June quarter are pretty close and then generally when the market is enjoying a solid demand, September quarter is a little bit stronger than the June quarter.

Ilan Daskal - CFO: Alex, I would also add regarding September, I mean, first of all, obviously, we do not guide for September, but even taking a flat revenue from June which basically implies when you normalize the 14 weeks to 13 weeks, it does imply about a 7% growth between June and September. Even for that, we see for that level, we see a nice margin leverage due to the better absorption and the high utilization that we expect.

Alex Gauna - JMP Securities: And if I could ask about that Oleg, you mentioned that also previously with the higher absorption and utilization even on flat, you would expect to see a gross margin improvement. Can you give us some idea on what that might be and I know mix is going to play a lot in how that moves around, but how much gas is left in the tank just from absorption in terms of margin improvement as you see it going into the back half?

Oleg Khaykin - President and CEO: Well, I mean there's clearly a lot of gas left in the tank because we just started right. If you think about our March quarter we were still prioritizing inventory burn over utilization, so we had an abnormally lower utilization. It's picking up in June. It's going to continue to pick up in September if the market demand persists, but what you do and what you're getting is you're getting about one quarter lag in benefit of the higher utilization. So, we actually see margin – if let's assume that the markets stays good and does not get any worse throughout the year, we can see our gross margin expanding through the rest of the year, purely on the utilization.

Ilan Daskal - CFO: From trough to peak I mean just utilization there's about 9% leverage there.

Oleg Khaykin - President and CEO: That's right.

Ilan Daskal - CFO: So, and we're not yet there.

Alex Gauna - JMP Securities: And are you where you want to be in inventory or is there still a little bit more work down on that? And then one more if I could, you mentioned getting back to your or towards you're on a normalized quarter basis back towards $75 million in OpEx can that $75 million be achieved in September or is there still a little bit more time as you consolidate facility?

Oleg Khaykin - President and CEO: So, I'll start with your question on the revenue and I will let Ilan address the OpEx. So, looking at the our inventories, well we believe right now we are at balance between what we're actually producing and what it's being shipped by our customers. Also if you look at the June quarter midpoint of our guidance around $260 million. While, one thing about the revenue even though it's a 14-week quarter. Revenue does not always come in linear. So, really your true, growth rate is somewhere between in terms of being purely linear and being more towards the backend loaded, right that's how our customers place their orders. So, if you take $260 million, as the number and recalculate how many weeks the current level of inventory in the channel translates to, what's 11-weeks of inventories on $224 million is significantly fewer weeks at $260 million run rate even if you discounted or normalized it for the 14-weeks. So, as a result, we feel the level of inventories that we're currently carrying and the production levels to which we are planning much better in line with what the end market demand is representing.

Ilan Daskal - CFO: Alex First, I'll address the inventory question also that you had there, generally speaking, we target to be at about 16-weeks, with that said, we had 17.7, but if you kind of break down the inventory into the different business units, obviously in the end markets, some of those, they've already normalized in terms of the level of inventory that we carry and therefore all have already indicated for the extended lead times in those parts, and in others we're still working to reduce little bit more, but we are not far apart from that, I mean, between 17.7 and the 16-weeks that we target to be at. To your other question on the OpEx, I don't guide currently for September, but the goal is definitely to get to (indiscernible) million in second half, could be also in September, but currently I'm not guiding for it.

Operator: Steven Chin, UBS.

Steven Chin - UBS: First question is on some of your comments on the European demand earlier in the prepared remarks. You mentioned that European market demand was up significantly. I was wondering if that's just – sort of for the near term here, as they replenish the inventory and especially given the macro backdrop, do you think that's going to normalize, maybe even soften up as we move into fiscal '14 here?

Oleg Khaykin - President and CEO: Sure. I think we all saw the article in The Wall Street Journal this morning and all those companies crying that their European business is not growing as fast and I think the emphasis was that the slowing growth. The reality for us was in the last year, year and half, a lot of our European customers were mainly focused on burning off inventory, so our demand for the component has dropped significantly and now that the demand and supply are more in line and inventories have been depleted. I think just purely returning to a more normalized run rate for the European demand represents a significant uptick on our quarterly run rate. So, that's what we mean by stabilizing as things are being more in line between supply and demand that are matched between, what's being shipped and what's being supplied.

Steven Chin - UBS: Then, my other question is on gross margins, when we look at the breakdown on the gross margin for different divisions. Obviously mix was a big factor in helping the improvement and also likely for the current June quarter. I was wondering are there any unique product ramps that are helping that to drive that mix up and will there be a potential reversal of those favorable tailwinds on the mix front, that may happen (indiscernible)..

Oleg Khaykin - President and CEO: Sure. So, clearly, one of the things that's really coming back is the industrial demand and that's where we enjoy generally better margins and the clear beneficiary of that is going to be the Energy Saving Products, that is the area where we have some of the biggest inventories that have been burned down significantly, and as a result, they are carrying the biggest share under absorption and it pushed their margins down significantly. Another business unit is Power Management Devices, and as industrial comes back the overall mix shifts and we should see further improvement in those margins, and of course, as our internal factories fill up, both front end and back end, Automotive is going to see much better absorption underutilization and we should see margins expanding there as well. So, I would say the three areas they're going to benefit the most from improved utilization and recovery in industrial automotive demand are the Power Management Devices business unit, Energy Saving Products business unit and automotive.

Operator: Amit Chanda, Wells Fargo.

Amit Chanda - Wells Fargo: This is Amit, calling in for David Wong. Oleg, in terms of linearity, could you comment on how POS sales progressed through the March quarter and if you saw any signs of restocking?

Oleg Khaykin - President and CEO: Well, I think the linearity, I mean, clearly in the March quarter, you had this dead spot called Chinese New Year. So, if you take that aside, I would say, probably end of January and kind of second half of February and March we're heavier at demand. Beginning of January it was lower demand coming after the Christmas Holidays. And restocking, I think we so much more restocking in Europe, we so much more portion in Asia, mainly due to the computing market weakness. But towards the end of the quarter and early in April, we actually saw Asia coming back and starting to place orders. As they saw lead times starting to stretch in some products lines and they clearly realize there is going to be no kind of end the quarter incentives coming from the industry, at least that's my view and trying to second guess their behavior.

Amit Chanda - Wells Fargo: And then as a follow-up. Can you maybe talk about your micro module launch and how that's tracking relative to your expectations and when we should expect micro module to start to contribute the ESP revenue in a material way?

Ilan Daskal - CFO: Actually, they are already contributing in a meaningful way and it's continues to ramp. So, probably I think – I would probably say already today, it's got meaningful percentage of revenue. It will be material share of ESP revenue over the next nine months.

Amit Chanda - Wells Fargo: And do you expect ESP revenue to naturally hit through the mid to high $60 million going into the back of calendar year '13 is that still reasonable expectation?

Ilan Daskal - CFO: I don't know but mid-60, but I mean judging from the momentum in all the segments revenue recovery. I think we definitely expect a significant snapback on the business unit throughout the remainder of the 2013.

Oleg Khaykin - President and CEO: Amit, obviously, we will caveat it with the micro situation. I mean we all experienced last year in the same time frame that, it did not materialize as we all expected last year in the second half of the year and we all like to be kind of remindful of last year.

Oleg Khaykin - President and CEO: It looks like there's no more questions. So, thank you very much for joining us today, and we look forward to speaking with you in person over the next several weeks. Thanks.

Operator: Ladies and gentlemen, this concludes today's conference call. You may now disconnect.