Power Integrations, Inc. (POWI) Q1 2013 Earnings Report, Transcript and Summary

Good day. Welcome to the Power Integrations First Quarter 2013 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Joe Shiffler, Director of Investor Relations. Mr. Schiffler, the floor is yours, sir.

Thank you very much. Good afternoon, and thanks everyone for joining us to discuss Power Integrations' financial results for the first quarter of 2013. With me on the call are Balu Balakrishnan, President and CEO of Power Integrations; and Sandeep Nayyar, our Chief Financial Officer. During today's call, we will refer to financial measures not calculated according to generally accepted accounting principles. Please refer to today's press release available on our website at investors.powerint.com for an explanation of our reasons for using such non-GAAP measures, as well as tables reconciling these measures to our GAAP results. Also, our discussion today, including the Q&A session, will include forward-looking statements, reflecting management's current forecast of certain aspects of the company's future business. Forward-looking statements are denoted by such words as will, would, believe, should, expect, outlook, estimate, plan, goal, anticipate, project, potential, forecast and similar expressions that look toward future events or performance. Forward-looking statements are based on current information that is, by its nature, dynamic and subject to rapid and even abrupt changes. Our forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied in our statements. Such risks and uncertainties are discussed in today's press release and under the caption Item 1A Risk Factors in Part 2 of our most recent 10-K, filed with the SEC on February 22, 2013. The conference call is the property of Power Integrations, and any recording or rebroadcast of this conference call is expressly prohibited without the written consent of Power Integrations. And now I'll turn the call over to Balu.

Thanks, Joe, and good afternoon. Our first quarter revenues were within our projected range albeit towards the lower end due in large part to a drop of almost 20% in sales for computer end market, reflecting the well-documented softness in the -- in that industry. Communications revenues fell by about 10% sequentially, as seasonal patterns were exacerbated by a sharp decrease in handset sales at a top-tier mobile phone OEM where we have a substantial share of the charger business. Sales into consumer and industrial markets increased sequentially by mid- and low-single-digit percentages, respectively. These markets, which account for nearly 70% of our total revenues tend to be better indicators of overall demand trend since they encompass a broad range of applications, customers and geographies. Whereas, a more concentrated computer and communications markets tend to be more prone to quarterly fluctuations. As further evidence of an improving demand environment, we saw a sequential increase in bookings up better than 10% in Q1, resulting in a book-to-bill ratio significantly above 1. We are seeing particularly strong bookings for our high-power IGBT driver products, which are focused on industrial applications providing an indication of accelerating demand at least in certain corners of the industrial market. Based on strong order trends, we expect high power to grow nicely in Q2, and we are equally encouraged by the long-term outlook for high power as the business builds momentum behind new design wins helped by an improving demand environment for infrastructure in China. Recent design successes include a new high-voltage DC transmission link in Southern China, multiple solar inverter projects and a large-scale DP link to Germany from an offshore wind farm. We are equally encouraged by design activity across our low- and mid-power businesses. Our new LYTSwitch family of high-voltage LED drivers has been extremely well received, thanks to its combination of high efficiency, reliability, ease of design and excellent dimming performance. Overall activity in LED lighting continues to be brisk with nearly 100 new designs won during the quarter with revenues up more than 30% from a year ago. In the mid-power market, which includes applications from 50 to 500 watts, our targets continue to gain traction in the range of applications, including street lighting, appliances and main power supplies for TVs and PCs. And we had multiple design wins in each of these areas in Q1. Energy efficiency is a major driver in this market, most notably, the new European limitation on standby power usage, which took effect earlier this year and is driving adoption of our energy-saving CAPZero and SENZero ICs in a variety of applications. Energy efficiency has been an equally important driver in low-power applications. In the first quarter, we won our largest design to date for a Zero standby application. In this case, a design for one of the world's largest TV makers. This is an example of an OEM going well beyond the requirements, tapping into growing awareness of energy usage among consumers and using efficiency to differentiate their products. We believe this is a long-term trend, and no company is better positioned than Power Integrations to take advantage. Before I turn it over to Sandeep, I'd like to touch on a couple of other recent developments. In March, we announced a new addition to our executive team. Radu Barsan has joined Power Integrations as Vice President of Technology and will be leading our technology development, foundry engineering and quality organizations. Radu was most recently CEO of a privately-held start-up company and previously held succession of engineering management roles at Cirrus Logic, AMD and Cypress Semiconductor. With more than 3 decades in the industry, Radu has an outstanding track record of commercializing new silicon and copper semiconductor technologies and leading engineering organizations at companies, both large and small. He's taking over responsibilities from Derek Bell, who will be retiring this month after 12 years with Power Integrations and a distinguished 4-decade career in the technology industry. Power Integrations would not be where we are today without Derek's leadership, and we wish him well. And we wish him the best in his retirement. Lastly, I'd like to note 2 key court decisions in recent weeks in our ongoing patent litigation against Fairchild Semiconductor. In late March, the Federal District Court in Delaware issued post-trial rulings in our second lawsuit against Fairchild following last year's jury verdict in which Fairchild was found to infringe 2 of our patents. In its first trial decision, the court not only confirmed the validity of our asserted patents, but also ruled that Fairchild infringed an additional patent, further expanding the list of Fairchild products subject to potential legal sanctions. Also in late March, a federal appeals court affirmed a lower court ruling related to our first Fairchild lawsuit in which Fairchild was found infringe several of our patents, a ruling that sustained a permanent injunction against more than 100 infringing Fairchild products. In its written decision, appeals courts stated that Fairchild had competed by reverse engineering and copying our products, noting that Fairchild had "fostered a corporate culture of copying." This stark language a court wrote of the original District Court ruling, in which the court wrote that Fairchild having engaged in "industrial stalking methods and blatant copying" of our products. In its decision, the appeals court did identify certain aspects of the case for reconsideration by the District Court including issues surrounding the calculation of damages. Nevertheless, we are gratified that the decision leads no doubt as to which 1 of these 2 companies is a true innovator. And we continue to believe that we are entitled to compensation for the harm done by Fairchild's repeated infringement of our intellectual property rights. With that, I'll turn the call over to Sandeep for a review of the financials.

Thank you, and good afternoon. Since Balu has already covered the sequential revenue drivers in his remark, I will start with gross margin and then quickly cover the remainder of the financials before we take your questions. Non-GAAP gross margin increased 10 basis points sequentially to 52.9% coming in above the high end of the expected range due to a favorable end market mix, reflecting the sequential revenue trends. On a year-over-year basis, non-GAAP gross margin was up more than 400 basis points due not only to mix but also our successful cost-reduction initiatives. On a GAAP basis, gross margin increased by almost 2 full percentage points to 51.7%, as we have now exhausted the inventory that was marked up in conjunction with the acquisition of CONCEPT last year. As discussed on prior calls, we see the possibility of a slight pullback in gross margin over the middle 2 quarters of this year, as our overall end market mix becomes a bit less favorable and as some newer products begin ramping in the second half. However, our gross margin does not yet reflect the recent upward movement of dollar versus the Japanese yen, which reduces the cost of wafers from our Japanese foundries. This benefit will begin flowing through meaningfully in the December quarter and should help offset the negative effects of a less favorable mix. All told, we now expect our full year non-GAAP gross margin to be in the range of 52% to 53%. Turning to expenses. Non-GAAP operating expenses for the first quarter were within our projected range at $26.3 million, up about $800,000 sequentially driven mainly by higher payroll taxes and the fact that the fourth quarter expenses were restrained by our year-end shutdown. GAAP operating expenses were $30.8 million, including $1.1 million of acquisition-related amortization expense and $3.4 million of stock-based compensation expense. Our tax rate for the first quarter reflect the outcome of last year's favorable resolution to our tax audit, as well as the reinstatement of the federal R&D tax credit. Specifically, the non-GAAP tax rate fell to just under 5% for the first quarter, and I expect it to be in the mid-single digits for the full year as well. Our GAAP effective tax rate was negative for the quarter, reflecting the retroactive application of the 2012 R&D credit, the benefit of which we excluded from our non-GAAP results. Earnings on a non-GAAP basis was $0.47 per share, flat sequentially but up 31% from a year ago due to the combination of higher revenues and gross margin, as well as the lower tax rate. GAAP earnings for the quarter came in at $0.37 per diluted share. We generated $21.6 million of cash flow from operations in the quarter and utilized just less than $4 million for capital expenditures. We also paid out $2.3 million in dividends during the quarter, reflecting the increase in our quarterly payout as announced in conjunction with last quarter's earning release. All in all, total cash and investments increased nearly $24 million during the quarter to $119 million. The rest of our balance sheet remains in excellent shape, particularly internal inventories, which decreased sequentially in terms of dollars and remains well within our targeted range at 107 days. Channel inventory increased during the quarter to about 6.5 weeks, mainly due to the abrupt slowdown in the PC market, which we serve primarily through distribution. As a reminder, we recognize distribution revenues on a sell-through basis worldwide for all products except IGBT drivers, so the increased distribution inventory does not create an overhang on our revenue growth for Q2. In fact, based on the favorable booking trends that Balu discussed in his remarks, we expect revenues of between $79 million and $85 million in the second quarter, which should be an increase of about 3% to 10% sequentially. Worth of that range reflects both the continuing uncertainty of the current macro environment, as well as the ever-present challenge of forecasting revenues given our sell-through revenue recognition policy, which applies to about 2/3 of our total sales. We expect non-GAAP gross margin to be in the range of 52% to 53%, while non-GAAP operating expenses should be approximately $27 million, plus or minus, $500,000. As mentioned earlier, I expect the non-GAAP effective tax rate to remain in the mid-single digit, while the GAAP tax rate for Q2 should be somewhere in the low single digits. With that, I will turn it back over to Joe.

Thanks, Sandeep. At this point, we'll open it up for Q&A. [Operator Instructions] Operator, would you please give the instructions for the Q&A session?

[Operator Instructions] The first question we have comes from Vernon Essi of Needham & Company. Vernon P. Essi - Needham & Company, LLC, Research Division: I just wanted to the revisit, Sandeep, your comments on the gross margin as it relates to the mix going into the second quarter. And I guess, as I hear it from your statements, you have a handset drop occurring, which would, in theory, sort of improve the mix. And then going into the third quarter, it's not clear to me what would be working against that, and then it almost seems that it washes out at the end of the year. Can you just walk through the mechanics of that again, please?

Yes. So as we had given guidance at the beginning of the year, we had expected our Communication business to increase, which, based on the macro trends and what happened with one of our key customers, that impacted it in the other direction. However, we still believe that the Communications segment will grow for us in the coming quarters. And given the -- what -- how mix can impact us, plus or minus, that's why you're seen the range we have given from 52% to 53% at this point of time. And as far as yen impacting us, that'll start happening us -- and benefiting us more in the fourth quarter, but as we had indicated to you, in the first quarter or so [ph] or beginning of the year, that we also have new product introductions coming in the second half. And typically, when new products come out, the margins are lower, and they have a kind of an offsetting effect to the benefit we would get from the yen towards the end of the year. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay. Can you remind us what the new product introductions would be specifically?

We don't generally discuss new products until they're out in the market. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay. And then just my follow-on question, a lot of attention paid to the LED industry recently at Lightfair a couple of weeks ago, and you obviously have a pretty sizable market share of the LED driver market for incandescents. It seems as though your growth rate has been consistent, but I'm curious. I know it's a question I suppose, but have you seen any signs that we are sort of at an inflection moment? We have a very -- obviously, a major North American vendor's now out there with a low-priced bulb. Have you seen any responses in the market that would lead you to believe revenue could accelerate in 2013?

Well, we certainly have seen signs in terms of the Lightfair and so on, a lot of activity, but in terms of actual revenues inflecting, we haven't seen that yet.

Next, we have Tore Svanberg of Stifel, Nicolaus. Evan Wang - Stifel, Nicolaus & Co., Inc., Research Division: This is Evan Wang calling for Tore. I was wondering if you can comment a little bit about the -- your TV design win. Could you give us some idea about maybe the timing of this design win, as well as the revenue potential?

Well, the -- timing wise, the design win occurred in Q1, and typically, it takes 1 to 2 quarters before it ramps up. It is the largest PC standby design win with Zero standby -- sorry, TV standby. What did I say? I said PC, sorry. So it's the largest TV standby design win we have won with Zero standby, and we are enthused because it's one of the largest TV makers. And they usually set the trend in the market, so we are very optimistic that other companies would go for Zero standby because of that. Evan Wang - Stifel, Nicolaus & Co., Inc., Research Division: And for my second or follow-up question, I'd like to ask about the handset that Vernon Essi mentioned earlier. At -- the California Energy Commission had put out a document talking about the California quality bulb. Could you comment on that requirement and whether you have any distinct advantage in fulfilling or for meeting that quality requirement for eligibility for the rebate?

Yes. We certainly meet all of the quality requirements of California Energy Commission, and I think what they're trying to do is make sure that the type of bulbs that are sold in California made significant minimum thresholds in terms of efficiency, in terms of efficacy, in terms of dimmability and so on and so forth. And it is in reaction to some bad experience that they've had with CFL lamps where there were a lot of lamps sold with claims of long life that didn't happen, and the quality of color was not so good. So they're just taking precautions. It's suffice to say, we meet all of those requirements.

The next question we have comes from Ross Seymore of Deutsche Bank.

This is Mike Chu for Ross. I know it's hard for you to see sometimes where your products are actually being used until after the end of the quarter, but on the softness that you saw in 1Q, in the Communications and competing segments from a handful of customers, do you see this as a pause? And should we expect to see some snapback in these areas on normal seasonality, perhaps continuation of the ramp in your design wins in both the handset side and on the PC power supply side?

I think I would agree because if you look at the decline in the computer segment of 20%, that seems like a little bit of overreaction because what happens to the supply chain, there may be inventories in different places, and since we sell to a power supply manufacturer, it is very possible that they are reacting probably more than they should be because of the slowdown. So that's a possibility. And that could also be true in cellphones, but it's hard to tell because there is so much fluctuation on quarter-to-quarter for various reasons. For one thing, we don't necessarily follow the shipments of chargers, again, because of the long supply chain and also the timing of purchase of chargers. Secondly, that market is volatile because the share of business that goes to a particular vendor can change quarter-to-quarter. Even their ordering patterns can change. They can buy a lot in one quarter and not buy as much in the next quarter. So it's very hard to determine on a quarterly basis what happens. It's much easier to say in the long term. We have -- we are very optimistic about this market because the trends in this markets are going in our direction, higher power, smaller size and so on.

Okay. And then on my follow-up, I just wanted to ask you about -- in your last call, you had mentioned some strength that you were seeing in China, that high level, we've been seeing a little bit choppier macro data out of that country. And I was wondering if you'd or seen any change in the environment there for your products.

Yes. We had 2 China customers ramping in Q4, and 1 of them is not as ramping as fast as we hoped. And the second one, again, that ramp rate is not as high as we hoped, so it looks like there was a slowdown in Q1. Certainly, the shipments of phones have slowed down across the board by, I think, low single -- double digits. So that has an impact at a macro level for us.

Okay. And on the -- I guess, on China, the industrial side as well, the IGBTs, any change in the demand patterns you're seeing from -- in that segment as well?

Yes, we are. It's actually positive. The IGBT driver demand in China is growing very nicely. We expect our high-power revenue, which is basically IGBT drivers, to grow in Q2 relative to Q1 very nicely.

The next question we have comes from the location of Andrew Huang of Sterne Agee. Andrew Huang - Sterne Agee & Leach Inc., Research Division: I guess the first question is, on the weakness in the computer end market, can you see -- say whether or not that was exclusively standby power supplies? Or was it primary as well?

Well, it was primarily standby power supplies. That is the largest portion of our revenue in the computer segment. The main power supply was also down but not to the same extent. It was down. The programs we are in were down, but we also got some new additional business. So the overall impact was less in the main power relative to the standby. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Right. Do you think that computers should rebound in Q2?

That's a good question. It's always hard to predict the macro market. If I assume that there has been some overreaction on the PC standby, it could potentially rebound. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Okay. Okay. And second the question, my follow-up is related to your TV design win, and you -- I guess, you described it as having Zero standby power. So can you show us how that works? Like you have the TV that's kind of waiting for the remote control signal. How do you have it running on Zero power?

Good question. It will be hard for me to explain that without going into technical details. But it's suffice to say that our LinkZero product is used to reach that Zero consumption, and the receiver for the remote control is still on, and it periodically checks to make sure that it's not receiving any signals. But most of the time, there is nothing going on.

[Operator Instructions] Next, we have Christopher Longiaru of Sidoti & Company. Christopher J. Longiaru - Sidoti & Company, LLC: So my question had a little bit to do with PC once again. In your opinion, at this point, judging from what you've seen going into April, would you call you're computing revenue kind of a bottom at this point? Or do you expect -- within your guidance that you gave for June, is there some continued weakness in PC?

Well, that's the same answer I gave earlier. It appears that this might be an overreaction. In which case, it could come back some in Q2 but no way to be absolutely sure. But in terms of share, we have actually grown our share in PC standby in Q4. So certainly, that would again indicate that there is a possibility it could come back given the level of decline we have seen in Q1, which seems to be quite a bit more than actual demand. Christopher J. Longiaru - Sidoti & Company, LLC: That makes sense. Can you comment on inventories and how they trended over the course of the quarter and into April?

Yes, I mean, we had slowed down a bit in the fourth quarter and pretty much if you look at -- if you're looking at our internal inventories, we are within that. Now as far as the channel inventories, obviously, they tended to go up during the quarter because of the PC abruptness that -- the slowdown that we saw, and that's why the weeks in the channel went up. Christopher J. Longiaru - Sidoti & Company, LLC: Got. Okay, that makes sense. Right. And then just in terms of your TV design win, are there others going on here? Or was this one that was ahead of the curve because they went and beat the standard? As you said, they went substantially above and beyond what the standard requires. Or do you think this is a trend for television manufacturers that they're going to continue to go above and beyond this standard?

We are clearly seeing a number of manufacturers going well beyond the requirements of the standard. In fact, I would go as far as to say that the OEMs are the ones who are driving the spec at this point not as much as standards. Although, standards do a play a role because it applies to all manufacturers, and generally, the large OEMs tend to be drivers in terms of energy efficiency. Whereas, the smaller ones will be followers.

The last question we have comes from Sumit Dhanda of ISI Group.

This Jason Jones for Sumit. I didn't hear you guys comment on the order patterns in the quarter other than the totals. Can you comment on that at all, the linearity of bookings?

Yes, the orders were very significantly high in January and came down pretty much to half of the January levels in February. And then we saw it ramp up back again, and then the month of April has been fairly strong again.

Okay. And I know you don't like to talk about it, but the turns for the quarter, can you comment on those with the slight miss to the midpoint?

Looking forward, yes, somewhere in the low 40s.

Yes, Jason, Joe here. For Q1, the turns, based on the shipments we did, turns were in the high 40s. Of course, we recognized less revenue than what we shipped during the quarter as we mentioned on the -- in the script. But for Q2, in order to meet the midpoint, if we assume that shipments and revenues are equal, it would be a requirement somewhere in the low 40s.

Okay. And then sorry, just one last quick one. The deferred income is getting up bit there a little bit. Is that reflecting this effect of the PC business in the channel also?

Yes. And that's the weeks in the channel going up.

And could you just repeat what that number was for the week? I missed that. I'm sorry.

About 6.5 weeks.

Next, we have a follow-up from the location of Tore Svanberg, Stifel, Nicolaus. Evan Wang - Stifel, Nicolaus & Co., Inc., Research Division: I had meant to ask about the handset. The sharp decline that saw, would you characterize that as a pushout of a program that you're expecting to ramp? Or was this an ongoing program?

This is an ongoing program with one of our Tier 1 customers who saw a significant decline in shipments in Q1.

[Operator Instructions] Next, we have a follow-up from the location of Andrew Huang of Sterne Agee. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Can you -- I seem to remember you talking about getting a primary power supply design win for the TV this year. Is that correct?

That is correct. Andrew Huang - Sterne Agee & Leach Inc., Research Division: And is that still within your expectations for this calendar year?

It is, I believe, our second TV design win, and it is again, a large company. But we are in our first program there. So we are encouraged that we got into this company, and we will -- we are optimistic that we'll get additional models as we go along. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Okay. And can you give us a sense of what the dollar content is in the primary TV power supply as opposed to the standby power supply?

Good question. I don't have it with me, but it is not a very large revenue component. But it is a very significant strategic design win. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Okay. And then my follow-up is, for the remainder of the year, Sandeep, can you give us some color on how we should think about OpEx through the end of the year?

Yes. I think through the end of the year, there should be a gradual increase from the guidance we gave for Q2, as we continue to make investments in R&D.

At this time, it appears that we have no further questions. We'll go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks. Gentlemen?

Okay. Thank you, Mike. Since we have no more questions, we'll end it there. Thanks, everyone, for listening. There'll be a webcast replay of this call available on our website at investors.powerint.com. Thanks, everyone, for listening, and good afternoon.

And we thank you, sir, and to the rest of management, for your time. The conference is now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you, and take care, everyone.