Power Integrations, Inc. (POWI) Q3 2013 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Power Integrations' Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jeff Shiffler, Director of Investor Relations. Please go ahead. I'm sorry, that should say Joe Shiffler, Director of Investor Relations.

No problem, thank you very much. Good afternoon, everyone. Thanks for joining us to discuss Power Integrations' Financial Results for the Third 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. Such 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-Q filed with the SEC on August 1, 2013. This conference call is the property of Power Integrations. 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 third quarter results featured record revenues of $91.7 million, up 4% from the prior quarter. For the second straight quarter, we had sequential growth in all 4 end-market categories, underscoring the breadth and the quality of our revenue base. Similarly, all 4 end-markets contributed double-digit year-over-year growth in Q3, resulting in overall growth of 18%. That growth is completely organic, with the anniversary of the CT-Concept acquisition having passed in the June quarter. Another highlight of the quarter was the continued expansion of our gross profit margin, which rose to 54.2% on a non-GAAP basis. That's up 130 basis points on a year ago, which helped drive record non-GAAP earnings of $0.71 per share, up 45% year-over-year. We also generated $29 million of cash flow from operations in the quarter and our balance of cash and investments increased to $180 million. Reflecting the strength of our business model and our balance sheet, our Board of Directors has approved a 25% increase in our quarterly dividend, beginning in the first quarter of 2014, when the quarterly payout will increase to $0.10 a share. For the December quarter, we expect revenues of $86 million to $92 million, roughly flat to 6% lower on a sequential basis. This is consistent with average Q4 seasonality, particularly in light of our current revenue mix, in which the industrial has become our largest end-market at 35% of sales. The midpoint of that revenue range would bring us to 13% growth for the full year, or about 10% on an organic basis. That should compare favorably to the overall analog semiconductor industry, where sales had contracted by about 1% through the first 8 months of this year. And while it's hard to predict how much we'll grow next year on an absolute basis, we are well positioned to continue outperforming the industry. We have an attractive array of incremental growth opportunities ahead of us, even as we continue to gain share and grow across the broader AC to DC power supply market, based on our hallmark of integration, reliability, ease of design and energy efficiency. These incremental opportunities include: LED lighting, where we have a substantial share of a fast-growing market, one that appears poised for an inflection, with price points becoming more attractive by the day and with significant subsidy programs on the horizon. Design activity in LED lighting remains brisk, reflecting the rapid pace of development in an industry that's undergoing a dramatic technological transition. We won more than 100 new LED designs in the third quarter, and are seeing especially strong uptake of our LYTSwitch product line, which enables LED drivers with just a handful of components, making them ideal for cost-sensitive, space-constrained, replacement bulb applications. Another key opportunity for the upcoming year is the rapid-charging for mobile devices, as OEMs seek to alleviate the bottleneck caused by the combination of larger batteries and the power limitations of standard USB chargers. Rapid-charging introduces a number of design challenges for device makers, including backward compatibility among chargers and phones, as well as size, since higher power usually increases the size of the charger, which is something users would find undesirable. Our unique combination of integration and energy efficiency gives us the meaningful competitive advantage when it comes to delivering higher power, from the small form factors that users now expect. As discussed on last quarter's call, we are working closely with Qualcomm Technologies on their Quick Charge protocol, which utilizes a simple communication scheme, to ensure that devices receive the maximum power they are capable of accepting. And that high-powered chargers remain backward compatible with non-enabled phones. While it's still early in the game, we are encouraged by the level of customer interest in rapid-charging. And earlier this month, received our first orders for a Quick Charge chipset, including CHY100 or CHY100, the interface chip we introduced in July for use with Quick Charge devices. A third key growth area is our push into higher power applications, most conspicuously through last year's acquisition of CT-Concept. That transaction has paid off in spades thus far, contributing substantially to our revenue growth and profit margins. That business is on course to grow nearly 40% this year, thanks to strong market penetration and improved demand in several key end markets, including industrial drives, renewable energy and DC transmission. Design activity for our IGBT drivers remain healthy, with key design wins in Q3, including a utility grade solar inverter for the Japanese market, and a 10 megawatt propulsion system for a large-scale locomotive project in China. As one of the world's only non-captive suppliers of IGBT drivers, we are well-positioned to capitalize on the critical trends occurring in the high power market, including the move to highly efficient DC motor drives, and the continuing growth of clean energy, electric transportation and the High-Voltage DC Transmission Systems. Reliable, efficient power electronics are critical to the success of each of these applications, which push these opportunities right in our sweet spot. In sum, we had a record quarter in terms of revenues and earnings, and our financial model is in excellent shape. We are executing on our growth strategy and we remain as optimistic as ever about the opportunities in front of us. With that, I'll turn the call over to Sandeep for a review of the financials.

Thank you, and good afternoon. Since our results are fairly straightforward, I will just quickly review a few highlights of the financials, touch on the outlook and then we will take your questions. In my remarks, I will focus primarily on the non-GAAP numbers, which are reconciled to the corresponding GAAP numbers in the tables accompanying our press release. Our third quarter revenues were $91.7 million, up 4% sequentially, and squarely in line with the forecast we provided on our July conference call. As Balu noted, all foreign market categories contributed nicely to the sequential growth, resulting in a revenue mix headroom was unchanged from the prior quarter at 35% industrial, 34% consumer, 21% communication and 10% computer. Non-GAAP gross margin was slightly better than forecast, increasing 60 basis points sequentially to 54.2%, due mainly to the benefits of the more favorable dollar yen exchange rate. We expect the exchange rate to benefit us further in the fourth quarter, as low-cost wafers continue to flow through our inventory. Non-GAAP operating expenses were $27.2 million, a bit below our forecasted range due mainly to timing as several key expense drivers we had planned for Q3, either came late in the quarter than expected, or will instead occur in the December quarter. The combination of higher revenues and gross margins, plus lower operating expenses, resulted in a significant expansion of our operating margin. Non-GAAP operating margins for Q3 was up 260 basis points sequentially to 24.6%. That's up almost 4 percentage points from a year ago, and a full 8 points over the past 8 quarters. The resulting non-GAAP earnings was $0.71 per diluted share, up 45% from a year ago and 16% sequentially. Cash flow was also very strong, with $29 million of cash generated from operations and capital expenditures of just $4.4 million. For the 9 months of the year, we have generated more than $75 million in cash flow from operations, with just over $11 million of CapEx. Cash and investments on the balance sheet rose to just over $180 million as of September 30, up $35 million during the quarter. Looking further down the balance sheet, internal inventories decreased by $3 million sequentially, and we had 85 days of inventory on hand at quarter end, down 9 days from the prior quarter. Standard inventories picked up slightly to 6 weeks, up from 5.8 weeks in the prior quarter. Turning to the outlook, we project fourth quarter revenues in the range of $86 million to $92 million, non-GAAP gross margin should increase again to approximately 54.5%, reflecting further benefit from the more favorable exchange rate. Non-GAAP operating expenses should be in the range of $28 million to $28.5 million. Please see our press release for an approximate reconciliation of this forecast to the corresponding GAAP numbers. Lastly, I expect the non-GAAP effective tax rate to be in the mid-single digits, while the GAAP tax rate should be in the low single-digits. With that, I'll turn it back over to Joe.

Thanks, Sandeep. We'll move now to the Q&A session. And in the interest of time, I'd like to ask callers to please adhere to a limit of 2 questions at a time. We will be happy to come back around for a second round of questions, time permitting. Operator, would you please now give the Q&A instructions?

[Operator Instructions] Our first question comes from Andrew Huang of Sterne Agee. Andrew Huang - Sterne Agee & Leach Inc., Research Division: The first question is, like in your prepared remarks, you talked about industrial being 35% of sales. And I seem to, I think I caught a nuance that was implying that because industrial's so high, that the Q4 revenue would be down sequential, is that correct, what I caught there?

Yes, that's part of the reason, that's why seasonally, Q4 is down, partly due to industrial being such a large portion of our business. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Okay, and then presumably, would that rebound to then, in the March quarter, industrial, typically?

Yes. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Okay, great. And then as a follow-up, I was wondering if you could give us a little bit more color on Quick Charge. Maybe remind us of what the revenue potential could be for calendar '14? And I'm wondering if any cell phone makers have talked about implementing Quick Charge?

Good question. So we have 1 second tier cell phone maker who has started ordering products. They expect to go into production in Q4. It's a relatively small volume. It's a high-end phone. It remains to be seen how many people will jump on the QC bandwagon. We are obviously fully prepared for that. We are optimistic that the QC, as a standard, would take off. But I do want to mention that there are several cell phone OEMs looking at alternative ways of doing this, and we are closely tracking those. But we feel that QC is a very simple method, it's a very cost-effective way to speed up the charging process. And so we will know a lot more in Q1 -- Q4, I should say. It's hard to predict at this time, because we don't know how many of the cell phone guys will jump on to QC. Andrew Huang - Sterne Agee & Leach Inc., Research Division: Great. And just to be clear, that's a cell phone maker, not a cell phone charger maker, that's signed on to do this, correct?

That is correct. I'm talking with the cell phone OEMs.

Our next question comes from Vernon Essi at Needham & Company. Vernon P. Essi - Needham & Company, LLC, Research Division: Sorry, Sandeep, I -- just a housekeeping thing, I hope this doesn't count against my 1 question allotment. I missed the split of distributor versus OEM revenue.

It's 75%, 25%. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay, 75%-25%. And then my 1 follow-on, just to dive into more the high power products out of CT-Concept, I guess, Balu, you listed a couple of different applications there, is there one in particular that outweighs the rest, I mean, you've described sort of these IGBT drivers as being pretty broad-based, but sometimes you keep bringing up the DC transmission side and renewable energy, are any of these particularly large programs that you have sort of a long or length of visibility that go into 2014 on, with governments or utilities or what have you, or is it still sort of a, somewhat I don't want to call it fragmented, but sort of, catch as catch can-kind of environment in some of these things?

It is definitely very fragmented, which is actually very good news, they have like thousand customers for the revenue they generate. If I look at the applications they ship into, the largest one is industrial motor drives, which is basically using electronic motors in place of AC motors to improve efficiency. This is not as much driven by the government as it's driven by the industry. But they are doing it because the governments want industry to consume less electricity. This is especially true in China. They don't want to build any more power plants than they have to, so they are asking industries to reduce their power consumption. And the easiest way to do that is to go to electronically-controlled motors. So that's probably the largest application segment. Followed by that will be the renewables, which is wind and solar. And we are seeing significant installations in Japan, in China. On China, specifically, on solar and wind. They are doing both. India has recently announced that they're going to install a very large capacity solar installation, and possibly even wind installation. And so those are the ones that are -- those are the -- that's the second-largest, I should say, application. The third one is traction, primarily locomotives. These are electric locomotives that require the motors that needs to be driven by IBGE drivers. Now there is also a category, the DC transmission, High-Voltage DC transmission, that really falls more into probably into the renewables. And that's another area which is up-and-coming. A lot of new installations of long distance transmission lines are now using DC rather than AC, because DC is much more efficient, a way to transmit energy over long distances. But DC requires electronics on both ends to convert power from AC to DC on one end, and convert it back to AC on the other end. And that requires a large number of IGBT drivers. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay. And then, just to dig in this one step further, the visibility side though, your lead time on this, I mean, this is still something that you're not getting more than say, a 2 quarter outlook on from any of these customers, is that a fair statement?

That is correct. The visibility in this market is gradually reducing. We are getting more turn starters than we used to, for example, end of last year.

Our next question comes from Tore Svanberg at Stifel. Evan Wang - Stifel, Nicolaus & Co., Inc., Research Division: This is Evan Wang standing in for Tore. I'd like to just follow-up on something that you mentioned regarding the LED lighting, you mentioned that a rebate may be on the horizon, I was wondering if you can provide any more specifics on that.

Sure, as much as we know, the CEC, the California Energy Commission, has made a decision to provide rebates to promote LED lighting. And one of the requirements for that is the LED lighting has to meet California Energy Commission's special requirements, if you will, which dictates not only high efficiency, but also long lifetime and color rendering has to be good, and so on. The reason they are doing that is to make sure the user experience is positive, which was not the case with CSLs. The rebates are supposed to start early 2014. No official announcement has been made to date. But there is certainly an expectation any moment now, there will be an announcement with the amount of rebates, and we are looking forward to that. And that should make a huge difference to the price of the LED to the consumer. Evan Wang - Stifel, Nicolaus & Co., Inc., Research Division: And I also detected a -- some mention of a potential share gain, a measurable share gain this year, is that the case? And are you being helped by this requirement that the CTC requires?

Yes, I don't think we mentioned anything about share gain in our prepared remarks. We do have a good share. We think we're on the top 3 worldwide. And we expect next year to be a strong growth year driven by lower prices. Evan Wang - Stifel, Nicolaus & Co., Inc., Research Division: Okay, great. I have a quick follow-up question for Sandeep, that you have mentioned that the gross margin is benefiting from the dollar yen exchange rate. And that this effect will last through Q4 or some of it will be visible at Q4. Could you talk a little bit about what happens after Q4, and how would that, how might the gross margin look from that, from then on?

So beyond Q4, of course, we are in the midst of our planning for next year, and we'd give you a better update in January. But directionally, as we had indicated that we should continue to see more benefit from the exchange rate going into Q1. Though, however, next year, we should start seeing that benefit and the benefit of seeing further to be impacted by the mix with communications trend, as well as, the pricing that Balu indicated, that you may see in the LED market. So I think we can give you a more specific answer in January, but I think the end benefit will get mitigated, and actually you should see that -- actually the margins having a little bit of a headwind, because of new products, the communication and the LED.

Our next question comes from Christopher Longiaru at Sidoti. Christopher J. Longiaru - Sidoti & Company, LLC: I'm going to piggyback on that gross margin question. So your margins have been escalating, partially because of the [indiscernible], but also I assume it's because of a higher incidence of industrial revenue, which is a higher gross margin. Can you give us an idea of how much of the gross margin improvement was due to the yen as opposed to just due to the fact that industrial continues to become a bigger part of your business?

Well, I think this quarter, bulk of the benefit of the increase was from the yen, because the mix didn't change very much from Q2 to Q3. So this was pretty much, this quarter was pretty much a yen story. Christopher J. Longiaru - Sidoti & Company, LLC: Then, just in terms of your operating cost structure going forward, you've been able to lower costs a little more than I think you had expected. Can you give us an idea of, are we going to kind of hang out around this range for the next few quarters, or are there any things coming up on the horizon, where we should be changing the model going forward?

Well, so this quarter was a little unusual because of the timing, as I indicated in the prepared remarks. We have certain expenses planned, because in the Q2 quarter, we had some extra expenses related to the Quick Charge, which were obviously trying to -- would be coming down, but we had planned for other expenditures. Those expenditures did not happen as we had planned, they happened more towards the end, and probably happen in the Q4 quarters. So the guide we have given you for Q4 is kind of where we are. But next year, as you know, you have the typical raises in the investments we make for our growth, and our model, on an average, that we have talked about is that if our revenue grows in the low teens, then our expenses will grow at half the rates, so. We'll give more specific guidance for next year in January. But I think from a modeling standpoint, that's what a multiyear horizon is the model I am talking to you about, and we can be more specific in January.

Our next question comes from Steve Smigie at Raymond James.

This is actually Elizabeth Howell on behalf of Steve. So regarding your QC product, which is compatible with Qualcomm, just curious if you have additional protocols that allow your product to work with other products beyond just Qualcomm?

We certainly can implement whatever protocol is necessary for the market. The reason we started with QC is because, we -- when Qualcomm came to us, and we still -- we believe that QC is the most cost-effective way to address rapid-charging. But if for some reason, some other type of standard becomes more popular, or if there are more than 1 standard, then we'll implement both the standards, if you will.

Great, okay. And then, just more broadly, what do you think will be your -- the largest drivers for 4Q, in terms of end markets? I know you said industrial, probably down, but what are you seeing for communications, consumer, computing and specifically, if you could maybe go into a bit of what you're seeing in handsets versus networking?

Well, that's very difficult for us to predict because 75% of our business goes to distribution. And we can't really tell from the products we ship, what end markets they go into. And we can only talk about very broad, seasonal kind of trends. And the only trend I know of is that, fourth quarter is usually slightly lower than Q3. And industrial is usually weak. There were -- some years have been a little bit different, but usually industrial is weak in Q4. But in terms of growth areas, LED should continue to grow, which is actually part of industrial. They will offset some of the weakness. And beyond that, I really can't give you any more color.

[Operator Instructions] And our next question comes from Ross Seymore at Deutsche Bank.

This is Mike Chu for Ross. Most of my questions have been asked, but just a question about the end market growth kind of outlook for next year, you guys have talked about LED and the industrial segment overall, just continuing to grow, and Quick Charge being a growth driver in the comms area. I wonder if you could talk about any other growth driver that you could -- you anticipate for next year, just to help us for modeling purposes?

Sure. We think that all 4 markets have a potential for growth. And we talked about LED in the high-power, in the industrial segment. We talked about the Quick Charge and smartphones in the Communications segment. And in the PC segment, we are seeing growth in PC standby, monitors, printers and also, main power, that's on what you call the mid-power products in PCs. And in the -- even though the PC market is declining, because we have a relatively low share of the main power supply, we have room to grow. And then, when you go to the consumer, appliance market is something we have been growing quite steadily for a long time. And even though the market for appliances itself is not growing, our content in appliances is growing, driven by more and more electronics getting into the appliances. And then on the electronics -- entertainment electronics side of the consumer market, we see a significant growth potential in TVs, because of both the main power supply there, where we are barely entering that market. And also, in the standby power supply, which is driven by very low no-load consumption, like 0 standby, for example. So we are pretty excited about the future growth potential for many years to come. We have a lot of room to grow in all of the 4 markets.

That's really helpful. And just a quick follow-up, Sandeep you talked being -- there being some headwinds to the gross margins later into next year. But just wondering if, given the fact that industrial now is a much higher percentage of revenues, and the manufacturing changes that you've made over the year, last year or so, just wondering if, kind of a 54% range is kind of a new baseline, plus or minus with those headwinds that you talked about.

Well, I think I would be able to give you a more specific answer in January, but we are hovering around the 54% with the headwinds, I think it will be more -- a little downward trend from there for next year. But I think we can be more specific in January. But with the mix as I talked about, with the opportunities in the cell phone area would be pricing, continued pricing pressure in the LED, plus we are coming up with a lot of new products that we're going to announce next year, which typically have lower margins as they initially come out, so that's why we're talking about a little bit of a headwind from mix, as well as new products introduction.

Our next question comes from Tore Svanberg at Stifel. Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division: So I don't want to make this a negative, because it's not, but inventory days are down to 85 days. So I'm just wondering, do you plan to operate this low? Or do you have plans to maybe increase inventories in the fourth quarter?

So I think this quarter's a little lower than normal. With our typical model is like 110 plus or minus 15. And even last quarter, it was on the lower end. I think it will be, in the near term, on the lower end. But this quarter, partly it was because of the distri inventory going up a bit where, because of the holiday that was there in China, people pulled in their inventory a little bit sooner to make sure that they had inventory when they came back from the holidays. And also, there was some timing of shipment from our fabs, which caused it, so I think we'll be back in our range, going forward. Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division: Very good. Then, can you also talk a little bit about how your business has been so far this quarter, as far as bookings are concerned?

Well, the October bookings was slightly ahead of the average booking for Q3. Tore Svanberg - Stifel, Nicolaus & Co., Inc., Research Division: Very good. And then last question, just coming back to the fast charger end-market, I understand this is a very sort of dynamic market, a lot of moving parts, but as far as meaningful revenue contribution for POWI, should we think of this as more of a second half event?

Yes, I would say second half next year would be where we see significant revenue. But it is possible we could see some in Q2, depending upon the design wins we get.

Our next question comes from Vernon Essi at Needham. Vernon P. Essi - Needham & Company, LLC, Research Division: I just was wondering, since you have such a broad range of geographies and end-markets, is there anywhere in particular that seems to be outperforming, relative to what you've seen in prior years, in this time of the season, which you have the time on the phone, I figured I might as well cherry-pick a question like that out of you.

Yes, we're in -- bulk of our [indiscernible] since the starter guys are in Asia, so the end product goes in different places. But obviously, in the high power area, we're continuing to see strength in the -- in China. So in certain pockets that we could talk about where we now we can, very specifically, I can mention that. Otherwise, it's a little harder. Vernon P. Essi - Needham & Company, LLC, Research Division: Okay, so in terms of at least the consumer electronics area, most of the traction you are seeing is just share gains and sort of design changes, if you will, towards both standby, 0 standby, those sort of things, not necessarily any specific areas that seem to be unusually active for you?

Yes, I would say it's very, very broad-based. And of course, a lot of these things happen in Asia, specifically. But even though business in U.S. and -- the Americas and the European area is doing really well, it's going very nicely. And it is much more fragmented in U.S. and Europe because they generally go into smaller companies. Whereas most of the high-volume manufacturing is now done in Asia. So we see across-the-board, a nice, gradual growth outside of Asia.

At this time, I show no further questions. I would like to turn the conference back over to Jeff Shiffler for any closing remarks.

Okay. Thanks very much. Thanks, everyone for listening. There will be a replay of this call available on our website, investors.powerint.com. Thanks again for listening and good afternoon.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.