Ladies and gentlemen, thank you for standing by. And welcome to the Power Integrations Second Quarter Earnings Call. [Operator Instructions] After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Joe Shiffler, Director of Investor Relations. Please go ahead, sir.

Thanks, Stephen. Good afternoon, and thanks everyone for joining us. With me on the call today are Balu Balakrishnan, President and CEO of Power Integrations; and Sandeep Nayyar, our Chief Financial Officer. Our discussion today, including the Q&A session will include forward-looking statements denoted by words like will, would, believe, should, expect, outlook, forecast and similar expressions that look toward future events or performance. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected or implied. Such risks and uncertainties are discussed in today's press release and in our most recent Form 10-K filed with the SEC on February 7, 2020. During this call, we will refer to financial measures not calculated according to generally accepted accounting principles. Non-GAAP measures exclude stock-based compensation expenses, amortization of acquisition related intangible assets and the tax effects of these items. A reconciliation of non-GAAP measures to our GAAP results is included in our press release. Finally, this call is the property of Power Integrations and any recording or rebroadcast is expressly prohibited without the written consent of Power Integrations. Now, I'll turn the call over to Balu.

Thanks, Joe, and good afternoon. Second quarter revenues were $106.8 million in line with our guidance and up 4% year-over-year in spite of a challenging demand environment. The year-over-year growth was driven by communications and industrial categories. Industrial grew high single digits year-over-year and was our largest revenue category in the quarter at 35% of sales. We saw a combination of the recovery and broad-based industrial applications as well as incremental growth across diverse range of verticals, where trends like home and building automation, electrification are creating opportunities for our products. On the automation side, we are seeing growth in USB wall outlets, smart meters, and other IoT applications such as network thermostats and door locks, where high reliability, compact size, low standby power consumption are critical factors. Meanwhile, electrification is creating opportunities in applications like lawn equipment, vacuum cleaners, and personnel transportation such as scooters and e-bikes, where rechargeable batteries are replacing traditional power sources. Growth in these areas was offset somewhat by lower revenues from high-power due to softer demand in the energy exploration and a slowdown in infrastructure projects due to the pandemic. However, high power has its own attractive verticals with strong long-term growth prospects including renewable energy, long distance DC transmission, and electric transportation. Our gate drivers are in use today in electric buses and locomotives and are in testing at several automotive OEMs and Tier 1 suppliers for drivetrain and charging applications in next generation electric cars. Several of our Scale iDriver ICs are also automotive qualified as we have discussed on prior conference calls. We are also aggressively pursuing low power opportunities in electric cost, which can contain as many as 10 power supplies to drive various subsystems from main high voltage battery. Our InnoSwitch 3 and LinkSwitch-TN2 ICs and our Qspeed diodes…

Thanks, Balu, and good afternoon. As usual, I will focus my remarks, primarily on the non-GAAP results, which are reconciled to GAAP in our press release tables. Our Q2 results were on target with revenues of $106.8 million down 3% sequentially. Consumer revenues were down more than 25% sequentially with air conditioning and major appliances both down sharply reflecting weaker demand and an inventory correction as Balu noted. All other revenue categories increased sequentially. Communications revenues were up more than 25% on strength in smartphone chargers as well as residential networking, driven by work-from-home. The computer category also benefited from work-from-home in addition to normal June quarter seasonality, increasing more than 25% sequentially with strength in desktops and monitors. Industrial revenues were up low-single digits sequentially with increases coming from broad-based industrial applications as well as high-power battery operated tools and home automation, which includes IoT connected devices as well as USB charging receptacles. Revenue mix for the quarter was 35% industrial, 31% consumer, 28% communication, and 6% computer. That's a decrease of 10 percentage points in consumer from the prior quarter and an increase of 6 percentage points for communication. This shift resulted in lower gross margins with non-GAAP gross margin falling 150 basis points sequentially to 51.1% in line with our guidance. Non-GAAP operating expenses were $34.7 million roughly flat on a sequential basis. Expenses were moderately below our expectation, driven partly by unanticipated credits and employment incentives in Asia related to the pandemic. Other income for the quarter was $1.5 million, down from prior quarter, due to the lower interest rate environment, which reduced income on cash and investments. The non-GAAP effective tax rate for the quarter was just under 7% resulting in non-GAAP earnings of $0.66 per diluted share. Cash and investments on the balance sheet…

[Operator Instructions] Your first question comes from the line of Tore Svanberg of Stifel. Your line is open.

Yes, thank you. First question for Balu. Balu, you talked a little bit more about automotive and it does sound like the automotive revenue is going to come in a little bit earlier, because I think in the past you've talked about being more 2022, but it sounds like you expect to get some revenues already next year.

Hi, Tore. Well, we will get a little bit of revenue from the low power products starting, I would say, next year we will get tiny revenue this year because we introduced the Qspeed diodes a couple of years ago and we'll get a traction of $1 million this year, but next year onwards we will see a gradual increase. But the real revenue, significant revenue won't happen till 2023 or 2024. When we get into the second generation drivetrains and chargers and on-board DC/DC converters and so on. So yes, we will get some revenue but it won't be significant in the next couple of years.

Very good. And moving onto Communications. You mentioned about a dozen new inbox design wins for fast-charging and I think you said the range was about 15 watt to 50 watt. Could you elaborate on the mix there? I mean is it toward one range or the other. And are the most of these phones 5G phones?

Well, it's a combination. I would say that the center of the -- center of gravity of the power is used to be around 20 watts, but some of them are going as high as 25 watts to 30 watts, it's kind of moving up and on top of that, the fast chargers are not only offered with the high-end phones, including the 5G phones, but they're also using them in medium and low-end phones, especially in China. In China they are really pushing toward that faster charging, higher power level and they're also expanding fast-charging to medium level and low levels phones.

Very good. Just one last question on the industrial, you mentioned high power taking a bit of a breather here. Do you have any visibility as to when that business could potentially start growing again.

So in terms of the infrastructure type projects like renewables and DC/DC -- sorry DC transmission lines and wind turbines and so on, but the wind is actually doing well. It's the solar that's a little bit right now. And DC transmission lines, it's just delayed. There is no -- the programs are still on, but they just seem to be delayed. So I think they will come back hopefully in the next few months. So in the long run nothing changes. High-power market is a very, very long-term market. The projects last many years. So we are not concerned about it. It's just a short-term pandemic driven softness.

Very good, thank you very much.

Thanks, Tore.

Your next question comes from the line of Ross Seymore of Deutsche Bank. Your line is open.

Hi guys, thanks for letting me ask a question. I just wanted to follow up on the industrial side. For the third quarter guide, you gave the color for the comps would be up strongly, the consumers flat, what are you thinking about industrial from a sequential point of view. And if you said it in there and I missed it, I apologize.

I mean industrial is a little bit, basically flat. We don't see any significant change in industrial in Q3.

And then as I look at the business, how are you thinking the percentage of your inbox versus kind of accessories sold separately and the charger market will unfold over the next 6 months to 12 months. And does it really matter to you either way? Is there a difference in profitability or price because those two channels can be different in some ways?

Yes, right now, I would say that the aftermarket type products are probably in the mid-single digit percentage, now that's due to the total inbox. So inbox basically dominates. But that is changing rapidly. We are seeing a lot more aftermarket design wins and the revenues are growing very quickly in that space. As far as the OEMs deciding to move the charger out of the box, I think it really varies a lot from OEM to OEM. For example, the OEMs in China are really using faster charging as a major selling point, and so they like to put it in box because [indiscernible] has a significantly higher power and capability. But it's very possible that in the long run some of them, some of the OEMs may choose to not sell the charger with the box. In this case, the consumer has to either have a charger from their past division phone or they have to buy a new one. In the short term they have to buy a new one, because the older ones that are not the USB PD compatible, or they don't have the fast-charging, they can't charge fast. So we are optimistic that even if they go out of box, the attach rates will be reasonably good. And so, there are pluses and minuses. A number of units that will come down, obviously, if you go out of the box. On the other hand, we will have exposure to the entire product line. For example, right now our attach rate is very small, because they are only on the high end, the faster chargers on the high-end phones. If the consumer has to make the decision, even the consumer who buys a lower end phone can't buy faster chargers or a higher power chargers for multiple reasons. Most of the lower end phones can't handle faster charging, they just don't come with it in box because of cost reasons. So we think that attachment rates could be significant, obviously not 100% but it is in the 10s of percent range, maybe 30%, 40% but it applies to the entire product line, not just the high end. So that's the plus of it. The minus of course is that the overall unit volume is lower. So it's not clear to us exactly how it's going to impact us, because these higher power chargers are higher ASP and also some of them are multi-port, which means you get 2 times or 3 times the ASP. So it's -- I think that there are pluses and minuses, but this is something we've known for a long time. We have talked about it in the past. And so this is not a surprise to us and it's not clear how many will actually follow that path.

Thanks for the detailed answer there, Balu. One, I hope relatively quick one for Sandeep. On the gross margin side, incredibly impressive that the third quarter gross margin is not really going to change sequentially despite the mix. I know you said you're doing some cost cuts, some efficiency gains, etc. Any sort of color on, are those really sustainable. Just a little more color on how you're pulling that off on the gross margin would be great.

Yes, it's going to be slightly down, right as I guided to 50.5% to 51%, it's slightly down because the impact of the communication sector is largely being offset and even in Q4, I think the mix will kind of be similar to what is in Q3. So I think the 50.5% to 51% non-GAAP will continue into Q4. And for the year, I have been talking nearly for about three or four quarters that approximately 51% and it's pretty much aligned to what I've been saying for a while.

Got it. Thank you.

And the cost reductions come from assembly and test area.

Perfect. Thanks, Sandeep.

Your next question comes from the line of Christopher Rolland of SIG. Your line is open.

Hi, David Haberle on behalf of Chris Rolland. Thanks for taking our questions today. I guess first question, you touched on consumer yet. Maybe you can talk a bit about the consumer seasonality for the back half of the year, as I think about the front half, I think you had a similar issue last year where there was an inventory correction and you kept seeing sell-through kind of better than sell-in and it sounds like you experienced that same phenomenon here in the second quarter. Maybe just talk about what you think for the back half of the year? Is seasonality changing given this is kind of the second year in a row, we're working through inventory in the second quarter.

Well, the main reason for the inventory build is because in the first quarter, they were very concerned of our supply chain disruptions. So they ended up buying a lot of products. So there's a little bit of a different reason for inventory build in the first quarter. Having said that, we think that other than the AC, air conditioning market, the rest of the market will actually recover a little bit in the second half, but because of the seasonality of AC in Q3, we think that it will be offset by the AC seasonality and therefore we are projecting roughly flat revenue in consumer. Now in the long run, consumer will do just fine. Right now, the pandemic is impacting the consumer market, more than any other market. You can imagine with so many people out of work around the world and the GDP contracting, it's not surprising that people are not buying appliances and TVs and so on and so forth. So, but once we are over this problem, there will be a pent-up demand and we think that in the long run, we will do extremely well for multiple reasons. We have our share of dollar content is growing significantly in appliances. And on top of that we have new products like BridgeSwitch that will go into the motor control. And so we see a number of -- our number one and number two competitors are moving away from that market. So we are gaining share as we speak. It's just that in the short term the pandemic is really pushing the demand down, but in the long run we are not worried about it at all.

Understood. Thank you there. And then my follow-up on kind of the inventory side, your internal inventory levels are kind of hitting as high as you've seen in years, and they are all time highs or not, but is this really concentrated. I think the color at the beginning was talking about inventory levels for consumer and I know a lot of the products go across end markets? Or is this possibly kind of smartphone that you are shipping more direct to OEMs and need more inventory in front of that. Any additional color on the inventory would be great?

Well, so the inventories. It is -- the majority of it is in wafer form. So, as you know our products go across the board. So it's kind of spread very well, and as I mentioned on my script that you'll start seeing it come back, we have started adjusting the wafer purchases, but we have to do it gradually, because we have very long-term partnerships and we kind of moderated because we want to keep our capacity, but our plan as I indicated is that by the second half of 2021, we will get back into our model, which is the 110 days to 125 days.

Your next question comes from the line of David Williams of Loop Capital. Your line is open.

Thanks. So I certainly appreciate it. I wanted to see if maybe you could talk maybe a little bit about the 5G handsets and what you're seeing there in terms of maybe the power levels and maybe if you could kind of maybe give us the split of what you're seeing in 5G in the comms segment versus legacy or 4G handsets, that mix would be helpful.

Yes, I heard the cellphone -- the other one is –

IoT 5G.

Oh 5G. Okay. So we are somewhat what we call, octagonal to 5G, meaning that the faster charging applies to both 5G phones and non-5G phones. But the 5G phones are more likely to use higher power faster chargers, simply because they can run down the battery lot faster than their 4G phones. The applications that will be used on 5G are power hungry applications. So 5G for practical purposes has to have a fast charger, otherwise you will have a hard time keeping the charge on the phone. You may have to charge it more than a once a day. So that is the benefit of 5G driving the faster charging market. In terms of power levels, the center of gravity, I would say if you had asked me last year, I'd have said it's roughly around 20 watts is where most people are, but we are definitely seeing that power level move up to 25 watts to 30 watts now. Some of the high volume designs in China are around 30 watts, outside of China, it's between 20 watts and 25 watts. So that's kind of the power range. But in the real high end, there are people using 50 watts and even 65 watts. We talked about a 65 watts design about six months ago and that was a cellphone charger design. That's probably on the real high-end. But we are, in general, seeing power levels increasing.

Okay, great. And in terms of maybe design win traction, are you seeing more design wins around the 5G-type handsets?

As I said, we are kind of octagonal to 5G. 5G benefits us to the extent it does require a faster charger but fast chargers that we sell -- the same charger can go to 5G and 4G phones.

Okay.

But 5Gs will most likely demand a fast charger, whereas 4G can do both fast and slow charging.

Okay, that makes good sense. And then maybe on the Qualcomm announcement, I guess earlier about the -- up to 100 box for their Quick Charge 5.0. What do you think in terms of how that maybe drive that market maybe domestically more so than internationally, but do you think that this helps maybe drive the adoption rates any more quickly than it maybe what you would have thought previously?

Absolutely. I mean, the higher the power more ASPD we have and more it drives the customer toward -- because when you go to a 100 watt charger, the charger becomes huge unless you use our technology, the GaN technology, poly GaN technology. I think the poly GaN will become much more attractive as the power levels go up. Even at 65 watts, the charge will be too big unless you use the GaN technology. So we see that as a significant advantage to us because we have the only commercially successful GaN technology to date. So we do have customers who are asking for 100 watts, we have customers who are asking for 65 watts for their cellphones. So we are working on them as we speak.

Great. And then the last one, if you can kind of frame-up the magnitude of revenue that you're receiving from GaN-based products today -- can you provide any color maybe directionally on how you expect that revenue to trend?

Last year, for example we did in the mid single-digit millions, this year, we think we will double that roughly and then next year it could be more than double, based on the design wins that we are working on designs, we are working on -- next year could be even bigger jump.

Great, thanks so much. Certainly appreciate your time.

Thanks David.

[Operator Instructions] Your next question comes from the line of Gus Richard of Northland. Your line is open.

Yes, thanks for taking the question. On the consumer business, revenue in that product line or end market peaked in -- '17 has been down, '18-'19 and looks like it's going to be flat to slightly down again. Over that arc of time, what's been happening to cause pressure in the growth?

Well, they are all different reasons each year. If you remember there was a downturn in China in appliances. And then this year of course is the COVID that is impacting the demand for appliances. Especially in places like China and India where they are completely shut down. India, the demand for appliances and cellphones has come down dramatically. I think cellphones as you said is down by 50%. So having said that, if we look at the sales gains, we are continuing to gain share. Our number one competitor in that market has been losing share to us and our number two customer -- competitor, which is primarily in the Japan market has actually left the market. So I think that we will continue to gain share, which is what we normally do even in a downturn and when we come out of it, we will be in very good shape. But you're right, for one reason or the other, the consumer market has been down, but it's not because of share. We are not only gaining share. Our dollar content is increasing.

Okay, got it. And then on the cellphone market, I know you're not working with Huawei, because they're banned, but they did announce a 65 watt charger, I think this quarter and I believe it's Richtek they're working with. I'm not absolutely sure and I'm just wondering is Richtek showing up at other accounts or is it just a function of -- Huawei is the only -- it doesn't have access to your technology?

They have certainly gone to a number of customers in China, but our solution is so much more superior that we have always won against them, primarily the component count. Their component count is more than 2x of our component count, it makes it very difficult to fit it into a small compact form factor. But in case of Huawei, they don't have a choice. So they have to go with that. But I think that there is a choice people would choose our solution. In fact, there is really no other solution that has the advantage of component count, advantage of efficiency and size. We really have the best technology for the cellphone charger market.

And Balu, if Huawei kind of goes away or struggles to gain traction in the market, because I think it was a number one phone company last quarter. If that starts to rollover does that accelerate your communication business or an accelerant and -- are you seeing that?

Well, it certainly will because the share will go to either the remaining Chinese companies or the non-Chinese competitors outside of China. So if they decline, we will see a positive impact on our revenue.

Okay, got it. All right. Thanks so much.

Thanks, Gus.

There are no further questions over the phone lines at this time. I'll turn the call back over to the presenters.

All right. We will leave it there. Thanks everyone for listening. We will have a replay of this call available on our investor website which is investors.power.com. Thanks again for listening, and good afternoon.

This concludes today's conference call. You may now disconnect.