Joe Shiffler - Director of Investor Relations Balu Balakrishnan - President and CEO Sandeep Nayyar - Chief Financial Officer.

Ross Seymore - Deutsche Bank David Williams - Drexel Hamilton Tore Svanberg - Stifel Nicolaus Ed Roesch - Sidoti and Company.

Good afternoon. My name is Tushan and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Power Integrations' First Quarter 2017 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 [Operator Instructions]. Thank you. I would now like to turn the call over to Joe Shiffler, Director of Investor Relations. The floor is yours..

Thank you. Good afternoon, and thanks 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 first question results are calculated using the sell-in method of revenue recognized on sales to distributors, reflecting our adoption of ASC 606 effective January 1st of this year.

On today's call and in our press release, all comparisons to prior result make use of recap financial information calculated as if the new accounting standards have been in effect for this period. As a reminder, we published the recap data for all eight quarters of 2015 and 2016 in conjunction with our fourth quarter earnings release in February.

That data can be found in the historical financial tables posted on our investor Web site, investors.power.com. Also, during the call today, we will refer to financial measures not calculated according to Generally Accepted Accounting Principles.

Please refer to today's our press release for an explanation of our reasons for using such non-GAAP measures, as well as tables reconciling these measures to our GAAP results.

Our discussion today, including the Q&A session, will include forward-looking statements denoted by words like will, would, believe, should, expect, outlook, estimate, plan, goal, 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 in our statements. Such risks and uncertainties are discussed in our press release and in our most recent Form 10-K filed with the SEC on February 08, 2017.

Finally, this conference 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. 2017 is off to a great start for Power Integrations. Our first quarter revenues grew 19% year-over-year, coming in near the high end of our forecasted range at $104.7 million. Non-GAAP earnings were $0.63 per share, up from $0.55 a year ago.

Our growth in the first quarter was broad-based with double digit increases in each of our three largest end market categories. The communications category grew 40% year-over-year, driven by fast charging applications for the smartphone market.

Consumer revenues grew at a high-teens rate, driven by continued strength in appliances while industrial category show double digit growth driven by a wide range of applications, including smart utility meters, home and building automation, power tools, LED lighting and high power applications.

We expect all of these revenue categories to grow at a healthy cliff in 2017, and we believe we are on track for another year of double digit top line growth overall.

In the communications end market, our InnoSwitch products continued to win a substantial share of the fast charging opportunity, thanks to the unparallel level of integration and energy efficiency, which enable designers to maintain small form factors, while delivering up to 4 times as much power as standard low power chargers.

In the first quarter, we won nine high-volume fast charging designs for five different OEMs, including several multi-chip designs, pairing InnoSwitch ICs with our digital interface chips, implementing the quick charge 3.0 protocol.

While fast charging has already been a significant growth driver for our business over the past couple of years, we believe the emergence of USB-PD standards and the new type-C connector will accelerate the adoption of faster charges and facilitate even higher power levels over the next couple of years.

Well the migration of USB-PD is just beginning in terms of volume shipments, we now have PD designs in progress at most major smartphone OEMs, and we are leading participants in the ecosystem forming in support of the new standard.

Earlier this week, we announced a joint reference design with Weltrend Semiconductor, a Taiwanese company with strong capabilities in the area of USB-PD interface controllers.

This reference design, which is already in production at a major smartphone OEM, pairs Weltrend’s digital protocol IC with an InnoSwitch chip to implement in 18 watt USB-PD adaptors.

This partnership follows a similar effort we announced last year with Cypress Semiconductor and we have other such efforts underway as we look to expand on our leadership position in the next phase of the fast charging rollout.

In the consumer end market, we continue to see rapid growth in appliance applications where OEMs value the reliability and energy efficiency benefits of our products. And where power silicon that has been rising steadily, thanks to the increasing use of electronics functionality in all manner of appliances.

While this trend has been ongoing for many years, we believe another leg of the growth is still ahead of us as the appliance market moves beyond basic electronic controls and displays and adopts more advanced features, including LED lighting, electronically controlled motors, and increasingly, IoT connectivity and other forms of electronic intelligence.

The demand for greater energy efficiency further magnifies the opportunity as tighter efficiency specs not only make our products more attractive versus the competition but also add to the available dollars content.

As a casing point, we won a high volume multi-chip design in the first quarter, pairing our TinySwitch-4 ICs with our captive chips in a washing machine for a major European OEM. This sole function of the cap zero is to reduce stand-by power consumption, which is tightly regulated in Europe.

As standard sizing overtime, while OEMs incorporate more and more electronic content into their products, we expect continued growth and demand for silicon based solutions to reduce energy consumption. We believe that content story in appliances will be amplified as our InnoSwitch products continue to gain traction in that market.

InnoSwitch not only acts to our competitive advantages on reliability and efficiency but also increases our dollar content, thanks to its superior level of integration. The one several appliance designs within InnoSwitch in Q1 and InnoSwitch now accounts for a sizable portion of our design pipeline for the appliance market.

In the industrial category, we are excited about the diversity and breath of vertical markets where new opportunities are emerging for our products, thanks to connectivity, automation and the replacement of liquid fuel and traditional AC motors with rechargeable batteries and efficient DC motors.

These things span a wide and growing range of categories from transportation and lighting to power tools and building automation, and we are seeing growth in all of them.

Applications where we're winning meaningful market share, include electric bicycles and scooters, battery powered lawn equipment, smart utility meters, smart lighting control, networks smoke alarms and occupancy sensors and USB powered outlet for wall sockets and power strips.

All of this application demands reliability, energy efficiency and low stand-by energy consumption, making them ideal targets for our products. We also expect growth this year from the high power component of our industrial business, driven by renewable energy and power grid projects.

China's largest electric utility is using our scale to IGBT drivers for a major high voltage DC transmission projects ramping later this year. We also expect growing demand from a major European customer in the wind energy sector, and one another new wind power design with a major Taiwanese customer in the first quarter.

Meanwhile, we're encouraged by the strong customer response to SCALE-iDriver product, which we introduced last year to address applications between 10 and 100 kilowatts.

This new product line, which incorporates the Flex Link isolation technology that is core tp pirInnoSwitch product, essentially doubles the dollar value of our addressable market for high power products, representing a major synergy of the CT-Concept acquisition.

We won several designs to SCALE-iDriver in the first quarter, including designs for solar inverters, light truck, power conditioning and we have a strong pipeline with designs in progress at more than 200 customers. While we're excited about the near-term growth opportunity, we are equally upbeat about the longer-term.

We have a strong pipeline of new products on the way, including our next generation InnoSwitch, which will bring the benefits of that revolutionary technology to an even wider range of applications.

Next generation InnoSwitch already has a healthy level of design activity, based on prelaunch engagements with key customers and in fact it is already shipping in meaningful volumes to a major Korean OEM for display applications.

We have a number of other product launches planned over the next several quarters, including products that will address segments of the power conversion market that we don’t currently serve.

All told we expect our addressable market opportunity to expand from its current level of about $3 billion to something north of $4 billion over the next 12 months. Before, I turn it over to Sandeep, I'll give a brief update on our ongoing patent litigation with Fairchild, which of course is now owned by on semiconductor.

In March, the judge over single of lawsuits in the Northern district of California entered final judgment in the case, affirming the finding of willful infringement against Fairchild, as well as the jury’s damage award of $140 million. The ruling also added prejudgment interest, bringing the total award to $146.5 million.

The ruling clears the way for appeal space for the case after which we hope to be compensated for the Fairchild's egregious and long-running infringement of our patent. And now I'll turn it over to Sandeep for a review of the financials..

Thanks, Balu and good afternoon. I will quickly touch on a few financial highlights, focusing mainly on the non-GAAP numbers, which I'll reconcile to the corresponding GAAP figures in the tables accompanying our press release.

As Joe noted, our Q1 financials are calculated using sell-in revenue recognition following our adoption of ASC 606 on January 1st, and all prior-period comparisons are to the recast numbers we published last quarter. First quarter revenues were $104.7 million, up 19% from a year-ago and 2% from the prior quarter.

On a sell-through basis, sales grew approximately 17% year-over-year and declined 1% sequentially. From an end market perspective, the 2% sequential growth in revenues in the March quarter was led by the industrial category, which grew more than 10% sequentially on broad based strength in the end market, including metering, lighting and power tools.

Consumer revenues increased low single-digits sequentially, highlighted by growth in air-conditioning and TV markets.

Communication revenues declined by mid-single digit percentage, driven mainly by seasonally low revenues from cell-phone chargers, while computing revenues fell sharply on a sequential basis, which is fairly typical of the March quarter as that market is heavily impacted by the Lunar New Year holiday.

Revenue mix for the quarter was 37% consumer, 31% industrial, 28% communication, and 4% computer. Non-GAAP gross margin was in line with our expectation at 49.2%, down 100 basis points from the prior quarter.

As expected, the decrease was driven primarily by the flow though of higher cost inventory stemming from the relatively unfavorable dollar yen exchange rate that was in place last summer.

As a reminder, a stronger yen puts upward pressure on the cost of wafers sources from our Japanese foundry partners and typically takes about two quarter to affect our results.

We do expect a meaningful recovery in gross margin the June quarter, driven by the post election strength of the dollar versus the yen, as well as a more favorable end market mix. Non-GAAP operating expenses for the quarter were $32.2 million, up $1.4 million on a sequential basis with about 80% of the increase coming on the R&D line.

The increase primarily reflects headcount additions and accelerated spending for product development, as well as seasonal factors, such as the resumption of FICA taxes and a reduction in vacation days taken after the holidays. Non-GAAP operating margin for the quarter was 18.5%.

Our non-GAAP tax rate was 4.3% for the first quarter, bringing non-GAAP net income to $19.1 million or $0.63 per diluted share.

Cash flow from operations was just under $6 million for the quarter, that’s lower than normal due to transitory factors, including higher accounts receivable, which was driven by the timing of shipments with significant volume shipping late in the quarter after the Luna New Year holiday.

Also affecting cash from operation was an increase in prepaid expenses as we took advantage of our strong balance sheet to obtain additional assembly and test capacity. Both of these items will reverse in the future period with corresponding positive impact on cash flow.

Other uses of cash during the first quarter included $6.4 million for capital expenditures and $4.1 million for dividends. Cash and investments in the balance sheet totaled just over $250 million at quarter end, essentially unchanged from the prior quarter.

Internal inventory fell slightly during the quarter to 86 days on hand, which is below our target range of 110 plus or minus 15 days. We expect inventories to remain at a similar level for the June quarter and then to rise gradually in the second half of the year.

Channel inventory stood at 7.3 weeks at quarter end, which is identical to the level of the March quarter of last year and slightly below that of March 2015. Looking ahead, we expect second quarter revenues to be in the range of $107 million plus or minus $3 million, which would be an increase of 10% year-over-year at the midpoint of the range.

As noted earlier, we expect gross margin to recover in the second quarter with a range of 50% to 50.5% on a non-GAAP basis.

We expect non-GAAP operating expenses to be approximately $33.5 million in eh second quarter with the sequential uptick driven primarily by annual merit increases, as well as our annual sales conference, which takes place in May. We then expect OpEx to tick down slightly in the third quarter.

Lastly, I expect our effective tax rate for the second quarter to be around 4.5%. And with that, I’ll it back over to Joe..

Thanks, Sandeep. We'll open it up now for the Q&A session. Operator, would you please give the instructions for the Q&A..

[Operator Instructions] Your first question comes from the line of Ross Seymore with Deutsche Bank. Your line is open..

I guess as we talk about the revenue side first, I believe you mentioned three out of the four segments that you thought would be stronger growers this year. I know computing is always very volatile in the short-term. But I thought in prior conversations, you expected all four segments to grow.

Did something changed in the computing side?.

Interestingly, we are growing on a portion of the computer business, which is monitor. So we talk about a major design win we had with a Korean display manufacturer, which we believe will expand to other monitor customers.

And we also have a tremendous level of interest in using Inno 3, our next generation InnoSwitch for tablets and notebooks, which will also allow us to grow the computer market.

But what happened in Q1 is really multiple; one is of course Q1 is the weakest quarter for computing; but on top of that, the desktop business seems to have gone down more than the rest of the business, that's where we have had most of our revenue; and thirdly, the revenue in computing historically has been in stand-by power supplies, and because of the reduction in power consumption of PCs, the power levels have come down to the point where you no longer need these stand-by power supply.

They can do -- they can meet the stand-by requirements without having an additional power supply. So there has been a more accelerated decline in the stand-by. Having said all of that, we believe we can start re-growing the computer business as we get into monitors and notebooks, tablets and printers..

And I guess two quick follow-ups for Sandeep. On the gross margin side of things, it's good to see that it's heading back in the right direction.

Is the trajectory into the back-half of the year changed from the steady climb to 50% that you prior had, given that the starting point is higher in 2Q?.

So basically what really happened is when we had guided earlier, we had said that the second quarter would be similar to the first. But what really changed with the level of inventory coming down, the benefit as -- if you remember, the yen last year around the beginning of the year was at 105 and then went back to close to 115, 116.

So in Q1, we had the unfavorable effect and we had thought we would get when the yen weakens we would get the benefit in Q3. What's really happening is with the lower inventory, a portion of that benefit is coming in Q2.

So I think considering we’ve got the earlier benefits from Q3 for the rest of the year, I would expect that we would remain slightly above the 50% level. And as a result for the year, we would be averaging at the best estimate we can do around 50% for the year..

And I guess as my last question, on the OpEx side of things, hopeful that you took the slight decline in OpEx in the September quarter. Is it still can be growing at 60% of revenues as your long-term target? And I know quarter-to-quarter there’ll be some perturbation.

But just want to make sure as we look longer-term that there is no changes?.

So our long-term model, if you look at as we’ve talk a long-term just to reemphasize the whole model is that that our margin will -- top-line growing on an average of low double digit margin and 50% to 55%, and then OpEx at 60%. But that’s on an average. If you look last year, even though we grew 13%, our expenses last year grew 4%.

So this year, if you remember I had mentioned because of the investments that we are making with the new opportunity, the OpEx would be higher than there. But if you average it out, that’s where our model at a 60% plus. So you can't take it quarter-to-quarter or year, but I think you have to take a multiyear perspective on the model..

And your next question comes from the line of David Williams with Drexel Hamilton. Your line is open..

I guess my first question is really about the health of the channel. And it sounds it compares pretty favorably with what you’re seeing last year.

But are you seeing I guess in general, any lengthening of older terms or are you seeing anything, I guess, that would give you any concern with the lead times over the last few weeks?.

Our lead times on a few of our products, has gone out primarily because of extremely high demand on those products; that’s relatively temporary, by Q3 that will come back to normal. But most of our products are under normal lead times, which is typically four to six weeks..

I guess can you talk a little bit about what you're seeing in China.

Are you seeing slow down there? Is there any I guess pockets of strength or weakness that you’re seeing coming through now that you -- may be you're keeping an eye on?.

We have heard and seen a little bit of slow down in the cell phone handset numbers. But in spite of that, I think, we’re going to do really well this year because of the share growth we are getting in handset with fast charging. But definitely there is some slight slowdown in that prospect. However, that could change in the second half.

It all depends upon how the new phone introductions happen in the second half. It’s generally a relatively volatile market, but we have enough customers now that I think overall it will be not so volatile for us.

And in terms of positive, we are increased investment in infrastructure projects in China, specifically high voltage DC transmission systems. China has come up with a master plan to connect entire nation with a grid using DC transmission, which requires converters on both sides that we can sell IGBT drivers to.

And we have won a large portion of that business and that would start benefiting us in Q4 onwards. We’re also seeing a significant drive to convert all the public transportation and scooters and bicycles to electrified vehicles, if you will, especially in large cities like Shanghai, Shenzhen and Beijing.

So we're seeing a lot of opportunities there where we have been designing to electric buses, e-bike chargers and scooters and so on. So that’s another area of significant growth for us in China..

And can you give us may be a round number on your design win today on that InnoSwitch 3 line. I know you’ve got a strong pipeline there.

But can you give us an idea of maybe on how many designs you’re working on today?.

It's a large number, but I don’t have an exact number. I would say in the order of 50 designs ongoing and out of which, we have about three or four of them actually in volume production as we speak. This is relating to display devices like monitors and also set-top boxes. But we expect to start contributing revenue in the second half of this year..

And your next question comes from the line of Tore Svanberg with Stifel. Your line is open..

First question is on communications. So Balu, you mentioned five different OEMs that you’re working on for fast charge.

Are all those on QC3 for now?.

No, there’s actually a mix set of protocols. First of all, all of those are in China. As you know, we pretty much have everybody every OEM who actually uses fast charge, uses InnoSwitch at this point. So these five designs are from the Chinese cell phone OEMs.

And they use a combination of protocols, each one uses a different protocol at the moment and none of them have started using USB-PD yet. But they are certainly seriously thinking about using USB-PD in the future. But as you know, we won what we think is the first USB-PD design for cell-phone chargers and that's the pixel charger..

And on that topic on USB-PD you now have their references design with Cypress and now also with Weltrend in Asia.

Is that how we should expect this markets to materialize for you with these reference designs, with digital interface companies? Or are you actually working on designs irrespective of the actual reference?.

Well, we have been working on designs even before we had the reference designs available. For example, the pixel charger uses the Weltrend chip, which is used in the reference design and that one is already in production. And that is as a combination of InnoSwitch and Weltrend’s chip.

Generally, what happens is that the high volume customers we start working with them even before pre-launch, we are working with the probably 40-50 customers with InnoSwitch and accelerating InnoSwitch. And so we do that ahead of time and then for the general market, we would use the reference design.

The whole idea is to put the protocol portion of it, which is purely digital in a separate microcontroller which is what Weltrend and Cypress are good at doing. And we do all of the power conversion and all of the difficult analog functions required for USB-PD in our product..

And moving on to the industrial side, you mentioned a DC transmission program in China ramping later this year.

Could you just add a little bit more color on that as, I mean, just trying to understand the opportunity and how that ramps over time; it can be a slow steady ramp or when we actually start to see some pretty material revenues already in the second half..

Relative to the high power revenue, it will be material in the second half of -- mostly in the Q4 time frame. But it does span several quarters or may be couple of years.

Basically, what China has done is come up with a plan of grids that go north, south and East, West and all of these are based on the latest technology, which is the DC transmission line. And typically these are running at 600,000 to 800,000 volts and about 1 to 2 gigawatts of power in each transmission line in terms of capability.

And it requires something like 10,000 drivers on each side, if you can imagine that. These are huge towers with the IGBT modules with our drivers on top of it. And so we have won a significant portion of that business, and we expect to start shipping in Q4; they will probably start buying some in Q3; they will certainly place orders in Q3.

And so that should help us grow high power, not just this year but over the next couple of years..

And then on the patent litigation with Fairchild, so you mentioned this final judgment in March, and I guess now being the next step is going to be the actual appeal process.

Any sense for how long that will take?.

I believe the deadline for the Fairchild and on guide to file the appeal is end of May. And it typically takes one to two years before you get the response from the circuit court. So we are hopeful sometime next year, we will get the good news and we’ll get the money that we deserve..

One last question for Sandeep. Sandeep you mentioned getting back to your target inventory days by the September quarter.

So I mean does that simply mean that you're trying to build inventory but demand in Q2 remains pretty strong, so it will probably just take you another quarter to sort of catch up?.

Actually, it’s going to take longer. What I was trying to say is that even in the next quarter, we won't be able -- that it’ll be not much change from the levels. I think in the second half of this year, we will probably get up to those, say from the 86 days to about 95, 96.

But I think it will take getting into the next year first half to be at the time we get back to our levels. So the demand is pretty strong for us and its going to take a little while to get the inventory build-up..

[Operator Instructions] And your next question comes from the line of Ed Roesch with Sidoti and Company. Your line is open..

Wanted to, coupled with Sandeep about gross margin.

Did you mention that favorable mix would be a benefit to gross margins?.

That is correct. What happens in the second quarter is where we generally have most trends in the air-conditioning area, which falls in our consumer segment.

So that is typically a very strong quarter, and I think what I would say the improvement that you're seeing of about 100 basis points from Q1 to Q2, half of it is coming roughly from the yen benefit with the weakening of the yen that happened in December, and the other half 50 basis points that’s coming more from mix..

And then I have one quick question here. I'm not sure how you manage high demand situation here.

But are you on allocation with any of your products currently or are you in recent quarters?.

Yes, on a few specific products, we are seeing such a significant demand, we are on allocation at the time being. However, we will be increasing our capacity and by Q3 we will be out of that. And those products of course the lead times have gone up as I mentioned earlier..

And then just on a broader question, what percentage of the product portfolio do you think the InnoSwitch or any type of chip, incorporating Flex Link, what percentage of the product portfolio could that represent?.

In the future do you mean?.

Yes, looking at how many years you have to comment on..

Well, first of all, our products never really die. I mean we are still shipping TOPSwitches and TinySwitches and LinkSwitches. In fact, our latest TOPSwitch product, which does introduced in 2010, which is TOP JX, is still ramping really nicely. In fact, there is one of the fast growers this year. And the tiny switch is also ramping in revenue.

So the way to think about it is overlapping ramps. So the InnoSwitch will continue to ramp for probably next 10 years and that InnoSwitch and its derivatives before we see in next generation taking over.

So it is kind of an overlapping ramp, and typically our products never die and we still sell the original TOPSwitch we introduced in 96, if you can believe it. So it is, in some markets, they just don’t want to change the device, especially in industrial and appliance type markets..

So there is not a lot of substitution going?.

In some cases, there is. So for example, if you’re in cell-phones, the product lifecycle is shorter it’s typically more like three to five years. There the substitution happens faster; however, if you get designed into some of the industrial applications, the product lifetime could be – our appliances for that matter, lifetime could be 10 to 20 years.

And that's the beauty of it, I mean we keep selling the same product for long periods of time. And the older products tend to have better margins for us because they’re into these types of markets, which are more fragmented than the much longer product lifecycle..

[Operator Instructions] And I see no further questions over the phone, at this time. I'll turn the call back over to Joe Shiffler..

All right I guess, we’ll end it there. Thanks every one for listening. A replay of this call will be available on our investor Web site, which is investors.power.com. Thanks again for listening and good afternoon..

And this concludes today's conference call. You may now disconnect..