Joe Shiffler - Power Integrations, Inc. Balu Balakrishnan - Power Integrations, Inc. Sandeep Nayyar - Power Integrations, Inc..

Tore Egil Svanberg - Stifel, Nicolaus & Co., Inc. Cody Acree - Loop Capital Markets LLC Edgar Roesch - Sidoti & Co. LLC.

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Power Integrations Second Quarter Earnings Call. I will now turn the call over to Joe Shiffler, Director of Investor Relations. You may begin your conference..

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. During the call today, we will refer to financial measures not calculated according to Generally Accepted Accounting Principles.

Please refer to today's press release, which is posted on our Investor website 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, 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 14, 2018.

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. Our second quarter results were solid across the board, with revenues above the midpoint of our guidance range, better than expected gross margins, and lower than expected operating expenses resulting in non-GAAP earnings of $0.74 per share.

Operating cash flow was also healthy at nearly $27 million and we returned nearly $35 million to stockholders through buybacks and dividends.

In the first half of the year, we returned $73 million to stockholders, including $63 million through share repurchases, buying back more than 3% of our outstanding shares at an average price significantly below our current share price.

This is consistent with our opportunistic approach to capital allocation, taking advantage of short-term fluctuations to repurchase shares in meaningful volumes. It's also a reflection of our confidence in the long-term growth of our business.

While the near-term outlook is somewhat clouded by global trade issues, we are increasingly bullish on our growth prospects for 2019 and beyond. InnoSwitch products are being adopted across a broad range of applications and we expect rapid growth from the product family in 2019.

Our industrial category is on pace for double-digit growth this year and we expect that to continue based on a breadth of opportunities we see in that market.

Most encouragingly, the next phase of growth in rapid charging is now beginning to take shape as USB PD finally approaches mass adoption and we expect this to be a major growth driver for us next year.

Our InnoSwitch Pro products introduced earlier this year are tailor made to address USB PD and other high power charging protocols that will continue to drive higher dollar content in mobile device chargers while further increasing the need for efficiency and integration.

While the adoption of rapid charging has been hampered by delayed rollout of USB PD, we believe that many OEMs are eager to deploy faster chargers, especially with higher end flagship phones, where larger batteries are becoming commonplace, and where premium features like superior charging speed can help support higher handset prices.

As a case in point, last month a major Chinese handset OEM introduced an ultra-high end smartphone co-branded with Lamborghini automobiles. The phone's charger which incorporates InnoSwitch Pro delivers 50 watts and is capable of fully charging the phone in just 35 minutes.

Notably, this charger is scarcely larger than many chargers currently in the market that deliver only one fifth as much power.

This power density is a testament to the efficiency and integration offered by InnoSwitch Pro, and to the level of engineering effort OEMs are now dedicating to their chargers which were regarded as commodities just a few years ago.

Emphasis on charging speed in such a high profile product launch sends a clear signal to the smartphone industry that faster charging is a must-have feature for next-generation handsets. We are already seeing a strong pipeline of designs for chargers ranging from 18 watts to as high as 60 watts.

And a growing list of designs have now been certified as compliant with the latest version of USB PD spec. Notably, among the designs that have been certified thus far, Power Integrations is the dominant supplier of power conversion ICs.

In short, though the industry has been in a holding pattern for a while waiting for USB PD specs to be finalized, we expect 2019 to bring a resurgence of growth as these advanced chargers begin to reach the mass market.

We also look forward to continued growth from the industrial category where revenues increased at a double digit rate in the first half of the year.

This growth was driven by a broad range of verticals including not only traditional industrial applications, but also emerging areas such as chargers for battery powered lawn equipment, vacuum cleaners and e-bikes, as well as home and building automation devices such as USB power outlets, network smoke alarms and other IoT devices.

Our high powered gate-driver business which makes up about a third of our industrial revenues also had a strong first half driven by energy exploration and renewable energy applications.

Electric transportation is also a growing vertical in high power and in the second quarter, we won a multimillion dollar design for an electric automotive at a major European customer.

While electric locomotives and buses are already important applications for our gate-driver products, we believe the automotive market holds far greater potential in the years ahead. As specialists in high voltage power conversion, our opportunities in the automotive sector have historically been very limited.

However, with electrification now bringing high voltage into the car market, we believe our turn is coming. In Q2, we took an important step in this direction with the announcement of AEC-Q100 automotive certification for our SCALE-iDriver product family.

SCALE-iDriver is a gate-driver IC for applications between 10 kilowatts and 100 kilowatts, a range that covers all of the key high voltage applications in an electric car, including the drivetrain inverter, DC to DC conversion and charging with tens of dollars' worth of available content.

SCALE-iDriver incorporates our FluxLink isolation technology, the same technology used in our InnoSwitch products, enabling a substantial improvement in reliability and component count compared with discrete optocoupler based designs currently in use.

Importantly, the product is capable of driving not only silicon IGBTs, but also silicon carbide MOSFETs, which are rapidly taking hold in the EV market.

Since introducing the automotive qualified SCALE-iDriver at the recent PCIM show in Germany, we have had extremely productive discussions with customers and built a promising pipeline of design activity.

While design cycles in automotive industry are long, we believe our entry into the market is well timed to coincide with the ramp up EV sales that is widely expected to begin a few years from now. Before I turn it over to Sandeep, I'll comment briefly on the effects of the current global trade dispute on our business and on our third quarter outlook.

First, we do not anticipate a significant direct impact from the proposed U.S. tariffs on ICs originating from China. Less than 5% of our sales are into the U.S. And while a portion of our assembly is done in China, virtually all of the products assembled in China are already sourced from multiple countries.

Having said that, we have seen indications over the past couple of weeks that uncertainty related to global trade disputes is causing some customers to take a more cautious approach to stocking components.

Over the past week or so, we have seen a handful of order push-outs from distributors serving the appliance market which has been affected by tariffs on finished products as well as steel and aluminum.

With roughly a third of our revenues coming from appliance market, this dynamic has naturally caused us to approach our third quarter outlook with some caution. Nevertheless, we expect sequential growth in September quarter consistent with normal seasonality under sell-in accounting.

Specifically, we expect revenues of $114 million plus or minus $3 million, driven primarily by the continuing recovery in smartphone chargers and a modest contribution from new USB PD designs. With that, I'll turn it over to Sandeep for a review of the financials..

Thanks, Balu, and good afternoon. Our Q2 results are fairly straightforward. So, I will just quickly cover the highlights and then we will open it up for Q&A. As usual, I will focus on the non-GAAP numbers which are reconciled to the GAAP figures in the tables accompanying our press release.

Second quarter revenues were $109.5 million above the midpoint of the forecast range, and up 6% from the prior quarter. The consumer category was the biggest driver of the sequential growth, increasing about 7% sequentially on seasonal strength in air conditioning, as well as growth in major appliances.

The communication category also contributed significantly to the sequential growth, rebounding from a weak first quarter and growing in the low-teens sequentially. Industrial revenues grew roughly 3% sequentially on seasonal strength in high-power products, while computing revenues were approximately flat versus the prior quarter.

Revenue mix for the quarter was 40% consumer, 35% industrial, 20% communication and 5% computing. Non-GAAP gross margin was 52.4% for the quarter, down 60 basis points from the prior quarter, reflecting the recovery in the communication category where margins are below corporate average.

Non-GAAP operating expenses were $34.3 million, up from the prior quarter driven by annual merit increases, but below our forecast of $35 million due mainly to the timing of head count additions. Non-GAAP operating margin was 21% for the quarter, up 70 basis points from the prior quarter.

The non-GAAP effective tax rate for the quarter was 7%, while weighted average share count fell by 370,000 shares or about 1.2%, reflecting share repurchase activity. Non-GAAP earnings was $0.74 per diluted share, up from $0.67 in the prior quarter.

Cash and investments on the balance sheet totaled $247 million at quarter end, a decrease of $11 million during the quarter. Cash flow from operation was $26.7 million, while CapEx was just $4 million resulting in a very strong free cash flow.

We utilized just over $30 million for share buybacks during the quarter, repurchasing 434,000 shares at an average price of roughly $69. In all, we returned more than $70 million to stockholders during the first half of the year in the form of repurchases and dividends.

Inventories stood at 118 days at quarter end, up from – up 2 days from the prior quarter and well within our target range of 110 days plus or minus 15 days. Channel inventories fell to 8 weeks, a decline of nearly a full week during the quarter.

Looking ahead, we expect third quarter revenues to be in the range of $114 million plus or minus $3 million, a sequential increase of about 4% at the midpoint. As Balu indicated, this is consistent with the recent September quarter seasonality undersell in accounting.

We expect a slightly less favorable end market mix in Q3, driven by continued recovery in cellphone related revenues, as well as a seasonal lull in higher margin air conditioning revenues. Nevertheless, we expect our Q3 gross margin to be similar to the Q2 level, reflecting the offsetting benefit of cost reduction efforts.

We do expect some incremental gross margin pressure in the fourth quarter, as the effect of wafer price increases begin to impact our P&L.

Non-GAAP operating expenses should be between $35 million and $36 million in the September quarter, with the sequential increase driven largely by head count additions and R&D project spending, as well as slightly higher litigation spending.

The non-GAAP tax rate should be between 7% and 8% while share count should be flat to slightly lower compared to the June quarter. And with that, I'll turn it back over to Joe..

Thanks, Sandeep. I will open it up now for the Q&A session. Mike, would you please give the instructions..

Your first question comes from Tore Svanberg from Stifel..

Yes, thank you. First question, Balu, could you just maybe elaborate a little bit more on the trading situation and especially as it relates to push-outs? Are these push-outs into Q4 or are these orders that are sort of put more on hold until there's more clarity? If you'd add some more color to that, that'd be great..

Okay. Thanks, Tore. What we are seeing is that the appliance customers are pushing it out mainly to Q4. What we don't know is whether this is just a temporary cautionary measure or because of the tariffs in the U.S., but that there would be a lower demand for higher priced appliances.

You might have seen the article in The Wall Street Journal that some of the appliances have already gone up in price by as much as 20%. And it was also reported by one of the U.S. OEMs where their results were impacted by the higher cost of aluminum and steel.

So, the answer is we really don't know whether it is just a temporary issue or it is going to have impact on the demand situation in the U.S. But having said that, overall, I would say that the appliance market is still a very strong growth market for us.

We expect that to grow very nicely next year in spite of these trade issues that are happening right now. So, roughly speaking, we have seen so far about $1 million of push-out, which is not a whole lot.

But what we are concerned is that there may be additional ones coming in the next week, and so accordingly, we have adjusted our forecast to be a little bit more conservative for Q3..

And Tore, the other thing the distributors are telling us is they are looking to reduce inventory in the light of this trade risk. And because we have short lead times, they can afford to carry a little less inventory, so that's another implication that we had to take into consideration..

That's very helpful. And my second question is on USB PD. So, sounds like you'll get some contribution in the second half, but that you'll get the bulk of the sort of ramp in 2019.

But would this be sort of across the board with multiple customers? Is that what your design wins currently are suggesting?.

Absolutely. We are working with a number of cellphone OEMs who are actually directly involved in the design of the adapter which is unusual.

In the past, it has just been a commodity, but because it now incorporates the protocol itself and the fact that it's at a much higher power level, they definitely want to make sure that the charger works well with the phone and plus the charger is very small. If you look at the Lamborghini charger I talked about, it is quite impressive.

The charger size is probably 10%, 20% more than the 10-watt charger that was used before this and it's 50 watts. It's a five times higher charging capacity, and it's made possible by our InnoSwitch Pro which provides a very high level of integration.

And it provides very high efficiency that allows them to make the charger very small without getting it too hot..

Sounds good. Just one last question. Sandeep, you talked about some gross margin impact in Q4 because of higher wafer pricing.

Could you elaborate a little bit on the extent of that? I mean are we talking about 50 basis points or more than that?.

Yes, I think it'll be in the 50 to 100 bps. So, I think the Q4 margin would be somewhere in the 51.5% to 52% range..

That's very helpful. Thank you very much..

Thanks, Tore..

The next question is from Cody Acree from Loop Capital..

Thanks guys for taking my question.

And maybe just to follow up, Sandeep, on the wafer prices, do you have any opportunity on the pricing side to pass this along into some of the major efforts, do you have any opportunity to do that?.

Generally, what we have seen here is what we are able to do is actually not give price reductions which typically happen more than price increases. So, to offset this, it's the substrate costs are going up, and so that is what is really impacting us..

Yes, I would also add that the passive components are in short supply, specifically capacitors and some other, and high voltage transistors and so on. So, it doesn't give us the ability to increase the prices, but it allows us to keep the prices firm. Otherwise, we would be giving annual deductions that we can now justify why we can't do that.

And they understand it because they see the increases in passives, and because of the level of integration we provide, we use far less passives than our competitors do..

How do your typical annual price breaks compare to what you're expecting in wafer price increases?.

Overall for the company, it has averaged something in the order of 5%, plus or minus 2%, so it varies from year to year..

And, Balu, on the appliance side, can you just remind us the percentage of the appliances in the back in the U.S.

that you're concerned with exposed to the tariff issues?.

As you know, they have imposed tariffs on certain appliances like washing machines. I believe it's in the 20% or 25% range. And as per this Wall Street Journal article, those prices are already impacting the market. The washing machines have gone up by 20% in price. So, the concern is whether that will reduce the demand for these appliances.

And I think that customers overseas, especially in China, are worried that their export business will not be as strong to U.S.

So, it looks like it is more of a caution on their part, but we won't know until a little bit later whether it is really true or whether it's just being cautious and reducing their inventory, both at the customer level, at the distribution level..

And I guess, what I was trying to get to, do you have a sense of the exposure of the appliances that you sell into that end up back in the U.S., so that we can maybe get some quantification of what the end impact might be if we see that demand in the U.S.

decline?.

Well, that's a good question. We really don't have a good handle on what percentage it comes back, but it's probably fair to assume that the U.S. is roughly one-third of the appliance market. Although, I have to take into account that the developing countries are becoming actually a bigger purchaser of appliances these days than U.S.

So maybe something in the 20% range would be my guess for what is shipped into China that comes back to U.S. But again, not all of the appliances are impacted. There are certain appliances where tariffs are imposed, so it's really hard to calculate that.

But as far as our revenue in appliances go, it's nearly 30% of our revenue – it's actually more than 30% of our revenue is exposed to appliances, but that includes also the air conditioning which is not impacted at this point..

Thank you very much..

You're welcome..

Your next question comes from Edgar Roesch from Sidoti & Company..

Yes, hi. Thanks for taking the question. First one is for Sandeep just about expenses being up under 5% year-over-year I think. It's a nice performance and I know you've got a lot of activity going on, you're not worried about capacity increases necessarily at this moment. But I believe you're certifying some new partners and suppliers.

Was there much cost driven by that type of activity in the second quarter?.

No, the expenses in the second quarter – operating expenses that you're talking about has mainly increased because we do our annual raises in the second quarter. That is what predominantly drove that. And in the coming quarter where we're giving guidance, we have R&D spend and litigation expenses going up and some head count.

As we have said earlier, our expenses, we try to average 60% of our revenue growth rate would be growth the topline low double-digit. If you look at the prior years, we've been below that. This year, we have said we're going to be spending more in operating because of the R&D opportunities. But over a long period, it kind of evens out..

Okay.

And how are the activities kind of line up capacity expansions for what you see coming in 2019?.

I think it's coming along very well and we feel very good about 2019 with the USB PD opportunities that Balu talked about. And we've got adequate capacity that is coming along to satisfy our demand over the next few years..

Okay. And with InnoSwitch Pro, it looks like some of the distributors at least have some long lead times.

Is that just because it's new and it goes a long lead time to get it designed in, so you don't need a lot of quantities on hand just yet or what's the approach there?.

I'm not quite sure I understand the issue, because Inno Pro was just announced about two months three months ago, and we have lot of design activity going on. We will probably start shipping some small quantities in the second half, but we expect to have significant revenue growth in the next year. As far as lead times, there is no issue.

We have – almost all of our products are in the four to six week range and we have – we now have plenty of capacity. As we discussed in the previous calls, we have invested quite a bit of money and resources into expanding our capacity. And right now, we are in a very good position to support the growth we are expecting in 2019 and beyond..

Okay, terrific. I didn't mean to imply any issue, just understanding the cadence of rolling that out. Thank you very much..

You're welcome, Ed..

There are no further questions at this time. I will turn the call back over to the presenters..

Right. We'll pause for just a second to see if anyone else gets back in the queue. I know there are a bunch of other earnings reports happening this afternoon..

.

All right. Well, it looks like there are no other questions, so we'll end it there. Thanks everyone for listening. There will be a replay of this call available on our website, which is investors.power.com. Thanks again, and good afternoon..

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