Good afternoon. My name is Dittus, and I will be your conference operator today. At this time, I would like to welcome everyone to the Power Integrations Third Quarter Earnings 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].

I would now like to turn the conference over to Joe Shiffler, Director of Investor Relations. Please go ahead..

Thank you. Good afternoon, everyone. 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 this call, we will refer to financial measures not calculated according to GAAP.

Non-GAAP measures for the September quarter exclude stock-based compensation expenses, amortization of acquisition related and tangible assets, and the tax effects of these items. The reconciliation of non-GAAP measures to our GAAP results is included in our press release.

Our discussion today, including the Q&A session, will include forward-looking statements denoted by words like will, would, believe, should, expect, outlook, plan, forecast, anticipate, prospects and similar expressions that look toward future events or performance.

Such 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 Form 10-K filed with the SEC on February 7, 2022.

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. Two quarters ago we called attention to a slowdown in the smartphone market and signs that other markets may begin to fade after the strong demand of the prior two years.

Last quarter, we noted that distribution sell-through had in fact slowed across all of our end market categories, likely signaling a broad-based downturn in demand. We also remind that investors that PI has historically been among the first in our industry to experience cyclical and macro driven slowdowns.

The summer slowdown has given way to a more rapid deterioration in the business environment over the past couple of months. End demand appears to have declined significantly, and distribution sell-through has continued to slow, particularly in our consumer category, which is about a third of our business and is dominated by appliances.

Our revenues for the third quarter were within our guidance range, but below the midpoint, down 13% from the prior quarter, and we expect December quarter revenues to be down more than 20% sequentially at the midpoint of our range.

For those less familiar with our history, it’s not uncommon for us to experience large cyclical fluctuations than our peers because we sell primarily to power supply manufacturers and therefore have an additional layer of inventory between us and the end markets. That same dynamic applies on both the downward and the upward swing for the cycle.

And just as we are typically among the first to see a downturn, we have historically been among the first to see the eventual upturn, and while it’s difficult to predict the timing of a recovery, we do see indications that our business is likely to hit bottom over the December and March quarters.

Our communications category, which was the first category to experience the downturn distribution sell-through, and our direct business were sequentially higher in Q3 and channel inventory fell significantly during the quarter.

Across the entire business cancellations were lower in Q3 than in Q2, and we have seen a modest uptick in turns orders in recent weeks with many customers already having eliminated much of their excess backlog.

And the product demand outlook improves, we expect recent market share gains and contributions from new products to enable the kind of outperformance we have historically delivered coming out of a downturn.

In the meantime, we will focus on what we control, managing the business for long-term growth and profitability rather than short-term operating metrics though we do expect to be within our target range of operating margin in 2023. Design activity continues to be robust.

Several competitors have retreated from the market and we are not slowing down our efforts to capitalize on the opportunities in front of us. We talked in depth about these opportunities at our recent Analyst Day, and I encourage anyone following our story to view the replay of the event on our investor website.

Our presentation covered a wide range of topics, including our unique system level approach to integration, our history of innovation in high voltage process and device technologies, including GaN and the contribution our products are making to a cleaner planet.

We also presented a detailed view of our plan to double our addressable market to $8 billion by 2027. Driven by a combination of investments in new products and technologies and big picture market trends, creating opportunities in areas like renewable energy, home automation, appliances, advanced charging and transportation.

We expect the largest contribution to SAM expansion from motor drive products as we expand our BridgeSwitch family to cover a wide range of brushless DC motor applications in the years ahead.

Current BridgeSwitch products covering applications up to 400 watt are rapidly gaining adoption at customers in major appliances as well as air conditioners and ceiling fans.

As we mentioned last quarter, new regulations in India are driving a wave of design activity in ceiling fans by essentially forcing the adoption of efficient brushless DC motors.

During Q3, BridgeSwitch was also designed in at a top tier European appliance maker for a next generation refrigerator, a design that will contribute meaningful revenues in 2023. The designs we are winning today will not only generate near-term revenue growth, but also pave the way for the higher power BridgeSwitch products in our pipeline.

Unlike the switch solutions, BridgeSwitch and our Motor-Expert software provide a platform solution that can easily be adapted to a wider range of end products by customers once they’re familiar with the architecture.

We expect an equally large increase in SAM to come from automotive, where the EV transition brings substantial high voltage semiconductor content to passenger cars and commercial vehicles.

As we explained at the Analyst Day, we have a content opportunity of more than $60 today in a passenger car, which we expect to increase by more than 2x as we expand our product offerings in the coming years. Heavy vehicles like buses, trucks, and construction equipment will have even greater dollar content.

While the major revenue ramp is still fewer years away, we are making excellent progress, establishing ourselves as a key supplier to the EV market, adding almost 200 designs to our opportunity pipeline so far this year.

A majority of these projects involve our silicon carbide based InnoSwitch ICs, which are ideal for next generation 800-volt systems.

Our success in converting opportunities into wins has been highly encouraging and speaks to the degree of differentiation we provides with InnoSwitch Switch in terms of ease of use, reliability, space savings, and efficiency.

Overall, we have now secured designs in at seven of the top 10 tier one automotive suppliers, and we expect to be in production with about 15 end customers this year, a number that should at least triple in 2023.

These include not only a wide range of power supply applications at automakers in the U.S., Europe and Asia, but also several designs using our SCALE-iDriver gate drivers in drive train inverters mainly at Chinese EV customers.

Another key topic of our Analyst Day was a detailed discussion of our GaN technology, a cornerstone of our product roadmap, and also a near-term driver of share gains and higher dollar content.

We presented not only the rapid growth in GaN-based products revenues over the past couple of years, but also the $100 million opportunity pipeline we are working to convert to design win and revenues. These opportunities cut across a wide range of end markets with more than half coming from industrial and appliance applications.

In fact, half of our GaN design wins in Q3 came from industrial and appliances. Going forward, GaN power switches will feature prominently in the automotive and motor drive products that will drive much of our SAM expansion.

We also have GaN-based products in our pipeline that will open up new markets for us, such as data center and comm equipment, another major piece of our SAM expansion roadmap. We also expect growth in the SAM for our high power gate driver products driven by wider adoption of renewable energy and the efficient DC transmission infrastructure.

Our high-power business struggled to grow over the past couple of years as projects was slowed by the pandemic, but we have seen a healthy rebound in this business in the past several months, and it is now on track to grow double digits this year.

We expect strong growth in high power again next year, driven by design wins in solar, wind and electric locomotives. In summary, our long-term growth story is on track and we are looking past the current downturn to the exciting future that we laid out for you at our event in September.

As a reflection of our confidence in that story as well as of strong balance sheet and ongoing cash generation, our Board has allocated $100 million for share repurchases, which we expect to begin implementing in the days ahead. And now I’ll turn it over to Sandeep for a review of the financials..

Thanks, Balu, and good afternoon. We are well positioned financially to weather the current downturn thanks to our strong balance sheet and our lean expense structure. And we believe market share gains, new products and secular growth opportunities will enable us to emerge stronger on the other end.

As we manage through the downturn, we will be guided by the long-term mentality that is integral to our culture and which was a key theme of our Analyst Day presentation. Accordingly, we are adjusting our spending plans, but will continue to invest in new products and greater sales reach.

We are moderating production, especially the conversion of wafers to finished goods, but we will keep our foundries active to ensure access to capacity when demand recovers. While internal inventories will run above our model for the short term.

Our products have long lives and are fungible across application and customers resulting in virtually no risk of obsolescence. This approach paid off when demand came back after the initial pandemic shutdowns, and we are following the same playbook now. I will now discuss the Q3 numbers and the outlook before we begin the Q&A session.

Revenues for the quarter were $160 million within our guidance range, but below the midpoint as demand tapered down over the course of the quarter. Revenues were 13% lower than the prior quarter.

Consumer revenues fail more than 25% sequentially, driven partly by seasonality in air conditioning, but more so by software demand and elevated inventories in major and small appliances. China continues to be the prime resource of weakness in the appliance market, but the slowdown is not isolated to China.

Communication revenues were down more than 20% sequentially reflecting continued weakness in the smartphone market. Computer revenues were up slightly from the prior quarter, driven by strength in tablet charges, as well as recent design wins in notebooks with our GaN-based InnoSwitch products.

Industrial revenues also increased slightly from the prior quarter, driven by strength in our gate driver business across a range of applications including solar, wind, energy exploration and rail. Revenue mix for the third quarter was 41% industrial, 32% consumer, 16% communication, and 11% computer.

As expected non-GAAP gross margin was sequentially lower at 57.8%. The sequential decrease was driven by less favorable pricing environment as well as lower backend manufacturing volumes.

Non-GAAP operating expenses for the quarter were $40.8 million below our forecast and down sequentially by more than $1 million, driven by slower than expected hiring in the timing of spending, which pushed some expenses out to the December quarter.

Non-GAAP operating margin for the quarter was 32.4% and non-GAAP earnings were $0.84 per diluted share Weighted average diluted share account for the quarter was $57.6 million down $700,000 from the prior quarter. Reflecting the impact of shares repurchased in the June quarter.

No shares were repurchased during the September quarter, but as Balu noted, our board has allocated a $100 million were additional buybacks, which I expect to put to work in the days ahead. We had $363 million in cash and investments on the balance sheet at quarter end an increase of $36 million during the quarter.

Cash flow from operations for the quarter was just under $50 million, and they used $5.5 million during the quarter for CapEx and paid out $10.3 million in dividends. Inventories and the balance sheet rose 29 days from the prior quarter to 161 days.

As I noted earlier, the long lives and flexibility of our products afford us the ability to build wafers –wafer inventory during a downturn ensuring continued access to capacity at our foundry partners.

I expect internal inventories to remain elevated through the first half of 2023 and then begin to taper back towards our target level in the second half of the year. Channel inventories at quarter end were 13.6 weeks up two weeks from the prior quarter.

Sell-in exceeded sell-through for the full quarter, though we saw a crossover in September with sell-through exceeding sell-in for the month.

Based on our preliminary checks, this also appears to be the case for October and we expect it to continue through the remainder of the quarter, resulting in a meaningful reduction in channel inventories as we exit the air.

Importantly, distribution inventory for communications category decreased significantly during the quarter and sell-through was up sequentially, indicating that the worst of the inventory correction in smartphones may be behind us.

We expect revenues for the December quarter to be $125 million plus or minus $5 million, and again, we expect sell-through to be higher than reported revenues. As we work to bring down channel inventories.

I expect non-GAAP gross margin for Q4 to be between 56% and 56.5% with a sequential decrease driven by lower backend manufacturing volumes and a less favorable end market mix. Non-GAAP operating expenses for the fourth quarter should be between $42 million and a $42.5 million, and the non-GAAP effective tax rate should be between 9% and 10%.

And now operator, let’s begin the Q&A session.

[Operator Instructions] And your first question is from the line of Tore Svanberg with Stifel. Please go ahead..

Yes. Good afternoon, this is Jeremy calling for Tore. Quick question, first on the communications.

Is there, can you give us maybe any, I guess, concrete signs of, that or early signs that you’re seeing of a potential bottoming besides, the channel inventories kind of, or the crossover in sell-through versus sell-in, are there discussions with customers that you can point to? Anything that you can give us a little bit more clarity on would be very helpful..

Sure. Jeremy, thanks for the question. The Chinese cell phone companies it looks like most of the inventory at the OEM has been depleted and does started pulling products from the channel. But in case of Korea, they still seem to have inventory, and so they are yet to deplete their internal inventory.

But we think that it’s, the tide is turning right now. We see the overall communications inventory at the channel has decreased significantly, but we still have some ways to go. We are thinking that by perhaps the second half of Q1, we will start getting higher shipments to this market..

Great. Thank you for that insight Balu. Maybe questions for Sandeep, with the weak yen, still kind of, you guys are a beneficiary of a weak yen with your manufacturing in Japan.

Are you taking advantage of that to kind of build some long-term strategic lower cost inventory at this time? And then maybe is there anything you can kind of forecast in terms of the potential impact growth margin? Thank you..

Yes.

So the way we have always done it, and it, if you just take a step back just pre-pandemic, we continue to build because we wanted to keep up, of our foundry partners economically profitable as well as what we know that we always come out of this downturn and when it comes, we do really well, and that really helped us with the having that inventory this time is going to be no different.

As we, I have talked earlier, these downturns take three quarters to four quarters and typically, this could be a quarter more, but as a result of which I’m expecting that, we may have a reversal of this year where next year could be like the back half of this year, while as the back half will be a much stronger back half.

So from a margin standpoint, I think I’ve, given you the guidance for Q4 for next year, I think we should be still in the 55% to 56%, mainly because the communication sector will come back and the mix is going to be a little less favorable next year compared to this year on an annual basis..

Thank you. And one last question….

Sorry, Jeremy. As – the impact of FX, the recent weakening, we’ll have to go through our inventory before we get the P&L benefit that won’t happen until the second half of next year, but you also have to remember that our input costs have gone up that will also flow into that at a very high level. They will offset each other to a large extent..

Thank you, Balu. And just one last question. You mentioned competitors exiting, or at least withdrawing from the market.

Can you remind us, how easy or difficult it is for these competitors to try to reenter if they wanted to? Or is it the case that, once customers switch the architectures is different enough that that switching costs are too high for the customer? Thank you..

Yes, so that’s a good question. I think that the level of integration, level of innovation we bring makes it very difficult for western competitors to compete with us and make good margins. So it’s a question of – they can make more margins elsewhere. They would rather go elsewhere. That’s what is happening right now.

In some cases, they’re completely decided to close down, like Panasonic has closed down, but many others are retreating from this market. Basically, they’re shipping what they have, but they’re not building new products. They look at our product and they, it’s very difficult for them to think about how to compete with us without infringing on our IP.

And as you know, we have been extremely protective of our IP, and we’ve been very successful protecting our IP. So, I think we are in such a strong position in terms of being years ahead of our competition, and we will continue to innovate. I mean, that’s never going to stop. So, I am pretty confident that this is not a reversible situation..

Great. Thank you very much..

You’re welcome..

Your next question is from the line of David Williams with The Benchmark Group. Please go ahead..

Hey, good afternoon and thanks for taking my question..

You’re welcome..

I guess, Sandeep on the first, if I kind of think about the industrial revenue, which, if I’m not mistaken, is one of the higher margin segments, it was up considerably in terms of percentage of business overall, and it seems like that’s still hanging in there, in being and fairly healthy.

I guess as we kind of think about that, can you maybe give us the puts and takes on the margin profile as we kind of think about just that industrial segment and just maybe any moving pieces there?.

Yes, industrial is the highest, but consumer follows behind that closely, and as you saw, the industrial kind of did well, but the consumer was quite weak during the quarter, so that kind of offset added to that, you heard we obviously with the volumes being lower, that had an impact on the margin.

And also, the pricing environment is not as favorable as it used to be. And that has started to also, because we do value pricing has started to also have a bit of an impact and will be have some impact next in the coming year also..

Okay, great. Appreciate that.

And then maybe can you talk about maybe any specific demand trends within the industrial that are either positive or negative? Is that holding in and what are the expectations maybe as we get out even past the fourth quarter, but longer term? How do you see that industry in general for your business?.

The high power part of industrial, which is roughly let’s say 25% or so is doing very well. As you, as we mentioned in the script the last two years a lot of projects, infrastructure projects have been delayed, but it has come back nicely this year. We expect double-digit growth this year, and it looks like next year also would be double-digit growth.

These are things like renewables, solar and wind, high-voltage DC transmission systems, traction that is electric locomotives and so on. So that’s doing very well. The home and building automation so far has done well, but there’s a possibility that could soften.

I’ve heard it from other companies, we haven’t seen it yet, but that’s an area that could soften. And the same is with the tools. But the rest of the market, we think we’ll do fine. But the overall industrial at least going into Q1, it could be roughly flat, maybe slightly down, depending upon as a percentage of revenue..

Great. Thanks so much for the questions..

You’re welcome..

Your next question is from the line of Ross Seymore with Deutsche Bank. Please go ahead..

Hi guys, this is Melissa Weathers. I’m on for Ross. Thanks for letting us ask a few question.

I guess first question, could you talk about like the linearity of demand that you saw throughout the quarter? I guess what changed from the guidance that you gave 90 days ago? Did anything change significantly from when you had your Analyst Day? And I guess it’s a good sign that cancellations have dropped quarter-over-quarter, I think, if I heard you guys correctly.

So how confident are you guys in your visibility that that this is sort of bottoming out in the December and March quarters?.

Well, in terms of in the bookings, they have been declining. And I would say that when we started the quarter, we had indicated that we are within the range of what we had in – what we had guided. But what happened throughout the quarter was there were bookings, but there were also push outs and cancellations that basically offset.

So, we never moved to the middle of the range. As far as going forward the bookings, as I said, was relatively low in the last couple of months. As a result we currently have bookings that is within the range, and based on that we are giving you guidance. But the good news is there is definitely a turnaround in terms of the turns business.

The turns business that we are seeing now is actually more than the cancellations and push outs. So, we expect some turns business this quarter and significantly higher turns business next quarter. So that’s where we are saying it is stabilizing. Therefore, we think that fourth quarter and the first quarter would be roughly bottom of the cycle.

And we also mentioned that the cell phone inventors are coming down very nicely, so we expect that to come back first and then appliances and industrial.

So going to Q1 quarter, our best estimate is we would be similar to Q4 and then Q2, our expectation is that it’ll be incremental growth, but second half is where we expect a stronger demand as this downturn turns into an upturn. That’s our best estimate right now..

Thank you, that’s really helpful. And then I guess that’s my follow up. I just wanted to touch on, you mentioned some softer pricing this quarter and that you expected to continue into next year.

What sort of expectations can we have for that on gross margins? And then also is that a temporary headwind just as we work through this cycle or is there something else going on there? Thank you guys..

Well, we price it price our products on value. That means that the components we replace, whatever they cost is what reflects our price. Of course, we get some additional for the integration and so on. So the discreet components prices are coming down. Supply chain issues are improving, at least in China it has improved significantly.

So that has some impact on our value pricing as we go forward. But also we’ve had impact from manufacturing being lower because of the lower revenues and lower backend manufacturing; our absorption is not as good. So that has also had a negative impact on the gross margin. As far as going forward, I will let Sandeep explain for next year..

Yes, as I had a guided, even at the Analyst Day, I had said 56%, but right now I’m guiding to 55% to 56%, because the volumes are much lower. And as I said, the mix is more going to slot towards communication, and as Balu had indicated, the cost increases from wafers will be offset by the yen more or less.

And obviously the value pricing, they’re expecting to have some impact in the coming year. Putting all that together, the non-GAAP gross margin guide to the best we can do and with the best indication we have for the mix is 55% to 56% for 2023..

Got it. Thank you guys..

Your next question comes from the line of Christopher Rolland with Susquehanna. Please go ahead..

Hey guys, thanks for the question. So, I guess just digging into; let’s say the comms market a little deeper here. So you guys have peaked in the $60s million’s [ph] per quarter, and probably down now to mid-teens per quarter.

I guess first of all, how do we think about that inventory burn versus a downtick in demand for next quarter? Is it balanced like at 50/50? And then secondly, what do you guys think kind of a cruising rate is or cruising altitude is once everything normalizes for your comms business? Thanks..

Okay, that’s a difficult question to answer. Let me tell you the landscape, perhaps you can judge for yourself. In China, as you know, because of lockdowns and all of the business, the challenges they’ve had in terms of the economy slowing down and so on. Many of the consumers are delaying purchase of cell phones.

They used to purchase a new phone every 18 months. Now, I think they say, okay, I’ll keep the phone, because I can’t afford to buy a new phone. When they will start buying, I don’t know, we are going through this timeframe where the demand for the phones in China is low.

And in fact, across the world things are slowing down, as you know, because of inflation and so on. People are not replacing phones as often, but the actual the performance is different for each and every OEM is differs from one to the other. So Chinese OEMs are doing the worst right now. And then as you know the other geographies are doing better.

So our best estimate is that at the current rate of demand, we can see how they’re depleting their internal inventory. So, we’ve already seen that the Chinese companies have started pulling from distribution. So that tells us that, how much there is in distribution. We say some sometime in Q1 we will – they will start ordering products.

Now, I have to be careful they’re already ordering some products because there’s a mix issue. If they need a product that’s not at distribution, we still have to ship. Obviously we are still shipping products, but it is to non – more to non-Chinese customers and less to Chinese customers.

So our best estimate is that it is likely to come back strong in the second half. We will see, I believe a some revenue coming back in Q1, but higher in Q2, but bigger change in demand will be the second half, and that is our best, I would say speculation of when the demand will come back to normal..

Okay. Thank you for that.

And then secondly, I was wondering if you had some extra color into the guide from a segment perspective, whether you want to force rank that or just call one or two out or however you want to do it?.

If you’re talking about Q4, clearly, the….

Q4, yes..

Yes, I think, common computer will be higher and you will see the other segments that’s why a bit of the margin impact. But I think all four segments bleed down in terms of the dollar wise. As a percentage, it’s kind of in the direction I give you..

Sorry, all of them down in the same on a percentage basis?.

Well, I would say the industrial be down – industrial will be down from where it is and all four, I mean, I would say the direction is dominant dollars, but percentage wise, you will see common computer slightly up..

Okay, thank you..

Your next question is from the line of Gus Richard with Northland. Please go ahead..

Yes, thanks for taking the question. Just real quick, I just want to make sure I get this right.

Did channel inventory decrease by about 15 million in the September quarter?.

The channel inventory in dollar terms decreased from Q3.

Are you talking from Q2 to Q3?.

Correct..

Yes, it went down about, yes about $10 million – roughly around $10 million or so..

Okay.

And sort of what do you expect the cash burned to be? I’m sorry, the inventory burn in the fourth quarter, how much do you expect to come out?.

You’re talking the channel inventory went up..

No, just going to say. [Ph].

Yes, that’s one. So channel inventory went up by $8 million..

Yes, channel inventory went up in the last two quarters, but in Q4, we expect the channel inventory to come down. In fact, we are trying to get that down. It is a higher than we need in the channel. And our expectation is roughly about $15 million will be the reduction in Q4. Obviously, we won’t get to our target weeks until a few quarters later.

We can’t correct all of it overnight..

And the weeks calculations get impacted by the denominator..

Yes. So even though we got big, yet to remember that there is a double whammy, right? The dollar value goes up, but the denominator also comes down and that amplifies the change in weeks..

Got it. Yes, absolutely.

And then, do you have any sense, I think in the communication market you do, but for the other markets, the – your customer’s customer, the OEMs, do you have any sense of what the inventory looks like downstream from your customers?.

We have a rough idea. They’ve been relatively open. Obviously, we can’t do it with all customers, but that top customers. As I mentioned the biggest challenge we had was in China. And that inventory seems to be – seems to have come down because we see them pulling from the channel.

And then the – now more recently, I will say from Q2, the China, we saw the inventory problem in Q2, but in Q3, we saw a significant inventory correction in Korea, both in the cell phone and appliance OEMs.

And they are really correcting very hard right now, and that won’t be corrected until probably end of Q1, because they do have – they have built more inventory based on their concerns before – during the pandemic.

The whole thing, if you look at it, what happened was they were trying to build enough inventory so that they don’t have supply chain issues, but the demand dropped up so abruptly they were not prepared. So they now are trying to correct it.

And China to a large extent is corrected at the OEM level, not at the channel level, but in Korea it’s still there at the OEM level..

Got it. Got it. All right. That’s it for me. Thanks so much..

You’re welcome..

[Operator Instructions] At this time, there appear to be no further questions. I will now turn the call over to Joe Shiffler for any closing comments..

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

Thank you all for joining today’s call. You may now disconnect..