Power Integrations Inc (POWI) 2008 Q3 法說會逐字稿

Thank you for standing by, and welcome to the third quarter 2008 financial results conference call for Power Integrations. Today's conference is being recorded. Now at this time, it's my pleasure to turn the conference over to Mr. Joe Shiffler. Mr. Shiffler, please go ahead.

Thank you, and good afternoon. I'm Joe Schiffler, Director of Investor Relations and Corporate Communications for Power Integrations. With me today are Balu Balakrishnan, President and CEO of Power Integrations; and Bill Roeschlein, our CFO.

Since there are a number of other calls going on this afternoon, we'll keep our introductory remarks very brief and try to get through as much Q&A as possible before the top of the hour. During today's call we'll make reference to financial measures that are not calculated according to Generally Accepted Accounting Principles. Please refer to today's 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.

I would also like to note that our discussion today, including the Q&A session, will include forward-looking statements reflecting management's current forecast of certain aspects of the Company's future business. Forward-looking statements are denoted by such words as will, would, believe, should, expect, outlook, estimate, plan, anticipate, suggest, project, forecast and similar expressions that look toward future events or performance.

Forward-looking statements are based on current information that is by its nature dynamic and subject to rapid and even abrupt changes. Our forward-looking statements are subject to risks and uncertainties which may cause actual results to differ materially from those projected or implied in our statements.

Such risks and uncertainties are discussed in today's press release and under the caption item 1a "Risk Factors" in Part 2 of our Form 10-Q filed on August 8, 2008. Lastly, this conference call is the property of Power Integrations and any recording or rebroadcast of this conference call is expressly prohibited without the written consent of Power Integrations.

With that, I'll turn the call over to Balu.

Thanks, Joe, and good afternoon. Obviously, the impact of the economic downturn is the number one issue on everyone's mind so I'll begin with an update on what we're seeing. It's not unusual for us to be on the leading edge of the downturn and that seems to have been the case this time around. As we indicated on the July call, we saw the first signs of slowdown midway through the second quarter.

That softness persisted through the month of September and the seasonal ramp that we typically expect in the third quarter did not materialize. As a result, revenues increased only slightly on a sequential basis coming in at $53.8 million. After holding up reasonably well through September, orders have dropped off significantly in October. As a result. we're projecting a sequential revenue decrease of 15% to 25% in the fourth quarter.

The wide range indicates the lack of visibility that we have in this highly uncertain environment. While our business is obviously being impacted by a very challenging macro environment, we remain confident about our long-term business model and we are staying focused on things we can affect, winning designs, developing new products, controlling costs and expenses and prudently deploying our cash.

Our strong balance sheet and cash flow allow us to take advantage of the current depressed stock price by aggressively repurchasing shares and our Board has authorized an additional $50 million on top of the prior $50 million program that is nearly complete. Our Board has also declared a quarterly dividend of $0.02.5 for the fourth quarter.

Despite the weaker end market demand, design activity continues unabated and our pipeline of opportunities continues to expand. Our current generation of products is highly competitive in the power supply market and is made even more attractive by the combination of factors that we've talked about on our past couple of calls including tightening energy efficiency specs and rising labor costs in Asia.

While metrics related to design wins have limited quantitative value we do look at them as a directional indicator of how we are doing in the market. The third quarter was our best ever in terms of the number of designs won as well as the expected dollar value of those designs.

Some designers of note included charges for TomTom GPS devices and Philips Shavers, a high volume cell phone charger designed for Huawei in China, a handful of cordless phone designs replacing linear adapters, PC standby designs for HP, Dell and Acer, and a number of home appliance designs ranging from washing machines to kimchi refrigerators.

We've also been designed in by two of the three vendors supplying utility meters for the upcoming conversion to automated meter reading in France. That conversion could result in the installation of 35 million new meters over a five-year period and we expect to get a healthy share of that business.

In all, we won more than 100 design wins in the industrial market in the third quarter, including about a dozen metering designs, more than two dozen LED lighting designs and a number of process control and motor control designs. We're also excited about our efforts to expand our (inaudible) market by introducing products for high power applications.

We are aggressively marketing our new solution for notebook adapter market and customer feedback thus far has been very encouraging. We expect to launch our next high power product between now and the end of this year with additional rollouts on track for 2009. All told, we expect these new high power products to increase the size of our [adjustable] market by at least 25% to more than $2 billion.

Before I turn the call over to Bill, I'll give you a quick recap of recent developments regarding patent litigation. In late September, the District Court in Delaware ruled that all four patents we asserted in our 2004 lawsuit against Fairchild are enforceable, rejecting Fairchild's claims of inequitable conduct by the inventors. As you may recall, we had already won favorable jury verdicts on validity and infringement along with a damage award of nearly $34 million.

The next step is for the court to rule on the remaining post trial motion, including damages and our request for an injunction. However, in the meantime, Fairchild has already informed its customers that they should no longer use the infringing parts in products destined for the U.S. market.

Despite resounding losses in the Delaware court and earlier at the ITC, Fairchild and it's [system general theory] appear to be undeterred. Fairchild and SG continue to violate our patents, including two of the same patents involved in the Delaware case and we are forced to initiate a new lawsuit earlier this year in response. Now in an apparent effort to confuse the marketplace, Fairchild has responded with a lawsuit of their own.

As we indicated in our statement last week, with regard to this lawsuit, it is baseless and completely without merit. With that, I'll turn it over to Bill for a review of Q3 results. Bill?

Thanks, Balu, and good afternoon. As Balu noted, the weak macro economic environment is clearly having an impact on our top line, but we're pleased with our progress on the things we can influence including gross margins, expense control and cash deployment.

We turned in a strong performance in all three of those counts with a gross margin above the upper end of our guidance, lower than expected operating expenses and an acceleration of our stock buyback program. All of these factors contributed to an in line quarter in terms of earnings per share despite lower than expected revenues and an elevated tax rate. Looking at revenues in detail, the areas of relative strength were the industrial and consumer end markets.

Industrial grew mid single-digits on a sequential basis driven by metering applications, tools and lighting. Consumer was up low single-digits sequentially with growth in video game consoles, appliances and flat panel TV's offset by seasonal weakness in the air conditioner market. Communications revenues were flat sequentially with strength in broadband modems and cordless phones offsetting revenues from cell phone chargers. Computer revenues declined mid single-digits driven by weaknesses in desktop PCs and also SmartPhone chargers, which we include in the computer segment.

In total, net revenues were $53.8 million, up slightly from the prior quarter and up 8% from a year ago. The distribution channel accounted for 65% of revenues for the quarter while 35% came from direct sales. Channel inventory remained at 4.8 weeks exiting the quarter, unchanged from the end of June. Distributors Abnet and ATM were our only 10% customers during the quarter comprising 18% and 11% of revenues respectively.

Turns orders as a percentage of revenues were in the low 60s and our average selling price was $0.35, up from $0.33 in the prior quarter primarily due to customer mix. Detail on revenue mix by product in end market is provided in the text of our press release and in the accompanying tables.

Non-GAAP gross margin, which excludes stock-based compensation, was 54.9%, up 30 basis points sequentially and 120 basis points year-over-year. GAAP gross margin was 54.2%, up 50 basis points from the previous quarter and 120 basis points from a year ago. The year-over-year expansion was driven by a combination of cost reductions and mix, most notably a lower percentage of revenues coming from the cell phone market versus a year ago.

Third quarter operating expenses totaled $20.5 million, down $1.3 million from the prior quarter. The improvement was driven by a variety of factors including reduced bonus accruals as well as cost cutting efforts we've undertaken in response to the weaker business climate. Also, as you may recall, we had some non-recurring expenses in the second quarter related to the CFO transition which explains a portion of the sequential decrease in OpEx.

As a result of the improved gross margin and lower operating expenses our non-GAAP operating margin expanded by 320 basis points on a sequential basis coming in at 23.6%. GAAP operating margin was 16%, an improvement of 300 basis points sequentially. Other income declined by about $700,000 on a sequential basis primarily reflecting the fact that we had non-recurring items in the second quarter that netted out to a benefit of about $0.5 million.

Our effective tax rate for the quarter was 23% on a non-GAAP basis and 26% GAAP which brings our year-to-date tax rates up to 21% and 22% respectively. That's higher than our earlier expectations reflecting the reduced outlook for the year which will cause a higher percentage of our profits to be on shore and subject to U.S. tax rates.

Diluted share count decreased slightly to 32.6 million shares. That reflects the fact that the bulk of the buyback activity came late in the quarter and had only a modest impact on the third quarter share count. Diluted EPS was $0.34 per share on a non-GAAP basis and $0.23 on a GAAP basis.

Looking at the balance sheet, we exited the quarter with $225.3 million in cash and investments, down $12 million from the prior quarter as a result of the stock buyback. We repurchased 788,000 shares during the quarter for a total of $20.2 million. Including shares repurchased so far in October, we've used $45 million out of the $50 million authorized by our Board back in February repurchasing a total of 1.9 million shares.

We expect our business to continue generating positive cash flow even in the event of a severe economic downturn and we believe our cash cushion is more than adequate to run our business. We believe that at current price levels share repurchases are a prudent way to deploy our cash and our Board has allocated another $50 million for that purpose. As in the past, we plan to use a price sensitive algorithm that varies our purchases according to the stock price.

In a further expression of our confidence in the future of our business and the strength of our balance sheet, our Board has declared a quarterly dividend of $0.02.5 per share with the first quarterly dividend to be paid to shareholders of record as of November 28. Looking at some other balance sheet items, we exited September with 28 days sales outstanding, down two days from the prior quarter.

Inventory increased by $2.8 million, reflecting the lower than expected third quarter shipments and we stood at 3.7 inventory turns exiting the quarter. We've adjusted production levels in response to the current business climate which will result in a slight negative impact on our gross margin in the fourth quarter as reflected in our guidance.

We'll see a larger impact in the first quarter of 2009, probably on the order of 2 percentage points relative to our fourth quarter gross margin. Turning to the outlook, as Balu noted, we are expecting a sequential revenue decline of 15% to 25% in the fourth quarter. We expect our gross margin to be between 53% and 54% on a GAAP basis, with roughly a 1-point impact from stock-based compensation.

Operating expenses should remain approximately flat compared to the third quarter. Our tax rate should be around 21% on a non-GAAP basis or 22% GAAP. We should also see a meaningful decline in the share count reflecting the ongoing share repurchase activity. With that, I'll turn it over to Joe.

Thanks, Bill. In light of the fact there are some other calls starting at the top of the hour, I would like to ask everyone to limit themselves to one question first time through the queue, and then we'll be happy to come back for a second round as time permits. Operator, would you please give the Q&A instructions?

Thank you. (OPERATOR INSTRUCTIONS) And we'll pause for just a moment to give everyone a opportunity to signal. And we'll go first to Tore Svanberg of Thomas Weisel Partners.

Yes. Thank you. Could you just repeat what you said about gross margin for 2009? I didn't quite understand that.

So our current quarter gross margin on a non-GAAP basis is expected to be 54% to 55%. But because of our decline in production which is occurring this quarter, we would expect up to 2-percentage-point decline in the first quarter of '09 on a non-GAAP basis with an additional point when you account for that on a GAAP basis.

Okay, so that comment was specifically relative to first quarter '09?

Yes.

Great. I'll follow-up later. I know you have more questions.

And we'll go next to Ross Seymore, Deutsche Bank.

Hi, guys. Balu, talk about how you see the end markets and the bookings activity as compared to at this time last quarter? I know you gave a little bit of lead into that, but any granularity would be helpful.

Hi, Ross. The last quarter, as we said, it started weakening the middle of the second quarter actually, but that weakness continued through the third quarter.

But in October, starting at the beginning of October, the bookings have dropped off quite significantly and it looks like the market has weakened across the board. It seems pretty broad from everything we can tell.

Is there any difference between like [DFID], OEM, any granularity along those lines?

I just don't know at this time because -- well do you have the numbers by any chance?

It's pretty consistent actually, Ross, across both distribution and OEM.

Great. I'll jump back in the queue.

We'll go next to Steve Smigie, Raymond James.

Great. Thank you. If you could discuss operating expense a little bit more. It seems like revenue is down quite a bit sequentially at the midpoint and you've kept OpEx flat so if you can talk about that, and what operating expenses would look like going into next year, particularly given the Fairchild lawsuit, how does that impact it? Thanks.

Sure. This is Bill. Well, for the current quarter, we are maintaining a flat OpEx structure and are continuing to fund the initiatives and high power projects that we have ongoing. Obviously, as the quarter and the next quarters go on, we will continue to reassess in light of the economic environment.

We've built in about a million dollars of litigation expense, which is consistent with the previous guidance that we've given on the call in previous quarters. And so as we look into '09, we're not giving OpEx guidance, just given the uncertainties of the economic picture right now. But we can just pretty much tell you where we stand in terms of Q4.

I guess, so would you -- I mean expect to be reducing OpEx in Q1, do you think -- you do not think you'll have time to get everything done that you want, and then that's one part of the question. And then the $1 million, does that account for the new Fairchild stuff or would you have to do some sort of discovery or something that might be one time or you would not know what quarter it would fall or something like that?

This is Balu. What we've done so far is we have cut back on our hiring quite significantly. I think that's the prudent thing to do especially in the area of sales where we've been adding a lot of people recently. We have also cut back on any discretionary expense that we can cut back on. Again, it's just the prudent thing to do.

Beyond that we really haven't had a chance to look at other areas simply because this has just happened to us in the last two or three weeks, we've seen a significant decline. And the first two weeks we weren't sure if this was just a trend or a blip, but so far it looks like a trend because it continues to be weak and obviously we will start looking at it very carefully as prudent managers of the business.

And as far as litigation, the second lawsuit we have filed with Fairchild is still in very early stages so there is really no costs associated with that this year to speak of. As far as how much that will add to the next year is extremely difficult to predict because we don't know when the trial is likely to occur.

The earliest we can think of is late in the year. So it's extremely difficult to predict. My estimate would be that it will be at least as much as it has been this year, probably a little bit more than that because of the additional lawsuit.

Okay. Thank you.

Our next question is from Vernon Essi, Needham & Company.

Thank you. I was wondering if you could comment on the competitive situation out there? Are you seeing any changes in the mix out there from either the switch mode side or the discrete side?

So far we have not seen any change in the [competition] in terms of, for example, discrete pricing, for example. But I would think that given the reduction in the costs of raw materials, that discrete could get cheaper over time and we'll have to deal with that.

And obviously we continue to reduce costs. We're moving our wafers to six inches as we speak in two of our fabs and so that will give us an ongoing cost reduction for the next couple of years.

Okay. Thanks.

We'll go next to Sumit Dhanda, Banc of America Securities.

Yes, hi, Balu or Bill, in terms of your outlook for the December quarter, what are you baking in in terms of an improvement or lack thereof in activity versus current levels. In other words what is the current target for the full quarter and really is there a bump up in the rate of turns that you're anticipating, which is of significance, through the end of the quarter?

To hit the midpoint of our guidance we need turns to the mid-50s and that may sound conservative, but you have to remember the fourth quarter is a front end loaded quarter. We normally expect a lower turns requirement.

And also our bookings in September related to October were significantly better. And, therefore, the beginning backlog relative to the total looks bigger than it should. But what we're assuming for the midpoint is that the business is going to be at the current rate and on top of that you have the linearity of the quarter, which is that November is usually weaker than October and December is almost always weaker than November.

Okay. And if I could just ask a quick follow-up as it relates to inventory. Do you have any sense of where your channel -- your channel inventories do not seem to have come down and the inventory and the balance sheet certainly moved up.

So the question is, what is your target, especially given the fact that the gross margins are anticipated to decline a couple of points in Q1? Do you have an inventory target by the end of the quarter which especially in light of the decline in revenues that you're talking about into Q4?

Yes, we do. And that's what actually impacts the gross margin because we are cutting back on our production in Q4 which has a little over two-month delay. It has a little bit of an impact on Q4 gross margin, but it has a more significant impact in Q1.

Normally we do not cut back on production so rapidly for a couple of reasons, one is we do not want to exercise our vendors. Secondly, it keeps our margins relatively consistent. But this time the downturn is so significant and unexpected we have no choice but to cut back more drastically than we would like.

I don't have an exact number. I'm sure we have it somewhere in the Company, but I don't have one. We're going to bring it back to the levels we need to service our customers, which is between 4 and 5 turns. We'll probably be closer to 4 turns than 5.

Thank you.

We'll go next to Christopher Longiaru, Sidoti and Company.

Hi, gentlemen. Can you talk a little bit more about the design wins in the quarter and how you expect that to play out from a timing perspective, whether you expect it to add to revenue?

Sure. We had a record level of design wins both in terms of dollar value. We do look at annualized dollar value and also in terms of number of design wins -- just the sheer number of design wins. And typically it takes two to three quarters for those design wins to ramp up to full volume.

Do you think that situation with the economy the way it is and the global environment the way it is, will that change your time frame?

That's a good question. I don't know how to answer that. I'm assuming that since these design wins just occurred, they will go into production. Whether they will be delayed or the volumes will be less than expected, it's very hard to answer that question. I think you're guess is as good as mine.

Okay. Thank you, guys.

(OPERATOR INSTRUCTIONS) We'll go to Ross Seymore, Deutsche Bank.

Good pronunciation twice in a row, I guess. The H and T side of things, a little color on what happened with the Samsung stuff and that bankruptcy as the quarter and your fourth quarter outlook progressed?

The ramp-up at Samsung was as we expected, ramped up very nicely in Q3. In fact, the volumes came out higher than we expected, that is the ramped up volume is higher than we expected because this particular vendor or the subcontractor got a larger share and so we are very pleased with that.

But as you know, the other -- the Nokia has -- demand has gone down significantly, that's the offsetting factor. But in addition to that, we also got another design win, a smaller subcontractor to Samsung. It's a relatively small design win, but we're hopeful we'll continue to go after other subcontractors and get a higher share going forward.

Great. Thank you.

Your welcome.

And it does appear there are no further questions at this time.

Okay. We'll leave it there. Thanks, everyone.

That concludes the call this afternoon. A replay will be available shortly on the investor info section of our website, investors.powerint.com.

The telephone replay is available for 48 hours by dialing 888-203-1112 from within the U.S. or 719-457-0820 from outside the U.S., and the replay code is 3001343. Thanks for listening, and good afternoon.

That does conclude today's conference. Thank you for your participation. You may disconnect at this time.