Power Integrations Inc (POWI) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to the Fourth Quarter and Year End 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. Please go ahead, sir.

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

During today's call, we will 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 and as well as tables reconciling these measures to our GAAP results. Also 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 towards 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 Two of our Form 10-Q filed on November 7th, 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 consent of Power Integrations. With that, I'll turn the call over to Balu.

Thank you Joe, and good afternoon. Obviously the impact of the economic downturn is on everyone's minds. So, I will begin with an update on recent trends. As you may recall, we had already seen a significant slowdown in orders at the time of our October Conference call and projected a steeper fourth quarter revenue decline than many of our peers did at that time. That forecast proved accurate and the revenues came in near the midpoint of our original projections at $42.4 million, down 21% sequentially. With distributors and end customers reducing inventories, bookings declined at a faster rate than revenues. Even compared to soft October bookings, orders fell off sharply in November before recovering slightly in December. In total, bookings for the quarter were down more than 50% from the third quarter. As a result, we entered January with a backlog nearly 50% lower than the prior quarter.

January bookings increased from December marking the second straight month of improvement, but remain below October levels. Forecasting our first quarter revenues is exceptionally difficult due to the combination of lower backlog, the Asian holiday and the general uncertainty of the economic climate. Our expectation at this point is that our first quarter revenues will be between $32 million and $36 million, and sequential revenues will be between 32 and $36 million, a sequential decline of 15% to 25%. We began the quarter with about 30% of our bookings needed to reach the midpoint of the range and including turns orders received thus far in the quarter ,we have approximately 65% of the bookings we need to reach the midpoint.

As we navigate this downturn, we are working to strike an appropriate balance between near term profitability and longer term growth. Setting aside patent litigation costs, we'll reduce our non-GAAP operating expense turn rate by nearly $2 million per quarter since the second quarter of last year, through a combination of head count reductions and other cost-saving measures. We're also taking steps in the production area, including head count reductions to mitigate the gross margin impact of lower production levels. In total, we'll reduce the size of the work force by approximately 6%, including the reductions taken in Q4 and Q1.

Lastly, we have put our balance sheet to work, returning a significant amount of cash to stockholders while reducing our share count, option overhang and stock compensation expenses. At the same time, we remain confident in the gross prospects of our business over time and we're encouraged that design activity remains healthy despite the weak economy. The power [to plane] industry is moving inevitably towards higher levels of integration, a secular trend that Power Integrations has led since 1994 through a relentless focus on innovation. While we continue to evaluate the balance between profitability and growth as the economic conditions change, we believe that the continuing investment in R&D and new products to support our future growth is the right thing for our business.

In the fourth quarter we introduced two products, LinkSwitch-CD and HiperPLC. LinkSwitch-CD is an extension of our LinkSwitch-II product family, targeting applications that require constant voltage but not constant current. This expands the range of applications in which we can offer the highly cost effective primary [side regulation] capabilities of LinkSwitch-II.

HiperPLC is our first ever product for applications above 200 watts. The product integrates a resonant LLC power supply controller with power factor correction circuitry on a single chip and combines this with our high voltage driver chips in a single package providing a level of integration never before seen at such high power levels. This targets high power applications that we have not historically addressed, including main power supplies for flat panel TVs and ultra-high efficiency desktop PCs and servers, as well as high power LED streetlights and industrial controls. HiperPLC is the first of several products in our pipeline targeting applications over 200 watts. Once fully launched, we believe these Hiper products could increase our addressable market from approximately $1.6 billion to more than $2 billion.

With respect to [regular efficiency and other] key growth drivers, there have been a number of developments since our last conference call. All were widely expected but it's worth recapping them quickly here.

On November 1st and January 1st respectively, ENERGY STAR and European Code of Conduct both tightened their voluntary specifications for external power supplies making them mandatories slighter than those across the US. The mandatory European standard for the external power supplies is expected to receive final approval in the next several weeks and would be enforceable early next year. Australia also [erupted] it's mandatory external power supply standards effective December 1st 2008 with new [newdelents] scheduled to follow on April 1st, 2009.

In November, 2008, world's five largest mobile phone manufacturers introduced a joint rating scale for cell phone chargers, rating chargers from zero to five stars based on the level of no load consumption. The five star rating requires no load consumption of 30 milliwatts or less which is 94% below the mandatory limits imposed by the 2007 energy bill in the US and 90% below the threshold of ENERGY STAR version 2. This is a very challenging spec but one that we can meet quite comfortably with our LinkSwitch-II products.

Meanwhile, the European Union's new blanket standards for standby received final approval in December and will take affect on January 1st, 2010. The standards mandate maximum standby consumption of one watt for a wide range of electronic products, with two watts allowed for devices containing a display. These limits are scheduled to be reduced by half, three years after the standards take affect.

A wide range of other standards are in development, including work on television power usage at California Energy Commission, set-top box and energy light bulb specifications by ENERGY STAR and standby limits in Canada, all of which we are watching closely. It also increased by the new Administration's credit, meant to energy efficiency as a solution to the nation's energy problem. While no specific proposals have been made regarding electronic products, the Administration's energy policy explicitly recognizes that efficiency is the cheapest, cleanest, faster energy source, something we've been saying for many years.

Before I turn the call over to Bill, I will give a quick update on the status of patent litigation with Fairchild's Semiconductor, where there have been a number of developments of late. As you may recall, we had previously won favorable rulings determining that Fairchild willfully infringed four of our patents and that all four patents are valid and enforceable. In December, the court granted our request for a permanent injunction against more than 100 infringing Fairchild projects. Although currently subject to a 90 day stay pending action by the appeals court, we believe the injunction is having the desired affect. In fact, we believe the infringing products had all largely been abandoned by Fairchild customers some time ago. And Fairchild itself claims it has seized shipment of these products. Eliminating infringing products in the marketplace was the principle goal of our lawsuit and we are very pleased with this outcome.

The court awarded us $6 million in monetary damages as well as interest on the damages owed. Our motion for enhanced damages and attorneys fees has been deferred pending the outcome of a new trial on the question of willful infringement which will take place later this year. The court's decision to order a new trial was expected in light of the 2007 Seagate Decision which effectively changed the legal standard for proving willfulness. However, we believe that Fairchild's infringement was clearly willful under the revised standard.

The second case against Fairchild remains pending and has been scheduled for trial in the fall of 2010. We believe Fairchild continues to produce infringing products over and above the products covered by the injunction. And in fact, we believe they continue to infringe two of the same patents they were found to infringe in the earlier case. Separately, the US Patent Office is in the process of re-examining several of our patents at Fairchild's request. A common tactic now being used by defendants in patent lawsuits. The re-examination process is on-going and we are optimistic that our patents will ultimately emerge in tact. With that, I will turn it over to Bill for a review of the Q4 results. Bill?

Thanks, Balu. And good afternoon. Before I run through the fourth quarter results, I'll touch on a few items that affected the quarter and will impact our financial model going forward. First, as Balu mentioned, we are returning a considerable amount of cash to stockholders while reducing our share count in option overhang in the process. In the fourth quarter, we utilized $53 million to buy back 2.9 million shares of our stock or 10% of total shares outstanding. We paid a dividend of $0.025 per share on December 31st.

For the full year, we bought back 4 million shares for $82 million. At December 31st, we had 27.5 million shares outstanding, down from 30.1 million at the end of 2007. Weighted average diluted share count for the fourth quarter was 29.8 million, down from 32.6 million for the third quarter. Expect our share count to fall further in the first quarter as the Q4 repurchases are fully reflected in the average and also reflecting continued buyback activity this quarter. At year end, we had about $18 million remaining on our current repurchase authorization and we've used two-thirds of that amount thus far in the first quarter.

Second, we executed a voluntary tender offer in December through which we purchased 2.4 million out of the money employee stock options for $9 million in cash. All of the options were purchased at prices below their current Black-Scholes value. We believe these options offered limited retention value at a high cost in terms of option expense on the income statement. As a result of the tender offer, the compensation expenses that would have been recognized over the remaining vesting periods of the tendered options were accelerated into the fourth quarter, resulting in noncash charges of $19.3 million on our income statement. Including this charge, total stock-based compensation for the quarter was $22.9 million.

Going forward, starting with the first quarter, our quarterly stock compensation expenses will be about half of what they were in the third quarter of 2008. A savings of about $2 million per quarter. Also, at the result of the tender offer, our option overhang was reduced by 30%, which should result in lower dilution down the road.

There are two other non-recurring items impacting our income statement for the fourth quarter, both reflecting the weakness of the current economic climate. One is an impairment charge of $2 million for certain intangible assets which is excluded from our non-GAAP results. The other is an increase in our inventory reserves which is included in our non-GAAP results. This item reduced our non-GAAP gross margin by approximately 200 basis points and our non-GAAP EPS by $0.02 per share. Lastly, our non-GAAP effective tax rate for the quarter was higher than expected at 31.5%, in order to bring our full year rate up to 22.7%.

With that said, I'll quickly review some of the financial metrics for the fourth quarter, focusing primarily on non-GAAP results which exclude the accelerated option expense charges, other stock-based compensation expenses and the write down of an tangibles. Revenues for the fourth quarter were $42.4 million, down 21% sequentially and 19% year-over-year. Full year revenues were $202 million, up 6% from 2007. This compares to a 2% contraction in revenues for the analog semiconductor industry. The consumer end market was the weakest performer in the fourth quarter. Down almost 30% sequentially with significant weakness in both appliances and electronics. Industrial revenues declined in the mid-20s while computer revenues were down approximately 20% driven by weaknesses in desktop PC's.

The communication segment was the relative bright spot, down by a low double-digit percentage, driven by stronger than expected revenues from the cell phone charger market. The distribution channel accounted for 63% of revenues for the quarter, while 37% came from direct sales. Channel inventory remained at 4.8 weeks exiting the quarter, unchanged from the end of September, although in dollar terms, inventories came down by about 25%. ABnet, our leading distributor, was our only 10% customer for the quarter, accounting for 15% of total revenues.

Turns orders as a percentage of revenues, were in the mid-50s and our average selling price was $0.32, down from $0.35 in the prior quarter, primarily due to customer mix. Most notably, the relative strengths in the cell phone market compared to higher ASP markets such as industrial.

Non-GAAP gross margin was 49.9%, down 500 basis points sequentially. About 200 basis points of the decline was due to the increased inventory reserve. Other remaining 300 basis points, roughly two-thirds, came from changes in the revenue mix, specifically the relative weakness of the higher margin consumer and industrial markets as compared to the lower margin cell phone market. The remainder of the sequentially decrease, about 100 basis points, was the result of lower fixed cost absorption, due to the production cuts we implemented in the second half of the year.

As noted on our October call, we expect further gross margin pressure going forward from a combination of lower production levels and the stronger yen versus the dollar. Plus, an increasingly competitive pricing environment. As Balu mentioned, we're working to mitigate these affects through a variety of cost saving measures in the production area. This includes scaling back our in-house test operations, which entailed a significant reduction in head count.

Assuming no significant changes in mix, we are expecting a first quarter GAAP gross margin of 50%, plus or minus 100 basis points with a further decline of approximately 2 points in Q2, due largely to the impact of lower production levels and the stronger yen. Non-GAAP gross margin should be about 50 basis points higher than the GAAP numbers. Non-GAAP operating expenses for the fourth quarter were $16.3 million, down $0.5 million dollars from the prior quarter, primarily reflecting the impact of expense reduction measures. These include the elimination of a small number of nonproduction jobs in various areas of the Company, a two week Company-wide shut down in December, a near freeze on hiring and a variety of other measures. As Balu noted, we have taken nearly $2 million out of our quarter non-GAAP expense run rate since the second quarter of 2008 setting aside patent litigation expenses.

Allowing for seasonal fluctuations in operating expenses such as the resumption of payroll tax payment, as well as a possible increase in litigation expenses, we expect first quarter non-GAAP operating expenses to be similar to the fourth quarter. Stock-based compensation expenses should total about $2 million, putting total operating expenses in the range of $18 million to $19 million.

As mentioned earlier, our fourth quarter effective tax rate for the quarter was 31.5% on a non-GAAP basis. We expect our 2009 non-GAAP tax rate to be in the range of 25% to 30% due to changes in the geographical composition of our earnings mix. Non-GAAP diluted EPS was $0.15 per share in the fourth quarter, which again includes a $0.02 impact from the increased inventory reserve.

We exited December with $174 million in cash and short-term investments, down $51 million for the quarter, reflecting the impact of the buyback. We had 28 days sales outstanding at December 31st, unchanged from the prior quarter, marking the seventh consecutive quarter of DSOs at 30 days or fewer. Inventory on our balance sheet increased by $2.1 million and we stood at three inventory turns exiting the quarter. Assuming we hit the mid point of our revenue projections, we would expect inventory dollars to level off in the first quarter and our aim is to return to the range of four to five turns within the next two to three quarters. With that, I'll turn it back over to Joe.

Thanks, Bill. Since there are some other calls starting shortly, I'd like to ask everyone to limit themselves to one question the first time around, so we can get to as many people as possible before the top of the hour. We'll be happy to come back around for the second time as the time permits. Operator, would you please give the Q&A instructions?

(Operator Instructions). We will take our first question from Tore Svanburg with Thomas Weisel Partners.

Yes. Thank you. Good afternoon. Balu, can you talk a little bit about the notebook adapter business? I know that's a new business opportunity for you and it's probably quite a small percentage of revenue, but as we walk throughout 2009, can you just talk about how you expect that business to ramp?

Yes. Hi,Tore. We have several designs ongoing right now. They're all -- I would say tier 2 type of designs and we are optimistic that we will get some revenue in the second half of 2009.

And Joe, can I do a quick followup?

Yes, go ahead.

So, with the tests being outsourced more, what type of savings could that potentially give you on a quarterly basis or has that saving already occurred?

We factored in the savings into the guidance that we gave on the -- on the call already.

Perfect. Thank you.

We'll take our next question from Ross Seymore with Deutsche Bank.

Hi guys. Can you clarify a bit on the turns required commentary you gave and then how much you need as of the -- today I guess?

Yes. Ross. This is Joe. The turns requirement for the full quarter is just under 70%. And the other commentwe gave was that if you include the turns we've gotten already this quarter, we're up to 65% booked to the midpoint of the guidance.

Okay. So -- okay. Got you. Okay. I'll get back in the queue.

We'll take our next question from Steve Smigie with Raymond James. And sir, your phone line is open. If you would check your mute button, we cannot hear you at this time.

Great. Thanks. I was hoping you guys could talk a little bit about how you think Chinese New Year has impacted orders here? How much shut downs there may have affected standard ordering patterns and what you think may be sure to happen the next week and the following weeks as we get past?

The Chinese new year was the last week as of January and as we normally expect, there was very little in terms of bookings from Asia. And of course, this week we're out of the Chinese New Year and we've seen the bookings pick up. So we are past that.

Okay. My understanding was there was a lot of shutdowns that were still going to be in place this week and it's really next week you would see the full force of orders coming back.

Well we've only had a couple days this week, but if I look at those two days, we think we've come back to the type of bookings we had before the Chinese New Year.

Okay. Great. I'll get back in the queue. Thanks.

And who'll go next is Vernon Essi with Needham & Company.

Thank you. A question on the balance sheet. I don't know if you clarified this at all, Bill, but there is a new item there, a note receivable, could you discuss that?

Sure. That is the reclass from long-term to short-term of VMD, our ex fab note receivable, which has been on our balance sheet now for a couple of years.

All right. Thanks.

And our next question come will come from Gus Richard with Piper Jaffray.

Thanks for taking my question. Just to get a better handle on the gross margins over the next couple of quarters, it looks like they'll come down about 300 basis points this quarter and then a couple hundred more next. And could you just talk again about the yen increased pricing pressure and other affects under absorption and the magnitude of each in those two quarters?

Sure. The yen, as most of you know, a 10 JPY change has approximately a one point impact. 100 basis point impact on the gross margin. And as far as the production levels going down, we estimate that that's going to be about two points, but it takes some time to move through the inventory. And so you see a little bit of it this quarter and you'll see the full impact next quarter because of the -- because of the flow-through of the inventory.

All right. And the under absorption? I'm sorry. You hit that. And then just real quickly, litigation expenses, is that going to be something that will be flat going forward or is that -- how should we think about those expenses?

Well that's the hardest one for us to estimate. The best we can come up with is approximately $6 million for the year. And we have said that $1 million to $1.5 million in the first quarter and that can fluctuate quite a bit from quarter to quarter.

Thank you. I'll jump in the queue.

You're welcome.

We'll take our next question from Sumit Dhanda with Merrill Lynch.

Bill, a quick clarification as it relates to the relative impact of the lower production versus the stronger yen. On the yen front, is the full impact of the 89 JPY to a dollar reflected by Q2, given the lag between the strengthening of the yen versus the impact on your actual cost line. And then is it fair to assume that bulk of the impact in Q2 is production related versus the stronger yen?

Well the bulk of the yen should be fully reflected by June, to be sure. But that would imply that there could be some spill over into Q3 because we are now paying 89 JPY here in December and it will probably take six months to have sell through on that. So I would see it being a Q2, Q3 issue.

And is the impact, the 2 point decline in Q2, is that -- how does it break out between lower production and stronger yen?

It's more -- it's more the yen, it's probably a point, a point and a half, and half a point production. We're seeing the impact of lower production levels sooner than we are going to see the impact of the yen. So we've already seen that impact on the production side, a lot of it.

Okay. Thank you.

We'll take our next question from Christopher Longiaru with Sidoti & Company.

My question was about -- just talking about scaling back the inhouse tax and the reduction in head count. Has that started yet, has that been done or is that something your planning on doing? What is the impact of that?

It's been done, and so we expect it's going to be reflected in the current quarter. The severance related to that. And where we've made that into the guidance for the next couple of quarters.

And the only other thing -- and even the share count for next quarter if you could?

The share count should be about 28 million shares.

On a diluted basis.

On a diluted basis. When everything is said and done, when the average -- it should average down to about 27 for the year, though.

All right. Thank you. I'll jump back in the queue.

(Operator Instructions). We'll take a follow-up question from Ross Seymore with Deutsche Bank.

Have you seen any changes in the pricing environment outside of the mixed implications you talked about in your spot ASP in the quarter?

We are definitely seeing a pricing pressure because of the slowdown and we were expecting that. And we are reacting to that as we speak.

And you didn't really mention the ASP as part of the gross margin pressure. Is that something that could be incremental to that or is that already included in your guidance?

Well the ASP reduction in Q4 was primarily due to the mix change because of the cell phones that were unexpectedly stronger related to other markets. But going forward, there is -- there will be impact due to pricing pressure. But historically, we've been able to offset that by cost reduction. So we are doing cost reductions. So the guidance we gave you is a combination of all of those things -- the cost reduction which allows some of the impact of pricing pressures, the lower production and the yen exchange rate.

One quick follow-up, that cell phone business doing stronger than you expected, what caused that?

Well two of our large OEMs did better than we thought. One of them was ramping up. We knew they were ramping up but they ramped up to much higher levels than we expected. We're not quite sure if that's going to be a run rate issue or it's just that one quarter benefit. The other OEM also did better than we expected. They actually grew slightly from Q3.

Great. Thank you.

You're welcome.

I'll return to Tore Svanberg with Thomas Weisel Partners. Please go ahead.

Yes, Balu, just a follow-up on the joint rating scale for the (inaudible) manufacturers that was announced. Has that already started to have a impact on your design activity?

It has definitely impacted our design activity, it obviously hasn't had impact on our revenue. We've had at least two of our largest OEMs in cell phones asking for the five star spec on the new designs.

Okay. And then lastly, on the new PLC product, I think you mentioned revenues in 2010, but could we start to see already some revenues here in 2009, second half maybe?

We may get very slight revenue in the fourth quarter maybe, but really it won't be material.

Great. Thank you very much.

You're welcome.

We'll go next to Gus Richard with Piper Jaffray.

Yes. Thanks again, for taking my question. In looking at past Chinese New Year's, do you have any sense as to whether production rates will start up? Have you gotten any indications from your customers?

I don't think we have much of a visibility. What we do see, is that a pick-up of bookings since the beginning of this year. It's still not as strong. It definitely was not as strong as the October, but then you have to remember we lost almost one full week in January to the Asian holiday, so it's hard to do the comparison. So, February will really tell us whether the pick-up has -- is real, essentially. And as I said, we only have a couple of days in February and they've come back to levels of booking that we saw in January, but that's only two or three days. It's very hard to tell whether that's the trend.

Okay. And if you had a full January, would that be similar to October?

If bookings had continued for that off week, at a similar rate to previous weeks, it probably would have been in the ballpark of October.

Got it. Thank you.

And we'll go next to Sumit Dhanda with Merrill Lynch.

And, Balu, just a clarification on what you said about backlog entering the quarter and where you are in terms of how much you're booked versus the midpoint of guidance. So you entered 30% booked within a month or so, or five weeks you were 65% booked. If you sustain this trajectory, does this imply that you're really ahead of plan or am I misinterpreting what you're saying here?

Well you have to remember, the bookings in January are almost entirely within the quarter. The bookings in February will be partly in the quarter, and partly in the next quarter. So, we are taking all of those into account when we gave you the guidance of $32 million to $36 million. Of course, there's a lot of uncertainty. We just don't know how February and March will turn out. Can it be better than that? Yes. Can it be worse than that? Yes. This is the best guidance we have, given all of the data we have.

Okay. And then, any update on incremental share recapture at Samsung or has that reached a status quo at this point?

That's a good question. We think that our customer who supplies chargers to Samsung got a larger share than they were anticipating in the fourth quarter. We don't know whether that's a permanent share gain or is it just that that quarter they were able to get more share. And we will know better in the next -- by the end of this quarter whether that will continue. And I would say that to the best we can estimate at this time, the share is in the 30% to 40%. If Q4 is an actual run rate, it will be in the 30% to 40%.

Okay. Great.

And that does conclude our question-and-answer session. I would turn it back over to you Mr. Shiffler, for any additional or closing remarks.

That concludes the call. There will be a webcast replay of the call available on the Investor Info section of our website which is investors.powerint.com. Thanks for listening, and good afternoon.

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