Power Integrations, Inc.
Q3 2008 Earnings Call Transcript

Published: 27 Oct 2008

[Operator:]

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, Director of Investor Relations and Corporate Communications. Mr. Shiffler, please go ahead.

[Joe Shiffler:]

Thank you, and good afternoon. I’m Joe Shiffler, Director of IR and Corporate Communications for Power Integrations. With me on the call today are Balu Balakrishnan, President and CEO of Power Integrations, and Bill Roeschlein, our Chief Financial Officer. Since there are a number of other calls going on this afternoon we will keep our introductory remarks very brief to try to get as much Q&A as possible before the top of the hour. 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 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.

[Balu Balakrishnan:]

Thanks, Joe, and good afternoon. Obviously the impact of the economic downturn is the number issue on everyone’s minds. So I will begin with an update on what we are seeing. It is 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 slow down mid way 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 down significantly in October. As a result we are protecting 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 that we can affect, meaning 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 $2.5 for the fourth quarter. Despite the weaker end market demand, design activity continues unabated and our pipeline of opportunities continues to expand. Our current [3

[Bill Roeschlein:]

Thanks, Balu, and good afternoon. As Balu noted the weak macro economic environment is clearly having impact on our top line. We are pleased with the progress on the things that we can influence including gross margins, expense control and cash deployment. We turned in a strong performance on all 3 of those accounts with a gross margin above the upper end of our guidance. Lower than expected operating expenses and acceleration of our stock buy back program. All of these factors contributed to an inline quarter 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 digit on a sequential basis driven by metering applications, tools and lighting. Consumer was up low single digit sequentially with growth and video game consoles, appliances and flat panel TVs offset by seasonal weakness in the air conditioner market. Communications revenues were flat sequentially with strength in broadband modems and cordless phones upsetting lower revenues from cell phone chargers. Computer revenues declined mid single digits driven by weakness in desktop PCs and also Smartphone chargers which were included 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 remains at 4.8 weeks exiting the quarter unchanged from the end of June. Distributors ADNET and ATM were our only 10% customers during the quarter comprising 18% and 11% of revenues respectively. Current orders as a percentage of revenues were in the low 60s and our average selling prices $0.35 up from $0.33 from the prior quarter primarily due to customer mix. Detail on revenue mix by product and end market is provided in the text of our press release and in the accompanying tables. Non-GAAP gross margins which excludes stock base compensation was 54.9%, up 30 basis points sequentially and 120 basis points year over year. GAPP gross margins were 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. Improvement was driven by a variety of factors, including reduced bonus accruals as well cost spending efforts we have undertaken in our response to the weaker business climate. Also as you may recall we have some nonrecurring expenses in the second quarter related to the CFO transition which explains the portion of the sequential decrease in our past. 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 have nonrecurring items in the second quarter that netted out to a benefit of about a $0.5 million. Our effective tax rates 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, at higher than our earlier expectations, reflecting the reduced outlook for the year which will cost a higher percentage of our profits, to be onshore and subject to US tax rates. Diluted share count decreased slightly to 32.6 million shares. That reflects the fact that the bulk of the buy-back 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 buy-back. We repurchased 788,000 shares during the quarter for a total of $20.2 million including shares repurchased so far in October we have 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 repurchases 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 $2.5 per share with the first quarterly dividend to be paid to the shareholders of record as of November 28. Looking at some of the balance sheet items, we exited September with 29 days sales outstanding down 2 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 have 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 will see a larger in the first quarter of 2009 probably in the order of 2 percentage points relative to our fourth quarter gross margins. 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 which is 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 will turn it over to Joe.

[Joe Shiffler:]

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

[Operator:]

(Operator instructions)Your first question comes from Tore Svanberg - Thomas Weisel Partners.

[Tore Svanberg:]

Could you just repeat what you said about gross margins for 2009? I did not quite understand that.

[Bill Roeschlein:]

So, our current quarter gross margin on a non-GAAP basis 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 2009 on a non-GAAP basis, with an additional point when you account for that on the GAAP basis.

[Tore Svanberg:]

So that comment was specifically related to Q-1of 2009?

[Bill Roeschlein:]

Yes.

[Operator:]

Your next question comes from Ross Seymore - Deutsche Bank Securities.

[Ross Seymore:]

A question for Balu. Talk about how you see the end markets and the bookings activity as compared to at this time than last quarter. I know you gave a little bit of lead into that, but any granularity will be helpful?

[Balu Balakrishnan:]

At the last quarter, as I said, that it started to weaken in the middle of second quarter actually, and that weekness 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 is weakened across the Board. It seems pretty broad from everything we can tell.

[Ross Seymore:]

Any difference to treating like DSP, OEM, any granularity along note lines?

[Balu Balakrishnan:]

I just do not know at this time because have – well do we have a number by any chance?

[Bill Roeschlein:]

It is pretty consistent actually Ross across both distribution and OEM.

[Operator:]

Your next question comes from Steven Smigie - Raymond James.

[Steven Smigie:]

Somebody could discuss operating system furthermore? Seems like revenue is down quite a bit sequentially at the mid point and you had kept OpEx flat. So, could you talk about that? And then, what would operating expenses would look like going into next year, in particular given the Fairchild lawsuit, how is that impacted? Thanks.

[Bill Roeschlein:]

Well for the current quarter, we are maintaining a flat OpEx structure and are continuing to fund the initiative to the high power project that we have on-going. Obviously, as the quarter in the next quarter goes on, we will continue to reassess in light of the economic environment. We have built-in an about a million dollars of litigations expense which is consistent with the previous guidance we have given on the call on our previous quarter. And so, as we look into 2009, we are not giving OpEx guidance just given to that, given the uncertainties of the economic picture right now but we can just pretty much tell you where we stand in terms of Q4.

[Steven Smigie:]

Yes. So, would you expect to be reducing OpEx in Q1? And you think you can adjust if you have time to get everything done Q4 if you want? And then, that is one part of the question, and the $1 million, is that account for the new Fairchild stuff or you would have to do some sort of discover something that might be one time, but you would not know if a quarter falls something like that?

[Balu Balakrishnan:]

What we have done so far is we have cut back on our hiring quite significantly. I think that is the prudent thing to do especially in the area of sales. We have been adding a lot of people recently. We have also cut back on any of discretionary expense that we can cut-back on; again it is just the prudent thing to do. Beyond that, we have not really had a chance to look at other areas, simply because this has just happened to us. Since the last two or three the weeks, we have seen a significant decline, and first two weeks will show that was just a trend or was just a blip. But so far, it looks like a trend because it is continuous to be weak, and obviously, we will start looking at it very carefully as prudent managers for 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 cost associated with that this year to speak of. For as how much that will add to the next is extremely difficult to predict because they do not know when the trial is likely to occur. The earliest we can think of is that of late in the year, of course it is 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.

[Operator:]

Your next question comes from Vernon Essi - Needham & Company, LLC.

[Vernon Essi:]

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

[Balu Balakrishnan:]

Well so far, we have not seen any change in the competition in terms of, like for example, discreet pricing for example, and but, I would think that given the reduction in the cost of raw materials, the discrete could get cheaper overtime. And that means, we have to deal with that, and obviously, we continue to reduce cost. We are moving our wafers to 16 as we speak in two of our fabs, and so that, will give us an on-going cost reduction for the next couple of years.

[Operator:]

Your next question comes from Sumit Dhanda - Banc of America Securities.

[Sumit Dhanda:]

Balu or Bill, in terms of your outlook for the December quarter, what are you baking-in terms of in 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 are anticipating which is of significance to the end of the quarter?

[Balu Balakrishnan:]

Well, to hit the mix point of our guidance, we need the turns to the mid 50s. And that may sound conservative, but you have to remember the fourth quarter is a front-and-loaded quarter. We normally expect lower turns requirement. And also, our bookings in September as related to October were significantly better. And therefore, the beginning backlog, relative today with the total, it looks bigger than it should. But, what are assuming for the mid point 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 no one, but is usually weaker than October and December is almost always weaker than November.

[Sumit Dhanda:]

And if I could just ask a quick followup on, again as relates to inventories, do you have any sense of where your channel inventories do not seem to have come down and the inventory on balance sheet certainly moved up. So, the question is what is your target? Especially given the fact that your gross margins are anticipated to decline a couple of point in Q1? Do you have an inventory target by the end of the quarter which, especially in line of the decline in revenues that you are talking about in the Q4?

[Balu Balakrishnan:]

Yes we do, and that is what actually impacts the gross margin, because we are cutting back on all of production in Q4 which has a too little over two months 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 cutback on productions so rapidly for a couple of reasons. One, is we do not want to exercise our vendors there. Secondly, it keeps our margins relatively consistent. But this time, the down turn is so significant and unexpected, we have no choice but to cutback more drastically than we would like. I do not have an exact number, I am sure, we have it somewhere in the Company, but I do not have one. We are going to bring it back the level we need to service our customers, which is between four and five turns and probably closer to four turns than five.

[Operator:]

Your next question comes from Christopher Longiaru - Sidoti & Company, LLC.

[Christopher Longiaru:]

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?

[Balu Balakrishnan:]

We have a record level of designs we’ve bought in terms of dollar value. We do look at the annualized dollar value, and also in terms of number of designs, just a share number of design wins. And typically, it takes two to three quarters for those design wins to ramp up to full value.

[Christopher Longiaru:]

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

[Balu Balakrishnan:]

That is a good question. I do not know how to answer that. I am assuming that since this design wins just occurred, they will go into production or we, whether they will be delayed or the volumes will be less than expected. It is very hard to answer that question. I think, you’re guess is as good as mine.

[Operator:]

(Operator Instruction)Your next question comes from Ross Seymore - Deutsche Bank Securities.

[Ross Seymore:]

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

[Balu Balakrishnan:]

The ramp up at Samsung was that, what as we expected, ramped up very nicely in the Q3. In fact, the volumes came out higher than expected, that is the ramp 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 Nokia demand has gone down significantly, that is the offsetting factor. But in addition to that, we also got another design with a smaller subcontractor to Samsung. It is a relatively small design win, but we are hopeful that will continue to go after other subcontractor, then get a higher share going forward.

[Operator:]

And I guess, it appears that there are no further questions at this time.

[Joe Shiffler:]

Okay, we will leave it there. Thanks everyone and that concludes the call this afternoon. The 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 United States, or 719-457-0820 from outside the United States, and the replay code is 3001343. Thanks for listening and good afternoon.

[Operator:]

And that concludes today’s conference. Thank you for your participation, you may disconnect at this time.