Power Integrations, Inc.

Good afternoon. My name is Kathy and I will be your conference operator today. At this time, I would like to welcome everyone to the Power Integration's first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star followed by the number one on your telephone keypad. If you'd like to withdraw your question, press the star one again. Thank you. And, Joe Schiffer, you may begin your conference.

Thanks, Kathy. Good afternoon, everyone. Thanks for joining us. With me on the call today are Balu Balakrishnan, President and CEO of Power Integrations, and Sandeep Nair, our Chief Financial Officer. During this call, we will refer to financial measures not calculated according to GAAP. Non-GAAP measures exclude stock-based compensation expenses, amortization of acquisition-related intangible 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, will include forward-looking statements denoted by words like will, would, believe, should, expect, outlook, 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. This calls the property of power integrations, and any recording or rebroadcast is expressly prohibited without the written consent of power integrations. And one additional note before I turn it over to Balu. We plan to host an investor day on September 8th in New York. More details will be coming soon, but please do save the date. Again, that's September 8th in New York. Now I'll turn the call over to Balu.

Thanks, Joe, and good afternoon. 2022 is off to a great start for power integration with another quarter of record sales, strong earnings growth, and healthy cash flow. Our growth continues to be fueled by share gains and rising dollar content across a broad range of applications, including appliances, advanced chargers for smartphones and notebooks, and a diverse set of industrial applications, including utility meters, battery-powered tools, and home automation. New growth vectors like our highly integrated GaN ICs and our bridge switch motor drive products will make significant contributions to our top line this year, and we are making good progress on our automotive initiative, a key piece of our roadmap to doubling our addressable market over the next five years. While market share gains are mainly attributable to the strength of our product portfolio and the impact of secular trends like energy efficiency and advanced charging, we also continue to capitalize on industry-wide supply challenges in multiple ways. First, competing products require far more external components than our ICs. Integration has always been the core of our value proposition, bringing reliability, ease of use, and time to market. In today's supply environment, integration has the added benefit of eliminating components that are difficult or more expensive to obtain. Second, our ability to deliver parts in a timely fashion has enabled us to win against competitors that have struggled to deliver or chosen to allocate capacity to other applications. Our superior delivery performance is enabled by our unique foundry models, recent capacity additions, and our efforts to shift to true demand. We have even sustained our delivery performance despite disruptions at some foundry locations following recent earthquakes in Japan, thanks to our strong inventory position and our practice of sourcing most products from multiple locations. Our operations team has also successfully navigated a variety of logistical challenges arising from China's lockdowns. Our ability to supply parts has been especially impactful in the appliance market where we have expanded our share of AC to DC power supplies and our entry into motor drives has been aided by the scarcity of incumbent solutions like integrated power modules. Last year's new efficiency standards for air conditioning in China are providing an additional tailwind for our motor drive products, as is a new incentive program in India designed to accelerate the transition to brushless DC motors in ceiling fans. We expect our bit switch ICs to be in mass production this year with at least 10 customers, and we have a strong pipeline of designs that will enable us to grow this revenue stream in 2023 and beyond. Another important growth vector is our proprietary GaN technology, which is tightly integrated into our power conversion ICs and utilized in complementary products like MiniCap and ClampZero, which reduce the size of input capacitors and transformers, the bulkiest components in the power supply. We were the clear market leader in high-voltage GaN products last year, and Q1 was another strong quarter in terms of shipments and design wins. Wins included multiple designs for notebook PCs and several multipurpose aftermarket and OEM-branded chargers, including a dual-port USB PD charger for a major cell phone and notebook OEMs. We also want a range of industrial and appliance designs demonstrating the expanding use cases for GaN beyond mobile devices. We expect GaN to replace silicon across a broad range of power supply markets in years ahead. And the technology features prominently in our roadmap as we look to double our addressable market over the next five years. Our newest GaN product is HYPR-PFS5, the fifth generation of our highly integrated power factor correction ICs, and the industry's first power factor IC to incorporate a GaN switch. Power factor correction, or PFC, is required in most power supplies above 75 watts and is implemented as a separate stage of power supply prior to the main power conversion stage. Thanks to efficiency of our GaN switches, HyperPSS-5 implements PFC without a heat sink in applications up to 240 watts, including game consoles, e-bikes, power tools, and high-power adapters for PCs and mobile devices. The new IC can be paired with any of our AC to DC ICs for the power conversion stage, including GAN-based InnoSwitch 4 ICs or the new HYPER-LCS2 for the more efficient resonant mode conversion needed at higher power levels. Introduced last month alongside the new power factor chip, HYPER-LCS2 illustrates an important difference between power integrations and competitors offering a single technology in the form of discrete transistors. CI is the only company focused on complete system solutions for the power conversion market, and we have developed a portfolio of switch and controller technologies, system topologies, isolated communication techniques, and proprietary IC packages, all designed to work together to enable customers to build the world's best power converters. As we develop products for different segments of the market, we can integrate these elements in whatever combination works best. For example, we designed our Hyper-LCS2 product with a proprietary cost-effective silicon switch, known as Threadset, to achieve the optimum balance of efficiency and cost in resonant topologies. This follows our recent introduction of a 1700-volt version of our InnoSwitch products incorporating a silicon carbide transistor making it ideal for EV power supplies in 800 volt systems. We now offer InnoSwitch products with silicon, GaN, and silicon carbide options giving customers a level of flexibility that no one else can provide. The ability to mix and match technologies in this way is unique to power integrations and provides us a significant competitive advantage. A couple of final notes before I turn it over to Sandeep. First, we recently published our 2021 sustainability data, including our estimated energy savings generated by our EcoSmart technology, which drastically reduces energy consumption from electronic products in standby or idle mode. This includes products like appliances, computers, and TVs, when they are not in use, or adapters less plugged into the wall outlet after charging a device. This technology has been included in all of our power conversion ICs since 1998, and we have shipped more than 18 billion ICs with EcoSmart technology over that time. This proprietary technology saves power without any effort on the part of the end user, and it helps our customers meet a broad range of regulatory requirements around the world. Last year alone, we estimate that EcoSmart technologies save roughly 15 terawatt hours of electricity, enough to power almost 2 million homes for the entire year. And this is just one way our products contribute to a lower carbon future. Our GaN technology offers a dramatic increase in active mode efficiency over silicon mosfets, and our gate drivers are widely used in carbon-saving applications like solar and wind power, high voltage DC transmission lines, and electric locomotives. We also have a huge opportunity ahead of us in EV drivetrains, and we'll hit another milestone in that effort next month when we introduce a new line of gate drivers specifically targeting the EV market. Finally, I'd like to acknowledge an important figure in the history of our company, Steve Sharp, who will step down from our board of directors at our annual meeting next month. Steve is a co-founder of Power Integrations, and we would not be here today had he not recognized the potential of the innovative process technology that served as the foundation of the company. In fact, Steve was such a believer in the technology that he left his venture capital role to help start the company, serving as an interim CEO in his earliest days. Steve figured prominently in the glory days of the Silicon Valley semiconductor industry, helping start several other prominent chip companies, including Triquent, where he served as a CEO for more than a decade. We thank Steve for his enormous contributions to our company and to our industry, and we wish him the best as he retires from the board.

Sandeep? Thanks, Balu, and good afternoon. Our Q1 results featured solid revenue growth against a difficult compare, strong earnings growth driven by continued margin expansion, and very healthy cash flow. We have also taken advantage of market volatility and the turbulence caused by our promotion to the S&P Mid Cap Index to buy back a substantial amount of stock, which will provide meaningful EPS accretion in the coming quarters. On a year-over-year basis, total revenues for the March quarter were up 5% to $182 million. Consumer, industrial, and computer revenues each grew in the mid-20s, reflecting broad-based market share gains, while communication was down nearly 30%, reflecting last year's strong first quarter. As you may recall, cell phone OEMs bought aggressively in the early part of 2021 as they sought to take advantage of Huawei's supply chain challenges, resulting in an inventory overhang that lasted through the duration of the year. The improved inventory situation is reflected in the sequential growth numbers for the March quarter, with the communications category rising nearly 20% from the prior quarter, driven by new design wins. The computer category also increased sequentially, growing high single digits, driven by monitors, notebooks, and server standby power. Consumer revenues increased mid-single digits sequentially on continued strength in appliances and air conditioning, while industrial revenues ticked down modestly. Total revenues were up 5% on a sequential basis. Revenue mix for the first quarter was 35% consumer, 29% industrial, 26% communication, and 10% computer. While the strong sequential growth in communication resulted in less favorable mix, non-GAAP gross margin nevertheless expanded for the fourth straight quarter, rising 120 basis points to 55.7%. The primary driver of increase was manufacturing efficiencies, including improved test times and yields, as well as the supportive pricing environment. Non-GAAP operating expenses for the quarter were $40.8 million, in line with our forecast, and up $2 million from the prior quarter, reflecting increased headcount, the resumption of FICA, and the impact of holiday shutdown in the prior quarter. Non-GAAP operating margin for the quarter was 33%, and non-GAAP earnings were $0.93 per diluted share, up 22% from a year ago. Weighted average diluted share count for the quarter was 60.1 million, down 1.3 million shares from the prior quarter. We repurchased 1.6 million shares during the March quarter for $135 million. We have bought back an additional 900,000 shares thus far in April, utilizing most of the $83 million that remained on our authorization at quarter end. In total, we have bought back nearly 3 million shares since November, offsetting most of the roughly 4 million shares dislodged from index holders on our promotion to the S&P 400 in December. Our board has allocated an additional $75 million to the buyback, reflecting continued confidence in our growth prospect and cash flow generation. Cash flow from operations in Q1 was very strong at $75 million. In addition to the buyback, other uses of cash for $15 million for CapEx and $11 million for dividends following the 20% dividend increase in the March quarter. Cash and investments on the balance sheet fell by $86 million during the quarter to $444 million. Internal inventory sticked up by one day to 115 days, inching closer to our desired level of 125 days and enabling us to continue leveraging our delivery performance to win market share. Inventory in the distribution channel rose to 7.1 weeks from 6.3 weeks in the prior quarter. Looking ahead. We expect revenues for the June quarter to be $190 million, plus or minus $5 million. We currently have backlog coverage to the midpoint of this range. I expect non-GAAP gross margin to improve again in Q2, driven by a more favorable in-market mix, reflecting weaker demand in smartphone market relative to appliances and industrial. Also contributing to the higher margin in Q2 is the stronger dollar versus the Japanese yen, which favorably affects our wafer costs. Specifically, I expect Q2 non-GAAP gross margin to be between 56 and 56.5%. I do expect higher wafer prices and other cost pressures to flow into the P&L as the year progresses, resulting in a tapering down of gross margin in the second half of the year. However, a near-term outlook for gross margin has clearly improved thanks to a combination of factors including manufacturing efficiencies, the stronger dollar, the pricing environment, and a richer mix. Non-GAAP operating expenses should be $44 million, plus or minus half a million dollars. The sequential increase reflects annual merit increases, our accelerated investments in R&D, as well as the expansion of our sales force to capitalize on our momentum in the market. The non-GAAP effective tax rate for the second quarter and the year should be between 9% and 10%, and I expect Diluted share count for Q2 to fall by about 1.5 million shares compared to March. And now, operator, let's begin the Q&A session.

Thank you. And at this time, I would like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster. And our first question will come from Christopher Rowland of Susquehanna.

Hey guys, thanks for the question and congrats on the quarter. I guess my first question is any thoughts on how the end markets kind of progress from here or even kind of force rank the various segments into next quarter as well. Just any thoughts there would be great.

Well, you know, we all know that there is a lot of things going on around the world. We have the war in Europe and lockdowns in China and, of course, higher fuel prices and the overall inflation. But for Q2... As we mentioned, we have backlogged to the midpoint of our guidance already, and so we really have to wait until the end of Q2 to see what the sell-through is like, and that will tell us how things will turn out in Q3 and Q4. We have had some cancellations in the cell phone area for all the reasons people know. week as a whole. And so as a result, the orders have moderated and we have had some cancellation. But that's all taken into account in our guidance for Q2. What we don't know in the second half is whether there will be an overall demand reduction across, you know, the macro type of issues. We just have to wait and see how that turns out. So the cell phone is well understood to us. What we don't understand is the impact of any slowdown fueled by the war in Europe and lockdowns and inflation.

Great. Thanks for that. And then secondly, you guys talked about this tight market and how you guys are a beneficiary of integration, for example, but also just having capacity to If we were to see a slowdown in the second half, do you think these share gains that you've taken, like for example in motor controller or something like that, do you think that's going to be sticky or do you think you give some back to competitors that are maybe more aggressive on pricing or something like that?

That's an excellent question. I believe that our products are so attractive, we would have gotten our share over time anyway. What has happened is, thanks to the supply issues with our competitors, that share transfer or share gains are happening in a very accelerated manner. But once we get those share gains, we really don't believe it will go back because the attractiveness of integration, attractiveness of efficiency, lack of heat sink, all of those things are the reasons we will stay, the customers will stay with us. So we are feeling very good. This is a permanent share gains. Awesome.

Thanks, guys.

Our next question will come from Matt Ramsey of Cowan & Company. And, Mr. Ramsey, your line is open. If you could just check your mute function. And hearing no response, we'll move to our next question, and that will be from David Williams of the Benchmark Company.

Hey, good afternoon, and congrats on another really solid quarter.

Thanks, David. Thanks, David.

Yeah, I just wanted to maybe dig in a bit on the industrial side. It was off a little bit sequentially. Just kind of curious if there was anything in particular from the industrial perspective that might be either shifting around or moving a bit.

Not really. I mean, if you look at it year over year, it grew something like 25%, 26%. So that shows how well it has done, it is doing. There are some cyclical issues where industrial is usually weaker in Q1. But we are actually growing our share very nicely in many areas like IOT, power tools, and so on. So there is nothing to be concerned about in industry. I think it will grow very nicely this year, you know, along with the computer and consumer. The only one that is not clear is the cell phones because it's down across the board. although some of our OEMs are doing actually better than they projected, and some of them are doing much worse than they projected.

Thank you. And then maybe just from the ongoing China and the COVID lockdowns, I know you talked about this a bit on the call already, but is there anything that you're seeing there maybe from a supply or a demand side that you think is going to be impactful in terms the second quarter, maybe even the third quarter. How do you think about China in general here, just given the volatility and the lockdowns?

You know, the lockdowns, surprisingly, are maybe very fortunate. It didn't affect our ability to sell to our customers. We don't have any major customers in Shanghai area. The Shenzhen lockdown was relatively short-lived. and other areas have not impacted us. What it did do was really complicate our logistics. When Shanghai airport shut down, we had to find ways to get our products to our assembly plants through other channels. And the same thing happened in Shenzhen. When they shut down, we had to bring wafers and assembled units in different routes and actually pay quite a bit more to do that. In some cases, We have to track it to the next available airport. But those were all very well managed by the company. Our team did a fantastic job. It had really no impact on our ability to supply products to our customers. Now, as far as we know, our Chinese customers are not directly impacted by these shutdowns in terms of production activities. What we don't know is secondary effects of this shutdown. And only time will tell what happens because I have to believe if people have to stay at home for so long, they're not going to be able to buy anything, certainly not buy cell phones or appliances and so on. On the other hand, it also appears to us that if there is a reduction in demand, that might be just temporary because it's just a situation they're going through now. Once the lockdowns are lifted, the demand should come back. At least that's our thinking.

Great, Keller. Thanks so much. And one last one if I can real quick. But just from a compute standpoint and the volumes, there's a lot of discussion there about what the volumes could be this year. but we're hearing of a better mix into the enterprise and maybe pro-consumer type applications. Are you seeing something similar? And then is there any way to kind of parse out your potential dollar content as we think about the higher end versus the mid or lower end units?

Just to be clear, when you say compute, you're talking about the computer market? Yes. Yeah, the good news for us in the computer market is we have such a low share of the notebook market It almost doesn't matter what the overall market is doing because we have a lot of room to grow and we expect computer to be a very strong growth segment this year for us. We already have one number of notebook designs that are going into production as we speak and we are a fantastic fit for notebooks. Our dollar content is very high because in many of them you have to use GAN and many of them are multi-port and so there are multiple devices. And you also have to remember, it's not just our InnoSwitch power conversion device. We can also sell mini-cap to reduce capacitor size and also clamp zero to reduce the transformer size. So there is quite a few. If they use all of that, you're talking multiple dollars of content. So it's quite an attractive market for us, and it's a very good fit for our technology and products.

Thanks again, sir, and I appreciate the help. You're welcome, David.

And our next question will come from Kunjan Sapani of Deutsche Bank.

Hi, this is Kunjan asking on behalf of Ross Seymour. My first question is, you had a great upside to gross margin both in the print and the guide. Could you talk about what were the drivers here? How much was pricing versus manufacturing efficiencies? And then I'll ask my follow-up.

As I talked about in my script, basically the manufacturing efficiencies have helped us a lot in this. I'm not going to try to quantify each one, but the pricing, the way it works for us is that we do value pricing. We just value with all the discreets that we eliminate. And the reason our Q2 margin is going up is because we're getting a yen benefit. But the one part I think you should realize is that there's a timing difference of this benefit versus the cost input increase. We've already seen some increases, but Q3 and Q4 are going to see further impacts from these cost increases that we know of today. And you know how the dynamic that market is. But the good news is also that the Efficiencies have really helped us, and typically we do these efficiencies to offset price declines that we have to give, which in this environment we don't need to do because of the challenges of cost increases. Additionally, as Balu mentioned earlier, with what's happening in the cell phone, the mix, as we had anticipated at the beginning of the year, is changing. Now what happens for the rest of the year is harder, but the best we can model we are definitely seeing that the cell phone is going to be a harder area for growth versus most of the growth will be coming from the other three areas, as a result of which we will have favorable margins.

Thanks. And the follow-up of that, you have now been at the high end of your long-term gross margin range. With that, given that and what you're modeling, do you expect one, your prior target of 53 to 54 range for the full year to upside? And is this going to be the new baseline going forward long term?

That's a good question. So for this year, it's again, it will depend on what's going to happen in the second half, which Valu mentioned is hard. But typically what happens in Q3 is air conditioning also tends to taper off. So you, along with the pricing pressures, you are going to see the mix also have a little impact. So as a result, in the third and fourth quarter, as I mentioned on the script, margins will taper down from Q2. The best I can model right now for the year for non-GAAP is around 55%. Again, the mix can really change that and the volumes can impact that. But my modeling tells me somewhere around 55% for the year could be slightly higher. As far as our model, our model is going to remain in the 50 to 55%, though as you know, we have changed our operating margin model, which used to be running in low 20s, but we had a target of 25%, and we have upped that to 25 to 30% because of the inherent leverage that we have in our model. So I think you should think about our model for growth margin in the 50% to 55%, though I think we will be tapering more in the higher end of that model in the near term. And the operating margin in the 25% to 30%, even though we are at the higher end of that model, but I think you should again see we'll taper back as we look ahead towards the 30%.

Thank you.

And again, as a reminder, if you'd like to ask a question, that is star 1 on your telephone keypad. We will now go to Ettore Svenberg of Stiefel.

Yes, good afternoon. This is Jeremy calling for Ettore. A quick question in terms of the backlog coverage for the current quarter. Am I correct in understanding that it's fully covered in backlog as of right now?

Yes, that's correct.

To the midpoint. For the midpoint, right. So if there's additional turns orders, is it possible to have some upside in that situation?

That's a good question. Surprisingly, because of the supply situation, people are booking way ahead, so our turns business is relatively small. It's actually quite very small compared to what it used to be. And we also have to assume there could be some push-outs. In fact, we've seen that in every quarter. So when you look at the terms business plus minus push-outs, it just washes out. That's why we are saying 190 is our midpoint, even though we are fully booked to that.

And as Balu had indicated earlier, we also have a lot of uncertainty going on with the cell phone business. And you know how some of our Chinese OEM are exposed to the Russia area and others, and that is impacting business. So I think we have to factor all this, and based on that, we feel the pluses and minuses is the guide we give.

And just to follow up on that, there's some shifting in terms of some people pushing out orders, some people wanting to take orders that absorb those shifts. How fungible is the inventory, whether it's cell phone manufacturers from one to the other? Can you give us any color on that?

Well, one of the things we have done actually very well, especially compared to other companies as I've heard, is that we are very careful to shift to real demand. And the way we do that is... we monitor the distribution inventory. By the way, 75% of our revenue goes through distribution. So we don't ship unless they are shipping through. So we don't want to distribute our inventory everywhere. This way, the inventory is all in one place that's with us so that we can take care of all of our customers well. And we have also talked to the OEMs, the end customers, And we have discussed this with them, and they have been extremely cooperative. And they also want to make sure that they have supply. And so they at least tell us that they don't have much inventory. And so we are reasonably sure, especially in appliances, that there is very little inventory at our customers. Cell phone is a little bit more dynamic because their demand is changing as we speak. So some of them might have some inventory. But I would say overall, there is very little inventory at the end customer. There is reasonable inventory at the distributor. As you can see, they come within our range, seven to eight, although they're on the low end of the range, seven to eight weeks. So they can serve the market very well as long as they're in the seven to eight week range. So the rest of the inventory we keep, and we don't ship it in distributors unless we know it's going through.

Great. Thank you. And as a second question, I guess, your new, I guess, automotive-qualified switching IC with the integrated silicon carbide MOSFET, is this your own silicon carbide MOSFET? Can you help us understand and just have a little bit more insight into that product? It seems like a very, very interesting product.

Yeah, this particular one is not our own technology. The volumes are not high enough for us to do it, although we could do it sometime in the future, I guess. But for the foreseeable future, we just outsource that particular dye.

Great. And in terms of potential for seeing this in production, I understand automotive tends to have long development cycles, but EDs can sometimes see a little bit of acceleration. Do you have a sense of how soon this could see market adoption?

Good question again. It depends on what application you're in. If you are, for example, a gate driver in an inverter for the main motor, that has like a four to five year design cycle because that becomes a safety component. But, for example, this particular product goes into what's known as an emergency power supply, and that has a shorter design cycle. In fact, we got a major OEM design win that just got into production, and that uses our silicon-based switch, because it's a 400-volt battery. But this silicon carbide base, you know, switch, which is for 1700 volts, which is used with 800 volt battery, we are actually engaged with one, another major OEM. And, you know, the design is in process. And it is very, very possible we could get that design in and get into production in something more like two-year time frame rather than four-year time frame, simply because that particular item is less stringent from a safety point of view.

Very good. Thank you very much.

You're welcome.

And once again, as a reminder, that is star one if you'd like to ask a question, and we'll pause again for just a moment.

And it does appear we had no further questions.

I would like to turn the conference back to our presenters for any additional or closing comments.

All right. Thanks, Kathy. Thanks, everyone, for joining us on a busy earnings afternoon. There will be a replay of this call on our website, which is investors.power.com. Thanks again, and good afternoon.

And this does conclude today's conference call. You may now disconnect.