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Welcome to the Power Integrations Third Quarter Earnings Conference Call. [Operator instructions] I would now like to hand the conference over to your speaker today. Joe Shiffler, Director of Investor Relations. Thank you, please go ahead sir.
Thank you. Good afternoon and thanks everyone for joining us. With me on the call today are Balu Balakrishnan, President and CEO of Power Integrations; and Sandeep Nayyar, our Chief Financial Officer.
During the call today, we will refer to financial measures not calculated according to generally accepted accounting principles. Please refer to today’s press release, which is posted on our investor website, for an explanation of our reasons for using such non-GAAP measures as well as tables reconciling these measures to our GAAP results.
Our discussion today, including the Q&A session, will include forward-looking statements, which may be denoted by words like will, would, believe, should, expect, outlook, forecast and similar expressions that look toward future events or performance. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected or implied in our statements. Such risks and uncertainties are discussed in our press release and in our most recent Form 10-K filed with the SEC on February 13, 2019.
Finally, this call is the property of Power Integrations, and any recording or rebroadcast is expressly prohibited without the written consent of Power Integrations.
Now I’ll turn the call over to Balu.
Thanks, Joe and good afternoon. Before we get to our third quarter results, I’d like to comment on the conclusion of our litigation with ON Semiconductor. We believe the settlement is a landmark win for our company, demonstrating the durability and the value of our intellectual property as well as our determination to protect it from unlawful use. As many of you know, this litigation began 15 years ago when infringing products from Fairchild were doing serious harm to our business, being a much smaller company at that time, we knew that patent litigation would have a meaningful impact on our bottom line and distract us from running the business. Nevertheless as an innovation driven company, we knew that the long-term health of our business depends on ensuring that our intellectual property is used solely for the benefit of our company and its owners. Indeed IP protection has been deeply engrained in our culture from the earliest days of the company guiding everything from our choice of manufacturing partners to the location of our R&D centers to our IT policies and our rigorous approach to writing patents.
We were confident from the outset that in spite of the cost litigation was the right path and the outcome has proved us correct. We won permanent injunctions in 2008 and 2014 covering hundreds of infringing Fairchild products [indiscernible] our market share and our margins while enhancing our reputation as the leading innovator in our space. And while the removal of infringing products from the market was our primary aim, we also start compensation for the harm done to our business, that goal was achieved in large measure this week, when we received $175 million from ON Semiconductor.
All litigations between the two companies is now being withdrawn and we expect a substantial reduction in operating expenses beginning in the first quarter of 2020. While this litigation is now in the past, we expect it to have important consequences going forward, as valuable as our earlier inventions have proved to be, we believe our biggest breakthroughs and our most value IP have only recently come to market. Innovation such as our InnoSwitch products, our FluxLink isolation technology and our new GaN Switches, our fundamental technologies that will help fuel our growth for many years to come and we have more such technologies in the pipeline. We hope that, our success in combating infringement in the past will discourage such activity in the future.
Moving onto our third quarter results, revenues increased 11% sequentially to just over $114 million that’s an increase of 4% compared to the third quarter of last year as we returned to year-over-year growth ahead of the broader analog industry. While revenues from the broad based industrial and consumer categories remain below the levels of a year ago, communications revenue grew nearly 40% year-over-year in the third quarter as we continue to win market share in the smartphone charger market.
As we have discussed on prior calls, the mobile device market is rapidly adapting faster chargers as OEMs look for new features to differentiate their products. This trend is enhanced by the use of larger batteries which of course take longer to charge unless they’re paired with a higher wattage power supply. The introduction of 5G phone should further reinforce the trend as 5G functionality is expected to stimulate even greater usage of mobile devices. Our InnoSwitch products are the clear leader in fast charging applications offering the highest levels of efficiency and integration available in the market. Efficiency is a crucial factor in fast chargers since wasted energy produces heat, dissipating heat typically requires two things neither of which is desirable in mobile devices. Heat sinks which add weight as well as cost and surface area, which by definition means a larger enclosure. This direction relationship between efficiency and size in fast chargers results in a substantial competitive advantage for our products.
In Q3, our InnoSwitch 3 and InnoSwitch 3-Pro devices won several new high-volume designs for fast chargers ranging from 15 to 30 watts. We also won our first inbox design for a GaN based charger, a 65-watt design for a major Chinese OEM which we believe to be the highest power adapter ever packaged with the phone. According to the OEM, it delivers a zero to 100% charge in half an hour with a small form factor and no heat sinks, which can only be achieved with the efficiency of the GaN based InnoSwitch products.
As we noted last quarter, we believe we are the only company currently shipping high voltage GaN products in high volume. In addition to this new inbox design our GaN based products are already being used in a variety of aftermarket chargers that are widely available at retail. In fact, I was pleased to deliver the 1 million unit of GaN based InnoSwitch products last month, to the CEO of Anchor Innovations one of the world’s leading suppliers of aftermarket power supplies and an early adapter of our GaN based devices.
Our sales of GaN based ICs are now closing in on three million total units shipped and we expect to be shipping more than 1 million units per month in the very near future. Looking ahead to the fourth quarter, we’re projecting revenues of $114 million plus or minus $3 million which would be an increase of 22% year-over-year at the midpoint. While smartphone chargers will again be the key growth driver, we also expect to return to year-over-year growth in the consumer end market.
Sell through in consumer has exceeded selling for four consecutive quarters, indicating that while there is apprehension in the supply chain, inventory levels are healthier than they were a year ago and while trade related headwinds continue, we remain as excited as ever about the fundamentals of the appliance market which not only values the reliability and efficiency benefits of our products, but also continues to experience raising Dollar content and growth from the expanding middle class in emerging markets.
In addition, our new BridgeSwitch motor driver products give us an entirely new growth vector in appliances and we’re highly encouraged by the level of customer interest. We expect our first design win with BridgeSwitch to go into production in Q4 and we anticipate a gradual but steady ramp beginning in 2020. With that, I’ll turn it over to Sandeep for a review of the financials.
Thanks Balu and good afternoon. While we’re still working to finalize the accounting and tax implications of the litigation settlement, I will begin by briefly summarizing our current expectations. First as Balu mentioned, we received a payment of $175 million from ON Semi earlier this week. We expect to pay out between 12% and 16% of this amount in cash taxes before the end of the fourth quarter including our normal quarterly free cash flow, we should exit the year with around $400 million in cash and investments on our balance sheet. We intend to continue managing our cash as we always have, using a combination of internal investment, selective M&A, opportunistic buybacks and dividends to return value to our shareholders.
As noted in our press release, our board has increased the quarterly dividend to $0.19 per share effective in the current quarter. On the income statement, our results for the fourth quarter will include again along with an offset in tax expense. Beginning in the first quarter of 2020, we also expect a reduction in operating expenses. Prior to the settlement, we were on a run rate of $8 million to $9 million in annual spending for partner litigation, the bulk of which was related to the now settled cases.
Our current expectation is that the litigation expense will fall to approximately $2 million in 2020 based on cases currently pending. We intend to reinvest 25% to 30% of the savings into the business resulting in an expected annual expense reduction of about $4 million for 2020. Now I will briefly cover Q3 financial results which are very straightforward. Revenues were $114.2 million just above the midpoint of our range and up 11% from the prior quarter. The increase was driven by communication category which increased more than 30% sequentially driven by strength in cell phone chargers [ph].
Industrial revenues were also strong increasing double-digit sequentially driven by high power applications, smart meters and other broad based industrial applications. Consumer revenues were down mid-single digits sequentially reflecting seasonal softness in air conditioning while computer revenues were down slightly from the prior quarter. Revenue mix for the quarter was 34% industrial, 32% consumer, 29% communication and 5% computer. From a margin standpoint, the strength in industrial largely offset the pressure from higher communications revenue, while cost reductions provided some uplift, resulting in a non-GAAP gross margin of 52%, that’s up 80 basis points from the prior quarter and at the high end of our guidance.
Non-GAAP operating expenses were $35.4 million down about $800,000 sequentially and below our forecasted range driven by the timing of headcount addition and equipment purchases. Non-GAAP operating margin increased by 500 basis points sequentially reaching 21%. The non-GAAP effective tax rate for the quarter was 7% bringing our non-GAAP earnings to $23.3 million or $0.78 per diluted share.
Cash flow from operations was $21.8 million for the quarter while CapEx were $6 million. Inventories were flat in dollar terms but fell by 15 days from the prior quarter to 144 days. Inventories are down by 34 days over the past two quarters, though I do expect a modest rebound in the December quarter. After a drop of two full weeks in the June quarter, channeled inventory picked back up as it’s typical of the September quarter. Specifically weeks in the channel rose to 7.6 week up 9/10 [ph] week from the prior quarter.
Looking ahead, we expect fourth quarter revenues to be in the range of $114 million plus or minus $3 million. I expect consumer revenues to be slightly higher as a percentage of revenue as air conditioning rebounds from the seasonal slowdown in Q3. As a result, mix [ph] should provide a slight help to gross margin along with continuing cost reduction. Specifically, I expect non-GAAP gross margin to be around 52.5% which would be an increase of about 50 basis points from the September quarter. Non-GAAP operating expenses for the fourth quarter should increase sequentially driven largely by headcount growth. I expect non-GAAP OpEx to be between $36 million and $36.5 million.
Lastly, I expect the non-GAAP tax rate for the quarter to remain at around 7% and with that, I’ll turn it back over to Joe.
Thanks, Sandeep. We’ll open it now for the Q&A session. Tiffany, would you please give the instructions?
[Operator Instructions] Your first question comes from the line of Tore Svanberg with Stifel. Your line is open.
Yes, thank you. Congratulations on the results and especially on the settlement. First question, Balu so now that we are looking at faster to market kind of moving into higher gear, I guess that means higher power levels. Could you talk a little bit about where is the market right now and let’s say 18 watt adapter and above and then perhaps on the other hand, how much of the market today would you say is GaN based adapters, just so we can get a sense for how low the penetration is right now and where it’s eventually headed.
Thanks Tore. In terms of fast charging, most of the OEMs have gone to somewhere in the 15 to 25 watt range for their smartphones. There are still some 5 watt designs in place, maybe 10 watt designs but we’re seeing that rapidly switching over to the higher power chargers is so dynamic I couldn’t tell you exactly what percentage at this moment it is. So that’s good news for us because we see that happening very fast.
Now as far as GaN based chargers that really go into the high end of the spectrum is just beginning as we speak, we mentioned the 65 watt charger announcement which happened on October 10, that is by far the largest wattage charger we’ve ever seen with the cell phone, but we are hopeful that other people will follow because it is a significant advantage to the user to be able to charge the phone faster.
So if there is a kind of a war between OEMs to see how fast they can charge, they can take off quite well, but it’s hard to predict at this point. We are working with number of OEMs and aftermarket customers and you’ve already seen that there are many aftermarket products using GaN based chargers because they are the early adapters. But we are optimistic that GaN will spread overtime. At this year, we’re expecting something in the mid single-digit million dollars in revenue and that could very well into double digits next year in terms of millions of dollars in revenue for GaN but it’s hard to predict at this point.
That’s very helpful and if we look at GaN technology in itself, you talked about being obviously a landmark for the company. Obviously today we’re talking a lot about fast charging, but when should we start to see GaN perhaps penetrating some of your other end markets and can you give us any examples or applications that you’re working on right now?
Sure, we already have a design win on a TV application with the large OEM once again the volumes are starting our small, but that could change very rapidly. We are just about to win a design at a large TV customer in China. We also have an appliance customer in Europe who is designing with GaN for a refrigerator application primarily because of the efficiency benefits required to meet efficiency standards. So we’re actually quite surprised at the interest in GaN across many different applications.
That’s helpful, just one last question for Sandeep. Sandeep, $175 million in cash coming in, we talked obviously about the dividend increase, we talked about reinvesting in the business. How should we think about where that cash eventually is going to go, going forward?
I think if you look historically, we’ve had that four prong approach, which you listed out two of them and we’ve done selective M&A’s, I’ve done buybacks. So I think the approach is going to be very consistent with four prong approach and again we’re going to do it very opportunistically. We’re not going to be in a hurry, but we do it very smartly. If you look historically even on our [indiscernible] as you know very well, we’ve been very opportunistic and it has paid us very well, so I don’t think we’re going to change our approach and don’t expect for us to do, the selective big dividend increases one-time, we won’t be doing those kind of things.
Sounds good. Congratulations again.
Your next question comes from the line of Ross [indiscernible] with Deutsche Bank. Your line is open.
This is Melissa on behalf of Ross. Congratulations on the [indiscernible] litigation win. I guess with the first question, I was wondering if you guys to talk about what you’re expecting, I know you don’t guide whether one quarter outbid. How can we think about seasonality and the cons segment now that you guys have this big win and what can expect in the first quarter?
So that’s a good question and basically considering that we’re gaining share in the rapid charging and cell phone area, you should see a meaningful decline which is typical in that business, but also for another area that typically comes down is industrial, which is in the high power business because of the infrastructure spend and the budgets being formed. So directionally, I would say that you should see a significant decline sequentially, but on the other hand I would say you should see for next year directionally a good sequential increase in Q2 and sequential increase in Q3.
We believe that we will outgrow the industry very nicely last year, not only by the success and the market share gains we’re having in cell phone by the introduction of new products that I think will start contributing like BridgeSwitch and InnoMux and others.
Okay, thanks and then, on the gross margin guide for next quarter. I apologize if I missed it, but so how much of that is being driven by mix and how much of the drag do you think comms [ph] will be for next quarter and then, so what are your expectations for the higher margin industrial?
Well you know the comms [ph] on a dollar basis between Q3 and Q4 you’re not going to see as much change, but as we’ve talked seasonally Q4 is a much better quarter for our consumer because of air conditioning [ph] coming back so that is part of the reason and also a little bit of the higher volumes that we’ve had has helping Q4. But directionally if you’re looking at gross margin with a continued success that we’re having in rapid charging and the continuous design successes, we believe next year from a modeling perspective the gross margin will be impacted and it should model, as I’ve talked before somewhere around 51% for 2020 on a non-GAAP basis.
Okay, got it and then one more high-level question. You guys have talked a lot about your competitive advantage with your GaN products. Could you talk a little more about how you’re differentiated in your other end markets like in industrial and consumer, how do you view the competitive landscape in those end markets?
Well GaN is only a part of the technologies we offer, we have InnoSwitch and a number of derivatives of InnoSwitch like you know Mux and also you know Pro. But we also have products that go into new markets like motor control which is our BridgeSwitch which uses its own unique technology. But the fundamental common thread between all of them is efficiency. We offer much higher efficiency than any existing solution and we also offer the highest integration that means fewer components, more reliability which is very attractive in industrial, consumer, computer market and of course the efficiency is also important to make the adapter small and that’s why we’re growing the most at the moment. But the revenue growth will follow in other areas which have a slightly longer design cycle like in industrial and consumer. So, it’s not just any one technology, it’s a combination of technologies that offers them a system level solution and the benefits that come from the combination of these.
Okay, thanks guys and congratulations on the [indiscernible] quarter.
Your next question comes from the line of David Williams with Loop Capital. Your line is open.
Thanks for the time and congrats on the good quarter and the litigation. Just kind of thinking about from the 5G opportunities in terms of the charging and the battery requirements. We’re seeing few 5G handsets on the market especially in China or at least in development. What are you seeing in terms of the power requirements? What they’re adopting? Are you seeing anything that really supports that expanded power expectation that you had?
Yes, in fact the 5G will make fast charging even more critical and the reason for that, is the 5G phones will be utilized more continuously because of the bandwidth it provides. There’ll be more video downloads and in general it will be used more often, which means that you have to charge the batteries – you either have to make the batteries bigger, if you make it bigger then obviously you need more power to charge it in the same time, so all of that bodes very well for us, so we look forward that to even higher power levels in charging cell phones and therefore, all of our technology will become much more relevant going forward.
Great and then just kind of listening to one of your peers, they had noted some pull in ordering the [indiscernible] specifically in surveillance, so just kind of curious you saw an uptick here that is typical in the quarter in terms of channel inventory, but are you seeing anything from any specific areas maybe where there could be some pull ins ahead of any further trade restrictions.
No there is no pull in, for us the little increase that popped in was because of some design wins that we had on the communications segment and that’s where [indiscernible] had to satisfy that, it’s just a timing issue. But as you know there’s always during this time a little uptick, so for us it’s not anything unusual considering how much our inventory had dropped in the last couple of quarters in the channel.
And then just one last one here, if we’re thinking about the BridgeSwitch which you mentioned for the motor control and just kind of given the industry 4.0 evolution that’s expected to happen soon and that’s really centered [ph] around the efficiency. How do you think you can perform in that market, I guess longer term what are your expectations specifically for the BridgeSwitch solution and the motor control as whole?
Well many countries have a very strict regulations and efficiency which continue to get tighter every year, so what is happening is, things like washing machines, dish washers and refrigerators there are new efficiency requirements that force them to go into BLDC or brushless DC motor that require electronic motor control, which is where the BridgeSwitch provides a solution. What is surprising to us, is even things like water pumps in a dishwasher which is used in frequently as going to BLDC. They used to be just either DC motors or AC motor, but now they’re going to brushless DC motors just to get that additional efficiency and also there are some other benefits the brushless DC motors bring like reduce noise and so on. But the biggest area is in refrigeration and air conditioning, where the motors run continuously and therefore their efficiency becomes extremely critical. Even a little bit of improvement in efficiency allows them to have lot more margin in other areas to meet the efficiency requirements.
Thanks so much for the time and best of luck on the quarter.
[Operator Instructions] Your next question comes from the line of Christopher Rolland with Susquehanna. Your line is open.
It’s David Averly [ph] on behalf of Chris tonight. Thanks for taking our questions. I guess first one from a bit of a higher level. Can you talk about the linearity of orders in the September quarter and what you’re seeing this forward in October and as your guide seems at flat, it might be a little bit better than some others you’ve heard so far in this early [ph] season.
So for us the quarter began with the backlog at the beginning a little lower, so the turns that we need – compared to the previous quarter so the turns we need is slightly higher, somewhere around high 30s, but as we have talked about the design wins that we’re having in rapid charging, our guide reflects and then also the seasonal uptick that we get in air conditioning is reflective in our guidance.
I would also like to add that the bookings in October this month have been stronger and so that’s also is used in calculating our guidance.
Got it and two quick ones on the GaN product. Is there a wattage threshold where you just see that GaN is such a no brainer for OEMs in terms of advantages? I guess for example like a 15-watt charger, are you competing with GaN in your traditional product there and is offering both the customers and what are they choosing?
Generally, GaN becomes interesting at 30 watts and above, almost independent of the application. but there is also a higher cost associated with GaN. GaN is more expensive, but at a system level it offers a number of advantages in terms of size, efficiency, lack of heat sink and so on when you go to higher power levels. I think in the long run we see GaN becoming very prevalent above the roughly 30 watts and above. We think we have by far the best GaN technology which is totally proprietary technology very different from everybody else and I think that we are the only company shipping GaN in high volume even though, there has been talk about GaN for a long time, going as far back 15 years. but if you look in the market it’s hard to find any commercial product using GaN until we started shipping in high volume and so I think that’s where the benefit is, we have a very cost effective GaN, we have a GaN that is proven in the market and so we think we’re in a very strong position to transition from silicon switches to GaN switches over a period of time, over the next few years.
Got it very helpful and then one last one for me. I know a lot of the GaN stuff is aftermarket right now, but I just thinking about going into the – kind of next year. How do you think about split between aftermarket versus inbox [ph] where do you think that’s ultimately going to shake out?
Well that’s a good question. Right now, I would say the aftermarket is relatively small. Is not very significant compared to the overall OEM market. Having said that, number of OEMs are actually looking at GaN as we speak, when they come out with GaN it will generally be on the higher end of their phones, so the wall ins [ph] will have to gradually grow because of the higher price of the product, but then if you want to go to something like 45, 50 watts. There’s really no other way to do this and have the size reasonable. People don’t want to carry big bricks for their cell phones and if you want to make it a small adapter, you really don’t have much of a choice and we hope that increase in power will drive more OEMs into the GaN technology.
Thank you.
There are no further questions in queue at this time. I turn the conference back over to our presenters.
Okay, we’ll leave it at there. Thanks everyone for listening. There will be a replay of this call available on our investor website which is investors.power.com. Thanks again for listening and good afternoon.
This concludes today’s conference call. thank you for your participation. You may now disconnect.