Power Integrations, Inc. — Q1 2011 Form 10-Q
Business context and reporting period. Unaudited results for the three months ended March 31, 2011, compared with Q1 2010. Power Integrations designs and markets high-voltage analog and mixed-signal power-conversion ICs; following its Qspeed acquisition, it also sells high-voltage diodes. Most revenue comes from low-power AC-DC products, with sales concentrated in Asia and through distributors.
Financial performance and position
| Metric | Q1 2011 | Q1 2010 / prior balance date | Change |
|---|---|---|---|
| Revenue | $76.8 million | $71.5 million | +7% |
| Gross profit / margin | $36.4 million / 47.4% | $35.9 million / 50.2% | Margin down 2.8 percentage points |
| Operating expenses | $24.7 million | $21.0 million | +18% |
| Operating income | $11.7 million | $14.9 million | -22% |
| Net income | $9.9 million | $12.3 million | -20% |
| Diluted EPS | $0.33 | $0.42 | -21% |
| Operating cash flow | $5.7 million | $16.8 million | Down $11.1 million |
| Cash, cash equivalents and investments | $206.6 million | $214.8 million at Dec. 31, 2010 | Down $8.2 million |
| Working capital | $222.5 million | $212.1 million at Dec. 31, 2010 | Up $10.4 million |
All financial amounts are in U.S. dollars. The company reported no borrowings; it established an unsecured credit facility of up to $50 million, with a $0.5 million letter of credit outstanding. Total liabilities were $63.9 million, including $30.7 million of long-term income taxes payable. Cash declined to $137.7 million from $155.7 million at year-end.
Operating cash generation was constrained chiefly by a $7.6 million increase in accounts receivable, a $2.9 million decrease in accounts payable and a $1.3 million reduction in deferred distributor income. Investing used $29.9 million, including $7.2 million for property and equipment, $6.9 million related to Qspeed, and net funding of approximately $5.5 million for the SemiSouth lease arrangement. Financing provided $6.2 million, mainly employee stock-plan proceeds, partly offset by $1.4 million in dividends.
Material changes and management commentary
- Revenue growth reflected stronger demand and greater market penetration. Consumer, communications and industrial sales increased; computer-market sales edged down. LinkSwitch accounted for 40% of revenue, TinySwitch 35%, and TOPSwitch 23%.
- Gross margin fell primarily because of product mix and a weaker U.S. dollar against the Japanese yen, which raised wafer costs. Management noted that Japan’s earthquake and tsunami had not materially affected suppliers or customers in Q1 and did not expect a material Q2 effect.
- Operating expenses rose with headcount and stock compensation, including R&D staff added after an acquisition and expansion of Asia sales personnel. G&A also increased in dollars, primarily due to patent-litigation legal fees.
- Customer concentration increased: the top ten customers accounted for 67% of revenue versus 60% in Q1 2010; the two largest distributors represented 19% and 12%. International sales were 96% of revenue.
- The company paid $6.9 million toward Qspeed, acquired at year-end 2010. The preliminary $12.2 million total consideration included a $5.25 million settlement of a pre-existing royalty arrangement; purchase-price allocation included $6.8 million of goodwill.
Outlook, risks and contingencies
For Q2 2011, management forecast revenue of $76–$82 million, gross margin of 47%–48%, and operating expenses of approximately $25.5 million. The filing provides no broader quantified annual guidance. Management said operating cash flow and existing liquidity were expected to cover working capital and other cash needs for at least 12 months.
- Tax dispute: The IRS intends to propose adjustments for 2003–2006 related primarily to intercompany R&D cost-sharing; 2007–2009 years were also under audit. The company disputes the IRS position, has recorded tax reserves, and says additional payments may be required. Resolution was not expected within the next year.
- Patent litigation: A February 2011 final judgment awarded the company $12.9 million against Fairchild for infringement; Fairchild appealed. No benefit from the award was recorded in the financial statements. Other U.S. patent cases and Chinese infringement suits remain unresolved; the Chinese suits seek approximately $17 million in damages and an injunction. Litigation may be costly and divert management and technical resources.
- SemiSouth exposure: The company held a $7 million equity investment, paid a $10 million prepaid royalty, and entered into a lease line allowing SemiSouth to borrow up to $15.5 million through January 2013. Approximately $5.7 million had been funded or deposited by quarter-end. A possible obligation to acquire SemiSouth under specified performance conditions was valued at zero at March 31, 2011.
- Key operating risks include unpredictable customer orders and cancellations, pricing pressure, product and customer mix, dependence on third-party foundries and assembly providers, yen exposure, international and distributor concentration, product development and quality risks, and potential inventory obsolescence. The company said it did not hedge foreign currency exposure.
- The board authorized a further $50 million share-repurchase program in February 2011, but its price/volume guidelines did not permit repurchases at then-current stock-price levels. Quarterly dividends of $0.05 per share were planned for 2011, subject to board discretion.
Most important facts for investors to verify
- Whether the Q2 revenue and margin outlook was achieved, and whether the gross-margin decline stabilized.
- Whether revenue growth converts into stronger operating cash flow as receivables and distributor inventory change.
- Customer and distributor concentration, international exposure, and the sustainability of demand across end markets.
- Developments and potential financial exposure in the IRS audit and pending patent litigation, including the Fairchild appeal and Chinese claims.
- Funding, repayment performance and any further commitments associated with SemiSouth, and the status of Qspeed integration and purchase-price allocation.
- Actual use of the repurchase authorization, dividend payments, and compliance with the $50 million credit facility’s covenants.