Power Integrations, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Unaudited results; comparisons are with Q1 2016. The company designs and markets integrated circuits and related components for high-voltage power conversion.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $104.7 million | $88.0 million | +18.9% |
| Gross profit / margin | $50.5 million / 48.2% | $44.5 million / 50.5% | Profit +13.5%; margin -2.3 percentage points |
| Operating expenses | $37.6 million | $34.0 million | +10.4% |
| Operating income | $12.9 million | $10.5 million | +23.6% |
| Net income | $14.1 million | $10.4 million | +35.9% |
| Diluted EPS | $0.47 | $0.35 | +$0.12 |
| Cash from operations | $5.9 million | $20.3 million | Down $14.3 million |
At March 31, cash, cash equivalents and short-term marketable securities totaled $250.1 million, versus $250.5 million at year-end. Working capital was $282.1 million. Total liabilities were $58.5 million and stockholders’ equity was $530.1 million. No borrowings were outstanding under the $75 million revolving credit facility; the company reported compliance with its covenants. Investing activities used $22.0 million, including $6.4 million of property and equipment purchases and net purchases of marketable securities. Financing activities provided $0.3 million, including $4.1 million of dividends paid.
Material changes and management commentary
- Revenue growth was attributed primarily to InnoSwitch products in the communications end market. Communications rose to 28% of revenue from 23%; consumer was 37%, industrial 31%, and computer 4%.
- Gross margin fell primarily because the weaker U.S. dollar versus the yen raised Japanese wafer costs, and because of a mix shift toward lower-margin communications sales.
- Operating expenses increased with workforce expansion and higher legal fees, particularly relating to ON Semiconductor litigation.
- International sales were 96% of revenue; sales to Asia were 80%. Distributors accounted for 77% of revenue. The top ten customers represented 59% of revenue; Avnet alone represented 17%.
- Operating cash flow declined substantially, with higher receivables and supplier advances/prepaids among the uses of cash; management attributed the receivables increase to stronger March sales.
Accounting, outlook, risks and contingencies
- The company early adopted ASC 606 on January 1, 2017 using full retrospective application. Distributor revenue is now generally recognized upon shipment and transfer of control (“sell-in”), rather than when distributors resell products (“sell-through”). Adoption increased Q1 2016 reported revenue by $2.7 million and net income by $1.5 million; it increased December 31, 2016 retained earnings by $15.0 million. These adjustments affect reported period comparisons.
- Adoption of stock-compensation guidance produced a $7.5 million cumulative adjustment to opening retained earnings and deferred tax assets. Q1 2017’s negative 5.0% effective tax rate included an approximately $1.0 million benefit from excess share-based-payment tax benefits.
- No specific quarterly revenue or earnings guidance was provided. Management expects cash from operations and existing liquidity to cover working-capital and other cash needs for at least 12 months. It also expects international, particularly Asian, sales to remain a large share of revenue, while warning that demand, pricing, product mix and operating results are difficult to predict.
- Key business risks include volatile customer demand and order timing, pricing pressure, customer and distributor concentration, international exposure, and sensitivity of wafer costs and margins to yen-dollar exchange rates. Management estimated that a 10% change in the dollar versus the yen could change gross margin by approximately 1.0%, all else equal.
- Significant patent litigation remains unresolved. In a Fairchild case, a January 2017 final judgment awarded $146.5 million including prejudgment interest; the company has recorded no benefit and cannot predict the amount, if any, ultimately recoverable. Other Fairchild matters and multiple ON Semiconductor disputes continue. The company said it could not estimate a loss or range of loss for ongoing litigation and warned that adverse outcomes could materially affect results.
- After quarter-end, on May 4, 2017, the company granted executive RSUs covering a total of 125,000 shares, with vesting over eight years beginning April 1, 2017.
Important facts for investors to verify
- Whether revenue momentum continues, especially in communications, and whether the margin decline from yen-related costs and end-market mix persists.
- Whether working-capital movements—particularly receivables and supplier advances—convert into cash, given Q1 operating cash flow of $5.9 million.
- The sustainability of earnings excluding the unusually favorable tax effects, including the share-based-payment tax benefit and opening retained-earnings adjustment.
- Developments in Fairchild and ON Semiconductor litigation, including appeals, potential damages, legal costs and any effect on intellectual property rights; the $146.5 million Fairchild judgment is not recorded as a financial benefit.
- Distributor/customer concentration and the estimates for distributor price adjustments and returns under the new revenue-recognition approach.