Power Integrations, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Financial statements are unaudited. The company designs and markets integrated circuits and related components for high-voltage power conversion, including IGBT drivers for higher-power applications.
Financial performance
Amounts are in millions of dollars except per-share data. Comparisons are with the same 2013 period.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $90.1 | $91.7 | $262.2 | $256.7 |
| Gross profit / margin | $49.1 / 54.4% | $48.8 / 53.2% | $143.8 / 54.8% | $134.8 / 52.5% |
| Operating expenses | $32.2 | $32.2 | $99.8 | $95.9 |
| Operating income / margin | $16.9 / 18.8% | $16.6 / 18.1% | $43.9 / 16.7% | $39.0 / 15.2% |
| Net income | $16.1 | $16.7 | $45.2 | $41.2 |
| Diluted EPS | $0.52 | $0.54 | $1.46 | $1.36 |
| Cash from operations | — | — | $73.1 | $75.2 |
Q3 revenue declined about 1.7% year over year, while nine-month revenue increased about 2.2%. Gross margin improved in both periods, which management attributed primarily to favorable end-market mix and a weaker Japanese yen lowering wafer costs; higher production volumes also helped the nine-month comparison. Q3 net income declined despite slightly higher operating income, as income-tax expense was $1.1 million versus near zero in Q3 2013. Nine-month net income benefited from stronger gross profit and a one-time tax benefit.
Liquidity, cash flow and capital allocation
- At September 30, cash, cash equivalents and short-term marketable securities totaled $213.9 million, versus $202.1 million at December 31, 2013. Working capital was $233.6 million, up from $227.0 million.
- Operating cash flow for the first nine months was $73.1 million. Investing activities used $63.9 million, including $17.4 million of property and equipment purchases; financing activities used $41.4 million.
- Inventory increased $14.7 million, to $57.0 million. Management linked the increase to lower-than-expected sales and noted higher distributor inventory. Deferred income on distributor sales rose to $18.7 million on the balance sheet; related deferred revenue was approximately $30.7 million.
- The company repurchased $45.3 million of stock and paid $9.7 million in dividends in the first nine months. The quarterly dividend was raised to $0.12 per share for Q3 and Q4. The board added $25.0 million to the repurchase authorization in October.
- No amounts were outstanding under the $100 million revolving credit facility, which was extended to April 1, 2017. The company reported compliance with its covenants. Management believes available liquidity and operating cash flow will meet projected needs for at least 12 months.
Material changes and unusual items
- Communications revenue weakened, particularly cellphone chargers and residential networking. Consumer and computer sales partly offset the Q3 decline. For the nine-month period, industrial, consumer and computer revenue grew, partly offsetting communications weakness.
- Operating expenses were flat year over year in Q3 but increased $3.9 million for the nine-month period, primarily from higher R&D staffing and engineering costs and expanded sales and application-support teams.
- The IRS settlement of 2007–2009 tax years generated a one-time $3.3 million tax benefit in Q2 2014 and permitted up to $5.0 million of foreign-subsidiary funds to be repatriated without additional U.S. income taxes. The nine-month effective tax rate was negative 0.9%; Q3’s rate was 6.6%.
- In Q3, the company reversed $0.8 million of previously recorded compensation expense after lowering its estimate of 2014 performance awards expected to vest.
Outlook, risks and contingencies
- No numerical revenue or earnings guidance is provided. Management expects international and particularly Asian sales to remain a large share of revenue; it cautioned that weaker demand, pricing pressure or other deterioration could jeopardize operating cash flow.
- Revenue is exposed to volatile customer ordering, distributor inventory and price-adjustment claims. Distributors accounted for 76% of nine-month sales; international sales accounted for 95%. Avnet represented 20% of nine-month revenue, and the top ten customers represented 59%.
- Management cited competition and selling-price pressure, reliance on third-party wafer suppliers, product-development and execution risks, foreign-exchange exposure, and sensitivity to end-market demand. A 10% move in the U.S. dollar against the yen was estimated to affect gross margin by approximately 0.8%–1.0%, all else equal.
- Patent litigation remains significant. A February 2014 jury awarded $105 million in damages against Fairchild and found infringement, but post-trial challenges and further rulings remained pending. The company recorded no benefit from the verdict and said it could not estimate any eventual recovery. Other U.S. and China patent disputes also remain unresolved; the company cannot estimate a loss or range of loss for ongoing litigation.
- The company reported no material change in market-risk exposure from its prior annual report, no off-balance-sheet arrangements, and effective disclosure controls at period end.
Investor verification points
- Check subsequent distributor sell-through and channel inventories, given the inventory build, higher deferred distributor revenue and reliance on distributor point-of-sale reporting.
- Track revenue trends in communications versus consumer, computer and industrial markets, along with gross-margin sensitivity to product mix, yen exchange rates and production volumes.
- Separate recurring earnings and tax rates from the one-time IRS settlement benefit; review the status and potential accounting consequences of remaining unrecognized tax benefits.
- Monitor the Fairchild and other patent proceedings, including whether the $105 million verdict results in any recoverable amount and the possible costs or restrictions from adverse rulings.
- Review cash deployment, including buybacks, dividends, capital expenditures and the October increase in repurchase authorization, against operating cash generation.