Power Integrations Inc Q3 FY2025 Earnings Call

Hello, and welcome to the Power Integrations Q3 Earnings Call. I would now like to turn the call over to Joe Shiffler, Director of Investor Relations. Please go ahead.

Thank you, Hayden. Good morning, everyone. Thanks for joining us. With me on the call today are our CEO, Jen Lloyd; and Interim CFO, Eric Verity. We're doing a premarket earnings release this morning since we'll be traveling later today to Chicago, where we'll be attending the Stifel Midwest 1x1 Conference tomorrow. We look forward to seeing some of you there. Later this quarter, we'll also be attending the UBS Technology and AI Conference in Arizona on December 3 and the Virtual Northland Securities Growth Conference on December 16. Our discussion today will include forward-looking statements denoted by words like will, expect, should, outlook, forecast and similar expressions looking towards future events or performance. Such statements are subject to risks that may cause actual results to differ from those projected or implied. Such risks are discussed in today's press release and in our most recent Form 10-K filed with the SEC on February 7, 2025. During this call, we will refer to financial measures not calculated according to GAAP. Non-GAAP measures in the third quarter exclude stock-based compensation expenses, amortization of acquisition-related intangible assets, expenses associated with an employment litigation matter and the tax effects of these items. A reconciliation of non-GAAP measures to our GAAP results is included in today's press release. 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 it over to Jen.

Thank you, Joe, and good morning, everyone. I'm going to cover three topics in my remarks today. First, I'll review current business trends and the Q3 results. Next, I'll expand on the opportunity for Power Integrations in data centers following the announcement last month of our collaboration with NVIDIA on their 800-volt DC power architecture. And finally, I'll offer some thoughts on my first 100 days in the CEO role and priorities for the months ahead. Starting with recent trends, we said on the Q2 call that we had seen a slowdown in orders in July with bookings down about 20% compared to the monthly run rate of the first half of the year. The lower run rate continued through the third quarter, accompanied by weaker distribution sell-through. Appliances are by far the largest driver of the slowdown with orders down about 40% in Q3 compared to the first half. Appliances make up the bulk of our consumer category, which accounted for about 40% of our sales in the first half. Throughout the year, we have called out the sensitivity of white goods and other appliances to tariffs owing to their high dollar value and their steel content. We've talked about the unusually strong growth in our appliance business in the first half, and we've highlighted commentary from the largest U.S. appliance OEM regarding what they've called 'extensive preloading' of imports from Asia in the first half. This was a key topic again on their Q3 earnings call last week. All of this is to say that the softness we're seeing in the second half is not a surprise. Appliances are a great business for us and typically generate a steady and fairly predictable revenue stream. But tariffs have severely disrupted that industry, adding to the difficulties caused by stagnant home sales in the U.S. and China's weak housing market. And because it's such an important part of our business, we are seeing volatility in our revenues. We expect fourth quarter revenues of $100 million to $105 million with the consumer category driving a large portion of the decrease compared to the third quarter. We also expect industrial to be sequentially lower, directionally consistent with recent Q4 seasonality. But our industrial business continues to be strong with revenues up nearly 20% for the first three quarters of 2025. That growth is coming from a broad range of applications where we are capitalizing on big picture trends like electrification and grid modernization, encompassing renewables, energy storage, high-voltage DC transmission and smart meters. Our high-power gate driver business sits squarely in line with these trends and continues to gain momentum with revenues up more than 30% year-to-date. In Q3, we built on our already strong position in the growing Indian rail business, adding a major new customer with our first design win at one of India's largest suppliers of systems for electric locomotives. We also won our largest design yet with our scale EV automotive driver boards at a major German manufacturer of drive systems for heavy vehicles. In low power, we continued our progress in passenger cars with six more design wins in Q3, adding to the 40-plus EV models now on the road using our products. We continue to win a robust share of inverter emergency power supplies and are using that foothold to go after other high-voltage sockets like auxiliary power supplies for battery management and onboard charging. We see strong interest in our GaN-based solutions helping to drive the market to higher power micro DC to DC converter architectures. We have a strong pipeline of design activity in these applications and expect a healthy revenue ramp over the next several years. Eric will cover the finer details of the quarterly numbers, but I do want to highlight our cash generation and return to stockholders. We generated $30 million in cash from operations in Q3 and are on track for more than $80 million in free cash flow this year. We naturally expect free cash flow and free cash flow margins to rise as revenues recover and that confidence is reflected in our cash returns. Including our fourth quarter dividend, we will return nearly $150 million to stockholders this year through buybacks and dividends. Our Board has also declared a $0.005 per share dividend increase effective in Q1 of 2026. Turning now to data center. At last month's OCP Global Summit, we published a paper demonstrating the advantages of our 1,250 and 1,700-volt GaN technologies in 800-volt DC AI data centers. We also announced our collaboration with NVIDIA to help realize the potential of the new architecture to improve efficiency, use less copper and reduce the amount of data center space consumed by power infrastructure. The white paper is available on our website, and I encourage you to take a look at it. In short, our proprietary 1,250-volt GaN accommodates an 800-volt input in a conventional power supply topology, while standard 650-volt GaN requires stacking of multiple devices, compromising power density and reliability while adding complexity. Another alternative silicon carbide can handle 800 volts but has significant limitations in terms of power density due to its slower switching speed. The paper also explains why our 1,700-volt InnoMuX2 is an excellent fit for the auxiliary power socket in the 800-volt architecture. The white paper includes reliability data comparing PowiGaN to other GaN technologies. Reliability has been an obstacle to GaN adoption in the data center as well as the automotive market and the fact that we're seeing traction in both these markets speaks to the superior reliability of our unique GaN technology. In fact, one of the key attributes of our technology that NVIDIA and others in the data center ecosystem have found attractive is the fact that it is automotive qualified and already shipping into the automotive market. While we're excited about the 800-volt opportunity, GaN can also bring significant improvements in power density to existing AI data center architectures, which are expected to remain prevalent for years to come. By the end of this year, we expect to deliver early samples of our system-level GaN product for rack-level AC to DC converters with production release planned for late 2026. And now I'll conclude with a few thoughts on my first 100 days in the CEO role. As I said on our call last quarter, just after I joined, that I was excited about our unique technologies and the depth of our expertise in high-voltage processes, packaging and systems. I could also see that the need for innovative high-voltage technology is growing because of the global trends that we've talked about, grid modernization, electrification, decarbonization, and of course, AI. A 100 days in, I'm just as excited about the opportunities ahead of us and developing a clearer picture of the steps we need to take to best capitalize on them. As I said last quarter, our core power supply business is back on a growth trajectory with a mix moving toward higher-margin industrial applications. The growth in our high-power and automotive businesses shows that our products and expertise have significant value in those markets, while our collaboration with NVIDIA validates the unique capabilities of our GaN technology. We continue to receive encouraging feedback in our conversations with other key participants in the AI ecosystem. I'm confident we have a lot of what we need in terms of technology and engineering talent, though it's clear to me that we need to adapt our organization and our processes to increase the ROI on our R&D spending and better match the needs of the markets that we expect to drive our longer-term growth. Data center, auto, and high power have different requirements and a different geographic footprint than the mass market power supply business, and we'll be taking steps in the months ahead to better align our R&D and go-to-market resources with those markets. And while we need to reallocate some resources, I don't believe we need to spend more to accomplish what we need to do. We have important hires to make, including some at the senior level, but are limiting hiring to critical needs, and I'm pushing the team to tighten up on OpEx and capital spending. Our top priority is to drive shareholder value by growing our cash flow. While revenue growth is really the key to that, disciplined spending will enable us to expand cash flow margins faster as we grow our revenues. So it's something I'm emphasizing as we plan for 2026.

Thanks, Jen, and good morning, everyone. I'll focus my remarks on the non-GAAP results, which are reconciled to GAAP in our press release. Third-quarter revenues were up 3% sequentially to $119 million. Looking at the sequential changes, Industrial was up high single digits on strength and traction in high-voltage DC transmission in our high-power business, as well as growth in metering and automotive. Communications was up high single digits, driven by strength in cell phones due in part to a design win that we announced earlier in the year for a GaN accessory charger recently launched by a major device OEM. The computer category was up mid-single digits, driven by tablets and aftermarket chargers. Consumer revenues were down mid-single digits, driven by softness in major appliances as well as seasonality in air conditioning, offset by strength in gaming. Revenue mix for the quarter was 42% industrial, 34% consumer, 13% computer, and 11% communications. Non-GAAP gross margin for the third quarter was 55.1%, in line with our guidance and down 70 basis points from the prior quarter, driven by higher input costs flowing through our inventory as well as a smaller benefit from the dollar and exchange rate. Non-GAAP operating expenses were $47.4 million, in line with our guidance and up sequentially due mainly to higher legal expenses. The non-GAAP effective tax rate was 2%, resulting in non-GAAP earnings of $0.36 per diluted share. Diluted share count was 56.2 million, down about 200,000 from the prior quarter, driven by repurchases. Inventories on the balance sheet fell by 18 days to 278 days. As Jen noted, we saw lower distribution sell-through in the quarter, which resulted in higher channel inventory of 9.8 weeks at quarter end. Sell-through has exceeded sell-in thus far in the fourth quarter, drawing down a significant portion of the channel inventory that accumulated in Q3. Cash flow from operations was $30 million for the quarter, while CapEx was $6 million. We used $42 million for the buybacks during the quarter, repurchasing 919,000 shares and completing our buyback authorization. We also returned $11.8 million during the quarter in the form of dividends. As Jen noted, the Board has increased the dividend by $0.005 to $0.215 per share effective in the first quarter of 2026. Turning to the Q4 outlook, we expect revenues of $100 million to $105 million. We expect significantly lower consumer revenues driven by the softness in appliances as well as somewhat lower industrial revenues. At the midpoint of the Q4 range, full-year revenue growth would be about 6%. We expect non-GAAP gross margin for the fourth quarter to be between 53.5% and 54%. The decrease in Q3 reflects a less favorable end market mix with appliances and industrial driving the sequential revenue decline. Lower back-end production volumes will also contribute along with the increase in the yen versus the dollar that took place in September of last year. As a reminder, at our current level of inventory, changes in the yen-dollar exchange rate take roughly a year to affect our gross margin. We expect gross margin to rebound from the Q4 level in the first half of 2026 as mix swings back toward industrial and appliances and the impact of the yen moves back in a favorable direction. The yen has weakened considerably against the dollar of late, which should provide further support for our gross margin towards the end of 2026. Non-GAAP operating expenses for Q4 should be around $47 million, down slightly from Q3. The effective tax rate for the fourth quarter should be around 3% before rising to high single digits in 2026, driven by a lower exemption for overseas income, a provision of the 2017 tax reform legislation. Lastly, I expect share count to come down by 400,000 to 500,000 shares compared to Q3, bringing our share count below 56 million. On a split-adjusted basis that's significantly below the share count at the time of our IPO in 1997. And now operator, let's begin the Q&A session.

Your first question comes from the line of Tore Svanberg with Stifel.

Jen, could you elaborate on the direction of the consumer business? There were some pull-ins in the first half that are now being processed in the second half. It seems you anticipate that the consumer segment will rebound in the first half of next year, especially considering Eric's comments on gross margin. Please help us understand the dynamics at play. Additionally, could you clarify what this means for channel inventory, particularly whether it will return to the 8-week level by the end of the year?

Sure. Yes. So first, maybe let me talk about the decline that we saw, what we're expecting, and then maybe talk a little bit about slightly longer term. So we knew that the appliance decline was happening. We knew that Q4 was going to be sequentially lower. It was difficult to forecast just because of the lack of visibility. And the inventory situation there is really finished goods that were shipped into the U.S. and we have very limited visibility to that. But what we did see at our distributors is they did bulk up in Q3. So as you said, the sell-through ended up being somewhat soft. But we are already seeing that channel inventory coming down right now, where we are in the fourth quarter. So we are expecting that to bounce back. We're just not 100% sure where the timing is going to be when that comes back. But we have heard from, for example, Whirlpool said in 2026, they're expecting that to normalize as that preloaded inventory clears out at the end of this year. So we are expecting our consumer business to get back to growth in 2026. Just it’s a little bit hard to predict the timing of that. I don't know if Joe or Eric wants to add to that.

Yes. We did see a significant sell-through in October to take down that inventory that you are mentioning. And we do see it normalizing next year and we're expecting moderate growth in appliances for 2026.

One more point on that, Tore. The consumer business usually experiences some positive seasonality in the first half of the year due to air conditioning builds for the summer. Therefore, that segment of the business should grow sequentially in Q1. The larger uncertainty is around major appliances, which is the largest part of the consumer category. As Jen mentioned, it is anticipated that the preloaded inventory will largely be cleared by the end of this year. The key question for 2026 is what will happen to consumer demand for appliances. Housing has been problematic, especially in China, but also in the U.S. There is limited turnover in existing homes, which significantly impacts major appliance sales. However, with rates decreasing, this could potentially boost demand for major appliances.

Maybe I'll add one last comment on that is that we still do see a great future for appliances. It's a great business for us. And I just wanted to reemphasize some of the growth drivers for that are really efficiency standards and the GaN adoption, which means more dollar content. So we do think there's going to be growth in units. And yes, on top of these macro and cyclical factors, the growth drivers are there.

Very good. That's very helpful. As my follow-up, I had a sort of longer-term question. And I think, Jen, you mentioned a little bit of this on the call where it does sound like data center, automotive and high power are going to be a big focus for the company. So I'm just wondering, does that mean you're going to change a little bit how you go to market, how you're structured internally? Obviously, today, you have the four main end markets and you've got tons of applications within each one. But yes, just wondering if that's going to cause a reorg and sort of the focus being more on data center, auto, and high power?

Yes, I have a couple of comments on that. First, you are right; we will be placing greater emphasis on those markets, both in our R&D investments and our go-to-market strategy. We have already begun to realign our project spending to expedite developments in these areas. However, I want to emphasize that we maintain a robust core business, and we will continue to invest in driving that segment. Our focus is simply shifting more towards data centers, automotive, and high power.

Your next question comes from the line of Christopher Rolland with Susquehanna.

I guess, first, if we could maybe talk about next quarter and how you see things playing out in terms of strength or weakness between comms, computer, consumer and industrial, that would be very helpful for us.

You mean Q4, Chris? Yes. As we mentioned earlier, we expect significant declines in the consumer segment after the channel inventory buildup in Q3, which occurred because sell-through did not align with distributor purchases. This aligns with what we've heard from Whirlpool regarding the inventory pull-ins in the first half, with shipments being preloaded from Asia. There remains one more quarter of inventory burn in finished goods that needs to occur. The consumer segment accounts for the largest portion of the decline, while industrial also experienced a sequential decrease, primarily due to seasonal factors affecting certain markets, such as tools and battery-powered lawn equipment. Additionally, other segments like high power experience normal fluctuations in order patterns, being largely project-driven. The timing of orders in high power and metering, which is influenced by government tenders in India, plays a role in this. However, as Jen mentioned, the industrial business is still performing well. Therefore, these two segments will significantly contribute to the sequential decline. The computer and communication segments are likely to remain flat or slightly down, but the majority of the decline arises from consumer and industrial segments.

Jennifer, I have a question for you regarding data centers. It seems like you're focusing on the main power conversion in the power supply units for data center AI power supplies. Initially, I believe this was based on silicon, but many anticipate a shift towards silicon carbide. You also have a unique high-voltage GaN product. It appears there might be a discussion about the merits of silicon carbide versus high-power GaN. How are your interactions going with the power supply unit original equipment manufacturers? How do you see market share developing? Do you believe you will be the leading player or more of a secondary option? It looks like GaN might have some cost benefits, so I'm interested in your thoughts on how market share will evolve between these two technologies in the long run.

Let me address that by discussing where we see the opportunities for GaN. I can also touch on silicon carbide. It’s hard to predict how market share will evolve because there are many competitors in this space. Recently, we have talked about future prospects as data centers transition to higher voltages, specifically 800-volt DC. Initially, this presents an opportunity for Powis and the auxiliary supplies, which we already support in current data center architectures. However, for the 800-volt DC architecture, a 1,700-volt switch is necessary. While silicon carbide could be an alternative, we believe that the 1,700-volt GaN offers certain advantages. We think the power density of GaN will be stronger, making it a preferable choice. There is also potential for Powis in 800-volt DC to DC conversion, where we expect the 1,250-volt technology to be relevant, and we’ve discussed its benefits. This technology is already being shipped to other markets, and we are actively working to develop products suitable for the 800-volt data centers. We are collaborating with NVIDIA and other partners at the architectural level to create products that meet their specifications, with an expected release in 2027. Additionally, we see more opportunities with high-power AC to DC converters located at the front end of the data center, for which we have suitable gate driver boards and drivers for silicon carbide modules. The decision on whether to use GaN or silicon carbide will vary depending on specific applications, but we believe that high-voltage GaN will dominate in auxiliary supplies and main DC to DC conversions.

And Jennifer, do you have wins at the power supply OEMs or through the supply chain? Or is it too early given the 2027?

We do have wins in the OEMs, yes, with the aux supply.

Your next question comes from the line of Ross Seymore with Deutsche Bank.

Why don't I just stick with the long-term question first, which is, Jen, what do you view to be the TAM opportunity for where POWI is playing in the AI data center side of things? And roughly speaking, what's the kind of time to revenue? What sort of slope are you looking at? And it was great that you guys got added to the collaboration list, definitely a positive, but you are just 1 of 13 other companies. So it seems like it is going to be a competitive field.

Yes, definitely. There are quite a few factors to consider. Regarding the total addressable market, it's still early for us to determine its size. I believe it's early for everyone to understand how quickly the 800-volt DC market will grow, making it difficult to estimate. Our main focus has been on our content within the AI server rack, which we estimate to be around 1,000, potentially more for the 800-volt DC. This gives you an idea of our rack content. In terms of time to revenue, we currently have products that can meet the needs of the existing data center market. As the market shifts to the 800-volt DC architecture, our content will increase. However, meaningful revenue generation is a few years away for us, and we anticipate releasing our first products suitable for the main data center supply by 2027.

One more point, Ross. That list of 14 includes many different sockets, and not every one of those 14 players is targeting all of them. In the 800-volt architecture, the two sockets where we have the best position are the auxiliary power supply with the InnoMuX2 products and the main converter, the 800-volt to either 12 or 54-volt socket. We believe that high-voltage GaN is essential for that socket, and not everyone on that list has high-voltage GaN. Therefore, we are not competing against 14 other companies for these sockets, as everyone is pursuing different segments of that market. Additionally, while we're focusing on the 800-volt opportunity, the larger portion of the AI data center market, at least in the near future, will still involve existing architectures with rack-level AC/DC converters. We have a product set to begin sampling soon, as Jen mentioned in her prepared remarks, which will be ready for release in the latter part of 2026. We've garnered interest from several customers for those early samples, and this product will allow us to start generating revenue sooner than the 800-volt opportunity.

I have a question regarding the consumer side, particularly about channel inventory. It seems you are experiencing a significant reduction in inventory during the December quarter. As that situation normalizes, how much of a boost do you anticipate for the consumer business in the first half of the year? You can address this in terms of what revenues might look like without the inventory reduction accounted for in the fourth quarter guidance or the expected revenue based on a normalized consumer quarterly run rate. I'm trying to understand the current challenges you’re facing and what a return to normal might look like.

We were at 7.6 weeks of inventory after the second quarter and added a couple of weeks, primarily in the consumer category, during the third quarter. Based on what we've observed so far in October, it appears we will reduce most, if not all, of the inventory that built up in Q3. It's difficult to determine exactly how many weeks we will be at, as it will depend on certain factors, but we expect to be in a much better position entering the first quarter. From there, consumer growth will be influenced by the demand in the appliance category. The air conditioning segment typically sees an uptick in the first half, while major appliances are more uncertain. Tariffs have disrupted order patterns and have also caused some demand reduction since they impact consumer pricing. This year, some inflation data indicated significant price increases in appliances. Despite these uncertainties, it seems likely that the excess inventory will be cleared out by the end of the year, according to Whirlpool, and our channel inventory should be in better condition as we close the year. After that, demand will be the key factor.

There are no further questions at this time. I will now hand it back to Joe Shiffler for closing remarks.

All right. Thanks, Hayden. Thanks, everyone, for joining. There will be a replay of this call available on our website, investors.power.com. We look forward to seeing some of you tomorrow in Chicago, and thanks again for listening.

This concludes today's call. Thank you for attending. You may now disconnect.