Good afternoon. My name is Mike, and I will be your conference operator today. At this time I would like to welcome everyone to Power Integrations' Fourth Third Quarter 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Joe Shiffler, Director of Investor Relations. You may begin your conference.

Thank you. Good afternoon and thanks 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. Our fourth quarter and full year results are calculated using the sell-in method of revenue recognition on sales to distributors, reflecting our adoption of ASC 606 effective January 1, 2017. On today's call and in our press release comparisons to prior year results make use of recap financial information calculated as if the new accounting standards have been in effect for the prior periods. Recap data for 2015 and 2016 can be found in the historical financial tables posted on our investor website investors.power.com. 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 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 8, 2017. 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. Revenues for the fourth quarter were $108.2 million, up 6% from a year ago, but slightly below the mid-point of our projected range. Demand moderated in the later part of the quarter with order activities slowing in December and distribution sell through coming in softer than expected. While all four end market categories exhibited sequentially lower sell through, demand related to Chinese smartphone customers continues to be particularly soft and sell through in appliance market was also notability weak. Although orders rebounded strongly in January, we nevertheless expect first quarter revenues to be sequentially lower compared to the December quarter. Specifically we expect revenues for the first quarter to be in the range of $103 million plus or minus $3 million. Notwithstanding the uncertainty of the short term demand outlook we are pleased with our 2017 results and we believe many of the growth drivers that enable these results remain in place for 2018 and beyond. We are capitalizing on global trends such as energy efficiency, clean energy, faster charging, IOT, the switch to power battery powered motors in area such as tools and transportation and the mass adaption of convenience and comfort appliance in developing markets. These trends are creating an ever greater need for innovative, energy efficient, power conversion technology and we are meeting that need with a strong portfolio of products currently in the market, as well as a robust product pipeline that will drive a meaningful expansion of our addressable market over the next couple of years. Our revenues grew 11% in 2017, led by the industrial and consumer markets which together comprise more than 70% of our sales and grew at a combined rate of about 18%. Industrial revenues grew 20% for the year, driven by a broad range of…

Thanks Balu and good afternoon. I will begin by commenting on the effects of the new tax law. First with respect to our ongoing effective tax rate, the net effect of the legislation will be very modest. While the reduction of the U.S. corporate tax rate will provide a slight benefit, other provisions of the law will offset that benefit with the net effective being a small uptick in our effective tax rate. Specifically I expect our non-GAAP tax rate for 2018 to be in the range of 7% to 8% compared to 5% in 2017. The GAAP tax rate should average about 100 to 150 basis points higher than the non-GAAP tax rate. Second, our fourth quarter GAAP results include a charge of $37.5 million, reflecting the transition tax on unremitted foreign earnings as well as changes in the values of our differed tax assets and liabilities on our balance sheet. The cash outflow associated with the charge will be approximately $15 million, which will be paid over 8 years according to the time table stipulated in the law. Naturally our initial estimates of the impact of the tax law could change as we refine our analysis and conduct tax planning activates or if any additional guidance on the new law becomes available. Turning to our fourth quarter results, revenues were $108.2 million up 6% year-over-year and down 3% sequentially. The year-over-year increase was driven by growth of 25% from the industrial category, while consumer revenues increased mid-single digits and the communication and computing categories each declined by roughly 10%. Revenue mix for the quarter was 37% consumer, 33% industrial, 25% communication and 5% computing. Non-GAAP gross margin for the quarter was 51.2%, just 10 basis points lower than the prior quarter as the negative effects of end market…

Thanks Sandeep. We'll open it up now for the Q&A session. Mike would you please give the instructions for the Q&A.

[Operator Instructions] Your first question is from Ross Seymour with Deutsche Bank.

Hey guys. Thanks for letting me ask the question. The first thing I wanted to get into was the bookings trajectory Balu that you talked about, where you said December weakened, but then January came back stronger. Could you just talk a little bit about the linearity of that, the magnitude of it and if there are any meaningful differences between the two sides or two end markets that you pointed out, the handset side and the appliance side.

So the bookings wise, it looked pretty normal through November and December had a sharp decline and then it came back really strong in January. January is usually a strong month, but December we’ve never seen such a significant drop off in the past. If you look at the whole of Q4 it was only slightly lower in bookings than Q3, so it really looked like a normal quarter until December happened. Did I answer your question or did you have something else to ask on the January?

No, well any color. You highlighted two things. I don’t think any of us are surprised by the handset side of things, but the appliance side was a little bit of a surprise. So if you could just give a little bit of color on what you thought was going on there and if the rebound was more acute than the decline for either of those two end markets.

Okay, so if you look at the end markets, all of the end markets were down in Q4, so it was pretty broad. Now if you look further and deeper into it, the Chinese cell phone demand was particularly down and appliances, which is usually stronger in Q4, because of this air conditioning was surprisingly down on a sell through basis. So on a sell through basis all four of them were down. Another interesting thing is it sounded like the distributors were as surprised as we are, because we were shipping all the way through December and in fact we could have probably shipped a little bit more at the end of December because of some mix issues. So it doesn’t look like the distributors realized that you know the demand is going to slow down until very late in the game and historically the sell through in Q4 is always stronger than sell in because the distributors are trying to minimize inventory and it was the opposite this time. The sell through was actually weaker than sell in, which was also a surprise. One more thing I would add is that in November we allowed the distributors to return some of their inventory if they choose to and they didn’t take full advantage of it this time, which again tells me that even in November they didn’t think the demand was going down. So if you look at the market, in the appliance market it looks like there was a significant inventory overhang and so that has caused appliance customers to buy less from the distributors. And as for the cell phone, of course that’s well known. They said the Chinese cell phone demand was down 4% for last year after eight years of growth and it looks like it is going to be continuously softer going into Q1.

So typically also Ross air conditioning starts picking up in Q4 and part of the inventory that we saw increase in the channel was related to that and it could have been that especially in the air conditioning appliance we have had a tremendous year with nearly a 30% increase and that’s probably got a little adjusted and plus we’ve also heard in China the government trying to tamper down on speculative building investments.

That’s really helpful. Just one quick follow-up then on the expenditure side of things. You probably don’t want to be too precise, but you talked Sandeep about the CapEx coming down but still being up versus normal. Can you remind us what normal is?

Well normal is typically we spend about $20 million a year if you look at it. Prior to 2017, in the prior two years we were actually spending much lower than that. So the norm is about $18 million to $20 million. So this year we did, in 2017 we did $32.5 million. In 2018 the best I can tell at this point is somewhere in the $25 million to $30 million range.

Perfect. That’s it from me, thanks guys.

Thanks Ross.

The next question is from Tore Svanberg with Stifel.

Yes, thank you. The first question back to Ross’s topic. So if cell phone is going to remain weak in Q1, what was it that sort of bounced back sharply in January? Was that the appliance business?

You know it’s hard to tell until we actually analyze exactly where these products end up, but January is usually a strong month because of Chinese New Year and this January we booked almost as much as last January, even though last January the Chinese New Year was earlier. This time it’s going to be in the middle of February. So it’s a good sign that it’s coming back, but it still doesn’t tell us the whole story for the entire quarter, because February is going to be very soft in terms of bookings because of the Lunar New Year and then we’ll have to see how March turns out.

Very good and you know regardless of the quarter-to-quarter moves in the end market, your strategy has always been to grow by expanding your SAM and I know in the past you talked about ’18 being a big year for SAM expansion. Is there anything else that you can share with us on that topic, especially in relation to that $4 billion number that you mentioned in the past?

That is going on t rack. We have introduced as you know a number of revolutionary products and you have a lot more to come this year and by the end of this year we expect our SAM to be crossing $4 billion, so that’s still on plan. In terms of growth into that SAM, the biggest area where we have seen the delay is USB PD and we talked about it last time. We expect USB PD to take off early this year, but thanks to delays in the specifications. It looks like it will be in the second half of this year. We have a number of designs going on. We have already talked about in my script two or three – two designs in USB PD. We already had one in cell phones earlier, but there is a lot more coming and we expect USB PD to gradually start ramping in the second half and 2019 should be a very strong year for USB PD. And even appliances, we expect appliances to bounce back, because it has been growing double digits for a long period of time and we had a very strong growth last year. Air conditioning alone we grew 30% over 2016, but our feeling is maybe it’s a little bit overdone and maybe there is a little bit of overhang and that will hopefully clear in Q1.

Very good. Just one last question; you’ve seen strong growth in industrial and I know China has been a big part of the high power growth. As you look at this year, maybe the next year, have you identified any potential opportunities especially in North American when it comes to big CapEx projects that you can take advantage of in high power?

Yes, in North America the big change we are seeing is that the oil production is coming back. So we had a significant share of the oil exploration market and we see that coming back this year. On China side, we have done very well in high voltage DC projects last year. This year in the first quarter it is – you know the first quarter is usually down for high power seasonality wise, but this year it seems to be weaker than normal seasonality. Part of the reason is that China has put some of their high voltage projects on hold for a few months. It looks like it will get restarted again in Q3 or Q4 of this year. But having said that it is a multi-year project with a lot of SAM and we are very optimistic. We are in a very strong position in that market, but like any government driven programs, it is somewhat controlled by their decision making on expenditures and so on.

Very helpful. Thank you.

Your welcome Tore.

The next question is from David Williams from Drexel Hamilton.

Hey, good afternoon guys, thanks for taking my question. I guess first, can you kind of maybe talk about how your thinking about the channel inventory? Is it in line with what your expectations are? Do you think we digested most of the exit inventories that are in the channel and are you expecting that to be pretty much rationalized as we get into maybe the back half of the first quarter?

So the channel inventories are a little elevated ending at about 8.4 weeks and that is what Balu had earlier alluded that typically we expect our sell-through to be higher than sell-in in the fourth quarter as people tend to adjust the inventory. But because of the inventory overhang in the appliance area, as well as the softness in the cell phones it got elevated. We expect and that’s why you can see that we have adjusted our Q1 guide to reflect that increase. If I have to look at it, I think the normalization would probably happen in the first half, but I think more so by the second quarter.

And then just kind of thinking about it on the handset side, we’ve got mobile – well congress coming out with several flagships so that it can be released there. I know you’ve got Samsung that they should be coming out of hold even probably second quarter. It sounds like there is some good movement going on in some of the non-Chinese handsets. Are you seeing that I guess in your business and is most of the weakness coming out of China or is it more maybe broad based?

It’s mostly from China, but we have a skewed exposure to China, simply because China was the early adopter of rapid charging. So we got a number of designs with the large OEMs in China. In fact we have designs at all of the large OEMs in China. So because we focus on rapid charging, a large portion of our business, more than two-thirds of our cell phone business comes from China, so we have a kind of skewed impact on that.

Great. And then just in terms of capacity expansion, where are you on that in your terms. I know last year you talked about the $30 million to bring that on. Where do you think you are in terms of getting back to capacity or to the capacity that you had expected to be at?

Well, you know capacity; kind of the expenses come in waves, because some of the capacity you can only put in certain chunks. We talked about adding one more fab to expand on capacity. They are also expanding capacity with our existing suppliers by helping them financially in some fashion or pre-paying for wafers in some cases. But on top of that they are also putting in capacity for testers and handlers, which will happen gradually. Even though we may buy these testers and handlers we won’t deploy them in production until we need them. So the whole thought process is that based on our forecast, long time forecast of low double digit growth, we are planning our capacity for the next several years, but some of it comes in chunks.

Thanks so much.

You’re welcome.

The next question is from Liz Pate with Susquehanna Financial.

Hi guys. Thanks for taking my question. Just a quick question on the channel inventory. If you think its normalizing by the second quarter, should we be thinking about sequential growth in 2Q I guess 1Q really being the trough this year?

Well so you know it’s pretty early to talk about that, but traditionally – I mean historically if look at it, the second quarter is a quarter of growth from the first quarter. So based on that we are expecting how much is yet to be seen.

Right, okay, and then just a question on InnoSwitch3 if I can. I guess last quarter you talked about the product marketing progress and the consumer segment. Are there areas outside of comps and consumer where you have seen some uptick on that one?

There is a lot of designs going on. There are several hundred opportunities that we are following with InnoSwitch3. It’s still in the early states because many of the markets like industrial and consumer have a longer design cycle than for example for example the cell phone business. And within the cell phone business InnoSwitch3 is really targeted towards higher power charges which is now tied to USB PD. When people move to USB PD the power levels will go up wherein Inno3 will become a very attractive solution for them. Once again we are working with a dozen different designs for USB PD solutions. We already mentioned three of them, there is lot more to come and it’s a brand new standard. People are getting educated, getting designs down, had to get compliance work done and our expectation is that the production will start – pre-production will start in Q3 and gradually grow though Q4 and through all of 2019. 2019 should be a strong growth year for Inno3 in the USB PD application.

Okay, great. Thank you.

Your welcome.

[Operator Instructions]. The next question is from Ed Roesch with Sidoti & Company.

Thanks and hi. One quick question, you mentioned the geographic footprint of the cell phone business. Can you speak on appliances, how that’s distributed a bit geographically?

Well appliance is a very different story. We have a very high share of pretty much all of the appliance manufactures around the world. It would be hard to name an appliance company that we don’t have a very high share in. So that’s very, very broad, so we are directly tied to the appliance market. Having said that, our content in appliances has been continuously going up, even though appliance in unit volume hasn’t grown as fast, but our dollar content and therefore our SAM has been growing much faster and this is related to the fact that there is more electronics going into appliances which didn’t have any electronic even a few years ago. Like coffee markets now have electronics in them and we have very share of the coffee marker market and on top of that all of the new features they are adding, whether it’s moving from AC motors to DC motors for lower power consumption or adding network capability for IOT type features or LED lighting which typically requires a separate power supply. All of that is increasing our content either in terms of number of power suppliers or even if it is a single power supply it now needs to be a higher power, power supply, which means our ASP is higher. –:

Okay, thank you for that. And then one clarification about the lunar New Year, the shifting to February this year from January last year if I understand it correctly. D that that was – that that shift is a significant contribution or made a significant impact of the strength you saw in January orders?

Well the point I was trying to make is that usually before the lunar New Year they tend to place all the orders they want, because when they come back they want to restart with all the parts in place. So to the extent, the lunar New Year is earlier like it was last year, it made the January unusually strong because they book everything in January and they don’t like to have too much inventory on their books as they exit the year, previous year. So what I trying to say was, this January was almost as strong as last January, although it was little bit less than last January, but it was independent even through the new lunar New Year is not until the February 16. That is a good indication. That means the demand; at least the distributors think that what they had is coming back. But it still doesn’t tell us the whole story for the quarter because you know February generally gets very quite. In this case we probably get one weeks of good bookings in February. After that it basically goes to sleep at least from Asia for a couple of weeks and then it was really the March that will tell us what the total bookings for Q1 would be and how much growth we would get in Q2.

Okay, thanks. A lot of my other questions have been asked and answered. Thank you.

You’re welcome.

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

Okay two quick clarifications. You talked a bit about what was going on in the China handset market and you talked about how big that was within your handset exposure. Any rough guidance on the 24% that you labeled communications. How much of that is handsets?

I would say roughly about 80% is handsets.

Great and then the only other follow up is there is a lot of moving parts in the first half of this year with the inventory etc, then you talked about USB PD in the back half of the year. The last couple of years, on this similar call you’ve talked about the end markets that you expecting to be the stronger ones, the weaker ones, etcetera for the year as a whole. Could you give us that color again looking at 2018?

Yes, from what we can tell all four of our end markets should grow in 2018. Our forecast shows growth in all of them. Now Q1 is little bit trickery just to explain, because of all the complexity as I mentioned, but if I were to guess Q1, the stronger in Q1 in terms of – of course we are not growing in Q1 but the stronger market is likely to be consumer, because I think the appliances is likely to come back. Usually Q4 and Q1 are strong quarters for appliance.

Is that despite the inventory burn that you said you ended the channel with. I’m a little surprised that appliance would be that strong.

Yes.

It was always the inventory.

Well so it’s basically I think what Balu is talking is relatively from a mix standpoint and not in terms of – because obviously we are guiding down. Typically air conditioning starts coming back in Q4, it didn’t and we think that was related to inventory position and we are hoping that will be back in Q1.

Got it. Thanks for the clarification.

You’re welcome.

And there are no further questions at this time. I will turn the call back over to the presenters.

Okay, thank you for the questions, we’ll leave it there. There will be a replay of this call available on our website, which is investors.power.com. Thanks again and good afternoon.

This concludes today's conference. You may now disconnect.