艾默生電氣 (EMR) 2004 Q1 法說會逐字稿

Thanks for holding, ladies and gentlemen.

Welcome to the Artesyn Technologies first quarter financial results conference call.

[OPERATOR INSTRUCTIONS]

Thank you for your attention and now turn the conference over to our host, Ms. Pamela Rembaum, Director of Investor Relations.

Good morning everyone and thank you for joining us for our first quarter 2004 conference call.

On the call with me this morning is Rich Thompson, Artesyn's Chief Financial Officer and Joe O'Donnell, Artesyn's President and CEO.

For those of you who have not yet seen this morning's press release, a copy is available on the major news wire services and is currently posted to the press release section of our Web site at www.artesyn.com.

Additionally, the company filed the earnings release this morning prior to this call on Form 8-K with the SEC.

This call is being Webcast live over the Internet on the Web site.

A replay will be available immediately following the call on our Web site or by dialing 800-839-0860.

The dial-up replay pass code is 1471 and will be available through May 4.

Before we begin, I would like to remind you that except for historical data, comments on today's calls may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements, including projections as to revenues or earnings another statements relating to expected future performance by Artesyn involve risks and uncertainties, which may cause actual results to differ materially from those discussed on this call.

Listeners are cautioned that these forward-looking statements may differ materially from actual future events or results.

Please refer to our filings with the SEC, including our 10-K filed on March 10, 2004, for additional information.

Now, I would like to turn the call over to Artesyn's CFO, Rich Thompson, for a discussion about the company's first quarter financial results.

Great.

Thank you, Pam.

Following our normal procedure, I will review the first quarter financial results and Joe will discuss significant operating developments.

For the second quarter in a row, Artesyn achieved profitability reporting net income for the first quarter of 1.9 million and earnings per share of 5 cents, which is 2 cents better than the first call analysts mean.

This compares favorably to Q1 of 2003, when we reported a net loss of 7.5 million, or 19 cents per share.

Sales for the quarter were 96.5 million, increasing 18% from Q1 a year ago, but down 3% sequentially from Q4, 2003.

Orders in the first quarter were 106 million, yielding a book to bill ratio of 1.1, which is at the highest end of our normally expected range.

Backlog at the end of the first quarter improved to 96.3 million, with approximately 93%, or 90 million, scheduled for shipment in the second quarter.

Over the past few quarters, customers have increasingly placed long-lead orders for a substantial portion of their next quarter product requirements.

This has resulted in less reliance on what we describe as our turns business, or orders received and shipped in the same quarter.

From an operating performance perspective, gross margin as a percent of sales was 25.4% compared to 22.4 in Q4 of 2003, and 16.4 in Q1 last year.

The improvement is from continued manufacturing efficiencies, favorable sales mix of higher DC/DC power supplies and continued growth in our communication products group.

Joe will address margins in more detail in his operating comments.

Total operating expense in the quarter, were 20.6 million, or 21.3% of sales, which is slightly higher than Q4, 2003, due to our continued commitment to R&D investments which were 10.2 million, or 10.5% of sales in the quarter.

Net interest expense in Q1 was 1.2 million, similar to last quarter, and we expect interest expense to continue in this range throughout the year.

The effective tax rate was 27% for the first quarter.

We expect an effective tax rate of approximately 30% of pre-tax net income during 2004, but you will see quarterly fluctuations in the tax rate as discreet tax events, such as change in tax rate, tax legislation or judgmental contingencies on tax filing positions influence quarterly tax expense calculations.

On the balance sheet, we ended the quarter with 95.5 million in cash despite spending more than 5 million on investments in manufacturing equipment to support new product offerings.

Continued focus on working capital management resulted in first quarter days working capital of 44 days versus 73 a year ago.

Included in days, working capital are receivable days of 48, inventory turns of 5.4 or 68 days sales offset by days payables of 71 days.

Inventories are approximately 5.6 million higher than last quarter, as we invested 2 million in strategic longer-lead items and added raw materials to meet expected demand for Q2.

As a comparison, working capital metrics based on publicly available information for direct competitors is approximately 108 days, more than two times Artesyn day's working capital.

Capital expenditures for the quarter were 5.7 million, up from the prior year, but in line with 2004 guidance given in last conference call.

At that time, we shared the 2004 capital additions would be between 15 and 20 million.

The increase is due to the purchase of surface mount and automatic test equipment to support new product introductions.

Depreciation and amortization for the quarter was 5.4 million, or about what we spent on capital expenditures.

Thank you, and now I will turn over the call for Joe's business review.

Thank you, Rich, and good morning.

As we did entering the year in 2003, on January's conference call, we outlined Artesyn's 2004 objectives.

These include maintain profitability, grow market share, enter new communication market segments and continue our industry-leading position in technology through investment.

Entering the second quarter, I'm pleased to report that we're well on our way to achieving each of these goals.

Some of which were highlighted in today's earnings release.

I would like to use my time with you today to discuss these objectives further.

I will conclude my remarks with an outlook for the coming year and quarter.

Profitability, the most visible goal for 2004 is to maintain and grow profitability.

Our objective is to re-establish Artesyn as the power sector's most profitable company.

We made a good start in the first quarter.

There were two principal factors contributing to reported earnings that were above street expectations.

First is product mix.

We experienced a favorable mix of DC/DC bricks and embedded computers.

Second, gross margins.

Benefiting from restructuring initiatives taken last year, in January, we indicated you should see a 4% gross margin improvement by year-end.

Q1's 3-point margin improvement to 25% is a result of improved manufacturing efficiencies and the favorable product mix I mentioned above.

It is the sixth quarter of sequential gross margin improvement.

The second objective for 2004 is to grow market share.

We judge market share by two criteria.

First is revenue and the second is by project wins.

Revenue, revenue's a measure of near-term market share.

With 19% growth in Q4 of 2003 versus prior year followed by an 18% sales increase in Q1 versus prior year, there is no question that Artesyn is gaining significant share in a market believed to be growing in the mid-single digits.

First quarter revenue by end markets breaks down as follows.

Server and storage 46%, Wireless 23%, Distribution 18%, and Telecom and wireless 13%.

Program wins, we report design wins to improve our investors' appreciation for future revenue streams.

Our goal for the year is 60 new program wins.

In Q1, we recorded 18 major wins with estimated lifetime revenue of 116 million.

In addition, we received more than 100 design awards for smaller programs with estimated annual revenue of less than 500,000 each.

Using revenue as a measure of current market share and the number and size of design wins for future market share, we are confident, Artesyn is clearly experiencing significant gains in the market.

New markets, the third prime objective for 2004 is to identify and enter new communication markets.

Entering new market sectors has been an important aspect of Artesyn's strategy.

We're, in fact, pretty good at it, at identifying new market sectors, making the necessary investment and than realizing significant revenue.

To help you appreciate the positive impact of this strategy in 2003, 35% of our revenue came from sectors in which we did not participate in, in the year 2000.

In 2004, we are entering two new sectors, power amplification and rectifiers.

We believe these two new areas will account for 15% to 20% of additional or incremental revenue in about 3 years.

Technology, the fourth objective for 2004 is to maintain Artesyn's industry-leading position in technology.

It took a great deal of effort and investment to gain our leading position in DC/DC bricks and point-of-load.

We have no intention of giving it up.

Consequentially, we have continued to increase our R&D spending, 10.5% in Q1, to ensure we retain Artesyn's technical leadership.

A good example of what that R&D investment yields is the Q1 introduction of an exciting, new point-of-load product family; the SMT 12F is the first of the series.

It's the smallest and most efficient point-of-load device to be announced in the industry.

To help you appreciate just how advanced it is when compared to competitors' offerings, we believe it is 60% smaller than anything any other company has even talked about introducing.

It is a complete point-of-load power supply that fits within the diameter of a dime.

I would like to clarify Artesyn's approach to product introduction.

Unlike a number of competitors who introduce products that are still in design, when Artesyn announced product introduction, it's ready to ship in volume production.

As a result, Artesyn's product introductions have a high level of credibility with customers, a distinct competitive advantage we currently enjoy.

In light of recent product or technology announcements from a couple of our competitors, several of you on the call today have suggested that I use this as an opportunity to discuss Artesyn's response to these announcements.

We work hard to be aware of competitive actions and plans.

With current competitive activity in mind, Artesyn does not find itself in a position where it is forced to react to product announcement from new entrants into the point-of-load space.

We're the recognized market leader in both technology and revenue.

We intend to leverage our number one market position through focus and investments and continue to distance ourselves from those competitors attempting to establish a position in the point-of-load market.

Let me provide a little background to help you appreciate the strength of our current position.

We introduced our first point-of-load module in 2001.

In retrospect, we were fortunate.

Most of our competitors and many of our customers were convinced that DC/DC bricks would continue to drive the market, and gave little credibility to point-of-load.

This has given Artesyn a significant head start.

In 2003, we shipped $40 million in point-of-load devices.

At the same time, some of those competitors making recent product announcements, shipped zero.

In addition, we anticipate approximately 50% growth in point-of-load revenue in 2004.

While our point-of-load road map is continually being revised, updated and added to, we have seen little from recent competitive announcements that tells us our vision for point-of-load is anything but spot-on.

We remain committed to maintaining our market and technology position, as the leading point-of-load modular supplier in what many now believe will one day be a $2 billion market.

The outlook, our expectations have not changed appreciably since the January call.

We continue to anticipate modest, sequential revenue growth through the balance of the year.

The second quarter should be in the 100 to 105 million range.

Year-end margins should be in the 20% range -- mid-20% range.

At this time, I would like to turn the call over to our Q&A session.

[OPERATOR INSTRUCTIONS]

And our first question comes from Mr. Lou Miscioscia from Lehman Brothers.

Hi.

This is actually Ajit Josh (ph) in place of Lou.

Great quarter.

I just have a question regarding gross margin.

I believe that in the last quarter's conference call, you said you would expect to exit 2004 in the mid-20s, and now that you released, just trying to get a sense of, you know, where the peak gross margins are, I believe in 2004, it's 27.5%.

Is that kind of where you would think gross margins think are given the shift in product mix?

Well, if the shift in product mix remained.. let me start again.

If the product mix remained as it was in the first quarter, a higher percentage of DC/DC and embedded computers, then our margins would be higher.

If we achieve the kind of mix that we're anticipating, I think the guidance we provided early in the year of 4% improvement year-on-year, we ended last year at 22% plus, and so that would say 26% plus is about where we would be at year-end.

So, it's very much dependent at that one point or two points one way or the other is very much dependent on the mix.

All right.

Great.

And also, that I saw that the communications products increased to about, more than 13% of revenues from 12%.

Do you see this segment growing faster than your power products, and how much margins are there in this business?

The margins are, let me try to answer it in pieces.

The margins are better.

We typically don't discuss the margins specifically because aside from a lot of important investors on the phone, we're confident that there's some competition listening.

The business grew faster; it's addressing the same markets.

Its largest customer base are the wireless companies.

It started from a smaller revenue base, so growth is easier to achieve in higher percentages.

I would picture through the balance of the year, both of these businesses would grow about the same.

It is certainly possible that communication products might grow a bit faster but not significantly.

All right thanks and just one last thing.

In your amplifier and rectifier business that you're looking to get into, who do you view as like your main competitors?

I was trying to get a sense of that.

We're not competing with --for example, Powerwave and Andrew in the amplifier business.

In fact, they would be and are turning into good customers, as well as other Telecom OEMs.

So, our competition, excuse me in that sector, appears to be the mid-sized power companies from North America or Europe.

In the rectifier sector, there our competition appears to be the companies that are traditionally been in the power systems business.

All right.

Thanks a lot.

Yes.

Your next question or comment comes from Todd Cooper from Stephens.

Joe, I have got a question on the gross margin and the sustainability.

How much of the increase do you think came from the product mix versus increased or improved manufacturing efficiency?

Right.

Todd, I think we would have had gross margins if the a product mix hadn't been favorable toward bricks and embedded computers, our gross margins probably would have been 24%.

Now, that's an approximation, and then the balance is from the heavier content of DC/DC.

Dan, all of last year, you were closing I believe two major manufacturing facilities and moving that production primarily to China, so I imagine China's beginning to hit its stride more now.

Should, is there any reason why that shouldn't continue and be reflected in better gross margin going forward?

No.

Todd, there is no reason.

I think, Todd, we don't want to get ahead of ourselves on the margin.

Right now, it's important on this mix issue to understand is the higher content of DC/DC, for example, sustainable verse other revenue streams.

Clearly, the performance of Asia is the major contributor to the higher margins we expected when in January we outlined you should expect about 1% a quarter or 4% by year-end improvement in gross margin.

I say China, but that would include Hungary, as well, of course.

OK.

And your rectifier business, I'm aware of at least two major design wins.

Are there others?

Can you comment more on the rectifier business?

There's more wins, Todd, but there's two prime companies, customers, and these rectifiers initially are targeted to the wireless, meaning cell site market, and in both cases, it's multiple applications or platforms for each of those companies.

So it's, I may be off by one here.

It's four or five or five or six distinct different design wins with two of the major wireless OEMs.

OK and one more about, if I may.

Your turns business over the last year or so has ranged anywhere from around 13% up to as high as 25%.

You commented on it, or I think Rich did.

Any guess of where it may come in this quarter?

Yes, Todd, if you looked at what's backlogged, we declared a shippable in Q2, which is 90 million, and if you look at the guidance Joe gave on the revenue range, that would mean turns business is between 10% and 15%, so we've seen that kind of steady over the last two or three quarters in the teens, and it's now going into the low teens, as customers seem more ready to place longer lead items to assure delivery of products.

OK that makes sense.

Congratulations on a good quarter.

Thank you, Todd.

Your next question or comment comes from Mr. Craig Irwin from First Albany.

Hi, guys.

First of all, great quarter.

My first question is I guess on the CAPEX, you can maybe give us a little more color on where the CAPEX went in the quarter and where you sort of look to spend money this year?

Sure, Craig, basically, as we said, the CAPEX is for new surface mount equipment and ATE to support the finer pitch of our new product.

We installed most of that equipment in China for the power business.

There are some additions into Hungary, but for most, for all intents and purposes, it went into China.

Throughout the rest of the year, we would expect most of our CAPEX would be in the manufacturing arena.

We believe that we have enough bricks and mortars to go for the next few years, and it will be focused on upgrading our equipment for our new product introductions.

OK, and then the major design win activity.

I mean, 18 is a great start for the year.

Do you guys have any guidance or any targets sort of as how many you are looking for in 2004?

I know you discussed this in prior years.

Yes, 60 is our target for this year.

Great.

Is there any color on the design -- the major design wins, which potential product groups or customer groups these came from?

I would say it's not disproportionate to any one group.

This particular quarter, it was pretty well spread throughout our end market sectors.

A little light -- if it was light in any one sector, it would have been light in the networking.

Meaning enterprise and -- the networking sector, we have to change our definition of this.

When we say networking, we're talking about Telecom landline and enterprise networking, and I would say if it was light in any one given area, it would have been in that sector.

OK, and I guess this is just another thing, just to check some numbers, but when I back into the numbers for all of your different market sectors you look at, it looks like this is the first quarter where you have been up year-over-year in every single one of your major market sectors.

Is that accurate?

I think that's accurate.

The big change would have been where the wireless -- I'm sorry, the revenue in the networking sector actually improved.

That would have been a shift from what we have seen through last year, so, and again, when we say networking, it's not just enterprises; it's the Telecom landline stuff, as well.

Great, and then, Joe, just a question that's coming up a lot with investors, people are really interested in the residual engineering expenses associated with supporting customer product sales.

I was just wondering if you could maybe discuss this and probably give us a little idea on sort of where you recognize this as a line item and potentially the percentage of revenue that this represents.

Residual engineering support we would call product engineering, if I understand what you mean by that term.

That would be you have to substitute components three years after a design or there's a quality problem with a dial that you're purchasing and you have to find a substitute.

Would that be the kind of residual engineering support you're talking about?

Yes, that's it.

OK.

That kind of product engineering is in our cost of sales.

We put that in our factories.

Our design engineering is in, which creates new products, is in our engineering numbers.

Now, there is some sustaining engineering we call it, which is in engineering -- the engineering numbers you see when a redesign of a product is required as opposed to a substitution of parts, so it's a mixed bag, but for the most part, it's over in the cost of sales because, for the most part, what you're doing is finding substitute components for products later in life.

And would you mind sort of giving us some rough guidance, maybe ranges on how much the two different engineering components of COGs might be?

I think it's not a major factor, Craig.

We'll find that out for you and let you know.

We mix it unless -- we have an engineering line within cost of sales, which is process engineering, product engineering, industrial engineering, manufacturing engineering and this falls under that grouping.

Great.

Thank you very much.

Great quarter.

And our next question or comment comes from Steve Smigie from Raymond James.

Great.

Thank you.

First question has to do with the R&D.

It looks like it's a percentage of sales and even the dollar amount is stepped up quite a bit.

Would you expect that 10.5% level going forward?

I think, Steve, through the balance of this year, you should expect it to be around that percentage.

OK, and similarly on the SG&A line, it looks to me like it's about 10.8%, which is up quite a bit from the previous quarter.

Again, we expect to see the sort of levels carried forward, as well.

I would think on the SG&A, you should expect to see it as a percent of sale less through the balance of the year, maybe a little over 10.

OK.

Could you give some sense of the mix of AC to DC versus DC to DC?

It's about -- excuse me.

I'm battling a cold here.

I will try not to cough.

It's about 60/40.

A/C is the 60.

OK.

If you can give us further update on the Typhoon product and is there any customers where you are seeing wins with that and, you know, where you might expect to see a more significant ramp in revenue or maybe you have already seen that?

Well, I think people have identified that pretty accurately in their expectations, and the people I'm talking about, analysts, and for the most part, they're saying the last quarter of this year and then ramping through '05, which to us, seems about right.

For those that haven't followed us long, when we or our competitors introduce products, meaning they're available to ship and shipping in small quantities for sampling or prototyping, it's roughly 12 months from that time before we see revenue of any size, and that's the customer's design cycle.

OK.

So we're right on track with that.

And you had mentioned you had the start of a new point-of-load product as part of the Typhoon family.

What sort of level of product activity do you expect to see there going forward, in terms of, you know, new extensions to that family?

Right, this was the SMT-12 that you would be referring to that I talked about earlier, right?

Yes, exactly.

Yes.

We're very excited about that.

As I said, it's by far the smallest product.

We think 60% smaller than anything else that people have talked about.

Not just introduced, but talked about.

It's a full, stand-alone point-of-load power supply.

We expect the market to be excited about this.

But it will still be that design cycle I talked about for that particular part number to be shipping in quantities.

Right.

You mentioned you expect some more parts coming out?

Oh, absolutely, absolutely.

I believe the next one is next month.

I'm getting hand signals here.

Less than that, so there will be at least one very shortly and then there will be a series following that.

OK.

Great and my last question is on a little bit on the AC/DC side, you had mentioned that looking at the gross margin, you might expect that not to improve as much due to the fact that the mix might shift back, and I assume that means back to AC/DC so I think I you might characterize how your AC/DC business looks through '04?

Thanks.

OK.

Our AC/DC business as far as pure volume is driven mostly by the server sector we're in, server and storage, but predominantly mid-size servers, and we expect that business to be steady to slightly up through the balance of the year.

Not different from what the end market projections are, and the end market projections are, you know, mid-single digit growth in that sector.

That's unit growth.

Since we're serving every one of the major server manufacturers, we're really --we will really be a reflection of how the end markets perform, and we envision that it will be good growth for us through the balance of the year.

Great.

Thank you.

Our next question or comment comes from Lee Zeltser from Needham.

Begin with a few questions, first to focus on the sales line.

Can you give us a better sense of the decline of sales sequentially and what drove that specifically?

Well, Lee, it was a --let's see here, a $3 million, little under $3 million change from quarter to quarter.

We felt sequentially, we felt the quarters would be about flat.

So, you know, what's about flat, plus or minus 5%.

This is certainly well within that range.

It's not really a particular market sector.

Wireless was up verse prior quarter.

Servers were down slightly verse prior quarter.

Those would be the two big pieces of business that would have had an impact on the revenue stream, but, again, Lee, I think it's important, we take great pride in being able to give you reasonably good guidance on what to expect out of our business.

We did that through all of '03 and so far through '04, and I --you know, I'm comfortable that we performed on the revenue line about the same, and that on the margins, we did a little bit better so consequentially earnings were a little bit better, but still within a reasonable range of what we led you to expect.

OK, fair enough, if you can talk about the linearity of sales possibly, Joe, month to month, if you have that data?

Yes, it's an unusual combination of events, which I don't pretend to understand very well, Lee, after all these years in the business, of why the back quarter, meaning the third month, not quarter, is heavier on a weekly basis in shipments than the first two.

For those that aren't familiar with how manufacturers keep their books typically, the third month of a quarter is five weeks, so the arithmetic is one factor that always makes it heavier, but there's also just more activity on a weekly basis, so it's a little over 40% typically of our revenue in a quarter.

It comes in the third month of the quarter.

That's actually typical across all quarters?

For the most part.

OK.

No major shifts from quarter to quarter in that.

OK.

So the quarter seemed to be fairly back-end loaded?

Yes.

At least modestly.

OK, just to get a better understanding of pricing trends, if you can talk a little bit about that and kind of where utilization levels are, how those two factors interact?

OK.

You're talking about our pricing?

Sure.

The pricing trends, and we're trying to get a better handle on this as we move through the year, seem to be less aggressive than what we would have expected going into the year.

So instead of say high single digits, and this is an approximation and it's across a number of different market sectors, which vary so, people listen having to keep that in mind.

So instead of high single digits, it appears it will be in the mid-single digits.

That's being impacted because of what is clearly a rising cost of some of the commodities or components that we buy.

Utilization levels, where are they at this point?

About, the major factory is China, and it's at about 75% and Hungary is probably still around 50%, I would imagine.

It's a long way from being anywhere near fully utilized.

OK and than just to get a little bit better understanding of your guidance for gross margins.

So should we expect gross margins to fall sequentially if you don't get that continued, sustainability in the favorable mix, it would be fair to expect them to fall modestly sequentially?

You know, that's a hard question to answer.

We're trying to understand it ourselves.

Let's put it in the right perspective here.

We still believe by year-end from year to year there would be -- about a 4% margin improvement, which would say around 26%.

If the next quarter would be down slightly because we got a head start for all the reasons we have talked about earlier, I, frankly, don't know.

I wouldn't expect it to be up.

That would take, you know, two quarters in a row of unusually heavy mix towards one product grouping.

So I would say flat -- this is for next quarter, flat to down a little bit.

OK.

That should be how you should look at it.

And than lastly, from a demand perspective, if you can talk a little bit more about, you mentioned wireless was up in the March quarter, storage and servers were down slightly.

Can you talk about what you're seeing currently?

I know we're early on in the June quarter here, but where do you expect to see strength given that the guidance you have given and where do you expect to see more moderate growth from that perspective?

I think the sectors will see strength and wireless will continue.

There's nothing to tell us that it won't.

Plus we're bringing on some incremental projects.

The second area within server storage would be the storage side.

I would anticipate from what we're seeing at the second quarter would be stronger on storage than the first quarter was and servers will be pretty flat.

Again, you know, we are a real reflection of that end market because we're -- we absolutely have great penetration across every single player in it, every meaningful player in it.

So you're not going to see our revenue stream change much in market characteristics in that sector.

OK, fair enough, and then on the networking side, that's still somewhat weak at this point?

Well the revenue's actually not bad.

As I mentioned, the revenue was picking up in the quarter.

It became a higher percent of our total revenue pie.

I think, while I don't have that in front of me, last year, it was 11% and the first quarter, it was at 13%.

So, you know, I mean, that's picked up itself.

It's the Telecom landline piece that, we lump those two together, that has not improved.

OK.

All right.

Thanks very much, guys.

You're welcome.

[OPERATOR INSTRUCTIONS].

Our next question or comment comes from Mr. Steve Smigie from Raymond James.

Thanks.

I just wanted to follow little bit on the '04 guidance, and I think you talked about it again a little bit today, but in the previous quarter, you talked about, you know, the high single digit or low double-digit growth '04 over '03, and it seems, you know, we've been going to the second quarter that business is starting to pick up quite nicely.

You know, your percentage of revenue that you have booked going in the quarter seems much stronger, and you know, somebody pointed out earlier that your turns business is going down in a positive way.

So it seems like, you know, maybe that guidance might be a little on the light side, does that seem accurate to you?

Right, I think -- if you took what I talked about by saying that this quarter would be 100 to 105 million and then showed sequential growth over that, if you went to the high end showing sequential growth, you'd get a number, you know, 15% plus, and if you went to the low end and grew that one, you probably would get where we were before.

I think most models -- I don't know most, I will correct myself.

I'm looking at a composite have as at about 16% year-over-year growth and that, you know, feels about right.

OK.

Great, thank you.

Our next question or comment comes from Mr. Alan Shane from J. Goldman.

Hi.

Quick question.

Did you expect SG&A as a percentage of revenues to start decreasing over time, or is the most recent quarter sort of representative of what we should expect going forward?

Alan, what I had mentioned and Rich will add something to it, if he would like, is that this quarter was a little high and that, which can happen in any given quarter, and that you should probably see around 10% for the balance of the year.

I don't know if you want to add anything to that.

Yes, I will I think what you're seeing partially in the numbers is certainly in the compliance of Sarbanes-Oxley 404.

Those are significant costs that the company has to incur to be compliant with 404.

We would expect in the tail end of the year that to be matched with the external cost of our assurance firm E and Y (ph) auditing the company's work, so that's added some G & A costs to our G & A expense that we had expected, but we didn't realize the level of it throughout the year.

So, if we are looking beyond this year and out to a point where, you know, more normalized operating margins would be expected, what are your longer-term operating margin goals now and how would that all flush out?

How would you expect to get there?

Well, as Joe mentioned earlier, or he actually last call, that we expect margins over time to approach gross margins, to approach or exceed that 2000 results which were in kind of the high 20s.

So we would expect our gross margins to get there.

Obviously, Joe, is driving our investment in newer programs, products, and research to about 10% to 10.5%.

Our SG&A should go below 10% over time.

You know, that's certainly what our goal is and our model is.

We just have a few spending bumps if you like to get over, so we would expect we can, over time, get back into a reasonable operating income profile of in the, say, low teens.

That's certainly what our goal is.

All right.

Appreciate it.

Thank you, guys.

And our next question or comment comes from Mr. Tim O'Tool from Delta Management.

Joe.

Hi.

First our congratulations on a - on some solid performance and a great turn over last year.

Actually kind of going on the, what has just been asked actually on the operating margins, R&D is actually running at a higher level and you have talked about it a little bit.

But, I guess, in dollar terms, do you expect that to step up and, then you know, how do you view return on R&D investment?

Obviously, in sort of general terms, you talked a little bit about what you're trying to accomplish, but you know on a year-over-year basis, that spending rate is up a fair amount.

Could you expound about that a little bit more, and at what point during the course of the year you start to see leverage on the R&D line?

I think you're starting to see leverage now verse last year when you look at our market growth rates and improving relative to what people believe is a market growing in the single digits.

Mid to low single digits, by the way, so I mean, that's part of the return.

I believe the other part of the return we're seeing is the margin improvement.

We talked about manufacturing efficiencies.

That's from consolidating facilities, of course, and then filling them up, an another part of manufacturing efficiencies is the amount that we get is the money we're investing in new products and then how those products are made.

So that adds to it, as well.

This year's R&D is going up or continues to go up, it did last year, as well.

We're investing heavily in DC/DC and point-of-load.

I spent some time at the suggestion of some people on this call to make that clear.

We intend to maintain our leadership position there.

We're spending money to do that.

We're also entering two new markets and we're heavily into the spending stage in the rectifier and amplifier markets right now filling out design commitments we have from customers.

I would expect if we were doing our job right that we're going to continue not necessarily increasing the percent, but increasing the dollars we're spending because it's very important to us to continue to enter new market space which when we have the products ready, you know, we'll tell the world about.

Did the - the two new markets you talked about earlier, any way you can parse those out in terms of what the R&D spend is and also, you know, by the same token, when some of the revenue actually starts to ramp, to become some you know meaningful.

I don't know what percentage they become ultimately, whether it's 5% or 10% or whatever.

But you know, what do -- where do you see though in a rough numbers where do you see the time line there?

Well, we certainly look at that in detail by not just product sector or market sector, but by investment in individual products and we look at it through the design cycle.

Does it still have a good return or not?

For this call, unfortunately, I'm not prepared, I just don't have that information to go through this in detail on the returns for individual products or even market space.

Well, I mean are you seeing revenues from those products - I'm not trying to quite so specific, but are you seeing revenues from those new products at this point, or you -- or you -- and are you booking orders on the new product spaces such that you see visibility of some that starting to ramp regardless of level you know later in the year?

All right.

So, the two new markets because that did not contribute to revenue last year it was not the products we talked about that didn't, but two new markets would be rectifiers and amplifiers.

And they will contribute to revenue call it the back half of this year in a meaningful way.

OK.

OK.

So, we spent money last year.

We're spending a lot of money this year getting into that revenue stage.

Sure.

OK.

And do you see, on those specific investments, do you see that investment, you know, backing off to a somewhat lower level, or do you maintain that investment to continue to penetrate that market space?

I think the investment rate may even increase as we get more and more penetration into the market, but as a percent of sale, obviously, it begins to come down.

OK.

Great, and then you know on a little different note, can you give me any feel for the differential in gross margin between the embedded computers and, you know, the kind of broad power supply space and obviously even within power supply, there's a difference in mixes you have alluded to, but you know how much more profitable gross margin wise are the embedded computers?

We try to be, if this call was only investors, we'd be happy to talk about that, but we know that our competition is sitting on these calls, as well so what I would tell you is the margins are higher because there's an intellectual property in the form or higher percent of intellectual property in the form of software.

It's directed, if the product line is directed to exactly the same customer base as our power business, so that's very consistent and in many cases, the same application, for example, if some customers were providing the embedded computer and the power for a cell site.

Sure.

Right.

So it's a consistent product area, consistent customer focus.

It is different product because of the software.

Again, I think most companies feel this way and what you don't have to tell your competitors you try not to.

I appreciate that.

If I look at other public embedded computer guys they range all away from sort of high 30s to low 60s depending and my guess is you fall somewhere in the, probably bottom half of that band, is that kind of at least a fair, you know, band?

We certainly fall within that band comfortably.

OK.

Great, all right thank you very much.

Again, congratulations.

Thank you.

Our next question or comment comes from Mr. Alan Mitrani from Copper Beech Capital.

Hi, Copper Beech, thank you.

What kind of interest income - what's the interest rate you got on your cash on the books, Rich?

Basically, it's 1%, Alan.

We're very conservative in how we invest this cash.

Obviously, we don't want to put it at risk so basically AAA and AA short-term investments.

OK.

Can I assume if interest rates go up and you have more cash than you have debt, your debt is fixed and so far, interest rates seem to moved up a little bit this quarter.

That your interest expense line, could then, your net interest expense line could trend down a bit over the next few quarters?

Yes, that's a good comment, Alan.

That's definitely true.

We would be taking advantage of the arbitrage.

We would still, because as hard as it was to accumulate the cash, you would see us short term and fairly conservative.

OK, and I realize, I mean, the order rates seem pretty good this quarter and I realize that we're talking about a small revenue base sometimes that makes the difference between an up quarter and a down quarter in revenues.

Were there any issues with any specific customers that chose not to pull down inventory this quarter, meaning timing issues either on products that got pushed into the next quarter versus this quarter?

Can you talk about the power converter side?

Well, Alan, it would be difficult to pick a customer or a part number.

There's a large piece of our revenue that is consumed and becomes a sale on the same day for us.

So I mean, that's a hard thing to answer, which is why, you know, when some investors like to talk about a precise revenue number, and I think most companies, at least in the world of communications find it difficult because so much revenue as the discussion earlier on comes on the end of a quarter, which can make a difference of -- if you're talking about a few million dollars, it can easily make a difference, as you say, of an up quarter or a down.

But we're very careful not to talk about particular customers, if it's something negative.

You just don't do that.

OK.

Also, on the R&D side, I assume you manage R&D besides percentage of sales on a dollar basis because you're paying engineers and trying to get product out and it takes a certain amount of dollars to do that, is that correct?

Right as a percent of sale has nothing to do with it when we create our budgeting process for product development.

The percent just is the result of what we decide to spend.

OK.

So I understand this quarter happened to be 10.5% of revenues because revenues were down sequentially, but can you talk on a dollar basis, do you expected to fall into like $40 to $42 million, is that a fair amount?

Is there a 20 plus percent increase?

Can you talk more in a dollar basis just for modeling purpose?

I think it will be in the low 40s by the end of the year.

OK.

Also on the SG&A that you answered before, it was up 400,000 this quarter on a down sequential sales number.

Is there any - you said how big an impact was Sarbanes-Oxley versus last year, Rich?

Well, last year, it didn't exist.

It was a few hundred thousand dollars.

OK.

So that's the increase in SG&A, in essence?

Right.

We wouldn't expect that to be ongoing.

We have a bubble of activity, investments in software etc, and we don't want to belabor Sarbanes-Oxley.

We think it's an important step forward for corporate governance, and we don't anticipate a problem complying either.

It's work to assure compliance that is costing us money.

OK.

And then lastly on the gross margins, you had a good number this quarter.

You talked, I'm under the understanding it's driven by revenue, mix of revenues as well as capacity utilization your factories.

What's the overall -- I know it's difficult to do.

What's the overall capacity utilization and where is the sort of hump you need to get over in Hungary because it sounds like on 50% utilization you're putting up good margins.

Where is the hump that gets the gross margins up?

Right.

Basically as Joe shared with you earlier, the China factory was about 75% utilized the same as last quarter.

The Hungary factory is about 50% utilized and we did mention, but our communication products or board business is about 50% utilized.

So if those businesses get above 70, as you saw when we achieved break even in power last quarter, those businesses fall-through rates improve dramatically, so as wireless continues to grow, which is most of the products that are loaded into the Hungary factory, you'll see continuation of margin improvements and contributing certainly to exiting the year at the mid-20s range.

OK, thanks.

You're welcome.

Next question or comment comes from Mr. Chris Lippincott from Key Bank.

Good morning, a couple of questions.

One, first a point of clarification.

I think you were talking about forecasts you were getting from customers starting to get farther out.

I think you mentioned some stretching the lead times.

First off, could you give us a sense of where the lead times are stretching at this point and I think you also mentioned something about reducing the certainty of shipments or at least your visibility into that.

I wonder if you can comment on that?

Chris, the lead times you're asking about are the lead times we see from suppliers or our lead time to customers?

Your lead times.

OK, our lead times.

We're fighting very hard to keep our standard lead-time, if we will, to 6 to 8 weeks.

The component market right now is making that a little difficult, so we've increased our inventory with a -- what we characterize as strategic inventory investment, which if everything was very smooth you wouldn't have and this is to allow us to react when there's a miss in a supplier delivery and our goal is to keep the delivery at 6 to 8 weeks.

So does that answer your question?

Yes it does.

Just with reference to the inventories, could you also comment just on the inventory levels that you are sort of seeing within the end markets?

I mean are you seeing things, are they low, are they building and perhaps how are the distributors responding as a result of some of the tightness that you were seeing?

OK, about 18% of our business goes through a division we call distribution, and the distributors, we work very closely with to stock inventory.

I mean, it's their inventory, it's not ours.

Based on a combination of what we think the appetite will be plus with their consumption has been.

So I would say distributors have been, aggressive is probably the right word, in increasing inventory levels to make sure they don't miss sales or they can fill in the voids if we do or one of our competitors does.

Fill in the voids by shipping parts.

That would be on standard products.

OK so it sounds like the inventory is increasing -- overall due to higher demand, the days sales seem to be relatively flat, a fair assessment?

I think so.

OK, and just on the -- your design wins, I think you mentioned 18 for the quarter and it looks like you're expecting about 60 or at least that's your target for the year.

I wonder if you could discuss perhaps how many of the new point-of-load product you are seeing either in this most recent round design wins or of the 60 that you are targeting.

We typically don't talk about where those wins come from as far as product area, but I would tell you this that it was a very good quarter for point-of-load wins, both on the large applications where we report 16, but where you see a lot of point-of-load wins are in that other number that we don't talk much about, and I think it was 100 at 500,000 or less.

Those -- there's lots of point-of-load products because -- in that category because customers will design, if they're designing a network switch, maybe there's 20 boards in that switch, and they design a corridor at a time and pick -- many times, not always pick the point-of-load devices current by current.

So you get same consequently in numbers or quite a number of small wins.

But it's clearly building, to be appetite for point-of-load across the customer base.

Not universally accepted by any means yet but clearly growing.

OK, what would you say some of the major comments happen to be from some of those customer that the examined your new products.

I mean you mentioned, obviously, the size being sort of the leading factor.

Are there any other comments that customers are coming back with regarding the new products?

Well, the thing with point-of-load is the customer is buying a system from you or from other, he's designing the systems, a better way to say it.

One of the real strengths that we have is we're capable of providing the AC/DC, the DC/DC, the intermediate bus if that's the architecture he chooses, and then the point-of-load, isolated or non isolated.

We have expanded our offering significantly with a couple of alliances that we have entered to, so the feedback I get, and I spent a lot of time with our customers, is there's nobody that's even close to us as far as the breadth of our offering on the distributed power and the point-of-load portion or aspect of distributed power and we have invested a lot of money to get there and it really does appear that that money is going to give us a good payoff.

: OK, thanks.

You're welcome.

And Mr. O'Donnell, there are no further questions at this time.

I now turn and hand it back over to Ms. Pam Rembaum.

I would like to thank everybody for joining us for today's call, and we invite you to listen to our second quarter teleconference on July 22nd.

Thank you.

Thank you.

Thank you.