Power Integrations Inc (POWI) 2003 Q2 法說會逐字稿

Please stand by. We're about to begin. Good afternoon, everyone, and welcome to the Power Integrations second quarter 2003 earnings results conference call. Today's call is being recorded. At this time, I would like to turn the conference over to the Chief Financial Officer, Mr. John Cobb. Go ahead, Mr. Cobb.

Good afternoon, thank you for joining us to discuss Power Integrations Q2 financial results. With me today is Balu Balakrishnan, President and CEO. Before we begin with an overview of the quarter, I would like to remind you that our discussion today will include forward-looking statements reflecting management's current forecasts of certain aspects of the company's future business. Forward-looking statements are denoted by such phrases and words as will, believe, should, expect, outlook, anticipate, and similar compressions that look toward future events or performance. Forward-looking statements are based on current information we have assessed but is subject to rapid and even abrupt changes. We may make forward-looking statements in response to your questions. Our forward-looking statements are subject to risks and uncertainties which may cause actual results to can I differ materially from those pro corrected or implied in your statements. Risks and uncertainties affecting our business which could cause actual results to differ materially are discussed in your forms 10K and 10Q filed with the Securities and Exchange Commission. I will turn the call over to Balu, who will take you through an overview of the business.

Thank you, John, and good afternoon, everyone. We are pleased to report strong financial results for the second quarter despite significant weakness in the cell phone market. In fact, we gained market share across a broad range of markets. Clearly, our diversification and market penetration strategy is working. We achieved second quarter revenues of $29.8 million, and net income of $4.2 million. Revenue growth was primarily driven by market penetration in the consumer and computer markets, which more than offset significant weakness in the communications market. Earnings of the second quarter was 13 cents per share which is at the high end of the guidance in April, and the manufacturing cost improvements made over the last year enabled us to nearly double net income on 10% higher revenues year-over-year. This quarter was also significant with the record number of new patents we were awarded. We added ten new U.S. patents, bringing the total portfolio to 70 U.S. and 58 foreign patents. We not only have reinforced our leading intellectual property positions in both the AC/DC and dc to dc markets, but our rate of innovations have increased. At the beginning of 2002 we have had 29 U.S. patents. Thus we added 41 new U.S. patents in just one-half years. Our chief revenue drivers in the quarter continue to be TOPSwitch-GX and TinySwitch-II. Both achieved high level of designments and continue to help us further diversify our revenue mix.

In addition to the ongoing TOPSwitch-GX and TinySwitch-II, we had new designs for LinkSwitch and DPS Switch, our latest product introduced last summer. With that introduction I'll now discuss the performance in each of the market segments during each of the second quarter.

Revenues from the communication segments declined significantly from the first quarter to due to overall weakness in the cell phone and excess handset inventory widely reported. The decline in revenue was almost entirely from reduced direct and indirect shipments to our top TSL phone customers. Shipments to our other customers, which consist mainly of Chinese manufactures, remained relatively flat despite of the reduced cell phone demands in China. Over the last year, we gained sizable market shares in the communication segment. In fact, Communications revenue, year-to-date was up nearly 16% compared to last year. We expect the market segment to be flat to slightly up in the second half of 2003.

Revenues from the two other main market segments, computer and consumer were both up sequentially. The increasing computer segment revenues was driven primarily by the market share growth in PC standby. In fact, the revenue from PC standby has grown 40% year-over-year, while PC market has grown approximately 10% during the same time frame. The attribute of dramatic growth to the decision of many PC manufacturers to redesign the products to comply with President Bush's executive order -- I'll talk more about this later -- we expect the computer segment to grow significantly during the remainder of 2003, driven primarily by market penetration of LCD monitors and PC standby. Revenues from consumer segment were also up significantly from the presence quarter due to set up boxes, DVD players and home appliances. Our DVD players and home appliances was driven by global energy efficiency requirements. Both TinySwitch 2 and TOPSwitch-GX are designed into DVD players and home appliances. The growth and set up boxes was driven by the success TOPSwitch-GX design in the application. We expect the revenues to grow significantly in the second half of the year as a result of the continued market penetration.

Revenues from industrial segments, which have increased significantly in the first quarter, stayed relatively flat sequentially. We expect the revenues from these segments to remain relatively flat in the second half of the year. Based on the latest available data, we now believe our revenue mix by market for 2003 will be communications, 37%; consumer, 27%; computer, 23%; industrial, 8%; and other, 5%. Now, let me turn to status of new products. In the second quarter, we achieved a high level of designs for both TOPSwitch-GX and TinySwitch-II. Both families introduced about 2 1/2 years ago were major revenue drivers in the second quarter. TOPSwitch-GX which targets applications between 10 and 250 watts, achieved designs in all major market segments. The computer segment which had significant design in LCD monitors as well as LCD projectors, printers, and server stand bys. In the consumer market Key designs for TOPSwitch-GX was top set boxes, DVD players and home appliances. We are very pleased with the number and diversity of designs achieved with TOPSwitch-GX. As a result we know expect TOPSwitch-GX to be a large percentage of the revenue this year. Tiny switch targets applications between 2 and 20 watts, achieved designmeants in all 4 of our market segments. Significant desingnments included cell phone chargers, PC standby, PDA’s , DVD players and home appliances. In PC standby another large Japanese PC OEM selected TinySwitch II to meet the requirements. To date there are 3 major US OEM’s, 2 Japanese OEM's and 2 clone manufacturers using TinySwitch-II to meet the requirement. This has helped us to achieve 40% year-over-year growth in PC stand by revenue. We anticipate the level of designments for TinySwitch and TOPSwitch-GX to remain strong, over the next several quarters, contributing significantly to revenue growth in '03, '04, and beyond.

Turning to a most recently introduced products, DPS switch and LinkSwitch. DPS switch, our first DC to DC was introduced in June of 2002. In the second quarter, they had two low volume designments, one in networking, and a second one in server application. Between these designments and those secured in the previous quarter DPS switch now design products in each of the four target does DC to DC target applications. They are telecom network infrastructure, digital phones including voice over IP, servers, and industrial. As anticipated, we have just started production shipments of DPS switch, which will generate initial revenue in the second half of this year.

LinkSwitch, which was introduced in September of 2002 is intended to replace the bulky transformers, also known as energy vampires in the 0 to 3 what range. We are excited to announce that we have started production shipments on a high volume LinkSwitch design for top ten cell phone OEM. This is a new end customer for us who is using power integrations technology for the first time. This cell phone designment is significant, because LinkSwitch has enabled us to penetrate a new high volume end customer by replacing linear transformers. LinkSwitch design activity continues to accelerate primarily in cell phones, cordless phones, home appliances, and industrial applications.

Our updated forecast for revenue mix by product family in 2003 has changed slightly with the TOPSwitch one and II projected to be at 19%, TOPSwitch-FX and GX at 28%, TinySwitch I and II at 50%, link switch and DPS switch as 3%.

Turning to the energy efficiency front, as you can see from the results today, more manufacturers are selecting the products to meet the energy regulations going into effect around the world. In the second quarter, energy efficiency was a major driver behind our performance in PC standby, DVD player and home appliance applications. Increasing stricter energy efficiency regulations help us in two ways First, encouraging manufacturers to redesign power supplies they may have otherwise left alone, giving us the opportunity to convert older technologies to our energy efficient products at a faster rate. Second, it makes our echo smart solutions more cost competitive compared with the usual solutions which typically require additional cost to achieve same level of savings. Linear transformer based power supplies will simply be unable to meet most efficiency requirements even at added cost. With our EchoSmart products capable of meeting all current and proposed energy efficiency regulations worldwide we believe energy efficiency has been and will continue to be a major growth driver.

Now onto our near term outlook. Visibility continues to be limited as evidenced by our 70% turn in the second quarter. As a back-end loaded quarter, it makes it that much more challenging to forecast the third quarter. However, based on available information, our estimate is for the revenue in the third quarter to increase 10 to 14% sequentially due to seasonality and continued market penetration. To achieve the midpoint of the range we need to turn to the similar to the second quarter. We expect growth between 48 and 49%. As we explained last quarter we have taken proactive pricing actions over the last few quarters to maximize our top and bottom-line growth. Market penetration remains our top priority and has helped us achieve strong financial performance, even with little or no growth in our end markets. Our cost-reduction efforts are expected to lift our gross margin slightly in the fourth quarter. In addition to ongoing manufacturing cost reductions, we now expect significant cost benefits from the purchase of the company in San Jose which John will talk about in more detail. We estimate growth margin for the year to be between 49 and 50%. We are on track with two long-term strategic initiatives, offshore testing and additional third foundry to lower costs and address future capacity needs. We began offshore testing on a small percentage of our products in the second quarter. We plan to gradually increase the number of products over the next two years. We have a qualification process with a third foundry, ZMB which is based in Germany. To summarize, in a market environment still in uncertainty I am pleased with market share gains and strength in earnings. The diversification of the product and revenue base has helped us stay on track. We are confident our continued execution of our diversification and market strategy will help us achieve our market shares and financial goals this year. Our fundamental growth and earnings power even under challenging conditions remain strong. I will now turn the call over to John review the financials. John?

Thank you, Balu. As Balu explained, we had a very good second quarter. We grew the revenue despite weakness in the communications market. This demonstrates our success in diversifying our revenue. Through continued focus on cost improvement we were able to grow net income 95% year-over-year while the revenue grew 10%.

Now onto the details. Net revenues in the second quarter were $29.8 million, an increase of 10% from $27.1 million reported in the same period last year, and an increase of 2% from $29.1 million reported in the first quarter. In the second quarter, our gross margin was 50.8% of net revenues. This compares with 42% in the second quarter of 2002 and 51.8% in last quarter. In the third quarter we expect gross margin to be in a range of 48 to 49%. The decline in gross margin is due to the proactive pricing actions discussed by Balu. In the fourth quarter we expect gross margin to improve slightly as a result of our ongoing cost reduction efforts. Income from operations in the second quarter was $5.2 million or 17.5% of net revenues, compared to $2.5 million, or 9.4% in the same period last year, and $5.3 million, or 18.3% last quarter. Net income for the second quarter was $4.2 million, or 13.9% of net revenues, compared with $2.1 million, or 7.8% in the same period last year and $3.9 million or 13.4% last quarter. Earnings per share for the second quarter were 13 out of approximately 31.1 million shares outstanding. This compares with 7 cents per share in the second quarter of 2002, and 13 per share last quarter.

We have revised our effective tax rate for 2003. Previously, we were estimate ago 30% tax rate. As a result of higher than expected tax credits, we are now estimating our effective tax rate will be 28%. As a result, the second quarter reflects year-to-date adjustment to the 28% rate. This adjustment did not change the earnings per share.

Looking at operating expenses. R & D spending in second quarter was $4.2 million or 14% in net revenue compared with $3.6 million or 13.4% in the same period last year and $4.1 million or 14% last quarter. Sales and marketing expenditures which include applications engineering were $3.9 million in the second quarter or 13.2% net revenues, compared with $3.6 million or 13.4% same period last year and $4 million or 13.9% in the prior quarter. G&A spending second quarter was $1.8 million or 6.1% of net revenues compared with $1.5 million or 5.7% in the same period last year and $1.6 million or 5.6% of net revenues in the prior quarter. Over all operating expenses increased 1.5% sequentially. As we discussed last quarter, we are adding sales and application engineering resources to support the revenue growth objectives. In addition we are investing in strategic activities to support the long-term capacity requirements and cost objectives, such as qualifying ZMD as an additional foundry and increase in offshore test capability. In the tired third and fourth quarter we expect the incremental spending will be largely offset from the savings resulted from purchasing our buildings which I will discuss later.

Moving to the balance sheet, cash at the end of the second quarter was $116.9 million, an increase of $3.8 million for last quarter. Net accounts receivable were $11.1 million at the end of the second quarter, an increase from $9.6 million in the first quarter. Day sales outstanding on net receivables were 34 days compared to 30 days the preceding quarter. Net inventory at the end of the second quarter was $20 million. It decreased from the $20.6 million last quarter. The inventory turns in the second quarter were 2.9, compared with 2.7 last quarter. In the third quarter, we expect our inventory turns to increase slightly to reach our target range of 3 to 4.

Let me spend a moment explaining the financial impact of purchasing our buildings. As we stated last quarter, we have signed a contract to purchase our two principal buildings for $30 million. In the second quarter, we paid a deposit of $3 million, and we expect to pay the remaining $27 million when the transaction closes later this quarter. The purchase of the buildings will have two specific financial benefits. First, we will receive a one-time benefit from the reversal of deferred rent. In accordance with generally accepted accounting principles, we have been accruing the difference between the rent paid and the straight line rent over the term of the lease. At the end of the second quarter, we had accrued $759,000 in deferred rent. As a result, our operating expenses in the third quarter will be reduced by $420,000. The remaining $339,000 will be reflected as a reduction of inventory costs and will benefit the gross margin.

Second we estimate the buildings will help our at lower the facility costs $600,000 per quarter. It will benefit both operating expenses and production costs. Our financial outlook, which includes the benefit from the buildings purchase, for the third quarter and 2003 is as follows We expect revenues in the third quarter to increase 10 to 14% sequentially. Gross margin is expected to be in the range of 48 to 49%. Operating expenses are expected to be relatively flat, sequentially. Earnings per share in the third quarter are expected to be in a range of 14 to 16 cents. Based on the latest end-market information, we expect 2003 revenues to increase 15 to 20%. Gross margin for the year is expected to be in a range of 49 to 50%. Earnings per share are expected to be in the range of 55 to 60 cents. That concludes our prepared remarks. Before we ask for questions, we would like to let you know that we plan to present the following conference CSFB small cap conference in Boston on July 30th, Adams, Harkness & Hill summer seminar in Boston on August 5th, Kaufman Bros. Communications and media conference in New York on September 3rd, Smith Barney city group technology conference on September 4th. Sadodi and Company 2nd Annual institutional investor forum in San Francisco on September 22nd.

Operator, can you please open the line for questions?

If you would like to ask a question, signal us by pressing the star key followed by the digit one on your touch-tone telephone. If you are using a speakerphone, we ask you please make sure your mute function is turned off in order to allow the signal to reach our equipment. Press star 1 to ask a question.

The first question is from Jim Liang from Pacific Growth Equities.

Thank you, guys. Great quarter, and strong outlook. I wanted to ask a couple of questions. First of all, can you talk just a little bit more about the 10 to 14% growth in the September quarter as far as, you know, what gives you the level of confidence to achieve that?

Well, several things. We look at all the available data that we have the backlog at the beginning of the quarter. It's a back-end loaded quarter. We have the sales forecast which gives us information on which products or which markets are growing. So based on all these factors, we estimate that we'll be between 10 and 14%.

And as we said in the comments, it's driven both by seasonality and market penetration. So the increments will revenue from design win.

Any particular end markets?

I think we said, in the conference call, that it is computer and consumer will be the strongest in the second half of this year. The industrial is going to be a little bit flat, and the communications is going to be as flat to slightly up.

Great. Next question, can you talk about 10% customers?

As typical, our two largest distributors were over 10%. Mimic was 24%, and Fenex was 23%. To follow on from last quarter's discussion, last year, Samsung used to be a 10% customer, and that was because we shipped all of the product directly to Samsung, who then shipped it on to some of their suppliers. Beginning in January, one of their largest suppliers, we began to ship directly to. So Samsung is not a 10% customer, but our overall level of business with them is about the same as it was before. It's just that we're now shipping to one of their suppliers directly.

Great. Last question: As far as your commentary about the business being relatively flat in the June quarter from the emerging odm's in China, which is a little different from some of the commentaries we've heard in terms of the weakness, can you give us a little flavor on that subject?

Yes, definitely. We believe part of the reason we have remained flat is due to our strong growth in market penetration in China. But there are also other factors, that is the Chinese cell phone manufacturers have appeared to gain market share over other international manufacturers. So that might have had some impact. So even though the end-market demand was publicized to be relatively low because of SARS, we haven't seen the impact of that in our business to Chinese manufacturers.

All right. Thank you very much.

Thanks, Jim.

And we'll take our next question from Tory Sandburg from U.S. Bancorp Piper Jaffray.

Thank you. This is Jeremy Kwan. Can you discuss your relationship with the Japanese foundries? Are these long-term in nature? Can you talk about potential currency impact and how it might affect your pricing?

Surely, Jeremy. We have had very long-term partnerships with MEI and Okie semiconductor (ph) in Japan. I believe at MEI, we are on the 12th year, and with Okie we are on the 10th year of our agreement. And we just extended our Okie agreement to 2008. And our contract with MEI is currently valid for another two and a half years. After that, you know, it will be subject to re-extension. So we have had very good relationships, and we continue to -- continue to do business with them. But the reason they're adding a third foundry is to additional capacity, and also for cost competitiveness. There are a couple of other reasons, the ZMD foundry we've chosen has a benefit in that they are in a different geography, and they are dollar-based. The current foundries, MEI and OKie, they are end-based foundries; we however, we have an agreement to share with them rate exchanges. So any change from the nominal value is shared equally between us; whereas the new foundry agreement with the ZMB is totally dollar based, which is definitely an advantage.

Okay. And, I guess, in terms of your new product initiatives, can you talk a little bit about 2004 and where you see, potentially, LinkSwitch and DPA-switch playing out.

Yeah, 2004 is, I guess, the first time in the history Of the country where there are four product families growing simultaneously in revenue. The TinySwitch-II and TOPSwitch-GX are still growing strongly. We expect that to continue for the next, you know, two or three years. But, on top of that, the LinkSwitch and DPS switch will start contributing revenue -- significant revenue -- in the next year. They'll contribute some revenue in the second half of this year.

Okay. And this one, final housekeeping item. John, you mentioned the benefit you expect to receive from buying your buildings. Is that included in the gross margin operating expense guidance for the second quarter -- or for the third quarter?

Yes.

Okay. Thank you very much.

We'll move next to Sumit Dhanda with Bank of America.

In terms of your expectations for the second half of the year, you're saying the market will be up slightly in the back half of the year. Are you expecting or anticipate anything changes in the cell phone market to the positive side when you're putting forth that guidance for that particular end-market segment?

Well, based on our forecast, we see approximately flat to slight improvement. I am sure all of us have heard the reported inventory issues in the market that is going to hold down the market for probably the next six months, based on what we have heard. So that is consistent with our forecast. So that's why we think that it's going to be flat to slightly up.

Okay. The next question I have for you is you're guiding to, obviously, significant sequential growth in the third quarter, and I understand the aggressive pricing stance you're going to take here, but there seems there is no real leverage on the gross margin line. Could you, sort of, address that in some more detail?

Our cost structure is highly variable, so volume is typically not a major driver in our cost structure. Where we've obtained the cost reductions in the past have been reducing test time, improving yields, reducing silicon costs, packaging costs, and volume is a piece of it. But that is not a major driver in our cost structure. So the slight margin reduction is because of the proactive pricing we've talked about in the past quarters. We continue to make cost reductions. As we said, by the fourth quarter, we expect the margin to start moving up from where at the we expect it to be in the third quarter.

Okay, thank you.

Steve Smigie from Raymond James.

I wonder can you talk about the DSL and cable market? Do you see any assignments will there or penetration there?

At the moment we do have many designments in the cable modems and DSL modems for the AC to DC supply and the DPA-switch in those areas. By as a percentage of communications business is not very significant.

Okay. And then, I guess, turning to the volume ramps on LinkSwitch and DPA-Switch, can you quantify what the maximum size of the programs might be?

Well, the first high-volume production shipment on the LinkSwitch, as we mentioned, is a cell phone customer. It's a pretty high-volume design. And we categorize, usually, high volume as over 100K per month. So we are very pleased with that for multiple reasons. One it is replacing linear transformers, secondly it is giving access to a brand new end customer who has never used Power Integrations, technologies, so this is the reason for introducing LinkSwitch. We have other cell phone customers and card less cell phone customers and home appliance customers, so we are very optimistic about the future of LinkSwitch.

Okay. And the volume on DPA?

The volumes that we have -- the designments that we have to date are relatively low volume, but we have many other design activities going on which are significantly higher volume, but they're not designed yet. And we are very strict about how we count designment. We don't count them till we get a pre-production or order.

Thank you very much.

You're welcome.

We move next to Brett Miller with. A G. Edwards.

Hi, John. Hi, Balu.

Hi, Brett.

Can you talk about not just your pricing but the over all pricing in the market, what you've seen out there from some of the other switch customers as well?

Well, the pro-active pricing adjustments made are not broad reductions in pricing. It is very specific to certain situations where we think there is some price elasticity that, by being aggressive, we can get a larger share of the market. So our product pricing has not changed. This is very, very targeted, focused on large volume opportunity. As far as discrete pricing, they have been relatively stable. What I mean is they re pricing, what do you call, attrition or erosion has been pretty normal, meaning in the single digits, compared to what it was in 2002 and 2001, where it was well into double digits.

Right. That's what I was getting at. That seems to have sort of stabilized to a normal level now?

Yeah, in the last two or three quarters, they have been relatively stable. In the fourth quarter of last year, I think I mentioned that the passive components had a double-digit reduction, but since then they've been stable also.

So people would notice your price changes last year with double-digit declines and free fall, basically, in the market, it would be hard for y'all to compete, but, now, you think on a price basis you guys can be noticed in the market on the targeted price reductions?

Again I want to say that when you say people notice, it is only those special situations where we've made the adjustments.

Are those OEMs or merchants?

Most of them merchants.

Lastly, moving to the DPA product, is it a little different sales cycle you do with the traditional power products, what are you doing as far as beefing up the field account engineers, whatnot, to drive the sale directly to the OEMs on the design cycle.

We are doing several things. We are training all our FAs, but we are also training our overseas (ph) FAs because the DPA business is much more fragmented compared to the AC to DC power supplies. There are a lot of smaller-volume customers. And, so, we have to train our distribution FAE's not only in the U.S. but also overseas. The other thing happening in the DC/DC business is the business is moving overseas. What we are finding is some of the early designs actually came from Asia, not from the U.S., as you would have expected. And the reason is, the Asian power supply customers are seeing a DC/DC as a lucrative market compared to the ace AC to DC market. They like using our technology which is fully integrated which makes it easier to design.

Anyone wants a piece of linear 75% gross margins.

Thank you.

We will move to Lee Zeltser.

Booking friends and linearity in the quarter and book to bill ratio.

We don't provide book to bill ratio. We don't find it helpful. We need 70% turns this quarter to make the numbers. This is a back-loaded quarter. September and October are our strongest months in the year because of the seasonality of retail market. About two-thirds of our business, we believe, ends up in the retail market including PC's and cell phones, a significant portion of them out in retail. So, based on that, the Q 3 is relatively nonlinear, but Q2 is relatively linear.

It wasn't a drastic spike in terms of June quarter of shipments?

No.

You mentioned pricing coming down, or you. Any product family, specifically?

No, it's only the situation where is we think there's elasticity and we can grow business by being aggressive.

Okay. Thank you very much.

You're welcome.

We move next to Gus Richard with First Albany.

Turns for the quarter, what was that?

70%.

And then tax rate for '04?

We haven't give thin guidance on '04 yet.

For my purpose, should we assume just the continuation of 28%.

We haven't given any guidance on '04 yet.

Okay. ASP for the quarter?

51 cents.

And then TOPSwitch, as -- was TOPSwitch down sequentially, slightly? It's kind of flattening out, now? When I do my model, it looks like TOPSwitch, given your new guidance for the year, looks like it was pretty flat sequentially. Was that the assumption.

We did reduce the revenue for TOPSwitch compared to what we had earlier.

Right, and, on a sequential basis, TOPSwitch was down a little bit?

It was down slightly.

Like a few hundred thousand? Is that about the right order of magnitude?

Yes.

Perfect. And then revenues for DPA and Link in the quarter, one 1- to 2,000 or 100,000 or so?

In Q2?

Yeah.

In Q2, it was negligible.

All right.

Very early shipments.

Okay. got it. And I think that's it for me.

And we'll move next to Rob Adams with Kaufman Bros.

Thanks, nice quarter.

Thanks, Rob.

If we could talk a little bit about -- obviously, you've got a product mix shift going on here or at least an application or an end-market shift in terms of the communications business being weaker and the consumer and computer businesses picking up the slack. Are you assuming, though, pretty much the same seasonality in those end markets? Are we still looking at a pretty solid September and October, or is there even a slight shift as a function of that?

We don't think there's much of a shift. If you look at the consumer market, it has all of the seasonality associated with the retail business. The computer, a portion of the computer market is retail, and a portion of the cell phone market, which is the majority of the communications market, is also retail. So I don't think this changes the seasonality very much.

Okay. Fair enough. Great, thanks very much.

And we'll move next to Shawn Slayton with Ferris Baker Watts.

Good afternoon.

Good afternoon, Shawn.

Could you talk about the DPA-switch compared to the LinkSwitch? I've got it saying LinkSwitch has more potential in the near term. Is that correct?

That's correct. The DPS switch is a an aggressive market of approximately $200 million.

Okay.

The ASP is much higher in the dollar of $1.50 so, the unit volume is lower than that. The LinkSwitch has a much higher unit volume, over a billion units. So the market is approximately $350 million. And there's also other differences. Link switch goes into a large market like cell phones, cordless phones, home appliances, a lot of major players in the market. So if you get a designment, it's a very high-volume one. Whereas the DPS switch goes into a much more fragmented market where each designment usually is a much lower volume but higher ASP.

Okay.

So DPS switch is more comparable to TOPSwitch-GX in terms of the way grows slower, but more steadily, whereas LinkSwitch appears to be more like TinySwitch-II, which has a much faster growth, because all you need is one or two designs and your volume goes up significantly. So it has a much more potential to grow faster than DPS switch, but DPS switch will be growing for a longer period of time, much more steadily.

Thanks. Maybe for John, you've got some ongoing cost reductions, and then you've got some cost reductions that are going to hit in maybe 2005 or 2006. From 2004, from a gross margin perspective -- I know you don't want to give specific guidance on gross margin for '04 -- but, you know, what can we expect? Are there going to be ongoing cost reductions in 2004 that impact gross margin favorably? Or is it going to be a cost reduction story, or an ASP/volume story for gross margin in 2004?

Well, we continue to focus on cost reduction. So, as we mentioned, we're gradually increasing our offshore testing, which will provide some cost benefits. And we continue to focus on reducing our silicon cost, packaging, improving yields, test times. So we'll continue to get cost reductions.

But didn't we kind of see a big -- most of the step function improvements for the ones you just mentioned?

Well, we saw a very large step function last year.

Right.

But we continue to focus on those areas and continue to reduce our cost in all those areas. In terms of what it does to our gross margin in 2004, it's too early to say, because we haven't, yet, achieved the cost reductions, plus, you know, we'll have to see what the market environment is, and our product mix, and how we -- what we choose to do with those cost reductions. So we will continue to focus on reducing our costs. But, at this point, it's too early though guess what the impact would be on our gross margin.

Our goal is to continue to reduce costs so that, at least at minimum, we can offset the price reduction.

Right.

But, of course, a lot depends on what happens with competitive solutions. So if everything was relatively stable, we -- I mean, our target is to continue reducing prices to offset and also have some room to be either more competitive in the marketplace or improve our margins.

Okay. Do you guys have a long-term gross margin model, goal, as some companies do or as some companies talk about on their conference calls?

Well, our long-term range has been in the 45 to 50%, that was our goal.

Right. Now we're there.

In the bad years, we've been below 40, in the good years, well above 50. So, I would say that is still, probably, still our long-term range. But we would like to get as high a margin as we can get, so we are focusing very heavily on cost reductions. But, at the same time, if we can grow the market by being more aggressive, we will do so.

Okay. I appreciate it. Thanks guys. Nice quarter.

You're welcome. Thanks.

We will move next to Brad Vere with Sandler capital management.

I hate to focus us back on the mundane, but the 55 to 60 cent sort of guidance for the year, that includes the reduced tax rate?

Yes.

So you're going to gain 1 to 2 as a benefit of the reduction in taxes; is that correct?

Our EPS would be higher, 1 to 2 at 28% tax rate, as compared to 30%.

Okay. Yeah, I just wanted to make certain I understood what was being guided to. Thank you.

Once again, as a reminder, if you would like to ask a question, signal by pressing the star key followed by the digit 1 on your touch-tone telephone. Next question from J.D. Padgett from Founders Asset Management.

I don't know how much you mentioned the handset. I know you talked about ODM's being flattish.

Well, the handset business was down significantly. We didn't actually mention a specific number. As I said, interestingly, the business to Chinese customers was relatively flat between Q1 and Q2. The same was true between Q4 and Q1. All the hit came from top tier customers which varies from customer to customer drastically.

Did your revenue from Samsung track to those shipments as well.

Thats correct. Its tracks exactly to their shipments.

And within that segment of ODM's, did you see existing customers, maybe, cancel orders or push out forecast but were able to offset that by market share gains?

Most of the orders are very short-term orders, so we don't see as many cancellations and push-outs. So, if you look at the bookings, it has been -- it is not like it is discontinued, it is just that it is a much lower rate than it has been with some of the top tier customers.

But on the ODMs, you saw the booking rates for the customers you had been working with kind of entering the quarter fall off as they grappled with their inventory problems, but you added new customers and gained penetration to offset it?

The top tier customers, OEMs, their order rate was significantly lower than it used to be. And, again, it varies, the actual reduction is quite different, but each one of those top tier customers,.

Yeah, I was thinking more the Chinese guys, because I don't think there's any way to say they didn't have inventory problems, and I was trying to get you at whether you felt the reduction orders from those guys already, but offset it by adding new customers and gaining share with those customers?

It's hard to say. There are so many customers in China. We have over 75 Chinese customers and almost all of them are distribution customers. The total is flat. We know we've been flowing market share, so we know that there has been a reduction in end and, which has been offset by market share growth, but we don't know the specifics of any individual customers because, in many cases, in fact, in most cases, we are shipping to a manufacturer in China, who is selling it to a Chinese cell phone manufacturing, sometimes a Taiwanese manufacturer.

So the distribution partners observe sky ring that, but that seems to be what's playing out?

Yes.

And, John, the savings on buying the buildings, the deferred rent is a one-time thing that helps Q3 and Q4?

Yes, but the savings began in Q3, because we get the benefit of the operating expenses from the one-time reversal. In Q4, we get the ongoing savings. So while the initial one is a one-time benefit, it's kind of the start of the benefits.

Right. But that's factored into your guidance, the one-time benefit in Q3 and Q4 as well?

Yes, it is.

Okay. Thank you.

You're welcome.

This does conclude today's question-and-answer session. I'd like now to turn the conference back over to Mr. Balu Balakrishnan for additional or closing comments.

Thank you for going us today. And we look for seeing some of you at the upcoming conferences. Thank you.

This does conclude today's conference. We thank you for your participation. You may now disconnect.