Power Integrations Inc (POWI) 2004 Q1 法說會逐字稿

Good afternoon everyone, and welcome to the Power Integration First Quarter 2004 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. Mr. Cobb, please go ahead, sir.

Good afternoon. Thank you for joining us to discuss Power Integration's first quarter financial results. I'm John Cobb, Chief Financial Officer of Power Integration, and with me today is Balu Balakrishnan, President and Chief Executive Officer.

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 forecast 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 expressions that look toward future events or performance. Forward-looking statements are based on current information that we have assessed, but which by its nature is dynamic and subject to rapid, and even abrupt, changes. We also 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 differ materially from those projected or implied in our statements. Risks and uncertainties affecting our business, which could cause actual results to differ materially, are discussed in our most recent reports on forms 10-K and 10-Q filed with the SEC.

I will now turn the call over to Balu, who will take you through an overview of the business. Balu?

Thank you, John, and good afternoon everyone. Today, we are pleased to report strong results for our first quarter of 2004. We achieved revenues of $34.2m and earnings per share of 16 cents, both at the high end of our guidance. We increased our cash and reduced our inventory. We also added three U.S. patents and one foreign patent. We are especially pleased with the rebound in the cell phone related revenues. This rebound is consistent with our understanding of the fourth quarter operational issues at some of our largest cell phone OEMs that we discussed in the last conference call.

Let me go on to other highlights of the quarter. First quarter revenues increased 6% sequentially. Year-over-year, revenues increased 17%, while operating expenses increased only 1%, resulting in a 31% increase in net income. We continued to gain share in many market segments. Also during the quarter, we had a high level of design wins on TOPswitch-GX and TinySwitch-II, and had strong design activity on LinkSwitch and DPA-Switch. We also introduced two new products to an enthusiastic market. In addition, market trends continued to become more favorable. The proposal of significant new energy efficiency guidelines and an improved competitive pricing environment are two of the most important trends from which we expect to benefit. I will discuss these in more detail later.

Now, on to performance in each of our market segments during the first quarter. Revenues from our communications segment were up 24% from the fourth quarter. In the cell phone application, shipments related to Samsung and Motorola were up at the high end of our expectations, while shipments to other customers were down, consistent with normal seasonality. Revenues in the communications segment from applications other than cell phones also had strong growth. Revenues from our consumer segment were up slightly from the fourth quarter, and up 47% year-over-year. TinySwitch-II and TOPswitch-GX continued to penetrate a wide range of consumer applications. Revenue growth was driven primarily by our sectors in set-top boxes, DVD players and home appliances. Our growth in DVD players and home appliances continues to be driven mainly by the adoption of our energy-friendly chip to meet new global energy efficiency guidelines.

Revenues from our computer segment were down sequentially, in line with the seasonal trend but up 10% year-over-year. We expect continued strength in the computer segment, primarily driven by further market penetration into LCD monitors and PC standby. Revenues from the industrial segment were up 12% sequentially, and 43% year-over-year. We've continued to see strength across a diverse set of industrial applications. Our expected revenue mix by market for 2004 is unchanged as follows: communication, 34%; consumer, 30%; computer, 24%; industrial, 8%; and other, 4%.

Now, let me turn to data support products. TOPSwitch-GX and TinySwitch-II continued to experience strong design wins and design activity in all of our markets. Both product families introduced approximately three years ago were once again the main revenue growth drivers in the first quarter, and continue to capture a growing share of the AC to DC power supply market. TOPSwitch-GX, which addresses applications between 10 and 250 watts, had design wins in a wide range of applications, including set-top boxes, LCD monitors, LCD TVs, DVD players, audio amplifiers and a number of industrial and consumer products. TinySwitch-II, which addresses applications between 2 and 20 watts, also achieved design wins in all four of our major market segments. Design wins included cell phone chargers, PC standby, TV standby, DVD players, digital cameras, home appliances, and industrial applications. We anticipate the level of design wins for TinySwitch-II and TOPSwitch-GX to remain strong over the next several quarters, continuing to contribute significantly to our revenue growth in 2004 and beyond.

Turning to our most recently introduced products, DPA-Switch and LinkSwitch. DPA-Switch, our first DC-to-DC product family, designed for distributed power architectures in the 0 to 100 watt range, was introduced in June of 2002. In the first quarter, DPA-Switch obtained additional low-volume design wins in the communications and consumer segment. DPA-Switch has ongoing design activity across all of our target DC-to-DC application areas, namely Telecom, networking, digital phones, including voice over IP, servers and industrial. We are also pleased with the initial interest in and design activity on the recently introduced extension to the DPA-Switch family for power over Ethernet applications. These applications include voice over IP phones, wireless access points, and security systems. We started production shipments of DPA-Switch in the third quarter of 2003. As we have mentioned before, the DC-to-DC market is highly fragmented and is a relatively new market for us, and so we expect DPA-Switch revenues to grow gradually over the next several years, similar to the ramp of TOPSwitch-GX.

Link switch, which was introduced in September of 2002, is intended to help manufacturers replaced bulky, inefficient linear transformers, also known as energy vampires, used in the 0 to 3 watt range. We estimate this market to be more than one billion units per year. In the first quarter, LinkSwitch had design wins in the consumer, communications and industrial market segments, including a high-volume design win for a large Japanese cell phone OEM. Ongoing LinkSwitch design activity includes several high-volume opportunities, and remains strong primarily in cell phones, cordless phones, home appliances and industrial applications.

In addition, LinkSwitch-TN, the newest member of the LinkSwitch family, had its first design win, which was in a vacuum cleaner for a large Japanese consumer products manufacturer. Over the last year, copper prices have nearly doubled, while iron prices have also risen considerably, increasing the cost of linear transformers. We believe the combination of higher raw material costs and tighter efficiency guidelines spells trouble for the linear transformers, and positions LinkSwitch for increased growth potential over the next several years. Our forecast for revenue mix by product family in 2004 remains at TinySwitch-I and II at 50%, TOPswitch FX and GX at 30%, TOPswitch I and II at 12%, LinkSwitch and DPA-Switch combined at 8%.

Let me turn a moment to energy efficiency, which remains an important growth driver for the company. We are proud to report that, today, Power Integration's eco-smart technology has saved consumers worldwide over $500m in energy costs. As we sell more eco-smart devices, the rate of savings will accelerate, helping consumer save even more in the future.

We are encouraged that the rest of the world is increasingly speaking our language on this critical issue. In the first quarter, the EPA proposed an EnergyStar specification for external power supplies. The proposal includes establishing a limit on no-load consumption. For low-power adapters, the limit is 300 milliwatts, which mirrors the European Union's specifications scheduled to take effect in January of 2005. In addition, the EPA proposal requires minimum efficiency during normal operation. The EPA's final standard is expected to be issued within a few months. The European Union is also planning to add an operating efficiency requirement to all external power supplies beginning 2007. We believe these requirements, for all practical purposes, will rule out the use of linear transformer-base adapters.

The EPA is also working with many countries and the California Energy Commission to harmonize energy efficiency standards across much of the world. Australia, Canada, Taiwan, Newfoundland and European Union, among others, already use many of the EnergyStar standards in their respective energy efficiency programs. EPA is now working very closely with China and Brazil so that they too will adopt EnergyStar specifications to harmonize standards going forward. The EPA has made special note of its efforts to coordinate with China. According to its recent press release, "EPA is closely coordinating its power supply efforts with China, a global exporter of power supply." We are of course encouraged by these developments.

In addition, Intel has recently collaborated with the National Resource Defense Council and EPA's EnergyStar to establish a new energy-efficient specification for power supplies used in desktop PCs. The specifications include the federal one-watt standby limit and operating efficiency requirements. Intel's public commitment to energy efficiency further propels the issue into the spotlight. While this announcement does not have an immediate direct impact on us, the broader awareness and increased pressure on industry reinforces the drive to make products more energy-efficient.

With all the heightened level of activity worldwide, underscores the fundamental shift that is occurring around the greening of power supplies. Our solutions, which meet all current and proposed energy efficiency guidelines, are uniquely positioned to benefit from these trends. Let me now turn to the discrete [ph] pricing environment, which has improved over the last quarter. This is especially true with small electronic power supply manufacturers who have seen discrete prices stabilizing and, in some cases, even moving up slightly. While high-volume manufacturers have not yet seen the firming up of Moss [ph] set and controller prices, they are no longer anticipating the declines seen in the last few years.

In addition, the lead times on many of the discrete and integrated components that our IT's replaced have stretched out to 12 to 24 weeks. The availability of these components is becoming a major concern for power supply manufacturers. As a result, our short product lead times and proven [inaudible] performance are making our integrated solutions even more attractive to manufacturers.

Now, on to our guidance. We look forward to continued profitable growth in the second quarter as we execute on our key strategies, including diversification of our end markets and customers, further penetration of key target markets, continued focus on cost reduction, and leadership in energy efficiency. As has become the more, our high level of turns business once again has limited our visibility and made quarterly forecasting very difficult. Having said that, based on the information available, we estimate that the revenues in the second quarter will increase between 2 and 6% sequentially. As John will explain, we expect our gross margins to decline in the second quarter and then recover in the third and fourth quarters. Earnings in the second quarter are expected to be between 14 and 15 cents per share. Our revenue and earnings forecast for the year remains unchanged.

In summary, we are pleased with Power Integration's strong performance in the first quarter. Our diversification and market penetration strategies continue to be successful. We also remain focused on cost reduction. We expect the continued adoption of TOPSwitch-GX and TinySwitch-II across many markets to drive strong revenue growth this year, while the initial ramp of DPA-Switch and LinkSwitch paves the way for the growing contribution to our revenue. Lastly, the increased cost of competitive solutions, tightening energy efficiency standards, and improving end market demand are creating more favorable market conditions for our products. Given all these factors, we feel great about the company's future, and believe that we are on track to meet the 2004 financial goals.

I will now turn the call over to John to review the financials. John?

Thank you, Balu. We are very pleased with our financial results in the first quarter. We achieved the high end of both our revenue and earnings guidance. We increased our cash and reduced our inventory. Now, on to the details.

Net revenues for the first quarter were $34.2m, an increase of 17% from the $29.1m reported in the same period last year, and an increase of 6% from the $32.3m reported in the fourth quarter. In the first quarter, our 10% customers were Memec at 22%, Kenex at 15%, and Samsung at 13%. In the first quarter, our gross margin was 48.9% of net revenue. This compares to 51.8% in the first quarter of 2003, and 49.6% in the fourth quarter, excluding the one-time benefit from the buildings purchase. The less than 1% sequential decline in the margin was due primarily to the impact of the stronger yen in 2003.

In the first quarter, we significantly reduced our wafer purchases and our test operations in order to return our inventory turns to the target range of 3 to 4. As a result, our overhead absorption was significantly lower, which will have a negative impact on our gross margins in the second quarter. In addition, as expected, the further strengthening of the yen in late 2003 will also impact the second quarter gross margin, which we expect to be approximately 46%. However, due to ongoing cost reductions, we expect the gross margin to recover in the third and fourth quarters. Our gross margin expectation of 47 to 49% for all of 2004 remains unchanged.

Operating expenses in the first quarter were $9.8m compared to $9.8m in the same period last year, and $9.3m in the fourth quarter. Overall, operating expenses as a percentage of revenue declined to 28.8% in the first quarter from 33.5% in the same period last year. Demonstrating the operating expense leverage in our financial model, our revenue increased 17% year-over-year while our operating expenses increased less than 1%. Income from operations in the first quarter was $6.8m, or 20% of net revenue. This compares to $5.3m or 18.3% in the same period last year, and $6.3m or 19.5% in the fourth quarter, excluding the one-time benefit for the buildings purchase.

Over the last two years, we have consistently improved our operating margin. In the second quarter, we expect our operating margin to decline. However, we expect it to recover in the third and fourth quarters and to continue to improve over the long-term. Net income for the first quarter was $5.1m, or 15% of net revenue, compared to $3.9m, or 13.4% in the same period last year, and $5.3m, or 16.3% last quarter. Earnings per share for the first quarter of 2004 on a diluted basis were 16 cents per share on approximately 32.8m shares outstanding. This compares to 13 cents per share in the first quarter of 2003, and 16 cents per share last quarter.

Moving to the balance sheet, cash and investments at the end of the first quarter were $123.5m, an increase of $8.1m from the prior quarter. During the first quarter, we generated $5m of cash from operations. Net accounts receivable were $13.3m at the end of the first quarter, up from $10.3m in the fourth quarter. Day sales outstanding on net receivables at the end of the quarter were 35 days, compared to 29 days the preceding quarter. Net inventory at the end of the first quarter was $21.3m, a decrease of $1.8m from the $23.1m in the fourth quarter. The inventory turns in the first quarter increased to 3.3 from 2.8 in the fourth quarter.

As I mentioned earlier, we reduced our wafer purchases and test operations in the first quarter in order to return our inventory to our target range of 3 to 4 turns. In the second quarter, we expect our inventory turns to remain in our target range. Our financial outlook for 2004 at the second quarter is as follows: our guidance for 2004 remains unchanged. We expect revenues to be in the range of 150 to $160m. Gross margin is expected to be in the range of 47 to 49%. Earnings per share are expected to be in the range of 70 to 80 cents. We expect revenues in the second quarter to increase between 2 and 6% sequentially. Gross margin is expected to be approximately 46% in the second quarter. Earnings per share in the second quarter are expected to be between 14 and 15 cents per share.

That concludes our prepared remarks. Before we ask for questions, we would like to remind you that we plan to present at the following conferences: the JP Morgan Chase conference in San Francisco on May third, the Piper Jaffray technology conference in New York on May 19, the Smith Barney Citigroup semiconductor conference in Monterey on June second, the CIBC World Markets conference in New York on June 7, the Bear Stearns technology conference in New York on June 14, and the Sidoti & Company conference in Boston on June 28.

Operator, can you please open the line to questions?

Thank you, gentlemen. Our question and answer session will be conducted electronically. If you would like to ask a question, please firmly press the star key, followed by the digit one on your touchtone telephone. We will come to you in the order that you signal, and if you find that your question has been asked and answered before you could ask it and you would like to remove yourself from the question roster, please firmly press the star key, followed by the digit two. Also, if you are on a speakerphone, please make sure that your mute button is disengaged so that your signal can reach our equipment. Again, if you would like to ask a question, please firmly press the star key followed by the digit one, and we will pause for just a moment to assemble the question roster.

And for our first question, we got to Tore Svanberg with Piper Jaffray.

Good afternoon. This is actually Jeremy Kwan calling for Tore. Balu, regarding your new power over Ethernet product, can you talk about some of the key features versus your competitors in this space?

Absolutely. We bring the same kinds of advantages we bring to the AC to DC market, which is a high level of integration. The number of components with our solution is significantly smaller compared to other competitors that offer just the controller without the Moss set. We include the high-voltage Moss set in our product. So, in addition to the high-voltage Moss set, we have a number of features that reduce external component count. So, the net result is the solution that we provide is lower-cost-- significantly lower-cost at the system level, and it takes much less board space, which is also very critical in this application.

Great, and I guess you mentioned previously that your expectations for unit volumes for DPA-Switch was generally smaller and at a slower ramp. So, does this power over Ethernet product, could that change the equation a little bit here?

Yes, I think this could add a higher growth potential to the DPA, and as any of our new products, it takes nine months to a year before we see any revenues, but it could impact the growth rate in 2005.

Great. And regarding your own lead times for your foundry partners [ph] has been changed at all? Will you be able to continue to support your short lead times to your own customers?

No, it does not change. Most of our products are less than or equal to four weeks.

OK. And lastly, John, if you could help of quantify for us again the effect of a stronger yen on the gross margins. I think previously you mentioned that some of this was capped, or it wasn't-- it was shared equally.

Right. As I mentioned, the main reason for the decline in the gross margin from Q4 to Q1 was the impact of the yen. The decline from Q1 to Q2 is about 2 points of the decline is related to the lower absorption that I mentioned from adjusting our inventory, and then one-third of the decline would be from the impact of the yen.

Great, thank you very much.

For our next question, we go to Vernon Essi with Janney Montgomery Scott.

Thank you. John, I'm wondering if you could give us any color on unit volumes in the quarter.

Our ASP for the quarter was 49 cents, so the volumes were around 70m.

Okay. And what was the split between distributor and OEM?

The distributor was 56%, and OEM was 44%.

OK, and your depreciation for the quarter?

Depreciation for the quarter was 1.7m.

And just sort of a larger picture question, I believe you addressed this, but how is the competitive environment shaping up? I mean, obviously the discrete side of life is making things probably very easy on the design side. The window is, I'm sure, pretty open for people to come in right now. But, is that also inviting more competition from other folks, and how do you see that shaping out as the year rolls on? Thank you.

When you say the other folks, you are-- are you referring to the integrated competitors?

The other folks meaning sort of just switching from a linear solution, linear transformer solution or a discrete solution to one that's more integrated, such as yourself. I'm talking about the competition from just the integrated folks, like in Infineon and SPS [ph] have a couple solutions in there.

There is no change in the competitive environment as far as the integrated solutions go. In the second and third-tier customers, we've actually seen some increase in some of the integrated competitors' pricing, and we have seen discrete pricing either be flat or increase at the second and third-tier customer. There are especially Moss sets-- certain types of Moss sets have gone up 10 to 15% for second and third-tier customers.

OK, so you're saying-- just so I'm clear on this, the integrated folks are actually trying to push in a price increase right now?

Some of them are, not all of them. Some of them have increased prices at the second and third-tier customers.

OK, all right, great. Thank you very much.

You're welcome.

For our next question, we go to Shawn Slayton with Ferris Baker Watts.

Hi, John, hi, Balu.

Hi, Shawn.

So, John, if I understand this correctly, the gross margin guides for the current quarter, it's entirely-- it's exogenous to what's-- entirely exogenous, the sequential decline? It's not an ASP erosion issue or other, coupled with some of the other items you'd mentioned?

No. As I mentioned a couple calls ago-- or questions ago, about one point of it is the yen, but two points of it, or the majority of it, is really an adjustment of our inventory. We dramatically reduced our wafer purchases and our test volumes first quarter really as a result of our revenue shortfall in the fourth quarter and, as a result, we had lower absorption, so a higher cost per unit. Now, we've corrected our inventory, but that higher cost flowed through in the second quarter. But, as we said, while we expect the one-time negative impact in the second quarter, we do expect the gross margin to rebound in the third and the fourth quarters.

OK, understood. Balu, are you guys getting design wins right now in anticipation of the new European power efficiency standards?

Absolutely. That has been happening for a while now. Some people are more proactive, and they have done it much earlier than others, but we certainly see a significant interest in meeting the European standard, which it looks like it's going to be harmonized also with EnergyStar, which is now being adopted by many different countries, so it's going to become a worldwide requirement over time.

OK. And so, I guess from your commentary, you seem more optimistic relative to past quarters regarding the overall competitive landscape relative to the discrete. Am I interpreting that correctly?

Well, we--even at the beginning of this year, in the last conference call, we had indicated that we are seeing the environment improving overall, both in terms of competitive pricing environment and also the energy efficiency. And what we are seeing is that is happening, and it just happened, and it's continuing to happen. So, we are very optimistic about the future going forward. In fact, our yearly forecast included some of this already, but the bigger impact will be long-term because all of the standards don't immediately change anything overnight. But what happens is, over the next year or two or three years, it will have a very significant impact in our ability to grow in this marketplace.

OK, I'll yield the floor for now. Thanks.

You're welcome.

For our next question, we go to Gus Richard with First Albany Capital.

Good afternoon, guys.

Hi, Gus.

Can you talk a little bit about the competitive environment? There's been some talk of your competitors aggressively pricing product at high volume customers in order to gain market share, and if you could then touch on sort of where you see on the electronic chargers your cost versus the other integrated guys, or people doing multi-chip modules, or what have you, and sort of where you see your cost delta.

Yes, we have mentioned that two of our competitors specifically out of five have been very aggressive in pricing, I would say, the second half of last year, but we have been very proactive in making sure that we are competitive with our existing products and our new products in terms of pricing. And we believe we are very competitive compared to their solutions. And as far as the pricing environment itself, at the largest volume customers, tier one customers, the pricing of our competitive solutions has not changed, meaning they went very aggressive last year, and they'll remain there.

In the tier two and tier three customers, we have seen price increases in the integrated solutions offered by our competitors.

OK, and then in days gone by, you've had significant die [ph] size advantage relative to the other integrateds. Can you speak to that? Is that still the case? Has that relative die size game that's been going on for years still intact, or has that changed?

Well, we continue to make improvements in our die sizes. In fact, we alluded to improving gross margin in Q3 and Q4, and that's as a result of several things. One is we have significantly reduced our silicon die size through design and technology improvements, and on top of that, we have negotiated lower silicon prices effective January of this year, which will impact the Q3 gross margin because when we order wafers, the price is fixed at that point, and we don't actually get the wafers for another two, 2-1/2 months. And then, it doesn't-- it has to flow through the inventory, so the January cost reductions, it will be actually reflected in Q3, so that's the other area. And on top of all of that, we are continuing to increase the amount of testing that's done overseas every quarter. We continue to ship more and more testing overseas. That was also part of this cost reduction. So, the combination of all these will give us a significant improvement in gross margin in Q3 and Q4 of this year.

Gus, back to your original question, some of the competitors have made comments about reducing their die size, and you can judge whether they have or not. But, we continue to reduce our die size also, and continue to have an advantage over our competitors in that area.

OK. And then just to be real clear, have you seen your competitors-- integrated competitors make any material gains in market share at top tier accounts?

No.

OK, that was pretty clear. All right, I'll yield the floor. Thank you.

For our next question, we go to Steve Smigie with Raymond James.

Great, thank you very much. My first question is regards to I guess what happened with your revenue in 2002, where you saw a pull-forward of revenue that's typically strong in the third quarter and in the second quarter. I was wondering if you could remind us what that second quarter started to look like, and if you saw signs early enough in the quarter to predict that, that essentially, it might indicate that it's the same situation now, or is it just too early to see that sort of thing?

I think in that quarter, if I remember correctly, the guidance that we gave for that quarter was 4 to 8% up, and as I think you're referring to, we actually were up sequentially 15% at the time that we gave the guidance, which would have been April 20th. We did not have insight into that. The demand was very strong in late April and then early in May, and then it tilled off quite a bit in June. What caused that was, for some reason, some of the suppliers and some of the competitors were supplying product, panicked and extended lead times, and made comments about allocation, and so it pulled in some of the demand from Q3 to Q2. That, in our view, was somewhat of an anomaly, and we wouldn't expect that to happen again.

OK. In terms-- obviously, you saw pretty strong units out of Motorola this quarter. I think it surprised a number of people, and very strong out of Samsung. Do you expect to see those levels sort of continue going forward for you in terms of units? Are they giving you sort of indications that in terms of their forecast, or do you expect it to tail off again in the second quarter?

I think it's safe to say we expect our cell phone revenue to be in the same range as our overall revenue of 2 to 6%, so we don't expect it to go down, and at this point, we don't expect it to be significantly stronger than the overall business.

OK. I guess Motorola had specifically mentioned that, despite their strengths, they had still seen a delay in getting cameras for the handsets, and my general impression is that that's an area that you guys are particularly focused on. So, assuming they roll those out in, say, the second and third quarters, would you have the potential maybe for some upside if they get those products rolling as planned?

Well, we always, at least historically, have had very strong sequential growth from Q2 to Q3, and Motorola as one of our customers, if they have a good quarter and it flows through their inventory, then we would expect to see increase similar to what they would increase. It may not be in the exact same quarter, but at some point we would see it.

OK. And my last question is just on the energy standard that you mentioned that the EPA is working on. What was the timing of that?

They're talking about next few months. I believe their goal is to have it done by about August time frame, but it's always a variable.

And so, when would that impact sort of when the linear transformers would be on their way out, so to speak?

Well, the way it works is the standard will become effective at the time, and to the extent your product meets the standard, you are allowed to put the EnergyStar logo on it. There is no time requirement on conforming to that standard. It's just a question of a marketing force that would compel you to design your product to meet that standard so that you can put that label on it. It is a voluntary standard that the manufacturers agree to meet with the EnergyStar agency, or the EPA. And generally, what has happened in the past is that they do meet it in a large portion of their product. They don't meet on 100% of the products, but it's not uncommon for them to meet it on 50 to 70% of their products so that they can put that EnergyStar label on it.

OK, great. Thank you very much.

You're welcome.

We go next to Lee Zeltser with Needham & Company.

Hey, guys, a couple of questions. First, if you can talk a little bit about the linearity of orders in the quarter, month-to-month?

It was slightly stronger towards the back end, but I wouldn't say dramatically stronger. It was fairly linear, with maybe a little uptick towards the end.

OK. And then, just a follow-up on a previous question. The guidance you gave of 2 to 6% sequentially in Q2, can you give us a sense of how the vertical markets track that? In other words, are they all fairly in line with that growth rate? Is one stronger than the other in Q2?

I think at this point, our expectation is that the end markets will be pretty consistent with that. There isn't one that we would expect to go down, and at this point it's hard to say that one would necessarily be stronger than another.

OK. And then, with regard to your pricing strategy, you mentioned you'd be aggressive on pricing. How long does that last? Have we seen most of the-- kind of the discounting done at this point, or is it going to be done mostly in the second quarter, or are you going to pretty much be continuing to be aggressive the balance of the year?

There are two separate issues. One is, as far as the pricing alignment goes, as I said, it is improving, so we'll have less pressure to reduce our prices generally across the board. However, whenever there's an opportunity with a specific customer situation where we think we can dramatically improve the volume by giving them an incentive in terms of pricing, such that we actually end up getting more profit dollars. We would always do that, because we would much rather get a larger EPS and a larger top line growth whenever possible. But, we won't reduce it. That's different from reducing it because of competitive pressures.

Understood. I understand you're being-- kind of driving this on your own. But, would you say that there is much more room to go in terms of further cutting prices?

It really is how the math works. If we can reduce the prices and the increase in volume does not give you total profit dollars more than what you would have had otherwise, we wouldn't do it. We would only do it if we can grow our EPS and revenue faster by doing that. In many cases, it doesn't work, so we don't do it. We only do it when there is a situation where we think that we can gain revenue growth and EPS growth.

OK. And then, with regard to margins, is Q2 probably the bottom quarter on gross margins in calendar year '04?

At this point, we would say yes. As Balu mentioned, we expect our volumes to be up this quarter and in Q3 and 4, which will drive our costs lower, plus we've negotiated lower wafer prices, plus, as Balu alluded to, we've made some design and technology changes to reduce our die size and, as we discussed before, we continue to move a higher portion of our final test offshore. So, all of those are going to drive our costs down and our margins up, but we are going to have this dip in the second quarter.

OK, fair enough. Thanks very much, guys.

You're welcome.

For our next question, we go to Sumit Dhanda with Banc of America Securities.

Hi, guys. This is Eric Renati [ph] on behalf of Sumit. Going back to the wafer pricing negotiation, have you negotiated pricing with both of your wafer partners?

That's correct.

OK. And with respect to the agreement, are you guys still sharing the foreign exchange fluctuation impacts?

Yes.

If that's the case, how is it that we don't expect any gross margin improvement, to be higher relative to your prior expectation for the full year?

I don't understand your question.

Your prior full-year guidance was for 2004 was 47 to 49%. How come you don't expect upside to that?

Why would we expect upside?

Well, you've basically negotiated pricing for all this-- for your wafers, and you expect better units to improve in the third and fourth quarter.

The pricing on the wafers we re-negotiated back to the December/January time frame, so that-- we purchased the wafers. There's a lead-time till we would receive the wafers, then it flows through our P&L about two quarters later. So, the actual changing and re-negotiation of the pricing occurred in December and January, so we were aware of it when we gave the guidance at the start of the year. It's just the impact of it won't flow through until beginning in the third quarter.

Yes. Just to clarify, all of the things that we know now we knew at that time, as-- in terms of our cost and gross margin. So, there's really no change in what we knew about our costs as of January.

Can you talk a little bit about the cell phone market dynamics that you've seen in first quarter?

Yes. We mentioned that we had a significant rebound, as we expected, from the higher volume OEMs, so it was at the high end of our expectation. If you remember, we had said zero to 6%, and we had also said that the reason we have such a wide range is because we don't know how well these guys are going to rebound. And they came at the high end of our expectations.

OK. And finally, just with accounts receivable, receivable days went up quite a bit sequentially. Can you just talk a little bit about that?

Our days outstanding are typically in the low to mid-30s. At December, it was lower than what you would typically have because the quarter was so front-end loaded. As we mentioned last quarter, where we really saw the shortfall in revenue was in December, so the revenue in that quarter was front-end loaded, which drives your DSOs down. So, what we saw in the March quarter is more of a typical number.

Thanks very much.

You're welcome.

We go next to Andrew Huang with American Technology Research.

Hi, guys, two quick questions. First, can you give us a sense of where Motorola came in as a percentage of sales for the March quarter and for the December quarters?

So, what percent was Motorola of the--?

--Of total sales.

Of total sales. Well, first of all, we don't ship to Motorola directly. We ship to two companies, Bihong [ph] and Solone [ph], and overall, they represented about 6% of our revenue in each quarter, 6 to 7% in each quarter. They were up from Q4 to Q1.

OK. And then maybe you could comment a little bit about the cordless phone initiative that I think we've been talking about for the past few quarters, what the kind of status is there.

Yes. The EPA is negotiating with the manufacturers, and their current thinking is that they would move the date to the first of the next year, January 1st of next year, even though it's not finalized yet. That's their top process right now, and it's most likely that it will happen starting January of next year. However, what we are seeing is that there is a renewed interest from the cordless phone manufacturers in using LinkSwitch, so we are working with a number of them. If you remember, we started going that beginning of last year, and then somewhere around third quarter they decided that they are not going to implement it last year. But the same people have come back now, and they are again serious about using LinkSwitch. So, there is a good possibility that we could get a number of cordless design wins later in the year.

OK, great. And then, the last question, given that I guess in the March quarter you just reported 16 cents, and then at the high-end guidance for the June quarter you've got 15 cents, that kind of implies that, if we were to get to 80 cents for the full year, you've got 49 cents for two quarters. So, my question is, what kind of-- assuming that you do hit the high end of expectations, what kind of number are you expecting for the third quarter, because it could pan out to be something like 28 cents or the 21 cents, or maybe 25 cents and 24 cents for the third and fourth quarters.

Yes. At this point, we can't give guidance specifically for Q3 and Q4, but you can do the math, as you've just done. We said 70, 80 for the year, just did 16 and 14 to 15. Typically in the last couple years, except for last year, we have some revenue growth, let's say low single digits, from Q3 to Q4, and as we also discussed, we expect the margins will improve in Q3 and most likely, at this point, expect to see some further improvement in Q4, so obviously at this point, we would expect Q4 to be our strongest quarter of the year.

OK. And then, lastly, maybe you could kind of give us a feel for what kinds of things have you factored in, or what would you need to kind of happen to get to the high end of the guidance that you've provided?

Well, the revenue, in terms of what happens in the end market-- overall end market, if the end markets are strong, then that will help us. We have lots of ongoing design activity. We won designs this last quarter. We have a lot of designs in process. If we are successful in winning those designs, as we mentioned, a lot of the designs ramped in the third quarter because the new power supplies will go into new products that are ramping for the Christmas season. So, if we are successful with the design win, the rest of this quarter and then even into early Q3, then that would get us to the upside on the revenue.

And then on the margin, we've already, as we've mentioned, have a lot of things in place that are going to take the margin up, but obviously, we will continue to work to reduce our cost and get our margins up.

OK, thank you.

You're welcome.

We go next to Rob Adams with Adams Harkness & Hill.

Thanks, guys. Can you update us on your relationship with ZMD and what the timetable is there, please?

Sure. We are in the process of qualifying our high-voltage technology at ZMD, and we are making good progress. Our timetable is to have the fab qualified by the end of the year and start production the beginning of next year.

And in terms of that contract, is that dollar-denominated contract, or is it similar to your current ones?

It is dollar-denominated.

Excellent. And John, did you give an op-ex guidance? Did I miss that?

I didn't, but I would expect the operating expenses to be somewhere between 10.1 to 10.3m.

Excellent. Thanks much.

For our next question, we go to Todd Cooper with Stephens, Incorporated.

Hello. I'm curious. Other than being all-around good guys, what leverage did you have to negotiate lower wafer pricing?

That's a good question. Well, I think I mentioned this a couple of quarters ago, that one of the reasons we brought in ZMD was to get some additional competition, if you will, in terms of wafer pricing, and so we were able to use that to put together a timetable for cost reductions over time that will get all three of our vendors in line by the time ZMD comes along. But it's a good question. Does it make sense?

OK. Yes, it does, and I guess the way this works is that higher wafer costs that you were experiencing before you negotiated down, that had the impact of negatively impacting the gross margin in the first quarter, as well.

That's correct.

That's true, because the price reductions didn't take effect until January, which means that the benefit of that we will see only in Q3.

Can you give us an idea of how much of a reduction in cost you've been able to negotiate?

No, I would rather not make that public because it's very sensitive to our vendors.

I understand, OK. Then let me move on to order trends at Samsung. Have you got any more-- do you understand why they took inventory down as low as they did in the December quarter?

We don't have 100% information, but I think, as we discussed before, when they said they took their inventory down, based on the way they described it, it appeared what they were referring to is the inventory in their sales channel, so not their own inventory, but in all their sales channels. And they indicated on their conference call that it was done in a manner more or less to push revenue from Q4 into Q1. And so, they took down the inventory so that they could show more revenue in Q1 since they'd already met their numbers in Q4.

And in the March ending quarter, they order more than you think their sell-through was? Do you think they're building inventory back?

Based upon what they've said publicly in terms of what they shipped, and based on what we shipped to them, it appears that they're fairly well aligned.

OK, thank you very much.

Thank you.

For our next question, we go to John Lopez with Donoe [ph] Capital.

Hi, thanks. Just two clarifications. The first, just so I understand the margin progression past the second quarter, you detailed a number of positives offset by two negatives. Is there a reason that the margin wouldn't return to the Q1 level in Q3 once you've worked through the wafer digestion?

It's difficult to say if it would get to that level, but it-- clearly, I think by the fourth quarter, it could get to that level.

OK, great. And then--.

--So, it'll depend upon how fast it flows through. But, by the fourth quarter, I would definitely expect it to be at the Q1 levels.

OK, great. And then, the second clarification was you referenced the cordless phone initiative, the potential for that to impact the second half. Is that embedded in the guidance that you've given, or was that the upside if that-- the timing does stick this time?

I said that we would get design wins on the second half. That doesn't necessarily mean any revenues in the second half. It will impact next year.

OK, great. Thanks very much.

You're welcome.

And as a reminder, ladies and gentlemen, if you would like to ask a question, please firmly press the star key followed by the digit one.

For our next question, we go to Clark Fuhs with Fulcrum Global Partners.

Thanks. On LinkSwitch, that's supposed to open up kind of more of the mid-range rather than the high end of the cell phone charger business for you. About how much-- I mean, your current products before LinkSwitch were at about 40% of the-- addressed about 40% of the cell phone market. About how much more do you think LinkSwitch opens up?

Well, the LinkSwitch opens up the rest of the market. It's not just medium, it's all the way down to the low end of the cell phone.

And were there any high volume starts that occurred during Q1? Was that ramping in high volume?

Yes.

And that mid-range area, mid to low-end area?

Well, we generally classify it as low end and high end, the high end being addressed by TinySwitch-II and the low end being addressed by LinkSwitch, and we had two high volume design wins before the first quarter, which we are shipping at actually significant volumes to those two customers, and both are European customers. And this quarter, we got another high volume design win with a Japanese cell phone OEM, and we will start shipping that either this month or next month in full volume.

Great. And then, kind of a small housekeeping. What were the turns for this quarter, and what do you expect it to be for next quarter?

The turns for this quarter were in the low 70s, this quarter being Q1. and then, for Q2, we expect it to be in the high 60s, so a bit improved from where it's been.

Great, thanks.

Thank you.

And with a follow-up question, we return to Shawn Slayton with Ferris Baker Watts.

Hi. Balu, just a quick question on inventory. Is it accurate to say you feel comfortable with the level of inventory that's out there at your customers right now?

Yes.

OK, thanks.

And also with a follow-up question, we return to Steve Smigie with Raymond James.

Great, thank you. Actually, just a follow-up on that previous question. In terms of the inventory at the distributors, do you have any sense of whether your sales into that channel are greater than their sales out, or that relationship? And then, do you sense that there's any need for them to build additional inventory in the channel of your parts, or from some of your discrete competitors, that maybe they're a week or so low in terms of inventory. I was wondering if you were facing that condition, too. Thanks.

We exited the quarter with about 3-1/2 weeks of inventory in our distributors, and just to remind you, we recognize revenue on sell-through, not sell-in. at the end of December, it was about three weeks, so a slight increase, but still at very moderate level.

OK, and any sense of whether what you're shipping to the distributors is equal to or greater, less than what they're shipping out to their customers?

Well, as I mentioned, we started with three weeks and we ended up with 3-1/2 weeks, so pretty much what we were shipping them they were shipping to their customers. Since they carry such a small amount of inventory, it's more or less what we ship them, they ship out, and they'll adjust it. Even when it goes up at a quarter end, sometimes it's just because they're going to ship it the next day. They generally keep the inventories pretty linked.

Great, thank you very much.

And ladies and gentlemen, we have no further questions on our roster at this time. Therefore, Mr. Balakrishnan, I'll turn the conference back over to you for any closing remarks.

Thank you for joining us today, and we look forward to seeing some of you at the upcoming conferences. Thank you.

And ladies and gentlemen, this does conclude today's Power Integration first quarter 2004 results conference call. We do appreciate your participation, and you may disconnect at this time.