Power Integrations Inc (POWI) 2004 Q2 法說會逐字稿

Please stand by we are about to begin. Good afternoon and welcome to the Second Quarter 2004 Earnings Conference Call for Power Integrations. Today's call is being recorded. At this time I would like to turn the conference call over to Mr. Joe Shiffler. Please go ahead.

Good afternoon. Thank you for joining us. I'm Joe Shiffler, Director of IR and Corporate Communications for Power Integrations. It's a pleasure to be hosting our quarterly call for the first time since joining the Company, and I look forward to working with all of you, going forward.

This afternoon, we've issued a press release outlining our second quarter results. That release has been sent directly to those of you on our distribution lists. It's also available on our website, www.PowerInt.com. With me on the call today are Balu Balakrishnan, President and CEO of Power Integrations, and John Cobb, our CFO. Balu and John each have a brief set of prepared remarks, after which we'll take your questions.

Before we being, however, I would like to caution you that our discussion today including the q-and-a session 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 words as, "will, believe, should, expect, outlook, estimate," and similar expressions that look toward future events or performance. Forward-looking statements are based on current information that is, by its nature, dynamic and subject to rapid and even abrupt changes.

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 10K and 10Q, filed with the SEC.

With that, I'll turn the call over to Balu.

Thank you, Joe, and good afternoon, everyone. We are very pleased today to report strong results for the second quarter. Our revenues grew 21 percent year-over-year, and more than 5 percent sequentially, coming in at $35.9m. That's at the high end of our guidance, and it represents record revenues for Power Integrations.

While we grew revenues 21 percent year-over-year, operating expenses grew less than 2 percent in the second quarter. As a result, we were able to achieve the high end of our earnings guidance, at $0.15 per share. The gross margin was 46 percent, this quarter -- down from 48.9 percent last quarter -- as expected. The primary reason for the decline, as explained in the last earnings call, was lower overhead absorption as we reduced our inventory earlier this year. To a lesser extent, the strengthening of the Japanese Yen over the last year also contributed to the decline.

The effect of the inventory reduction is now behind us, and as a result, we expect to see gross margins increase to approximately 48 percent in the third quarter. From a market performance perspective, our diversification efforts are really very prudent fro us. Despite a relatively modest growth in our communications market, we achieved strong overall revenue growth for the quarter, thanks to continued strong performance in our other markets -- namely consumer, computer and industrial.

In particular, our continued penetration in PC standby, set-top boxes, DVD, home appliance and industrial applications was a major contributor to our growth. In terms of products, TOPSwitch-GX and TinySwitch-II continued to ramp very nicely, with each having dozens of designers this quarter, and our newer products -- LinkSwitch and DPA-Switch -- continued to gain market acceptance.

On the intellectual property front, we added two US and two foreign patents -- which is an all-time record for a single quarter. Our portfolio now includes 94 US and 64 foreign patents. We also initiated a foreign patent infringement suit in order to enforce our intellectual property rights. I will talk a bit more about that in a moment.

Now let me move on to the specifics about each of our markets. Revenues from our consumer market, which we now believe will be our largest market this year, grew 43 percent year-over-year and 13 percent, sequentially. This growth is coming from a diverse mix of applications. In set-top boxes applications, for example, we were up more than 90 percent, year-over-year. In DVD-player applications, we grew more than 80 percent. In home appliances, where energy efficiency is very important, we grew nearly 40 percent. Obviously, we're growing substantially faster than the end-market for each of these applications. So we are gaining market share very quickly.

Moving to the communications market, revenues were up 5 percent year-over-year and down 7 percent, sequentially. We believe that sequential decline was due primarily to softness in certain segments of the cell phone market, and to the transition to our [Leslie] products at some [charger] manufacturers.

Looking at the year-over-year perspective, our unit shipment for the cell phone application grew at the rate consistent with the end-market. However, revenues grew only slightly due to a mix-shift to lower power devices and lower ASPs. Nevertheless, we remain very optimistic about our revenue growth prospects in cell phones.

Until recently, we could cost-effectively address only high-end cell phone chargers, which constitute less than half of the cell phone market. However, with LinkSwitch, we address many of the transformers used in lower-end chargers, which are able to attack the entire cell phone charger market. As such, we believe we have a second stage of growth ahead of us in the cell phone applications

I should add that while we're diversifying our overall business, there's a diversification story even within the communications market. Within the cell phone business, we have added several new end-customers in the last year, including LG and Alcatel. Also, communications applications other than cell phone chargers grew 38 percent year-over-year and 9 percent, sequentially. These applications include [Y over IC] phones, network hubs, modem and wireless access points.

Moving to a computer market, revenues grew 18 percent year-over-year and 23 percent, sequentially. PC standby is the key driver, here -- the server standby also contributing, significantly.

Our ancillary monitor business grew year-over-year, though growth has moderated somewhat, recently. This is due to end-market weakness and to competition from System General, a Taiwanese telecommunications company. We believe that System General's controller chip, which is used in discrete solutions, [inaudible] several of our patents. As you know, we have initiated a lawsuit against them in order to enforce our patents.

In the industrial market, revenues grew 21 percent year-over-year, although they declined, sequentially. It's a very fragmented market, so quarterly fluctuations are difficult to anticipate or explain. The year-over-year growth was driven mainly by applications such as industrial and motor controls.

We continue to see strong, ongoing design activity across a number of industrial applications. Our expected revenue mix by market for 2004 is -- Consumer 34 percent, communication 32 percent, computer 21 percent, industrial 9 percent, and "other" 4 percent.

Now let me say a few words about each of our products. TOPSwitch-GX and Tiny II are in full stride, showing strong design ideas and design activity across all of the DC market, and providing the primary engines for growth. -GX, which address applications between 10 and 250 watts, has designs this quarter in a wide range of applications. It is the key driver behind our set-top and set-top boxes, where we won several new designs this quarter. TOPSwitch GX also won designs in DVD players, PC standby, LCD monitors and TVs and a number of other consumer and industrial products. TinySwitch II, which is for applications between 2 and 20 watts -- all sorts of designs and all four of our major market segments. Designs include cell phone chargers, PC standby, TV standby, DVD players, home appliances and industrial applications.

We added two new products to the TinySwitch-II family this quarter, with the introduction of TNY263 and TNY265. These products enable us to offer customers the ability to choose the lowest-cost product for the power level they need.

Turning to our most recently introduced products -- LinkSwitch and DPA-Switch. Our LinkSwitch product is intended to displace linear transformers, also known as energy vampires. Linear transformers are still the most-common solution of applications below 3-watt. But they will ultimately be squeezed out of the market by energy-efficient regulations.

This is a very high-volume market with greater than a billion units, annually. A large portion is in the cell phone market, with more than half of all chargers are currently linear transformers, as I mentioned a moment ago.

LinkSwitch also opens up opportunities for us in applications such as cordless phones, as well as countless small appliances and industrial applications. LinkSwitch remains in the design phase or the designing phase with a modest revenue contribution at this point in its lifecycle, which is typical of our products.

The one design in the consumer communications and industrial markets this quarter, including a high-volume design win with another major cell phone OEM. Today's LinkSwitch has won high-volume charger design at 4 major cell phone OEMs.

While the pace of design met with LinkSwitch has met our expectations, the revenue ramp has been slower than initially projected by customers, due to softness in segments of the cell phone market and delays in introduction of new products.

As a result, LinkSwitch will not contribute as much revenue this year as we initially expected. However, we believe this is simply a short delay in the revenue ramp, and we remain very optimistic about the growth prospects of LinkSwitch.

DPA-Switch. Our first DPA-Switch product family, designed for distributed power architectures up to 100 watts, continues on its designing ramp. We ran a number of low-wattage designs during this quarter, and a medium-watted design for a stackable, Ethernet switch access call. We're excited about the first entry of our DPA-Switch family into a large telecom OEM.

Design activity continues in all targeted applications, included power over Internet, which is addressed by our recently-introduced extensions to the family. As previously stated, this is a brand new market for us, and also because it's a highly fragmented market, we expect revenues from this family to grow gradually over the next few years.

Our forecast for revenue mix by product family is now TinySwitch I and II at 50 percent,-FX and GX at 30 percent, TOPSwitch I and II at 14 percent, and LinkSwitch and DPA-Switch combined at 6 percent.

Let me draw you a brief update on energy efficiency, where trends remain highly favorable for us. First, I'm happy to report that Power Integrations' EcoSmart technology is now generating energy savings at an estimated rate of more than $1m per day, worldwide. Of course, the rate continues to accelerate as we gain market share and more EcoSmart devices are sold around the world.

Total estimated savings since the inception of EcoSmart now exceed $620m. For every dollar spent on our Power Integrations' EcoSmart devices to replace older technologies, we estimate that consumers save $10-15 on their electricity bills over a 5-year period.

Numerous standards are in development around the world to improve the energy efficiency of a broad range of electronic products. For example, the EPA supports a electric classification for external power supplies, including a limit on normal consumption, as well as minimum efficiency requirements during normal operations. These guidelines are scheduled for release in September, at the International Power Supply Exhibition in Beijing.

In addition, the EPA is working with may other countries, including China, to harmonize energy efficiency standards around the world. The new, tighter European Union corded product guidelines for external power supplies are scheduled to take effect January 1st, 2005. These standards impose tough requirements for normal consumption, which are very difficult to meet with linear transformer designs. As a result, we continue to see an increase in the level of design activity to meet these standards -- especially in cell phones and cordless phones. These developments are clearly beneficial for Power Integrations, both short-term and long-term. Our products enable manufacturers to meet all current and proposed energy-efficiency standards, and we believe we are positioned as a provider of choice for manufacturers faced with ever-tightening requirements.

Now let me turn to the competitive pricing environment. The competitive pricing at high-volume power-supply manufacturers continues to be aggressive, but relatively stable. The slight increases in competitive pricing we saw at lower volume manufacturers in the first quarter, appear to have leveled off. We believe this is due to the recent softness in overall market demands, which have eased capacity issues and reduced lead times for competing discrete and integrated components.

On the flip side, we continue to reduce our manufacturing costs, which should help us offset price erosion, and allow us to be more aggressive in the marketplace, while maintaining lower margins. As we mentioned before, we are shifting and increasing and monitoring testing offshore, which will help us reduce test costs over the next two years. We are also making significant strides and reducing test times and improving our process technology to further reduce costs.

Finally, let me add a few words about our outlook, before I turn it over to John. We are looking ahead to a significant growth in the second half of the year. As we have said in the past, we expect the majority of our growth to result from market penetration, regardless of cyclical factors, and growth rates in the end-markets. Thus, despite the reported softness in some of the end-markets, we expect our results for the year to be within the ranges we provided at the beginning of the year. We now expect the revenues for the year to be between $150m and $155m, which is the lower half of the range we initially provided. John will provide additional details on the guidance in a moment.

In summary, we are very pleased with our second-quarter performance. And we believe that we are well-positioned for growth in the remainder of the year. Our products are showing great traction in the marketplace, across a very broad array of applications. We are doing very well in terms of penetrating the [inaudible] market, and we are taking advantage of our operating expense leverage to drive higher profitability.

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 from the second quarter. As Balu said, we achieved the high end of both our revenue and earnings guidance, demonstrated considerable operating expense leverage, and further strengthened our already excellent balance sheet -- increasing our cash balance and reducing inventory. Now on to the details.

Net revenues for the second quarter were $35.9m -- an increase of 21 percent from the $29.8m reported in the same period last year, and an increase of 5 percent from the $34.2m reported in the first quarter.

In the second quarter, our 10 percent customers were distributors [Memex and Synex], at 19 percent and 18 percent, respectively. And Samsung at 11 percent. Distributors accounted for 55 percent of revenue for the quarter, and as a reminder, we recognize revenue on sell-through, not sell-in. Average selling price for the quarter was $0.48, and turns orders comprised 69 percent of revenue. For the quarter, our gross margin was 46 percent of net revenues -- in line with our guidance. This compares to 50.8 percent in the second quarter of 2003, and 48.9 percent in the first quarter.

As we have explained, the decline in gross margin was due primarily to lower absorption of fixed overhead, as we scaled back production earlier in the year in order to reduce our inventory. To a lesser extent, the impact of a stronger Yen over the last year also contributed to the decline in gross margin. We expect our gross margin to improve to approximately 48 percent in the third quarter, and we expect gross margins for the full year to be about 48 percent, as well.

Operating expenses in the second quarter were $10.1m, compared to $9.9m in the same period last year, and $9.8m in the first quarter. Overall, operating expenses as a percentage of revenue declined to 28 percent in the second quarter -- from 33.2 percent in the same period last year. Demonstrating the operating expense leverage on our financial model, our revenue increased 21 percent year-over-year, while our operating expenses increased less than 2 percent.

Income from operations in the second quarter was $6.5m or 18 percent of net revenue. This compares to $5.2m or 17.5 percent in the same period last year, and $6.8m or 20 percent in the first quarter. In the third quarter, we expect operating margins in the range of 21 to 22 percent.

Net income for the second quarter was $5m or 15 percent of net revenues, compared with $4.2m or 13.9 percent in the same period last year, and $5.1m or 15 percent last quarter.

Earnings per share for the second quarter of 2004 on a diluted basis were $0.15 per share, on approximately 32.6m shares outstanding. This compares with $0.13 per share in the second quarter of 2003, and $0.16 per share last quarter.

We have revised our effective tax rate for 2004. Previously, we were estimating a 28 percent tax rate. However, as a result of higher-than-expected tax benefits from our international operations, we are now estimating that our effective tax rate will be 26 percent. Our second quarter financial statements reflect a year-to-date adjustment down to the 26 percent rate. The full-year impact of the change should amount to about $0.02 per share, though the adjustment did not change our EPS for the second quarter. We were at $0.15 with or without this adjustment.

Moving to the balance sheet. Cash and investments at the end of the second quarter were $134.9m -- an increase of $11.4m from the prior quarter. During the second quarter, we generated $11.7m of cash from operations.

Net accounts receivable were $13.1m at the end of the second quarter -- down from $13.3m in the first quarter. Days sales outstanding on net receivables at the end of the quarter were 33 days -- compared to 35 days the preceding quarter.

Inventories at the end of the second quarter were $19.8m -- a decrease of $1.5m, from $21.3m in the first quarter. Inventory turns in the second quarter increased to 3.9 from 3.3 in the first quarter. In the third quarter, we expect inventories to remain in our target range of 3-4 turns.

Turning now to the outlook for the balance of the year. As Balu noted, we expect 2004 revenues to be in a range of $150-155m, which is within the range we provided in January. Again, full-year gross margin is expected to be approximately 48 percent, which is the mid-point of the range provided in January. Earnings per share, including the $0.02 positive impact of the lower tax rate, are expected to be in the range of $0.72 to 0.77, also within our prior guidance.

As always, with our high level of turns business, forecasting is quite challenging. This is particularly true for the third quarter. The months of September and October are typically stronger than other months, but since these months straddle two quarters, it is difficult to predict how much business will come in the third quarter and how much will come in the fourth.

That said, based on information available today, our estimate for sequential revenue growth is between 6 and 12 percent for the third quarter. We require turns orders in the mid-70 percent range, in order to meet the mid-point of this guidance. This level of turns business would be slightly higher than last year's third quarter number. Gross margin for the third quarter is expected to be approximately 48 percent, and we expect EPS to be between $0.18 and $0.21.

That concludes our prepared remarks. Now I'll turn it back to Joe. Joe?

Thanks, John. Before we take questions, I'd like to mention a couple of upcoming conference [inaudible]. We will be at the Adams Dartmouth Summer Seminar in Boston on August 3rd. Then the SG Cowen Technology Conference, also in Boston, on September 10th. We look forward to seeing many of you there.

Now, Operator, could you please open the line for questions?

Thank you. Ladies and gentlemen, if you would like to ask a question at this time, you may do so by pressing the star key, followed by the digit 1 on your touchtone telephone. Again, star-1 for questions or comments at this time. It's star-2 to remove yourself, should you find your question has been answered.

Also, if you're using a speakerphone, please be sure to pick up your handset or make sure that the mute function is turned off in order for your signal to reach our equipment. Again, star-1 for questions or comments at this time. We will pause for only a moment to assemble our question roster.

We'll take our first question from [Steve Midgi] with Raymond James.

Great. Thank you very much. My first question is with regard to the guidance for the 6-12 percent sequential growth. I was just wondering -- obviously in the past four quarters, you've seen pretty strong growth in the third quarter. You'd mentioned maybe something that gets pushed off and talked to [over]. I guess my question is, is that why you're guiding somewhat lower than some of the growth perhaps that you've seen in the last couple years in this sort of timeframe?

What you're seeing is since the beginning of June, the bookings have slowed down. Slowed below our normal expectations. I think that's something that everybody else has seen, and it continues to be below normal for the first three weeks of July. So based on what we have gathered from our sales people, it looks like we will have a stronger Q4 than Q3, because the customers are delaying their purchases in Q3. And to a larger extent, it will depend on which month will be stronger -- whether it will be September or October. So our best estimate at this point is 6-12 percent in Q3 -- which will translate to higher-than-normal growth for Q4.

Great. So it sounds like it's more just a shift thing -- a little bit of a pushout rather than demand sort of drying up in general?

Yes. It looks like everybody's seeing that. There is a slowness in bookings, now. We expect that the change in August and September -- we expect the bookings to get much stronger as people get ready to build the products for the holiday season.

Great. My second question relates to the cell phone business. Is the weakness that you experienced there related to some market share losses? Or was it more of a particular weakness, say, in one specific segment -- maybe mom and pop shops in China versus say Motorola or Samsung type business?

We have not lost any market share that we are [weak in material] in period in 2004. So the softness comes from China, where the end-demand seems to be significantly softer. It also comes from some customers of ours transitioning to lead-free products. As you know, a lot of customers are now moving to lead-free. So there are some transitional issues in terms of switching over from the regular products to lead-free products.

Okay. Thank you very much.

You're welcome.

We'll go next to [Vernon Nephew] with Janney Montgomery Scott.

Yes. Thank you. First off, just on the financial side. Wondering if you could give us a little bit more color on the operating expenses, John, as we go into the third and fourth quarter. I appreciate the operating margin guidance, but these are kind of bounced around a little bit. Can you dive into this a little bit more for us?

So in terms of operating expenses for the third quarter, we could expect our operating expenses to increase about 2-3 percent, sequentially. That would be pretty consistent across the three elements. Then in the fourth quarter, we expect the operating expenses to maybe go up 4-5 percent beyond the third quarter.

Okay. And if I had just any reason in particular -- maybe you mentioned this and I missed it in my notes here on G&A -- why it bumped so heavily?

Yes. G&A increased for two reasons. One was the legal costs incurred relating to our patent infringement suit. And then secondly is the Sarbanes-Oxley 404. Joe Shiffler: We are in process of doing all the documentation and the evaluation and the testing. And so we have some outside people that are helping us do that. So that was a main reason for the increase in that area.

Just to dive in on that one, would you be expecting that to decline on a dollar basis, sequentially, or be flat?

That piece of it, probably down a bit slightly, in Q3. And then hopefully maybe down -- the Sarbanes-Oxley 404 may be down a bit more in Q4.

Okay. And then just on the macro here, and I'll hand the line over. I wondered if you could discuss the pricing environment. It sounds to me like you have some folks out there that don't want to take supplies until later in the year on their pull rates. Is that coming into the pricing equation? You're seeing a little bit of ASP erosion, here. Is this something we should expect to continue for the rest of the year? And can you give us some comfort that it may or may not happen?

Well, as I mentioned, the pricing continues to be aggressive at our large-volume customers. They never went up. We were hoping that they would go up. We saw some price increases on discrete components and individual components on the smaller-volume customers, and that has leveled off. But the high-volume customers are stable. They're relatively stable, but they've not gone up.

But I mean it just seems that your ASP has been declining the last couple of quarters, and I'm just curious if you're expecting this to sort of -- it sounds like you're saying this will stabilize then, for the rest of the year?

Well, a significant part of that is a mix rather than a price erosion. Because as you go to lower power levels on DVDs and cell phones and so on, the components that we sell at lower power levels are lower ASP.

Okay.

Many of these products have gone to lower power levels.

And then, well, I guess, and then to back up a little bit. Another part of my question is, is there any particular reason in particular from your customers' discussions and dialogues, why there would be sort of a postponement until the September or October timeframe, before they start increasing their pull rates? Is that more of a demand-based environment from their perspective, or is this a jockeying-for-price perspective?

Yes. To the best we can understand, a couple of factors. One is, it looks like in the overall market, they were more optimistic than they should have been in the first half of the year. So they ended up building more products, and I think they're taking a breather now. Because the end market, from everything we've heard and that's been reported, it appears to be softer in the second half than people were expecting.

So we expect our bookings to pick up in the August - September timeframe, which means that it's been kind of shifted out a little bit in time. And that's also the reason we actually moved our yearly guidance to the lower half of our range. Because the end-markets, we believe, are going to be softer than originally thought.

Okay. Thank you very much.

You're welcome.

We'll take our next question from Lee Zeltser with Needham & Company.

Hey, guys. I was wondering if you could talk a little more detail about linearity in the quarter, month-to-month in the June quarter.

In the June quarter, our bookings were very strong, actually, in the first two months. June saw a significant decline in our bookings.

But the shipments during the quarter were fairly linear.

Okay. And if I understand the guidance correctly, the seasonal pattern going into the second half is going to be a little bit more weighted to the back half or the second half. Is that your expectation?

That's what it looks like, right now. Based on our forecasts from our sales people.

Okay.

If you go through the math, we said 6-12 for the third quarter.

Right.

And then that would imply the fourth quarter would be around 8 percent. So we're expecting lower growth in the third quarter, but lower in the fourth quarter than what we've historically seen.

Right. Understood. Okay. And as you look to the pricing ground -- I know you've been aggressive in 2004 -- in an effort to gain share and drive volume -- how long do you think that's going to continue?

Well, the adjustments we made in 2004 continue to impact us through this year. But we're also making significant cost reductions, and so from a margin point of view, we are doing -- we will maintain the margins unless there's a dramatic change in the marketplace. So as far as pricing, it looks like the softness in the last month or month and a half has directed competitive solutions from increasing their prices. They've decided to leave the prices alone. Especially with high-volume customers.

Yes.

But we continue to reduce our costs. Reducing our test costs, reducing our silicone costs -- and we'll continue to do that. In fact, we have plans to continue to reduce the costs over the next two to three years.

Okay. I'm going to ask the question a little bit differently. How much would you say your ASPs -- not on a mix-adjusted basis, but just on a product-to-product basis -- how much have they dropped this year? Or how much should they drop this year?

Probably in the high single-digits.

Okay.

And that's the result of the pricing adjustments we made last year.

Right. Okay. Thank you very much.

We'll go next to [Andrew Wang] with American Tech Research.

Oh, hi. I just wanted to clarify one thing on the end-market demand. The commentary suggests that second-half demand is not what you expected it to be.

From the end-market perspective. Yes.

Okay. And is there any one particular end-market where you're seeing more weakness? More relative weakness than others?

Cell phone, probably, on a relative basis. But frankly, it seems somewhat broad based. But probably more so in cell phones than in other areas. Again, this is relative to expectations. Not just our expectations, but I think a lot of other people.

But as you noticed, we are growing market share very, very nicely, in consumer and computer and industrial markets.

Okay.

So overall the expectation is lower, and it's widely reported it looks like the first half of the year was stronger than expected. Relative to the second half, the cyclical seasonality is a little different, in that respect.

Okay. And I was wondering maybe without giving away too much competitive information, if you could give us a sense of the number of units you shipped to cell phone type customers -- what that sequential growth was?

To cell phone customers? Our cell phone revenue sequentially was down about 7 percent.

Okay. So I guess then the question is, you said in your prepared remarks that you're confident that you're not losing share.

Right.

In the cell phone market.

Right.

Yet if you look at the top five cell phone manufacturers, in units, they reported a sequential increase.

Yes. One thing that we've always commented on is that we never align with the end-market. So as an example, our shipments to Samsung were down sequentially from the first quarter, and as Balu mentioned earlier, that was due, we believe, to transition from leaded components to lead-free components. We are very confident of our position at Samsung, in terms of we know that a portion of the business Fairchild has. But we have all the remaining business. So we know that. And we have a very high level of confidence in that.

In Motorola as an example, they were down, sequentially. But our shipments to their suppliers were up, sequentially, more than 30 percent. Which is just on the flip side of how we just don't always align perfectly with our end customers.

Right.

And then as you know, we do have a large exposure to China. And while we don't have final information there, the preliminary indications are that things are still a bit weak in China.

Okay. Thank you.

Sure.

And once again, ladies and gentlemen, that was star-1 for questions or comments at this time. Again, star-1 for questions or comments. We'll go next to Sumit Dhanda with Banc of America.

Hi. This is Jason Jones for Sumit. Just a quick question on the pricing environment in your other segments besides handsets. Can you comment on that a little bit?

Could you repeat that question? I missed the last part.

Right. Could you comment on the pricing environment in the other segments besides handsets?

Actually, the pricing environment is pretty much independent of the market segment to a large extent, I should say. The reason for that is we sell our products to power supply manufacturers, who then sell the power supply. Whether it's for DVD or it's for a cell phone or for a set-top box. So our customers are pretty much the same. The driving issue is across the board.

The only difference would be in something like the steel markets, where it's very fragmented. And many times we sell directly to the OEM. But that's a very small portion of our market.

Okay. Thank you.

You're welcome.

We'll go next to [Eliot Ransel Reese] with Waddell and Reed.

Hi. Running some math -- looking historically at your vertical mix and the percentages you've reported. And your guidance here, now, for communications. I've come up with a single-digit revenue growth for '04 over '03, which was down from '02. '02 had a big growth on top of a weak comparison in '01. It just looks like that this segment of the business is long-term floundering along. I'm wondering why this shouldn't comp strongly into '05.

Yes. That's a good question. If you look at our shipments in Q2, versus the same time last year, in terms of unit shipments, we grew [16] percent, which is consistent with the market growth. But in terms of revenue growth, it was about 2 percent -- mainly because of the shift toward lower products and also because of price erosion -- price reduction over time.

So in the cell phone market, we have not gained market share. We've maintained our market share, but we haven't gained it. And that's where we believe the links which will help us penetrate the other half of the market, which we haven't been able to address. So the main reason for that is that we have already a very high percentage of the high-end market, and we are finding that our customers are not willing to give us 100 percent of this business. They always want to have a discrete or some other alternate solution as at least part of their business, so that they can keep us honest and beat up on us on pricing.

The growth going forward will come from the lower end of the market, which will be [deflating media] transformers with LinkSwitch. For the last year or year and a half, our share has been fixed in the cell phone market. We've grown with the market, in terms of units. But going forward, we believe that we can grow our market share in cell phones.

It seems to me just within the universe of handsets that what I would characterize as high end, what would need an advanced charger, would be growing sequentially through the handset numbers. Which makes it seem like ASPs for you, and mixed for you. It has to have been pretty negative over quite a period of time to've not captured any real revenue growth out of that.

Well, two things. The high-end phones -- the power levels have come down dramatically. I mean you just look at two years ago. The high-end phones required anywhere between 6-9 watts. Now the same high-end phones, thanks to all the power management and improvements in cell phone design -- they require only anywhere between 1.5 to 2.5 watts to charge the battery. So that has reduced our ASP, because now they can use a lower-power product.

But if you really look at the numbers, unit volumes shipped -- we have maintained our share. It's just a question of increasing our share through displacement of linear transformers. Now in terms of the ratio between linear and the high-end chargers -- it varies quite a bit from one volume to the other. If you look at Nokia, most of their phones use the linear transformer-type charger. That's also true for a significant portion of the China market, which has the PHS phone. They're all linear, right now.

So there is a large percentage, which is more than half of the cell phone market, continues to use linear transformers. Although they're all in the process of redesigning them to use the switching-type of solutions which we support. And over the next few years, they will all become [inaudible] switching solutions or high-end solutions, because of the energy-efficiency requirements.

Should you have enough visibility in terms of design wins to feel pretty comfortable about handset revenues accelerating for you sometime over the next year and a half? Or do you need more than what you have in hand now?

Well to a large extent, it depends upon how quickly the OEMs can work from linear transformers to high-end solutions. Frankly, I'm disappointed by the rate at which it is happening. I expected them to switch a lot faster. Having said that, we have been able to do that at four large customers with LinkSwitch -- which is what we expected in terms of design wins at the beginning of the year.

However, these four customers have had delays in their products. And also, the volumes they projected were a lot higher than what they're actually buying, now. Although long-term that doesn't change anything. They're still saying they're going to convert over to the electronic solution. It's just that it's happening slower.

Okay. Thank you very much.

You're welcome.

The next [Eliot Glazer] with [Dupas Choir].

Yes. Gentlemen, I apologize if this question's already been asked. Can you give us a description of both your inventories and your opinion of your customers' inventories?

Well, our inventories were down from the prior quarter. We're at 3.9 turns, which is at the high end of our target range. So we're in outstanding shape. Our distributors, and as I mentioned in the script... Our distributors we recognize revenue on sell-through. So they typically don't carry much inventory. At the end of last quarter, they only had four weeks' of inventory.

While we don't' have perfect visibility into the actual OEMs or charger manufacturers themselves, we believe their inventories at this point in time are fairly lean. So in general, the inventory throughout is fairly low.

Thank you very much.

Well go next to [Shawn Sleighton] with SG Cowen.

Hi, Balu -- John. This is [Deepak Situr]. I work for Shawn. I know you guys have touched on this briefly, but can you go over sort of where you see room for improvement, or where you see the opportunities in the cell phone charger market?

The biggest opportunity we have is to replace the linear. There is no question in my mind that over the next two or three years, all of the linear will be replaced. For many reasons. One is energy efficiency. Number one is energy efficiency. There are many regulations, and they're spreading to a wider range of products and more countries, including China, Australia, Taiwan, and so on -- and certainly Europe and the US. The second reason is that the linear, which have a lot of material content -- they're made of a lot of raw materials like copper and iron -- the prices of those raw materials have gone up dramatically over the last year. Copper has almost doubled. Iron has gone up about 30-40 percent. The predictions are that these will remain here or continue to increase in price as the economy improves worldwide.

So the linear are becoming more expensive, and they're becoming less desirable from an energy-efficiency point of view. Also, I think that once you switch over a portion of that market to the electronic power supply, it'll be harder for the remaining market to continue to sell linear.

One of the reasons linear is so cheap is because of their volume. They manufacture such high volume. But if you take some of the demand away, there'll be less incentive for the linear particle manufacturers to offer the prices they're offering, because they'll be running at much lower volume.

Great. Also on the competitive front, you talked about discrete. But are you aware of any activity from Integrated competitors?

Certainly. We have a number of Integrated competitors. At the moment, the most active are Fairchild and [SD]. They'll have a small portion of our market. I think we talked about that last year. At Fairchild, they have a small portion of the cell phone market. We used to have 100 percent of the market, and before that, they had a portion of the market. Now they have come back and they have a small portion of the market. However, they have one design at one of 7 or 8 subcontractors that supply to Samsung. And the subcontractor which chooses Fairchild also uses us in all other designs except this one model. And that situation hasn't changed in the last three or four quarters.

Okay. Great. Thank you very much.

You're welcome.

The next question comes from Todd Cooper with [Steven], Inc.

Yes. Balu, to address a previous question regarding cell phone growth or lack thereof, would you maybe from a different perspective -- can you tell us why you were just now able to penetrate LG and Alcatel?

The LG had used linear for a long time, because they're a significant percentage of their business. So with the LinkSwitch, we're able to replace those linear. And in the process, we're also able to get into the high end of their business.

And we've also significantly expanded our sales force in Korea, so they're able to go after new customers. Not only LG -- medium and small-sized customers.

What percentage of LG's business do you think you have, now?

You know actually, I don't have that information with me. I know we've got several different [inaudible / crossing]

Todd, I would estimate it somewhere between 20 and 30 percent, based on what we ship to them and the handsets that they ship.

And who did you compete with to win that business? What type of competitor? Discrete? Or the...?

Well it's discrete, it's linear transformers. And also, the Integrated competitors I talked about.

Where is the next biggest opportunity like an LG for you to penetrate?

Well we still have a lot of opportunity within LG. We only have a small percentage, as we said before. But we have a significant opportunity in China and of course Nokia is a big one, too.

Has Nokia's attitude toward using solutions like yours changed?

It is definitely changing. They're asking their vendors to propose electronic solutions that will meet the energy-efficiency guidelines. And they've also signed up to meet the European guidelines -- which is voluntary -- but they signed up to it. But it's gradually. It's a gradually-increasing percentage of their business.

And not to forget, Motorola still uses linear on a portion of their chargers. And we are certainly going after those.

Okay. Thank you very much.

You're welcome.

We'll go next to follow-up from [Steve Midgi] with Raymond James.

Great. Thank you very much. I was wondering if you could comment on -- you talked about linearity. I'm not sure. Did you discuss July at all? If you could talk about that, briefly.

The only comment on July at this point is we mentioned or Balu mentioned earlier that the orders were strong in April and May. And they weakened in June. They've continued to be fairly weak in July.

That's pretty normal, though, to see weakness in July?

Not to the degree that we're seeing it.

Okay. Fair enough. Then if you could comment on lead times. I know they've been very short for you. And you had pretty high turns again. But have they extended at all? Or are you still in the same place?

Not for us. But competitive products. What we hear from customers is that the lead times have come down a little bit because of the softness in the market.

Okay. Thank you.

Once again, ladies and gentlemen, that was star-1 for questions. Again, star-1 for your questions or comments. We'll go next to Lee Zeltser, with Needham & Company.

Hey, guys. You gave a breakout in terms of product revenue for the LinkSwitch and DPA-Switch? It think you said about 6 percent. If you could just give that a little bit more detail -- how much of that is the DPA-Switch?

It is a smaller percentage. Link is going to be a significant portion of that. We won't know for sure until the end of the year. The reason is because we're ramping up by definition. They're back-end loaded. Depending upon one or two programs, it can change quite significantly. But you could assume that the LinkSwitch is a bigger portion of that 6 percent.

Can you just give us some design win metrics? How many design wins do you now have for DPA-Switch and LinkSwitch? What's a good way of kind of tracking progress, on which [inaudible] is the more significant as it contributes to revenues?

Well apparently our design wins are not created equal. We have probably 15-20 design wins on DPA-Switch, but they're small-volume. The Link-Switch, we probably have a similar number -- however, the four large-volume design wins I talked about in cell phones, by far dominate the volume. So that's why they're relatively small -- because they're industrial applications in appliances.

So giving you a number on the design wins is not a very good way to gauge the revenue impact. The best way I would describe it is we have four large... When you say "large-volume," you're talking about at least 100,000 pieces a month. And some of them are 100,000 pieces in the case of LinkSwitch. But the DPA-Switch has a very high... It's a relatively high ASP. And the ASP on the DPA-Switch will be a little over a dollar, whereas a LinkSwitch will be closer to 1/3 of a dollar. So again, that also has an impact on the overall revenue generated.

That's if we're kind of talking low-volume applications for DPA-Switch. What changes that? What's kind of a good milestone where we could see DPA-Switch becomes a bigger contributor?

I think that as we get into the Voice-Over IP and the Power-Over Ethernet applications, you will start seeing more significant volumes. The PC-to-PC market in general is very fragmented. Lots of lower- and medium-wallet designs. But there are certain areas where the volumes are quite high. One of them is the power-over Ethernet. We are very optimistic about getting some design wins there.

Does it in part have to do with the growth of the point of load market or is a DPA-Switch not a point of load product?

It is not a point of load product.

It's a brick-oriented product?

Yes. The easiest way I can describe it is it converts 48 volts down to lower voltages, whereas point of load is usually low-voltage products that converts 12 volts down to 1.1 or whatever. So we don't play in that market at all. We play in the distributed power architecture market.

Okay. Understood. Thank you very much.

You're welcome.

We'll go next to [John Slovik] with Westfield Capital Management.

Hi. Sorry if this is redundant. Balu, could you characterize the most recent LinkSwitch design win at the OEM? Are we talking top 10 OEM or top 5 OEM?

I would say 3 out of the 4 I described are probably in the top 10. The other one is a lower volume. But they're still high-volume. Meaning that they're still 100k-plus per month. But you know, a couple of them are in several hundred k per month.

Okay. Just one more thing. On the design win at Cisco. Maybe just a little more granularity on that side for DPA-Switch, please?

Sure. This goes into an Ethernet-stackable switch, which is actually a medium- to high-volume product line, from our point of view. I mean for Cisco, it may be large-volume because they sell whole systems. But it ramps up over a period of a year or so. It starts with a few thousand pieces, but it goes up to 50-100,000 pieces by the beginning of 2006. It ramps up over a year to a year and a half. So it's actually a pretty medium- to high-volume business.

Okay. Thanks a lot.

Thanks.

And ladies and gentlemen, that does conclude today's question-and-answer session. At this time, I'd like to turn the conference back over to Mr. Balakrishnan. Please go ahead.

Thank you. That concludes our call this afternoon. Thanks everyone for joining us. We look forward to seeing many of you at upcoming conferences. Thank you.

Thank you for you participation. You may disconnect at this time.