Power Integrations Inc (POWI) 2004 Q3 法說會逐字稿

Good afternoon everyone. Welcome to the third quarter 2004 earnings conference call for Power Integrations. Today's call is being recorded. At this time I would like to turn the conference over to Joe Shiffler. Please go ahead sir.

Good afternoon. Thank you for joining us. I'm Joe Shiffler, Director of IR and Corporate Communications for Power Integrations. This afternoon we have issued two press releases, one outlining our third quarter result and announcing our new share repurchase program and a second announcing that Power Integrations has filed a patent infringement lawsuit against Fairchild Semiconductor. Both releases have been sent directly to those of you on our distribution list and are also available on our website www.powerint.com.

With me on the call today to discuss today's announcements are Balu Balakrishnan, our President and CEO; and John Cobb, our Chief Financial Officer. Balu and John each have a brief set of prepared remarks after which we'll take your questions.

Before we begin, however, I would like to caution that our discussion today, including the Q&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, would, 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 10-K and 10-Q filed with the SEC.

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

Thank you Joe. Good afternoon everyone. As Joe mentioned, we have several pieces of news to announce this afternoon. First, of course, we are announcing our financial results for the third quarter, which were in line with the revised forecast that we issued a month ago. Revenues were down 8 percent sequentially to $32.9 million. Gross margin was 47.8 percent, up nearly 2 points from the prior quarter as expected. EPS was 18 cents, a penny above our revised range due to lower-than-expected operating expenses. The 18 cents includes a 3-cent tax benefit as we explained in our announcement last month.

Our second announcement today is that our Board of Directors has authorized a repurchase of up to $40 million of our stock, which at the current price, would be about 6 percent of outstanding shares. This position reflects the fact that our balance sheet is stronger than ever with $144 million in cash and investments, and no debt. We have increased our cash investment balance by nearly $29 million since the beginning of the year. Our cash resources are now more than adequate for business purposes.

Our third announcement today is that we have initiated a patent infringement lawsuit against Fairchild Semiconductor. We believe that several of Fairchild's integrated power conversion products, including many of the green Fairchild power switch products, violate one or more of our patents. We have a policy of respecting the legitimate intellectual property of others. We expect others to honor our intellectual property as well. We have successfully defended our intellectual property in the past. We believe that our patents will be upheld in this case.

Returning now to third quarter results, as I noted earlier our revenues and earnings were in line with the revised forecast that we issued a month ago. Obviously we came in well below what we were expecting at the time of our last earnings report in July. It's clear that throughout much of industry the business environment has been extremely challenging over the past several months. On the second quarter call, we talked about a board-based slowdown in orders that began in June and continued into July. That trend was factored into our earlier guidance for the third quarter. This guidance also had (indiscernible) a pickup in September, which is normally one of our strongest months of the year. This year, however, September revenues actually declined compared to August. The slowdown in orders appears to be the result of board-based energy (ph) correction and possibly reduced expectations for end-market demand. Over the course of the slowdown, we believe that inventories of our products at distributors and our power supply and OEM customers have remained electively lean as they normally do given our short lead times. However, it seems that inventories further down the supply chain have been running higher than expected and that electronic manufacturers have essentially put on the brakes over the past few months in order to correct that. This situation appears to have continued into October as orders have remained electively weak thus far.

Revenues for all four of our markets - consumer, communications, computer, and industrial were down sequentially. Consumer revenues were down 8 percent. Communications was down 13 percent and computer and industrial were each down 4 percent. On a year-over-year basis, consumer revenues were up 18 percent, industrial was up15 percent. Communications was down 25 percent and computer was down 8 percent. Geographically the overall sequential revenue decrease was entirely in Asia and particularly China where revenues were down about 20 percent from the second quarter.

In each of our markets we have seen softness across nearly all of the major applications. In the consumer market, for example, shipments for DVD players, set-top boxes, and appliances, which had all been growing rapidly earlier in the year were all down sequentially. In computer, PC standby and service standby were down while LCD monitors were essentially flat. In the communications market, both cell phone and non-cell phone revenues were down at double-digit rates sequentially. Year-to-date cell-phone revenues are down 12 percent over the first nine months of last year despite slight growth in unit volume. This decline in revenues in cell phones is due to severe weakness in China market, price erosion driven by competition, shift in our volumes to lower-power, lower-cost devices, and delay in LinkSwitch production ramp at our customers.

The vast majority of sequential decline in cell phones is attributable to OEMs other than Samsung and Motorola. Total revenues related to those two OEMs were down slightly and units were up slightly. However, revenues related to other cell phone OEMs were down about 50 percent sequentially. The biggest piece of this other category is the China market. We believe there has been an oversupply of cell phones - and of course, cell phones chargers in the China market due to a variety of factors including reduced demand, market share gains by non-Chinese OEMs as well as consolidation among the high number of local vendors. Despite the challenging conditions at the moment, we believe China is strategically critical to us in the long term and we continue to expand our resources and capabilities there.

Notwithstanding the decrease in order volumes, we continue to see strong design activity and interest in our products remains high. The number of design opportunities in our pipeline increased significantly during the quarter. The dollar value of design-wins was up both sequentially and year-over-year. We had sizeable design-wins across a wide range of applications in all of our major markets. For example, with TinySwitch-II we won PC standby designs for HP, IBM, Sony, and Apple computers, a large-volume design for Toshiba DVD player, and a significant number of designs for white (ph) goods, cell phone chargers, and industrial controls. With tops at GX, we won design for LCD monitors, for Sony and Samsung, a number of printer designs and several cable and satellite set-top box designs.

Design activity also continues to ramp on our newer products LinkSwitch and DPA-Switch. DPA-Switch had numerous design-wins during the quarter primarily in the communications and industrial markets. We are seeing a high level of interest in DPA-Switch for power-over-ethernet applications such as voiceover IP phones. We also had numerous design-wins with LinkSwitch in the third quarter including a multi-million unit volume design-win for the room air-conditioner as well as smaller volume wins in consumer, industrial, and communications markets.

We also added a new member of the Links (indiscernible) product family this quarter called Link302. Link302 is part of the LinkSwitch-TN line, which is targeted at non-isolated applications such as many appliances, personal care devices, utility meters, and industrial controls. This particular product extends the cost-effective range of the LinkSwitch-TN line to lower power levels and should expand the number of applications we can target with LinkSwitch.

Another key piece of good news for us is that we continue to see improvement in our gross margin in spite of a pricing environment that has become more competitive as demand has weakened. We've been able to offer the impact of competitive pricing by reducing our production costs. In the fourth quarter we will see the full benefit of the vapor (ph) cost reductions negotiated earlier this year. We also continue to lower our test costs by reducing test times and by redirecting incremental test volumes to offshore test facilities. In addition we are reducing costs through ongoing improvements in our process technology. We have also just completed qualification of ZMD in Germany as our third foundry partner. We expect to begin taking delivery of production wafers from them in the fourth quarter. The addition ZMD will ensure ample capacity over the longer term and in the short term gives us additional leverage to further reduce wafer costs.

Netting the impact of current pricing environment against our cost reductions, we expect to see an improvement in gross margin in the fourth quarter to a range of 48 to 49 percent. By increasing gross margin and controlling operating expenses, we believe we can deliver respectable bottom line results and generate cash as we wait through this period of weakness in demand.

As to the revenue outlook, we entered into the fourth quarter with a lower-than-normal backlog due to the weakness in the orders in September. Also, as I mentioned earlier, we have not seen a significant improvement in orders thus far in October and we have low visibility into the inventory situation in the supply chain. So we are facing a high degree of uncertainty in our forecast. At this time we are expecting fourth quarter revenues to be down 2 percent to 8 percent compared to the third quarter. We expect earnings per share for the fourth quarter to be in the range of 11 to 13 cents. Revenue mix for 2004 by products is expected to be 53 percent TinySwitch I&II, 29 percent TopSwitch affecting (ph) GX, 15 percent TopSwitch I&II, and 3 percent LinkSwitch and DPA-Switch.

Now for a more complete review of financials and guidance I will turn it over to John. John.

Thanks Balu. Good afternoon everyone. As Balu noted, this was a difficult quarter for us as the already soft business environment we were seeing at this time one quarter ago turned even weaker after Labor Day. Thus, our revenue came in well below our original expectations, but in line with the revised forecast that we provided a month ago. However, our gross margin improved nearly two points in line with our guidance provided on our July conference call. We came in below our July guidance for operating expenses. We also increased our cash balance by $9.1 million, reduced DSO, and kept our inventories within our target range of three to four turns.

Returning to revenue. The total for the quarter was $32.9 million, down 8 percent from last quarter and 5 percent from a year ago. Average selling price for the quarter was 47 cents, down a penny from the prior quarter and 3 cents from a year ago. Turns orders were 70 percent of revenue for the quarter. Customers accounting for more than 10 percent of revenue were Cenix (ph) at 17 percent and Memic (ph) at 16 percent. Both of these companies are distributors and net revenue is recognized on sell-through, not sell-in. Total revenues relating to Samsung also exceeded 10 percent, though Samsung technically was not a 10 percent customer since we shipped a larger-than-normal share of our I T s to Samsung's charger suppliers rather than directly to Samsung.

Gross margin for the quarter was 47.8 percent, up nearly two points from the prior quarter. You may remember our gross margin dipped in the second quarter after we reduced our production levels in the first quarter in order to reduce inventories. That was a one-quarter issue so we regained those two margin points third quarter.

Operating expenses for the quarter were $9.9 million, down 2 percent from the prior quarter and up less than 1 percent from a year ago. This includes a 16 percent sequential increase in G&A expenses due to legal expenses and costs related to Sarbanes Oxley section 404, which requires documentation and testing of internal controls. By the end of the year, we will have spent $1m on section 404 compliance. The increase in G&A was offset by a decrease in marketing and sales expenses. We have been increasing our marketing and sales headcount in key markets such as China. However, sales and market compensation are lower as a result the decrease in our revenue outlook for the year. Income from operations in the third quarter was $5.9 million or 17.8 percent of net revenues. Operating margin was approximately flat compared to an 18 percent operating margin last quarter as an increase in gross margin was offset by the impact of lower revenues.

Provision for income taxes was $502,000 for the third quarter. Our base effective tax rate remains at 26 percent. However, as we announced a month ago, we received a tax benefit in the third quarter, reducing our income tax liabilities by $1.1 million. This reduction provided an earnings benefit of 3 cents per share. We expect our effective tax rate for the fourth quarter to remain at 26 percent. Net income, including the tax benefit was $5.7 million or 18 cents per share. That is 1 cent above the 16- to 17-cent range we gave when we updated our forecast a month ago with the upside coming from lower-than-expected operating expenses.

Moving to the balance sheet, we ended the third quarter with the strongest balance sheet in our history. We had $144 million in cash and investments, our highest level ever. Cash and investments increased by $9.1 million during the quarter, due primarily to strong cash flow from operations, which was $8.4 million. Accounts receivables declined by $3.4 million to $9.6 million with DSO coming in at 26 days down from 33 last quarter. The lower DSO was mainly due to lower-than-normal September revenue. We expect DSO to increase in the fourth quarter.

Inventories increased by $2.4 million to $22.2 million. Inventory turns were 3.1, within our target range of three to four turns. Because we took action to reduce inventories early in the year, we are comfortable with our current level of inventories in spite of the weakness in demand. At this time therefore, we are not making any major adjustments to our production levels, though obviously we will continue to look at that issue if the ongoing slowdown continues beyond the fourth quarter.

Turning to the outlook, as Balu noted earlier, given our low level of visibility down the supply chain, it is difficult to forecast the duration or severity of the current weakness in demand. With that caveat, our current forecast is for order trends to remain relatively soft for the remainder of the quarter as they have for the first three weeks of October. We believe this will result in fourth quarter revenue that is down 2 percent to 8 percent compared to the third quarter. Slightly more than 70 percent turns orders would be required to meet the midpoint of this range. This level of turns is consistent with our performance over the past several quarters. Due to our ongoing cost reduction efforts, gross margin should improve again in the fourth quarter to between 48 and 49 percent. We expect operating expenses to increase 2 to 3 percent sequentially driven by incremental hiring of sales people and field application engineers. This would result in earnings per share in the range of 11 to 13 cents.

With that I'll turn the call back to Balu for a few final remarks before we take your questions. Balu.

Thanks John. So while we are disappointed with our results in the cell phones applications, we are very pleased with our growth in all other markets, which has been a direct result of our proactive diversification strategy. Revenues from non-cell phone applications are up 22 percent year-to-date compared to the first nine months of 2003. Specifically, revenue in the consumer market is up 35 percent. Consumers will be our largest market this year for the first time. Revenue from the computer is up 5 percent year-to-date and industrial is up 26 percent.

I'd like to conclude simply by saying that in spite of the current period of market weakness, we believe that our business fundamentals remain very strong and our opportunity is still as large as ever. Only about 10 percent of our addressable market has been converted to integrated solutions while the other 90 percent continues to use discrete components in linear transformers. Just as the rest of the appliance industry has done, the power supply industry will continue to move away from these older solutions in the direction of integrated circuit technologies like ours. Power Integrations is by far the Company in the best positioned to capitalize on this opportunity because we are the leading innovator in our market. We will leverage our technology leadership to continue increasing our penetration rate against the older technologies. We will stay ahead of the competition by continuing to innovate, by developing more cost-effective products targeted at a wider range of applications, and by vigorously protecting our intellectual property. We are very confident in the future of our innovations (ph) and we are extremely focused on executing our strategy to grow as fast as we possibly can.

With that I'll turn it back to Joe. Joe.

Thank you Balu. Before we get to questions I'll quickly run through our fourth quarter conference calendar. We will be at the AeA Classic in Monterey on November 8 and 9, the Deutsche Bank semiconductor conference on November 10 in Las Vegas. Then on December 7 and 8 in New York we'll be presenting at the First Albany annual growth conference and the Raymond James IT supply chain conference.

Now Operator, would you please open the line for questions.

(OPERATOR INSTRUCTIONS). Tore Svanberg, Piper Jaffray.

It is actually Jeremy calling for Tore. Balu, can you give us a quick update on your exposure right now to China.

Currently our total revenue from China is about 24 to 2Lee 5 percent. About half of that relates to cell phones. The 24 to 25 percent is obviously what we shipped into China. A lot of those products, excluding cell phones, typically get exported into the US, Europe, or other markets.

Great. I guess turning to more of product update, can you remind us again how much you expect LinkSwitch and DPA-Switch to account for 2004? I didn't quite catch that.

In 2004, it'll be 3 percent.

3 percent, okay. Of those new products, focusing on your power ethernet product, can you talk about what features and performance levels that is enabling you to attack - versus your competitors - better address that market.

The biggest advantage we have is the number of components. We reduced the number of components because we have the most integrated solution for that market. The second one is cost-effectiveness. We are significantly more cost-effective than all of our other analog peers who offer products to that market.

Finally, it looks like you are doing pretty well with LinkSwitch with new product. Are you trying to address higher power applications as well and what new end markets, new applications you can go after?

With the TopSwitch-GX we are addressing the higher power applications like LCD monitors, printers, and so on. I think we have talked earlier about potentially being able to address PC main power supply. But that has gone outside of our power range.

And any efforts in the notebook arena?

We don't have any products for notebooks at this point.

Okay. Thank you very much.

Terrence Whalen, (ph) Smith Barney.

My question first relates to China. Do you feel like you've reached the bottom in China? Or do you again expect China revenues to go down on the order of 20 percent next quarter? Thanks.

That's a hard one to answer. Given how much it has gone down, I hope it's the bottom. I am afraid that I don't have any more intelligence than everyone else does.

OK, great. Looking outside of China and the cell phone problem there, can you give us some other specific areas of strengths that you might see potentially in consumer market. It seems like you've been doing pretty well there.

I think in the consumer market we are very broadly diversified into many, many different applications. Obviously the ones we have talked about are set-top boxes, DVDs, digital cameras. We are going to a wide range of appliances including refrigerators, washing machines, dishwashers, microwave ovens, and also personal care items like shavers, electric toothbrushes, and so on. That is one of the things I really like about that market is that it is very well diversified both in terms of applications and customers in contrast to the cell phone market, which is highly concentrated.

OK, great. My final question relates to ASPs. I think that ASPs this year are going to be down around high single digits. What is your expectation for next year given that we have seen some slowing and some reduction in orders already? Thank you.

It really would depend upon how the competitive pricing situation is going to change between now and next year. We obviously have to be competitive in the marketplace, especially on the new designs. I'm afraid I'm not able to give you any more information than that.

Okay, great. Thanks.

Vernon Essi, Janney Montgomery Scott.

Thank you. Just a follow-up on that line of questioning. I think I mentioned this before. In this quarter, you've obviously got serious competition on the China front in the cell phone area. Can you give us an understanding of how much business you might actually be leaving on the table from a price perspective. How much of that is demand related?

The main problem in China is that China itself is weak. You could say we have X percent of the business in cell phones in China. But if China has lost market share to other people or they have an inventory problem, we loose market share overall, at least temporarily. So it's not as much a pricing issue. But pricing is aggressive across the board versus ever since the weakening of the market started in June. For awhile we thought that prices may firm up. It never did in the tier one customers. It did go up a little bit in second and third year customers. Even there, now the pricing pressure is quite heavy simply because the market is weak and there is a lot of supply.

Alright. And also talking about design activity you've had, you've had some design-win gains. Is there any metric you can give us to get more granular on that - the third quarter relative to the second quarter?

I think we have said that it increased both sequentially and year-over-year. The opportunities that we are - designing wins has increased quite substantially. We don't like to give out numbers, because unlike other analog counterparts where the numbers do make sense, for us it doesn't because some designs are much larger volume than others. They would be misleading.

Just to follow in on the design side. Has the dialog been better going into later in the year in terms of actual design engagements as opposed to wins themselves? Or have things still been stalemated since summer?

I think of them both as important. The number of opportunities that we are engaged with is important longer term. Design-wins are important shorter term, meaning in the next two or three quarters. We monitor both of them. We measure it in terms of the dollar value rather than just the number of opportunities. When we said we are sequentially growing in design-wins and year-over-year in design-wins, we are talking about the dollar value of those design-wins.

Our design activity generally remains fairly constant and increasing. It does not fluctuate as our revenue may fluctuate. So even in down periods of demand, there is still plenty of design activity.

I guess it was more in relation to the pricing on the competitive, discrete side of life. The prices have fallen on that front. I wanted to get color in terms of the engagements have increased or decreased over the last couple of weeks - or months, rather.

Pricing is usually a bigger issue at tier one customers. Of course, the PC and cell phone markets have a lot of tier one customers in them. When you go to industrial and consumer markets there are a lot of tier two and tier three customers where it's much less of an issue. They are more interested in the design support and all the intangible benefits we provide including energy efficiency. The number of opportunities could represent a diversification rather than just the tier-one type customers.

Pricing impacts the level of design-wins, but it doesn't have much of an impact on the level of design activity.

Okay. Thanks for the clarification.

Steve Smigie, Raymond James.

Great, thank you. Could you comment a little bit on the lawsuit against Fairchild. Is that specifically against their green room power switch. Is it possible that some of the weakness that you are seeing in this quarter and next quarter is a little bit related to products that you're going after them on?

To answer your first question, many of the chips are green mode or green Fairchild power switches. They do include many of those switches, but not limited to them. Your second question was whether that was the reason for the impact. We did loose a design at Samsung last year - I think third quarter of last year, which we talked about. A bigger impact they've had is in terms of their aggressive pricing.

Okay. Just a follow-up question. In terms of the weakness that you did see or that you're guiding to in the fourth quarter, is that broad-based across all of you categories?

Yes.

Okay, Thank you very much.

Lee Zeltser, Needham & Company.

A couple of questions. First off, on the inventory front, I understand that you (inaudible) inventories. By my calculations inventories in the September quarter were up about 12 percent sequentially on lower sales. Could you talk a little bit more about that - the rationale there?

As we talked about in our comments, we proactively reduced our inventory in the first quarter and in the second quarter so that at the end of the second quarter we were at 3.9 turns, which is at the high end of our range. We did increase our inventory this quarter because at the start of the quarter we thought our revenue was going to be higher than what it turned out to be. However, we're still within our 3 to 4 target range at 3.1. We have increased our inventory and it's still within our range of comfort, which is why I commented that at this point we're not taking any specific action to reduce it because it's within our range.

OK. You talked about guidance of down 2 to 8 percent on the revenue line in the fourth quarter - a little bit of a broad range. Could you talk about what scenarios need to take place both at the high end and low end of that range. What are your assumptions?

It really depends upon whether the inventory gets corrected and when it gets corrected, which we don't know. That is one of the reasons we are comfortable with our inventory because we want to be able to respond very quickly if the demand comes back very quickly. It is really the lack of visibility that is forcing us to give you a wide range.

OK, so I guess if you come in down 2 percent, the excess inventories get resolved in maybe the October timeframe. If you are down 8, you are thinking that they would probably get resolved toward the end of the year. Is that a fair assumption or is there some other----

Roughly speaking, that is right. It is also, of course, how strongly it comes back.

OK. If this is in fact just an inventory correction - and certainly understandably the visibility is tough - whether we can say that or not. Would you expect a snap-back as you look into early 5? Would you expect better-than-normal seasonality during that timeframe as the inventory gets worked off and you get a bit of a boost that you wouldn't normally get?

To be honest, I wish I knew. We just don't know. It's very unusual for us to have this kind of a seasonality. We certainly did not expect that at all.

Okay, so there is just not enough visibility to tell.

That's right.

Okay. If I can ask in a little bit more detail on the Fairchild lawsuit. How much in revenues, if you can quantity this, do you feel that Fairchild - that their products infringe on your patents? Are you asking for any lost royalties? What kind of damages are you asking for?

I think we mentioned - you can look at our complaint - that we are calling for injunction and damages. For legal reasons we really can't go into it any more.

Okay. Is it a substantial portion of Fairchild's revenues? How much would you quantify that?

I just can't answer that. Our attorneys won't let me do that.

Okay, fair enough. Okay. Just one last question, if I could, on LinkSwitch and DPA-Switch. What are your current expectations as to when the revenue will start to ramp for those products?

The design-win activity is very strong. So I think if the market comes back, we should start ramping both of those products next year. However, as we have said before, LinkSwitch goes to high volume markets whereas DPA-Switch has much more fragmented customer base. So in terms of ramp-up, LinkSwitch will be a faster ramp-up than DPA-Switch. But the DPA-Switch will probably ramp for a much longer time.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS) Andrew Huang with American Technology Research.

Good afternoon. I have a question on the litigation again. Can you quantify about how much you plan to spend on litigation for '04 and what that number could be in '05?

It really will depend upon how the litigation progresses. We will include that in our guidance. We are not able to give you a number right now because we can't predict how exactly it will go.

Is it fair to assume that it will be up in '05 relative to '04?

Relative to '04?

For the full year. I'm sorry.

I would expect legal expenses to be higher in '05. On the converse, I would expect our Sarbanes Oxley expenses to be lower in '05. The legal expenses, as Balu mentioned, will be a function of how quickly things proceed.

Okay. Are those two types of expenses included in general and administrative?

Yes.

Okay, great. When you commented on the ASP erosion, were there any particular competitors that you can talk about that were more aggressive than others? Were there any particular end markets where pricing pressure was greater than others?

It is number one - it is discrete, but discrete by being very aggressive because it's a commodity market. Number two, the integrated competitors -and as you know, we have five large competitors. At any given time, some of them are more active than others. At the moment, I would say Fairchild is probably the most active, and then followed by ASP.

From a market standpoint, cell phones are typically the most competitive market only because it's such high unit volumes.

Thank you.

Auguste Richard, First Albany.

(inaudible) cell phones just one more time. When you look at the decline in revenues, can you attribute some of it to a mix-shift from top to tiny pricing pressure? Can you take those factors and ballpark what percentage each was?

Yes. There is a little bit of a move from TopSwitch to TinySwitch. There are some high-end phones, which use TopSwitch for higher power. With the improvements in power management, those phones take less power so they can use TinySwitch. But even within TinySwitch we have seen a migration from the higher power products to lower power products over the last year or so mainly because the phones are getting much more efficient so they can use smaller batteries and take less power to charge them.

So, is that migration to smaller power products most of the pressure you've seen? Or is it half? How would you ballpark it?

In terms of ASP erosion, you mean?

Yes, exactly.

(Discussion of technical difficulties and (OPERATOR INSTRUCTIONS).

I'm still here. You can finish up answering the question.

I hate to do this, Gus. Can you remind me what the question was.

Certainly. We were talking about cell phones and trying to attribute the revenue decline to a shift-down in power versus pricing pressure for a specific product.

We mentioned in Balu's piece of the script that there were four factors. In terms of the revenue, the impact of China has had the biggest impact on our cell phone revenue. The second largest impact is ASP-or just price competition. The third is a shift in mix from higher-power, higher-cost devices down to lower-power, lower-cost devices. Lastly, and really not as significant, is the slower ramp in LinkSwitch. The first three in that order are the most significant factors.

Just to clarify, it's ASP erosion due to competition.

Right, exactly. Then after that there is mix shift from higher power to lower power.

Correct.

Just quickly. In the lawsuit with Fairchild, are you suing over the same patents as you sued Motorola a few years back? Is it a different set of patents? Can you size that up for me?

I believe it's a different set of patents. The list of patents is public information. If you like, we can send it to you. I don't want to spend the time going over it. There are four or five patents.

Okay. Finally, what were the turns in the September quarter and I'm done.

It was about 70 percent.

Okay, great. Thanks.

Susan Johnson, (ph) (inaudible).

This is Jason for Susan. I have a quick question on gross margins and cost savings. How much more cost savings do you think you have in overseas (inaudible) and wafer costs? Do you have a sense of that?

We have lots of opportunities across the board in cost savings. We put our costs into three different categories. One is the wafer cost, which as we mentioned, we're working from a technology standpoint to get additional cost reductions. We've added a third foundry, which will provide not only additional capacity, but also improve the cost of the wafer. We will continue to reduce the wafer cost overall. The packaging costs - we continue to work with our packaging partners to get lower prices and design in newer, lower-cost packages again to further reduce costs. And we continue to move our testing from our San Jose location offshore, which will reduce our test costs and reduce our test times. There are lots of opportunities to continue to reduce costs for the foreseeable future.

And in terms of where you think gross margins can go independent of - let's assume flat revenues? How much upside do you think there is?

That really depends upon the competitive environment. If the competitive pricing is stable, the cost reductions will translate into gross margins. It's a combination of those two factors.

So far you've been able to offset the ASP erosion. Do you think that is going to continue?

You mean relative to the price? Let's say the competitive pricing is going to get more and more aggressive?

If you can reduce costs to keep ahead of lower pricing.

Yes. We have done this over the last three or four years. Even though the competing solutions have gone down in double-digits for three years before 2004, we managed to maintain our margins through new product introductions, which are more cost-effective, and through very aggressive reduction of manufacturing costs.

Okay. Sounds good. Thanks.

Terrence Whalen, Smith Barney.

Following up with the prior question regarding cost reduction, what is a number to think about in terms of putting all the different elements together. What cost reductions we could expect in 2005. I have a follow-up.

At this point, it's way too premature to try to estimate that. I think if you look at what we did in '04, our ASPs came down - have come down about 6 percent and our margin for the year will end up being about two points lower than it was in 2003. Those two points can be attributed solely to the strengthening of the yen. We purchase wafers from our two Japanese foundries in yen. Because the yen strengthened, the margin was impacted two percentage points. Aside from the yen, we offset the impact of the price reductions in 2004. Obviously we would hope to continue to do that as we go into '05. In terms of the actual outcome, it's too premature.

Okay, fair enough. My other question is regarding - you mentioned, I think, regarding October orders continuing to be fairly weak. Can you give us an idea of what October looks like versus September and versus August? Thanks.

Obviously October is not over yet. We still have about a week and a half. I think in general it will probably be fairly flat with September. As we mentioned in the comments - September was lower than August.

Right, okay. Last question. Looking ahead next quarter, your guidance is for a sales reduction of 2 to 8 percent with gross margin of 47 to 48----

48 to 49.

I'm sorry, 48 to 49. If revenue were to come in below that, between 10 and 15 percent sequential decline, what would be a gross margin? All I'm trying to do is gage the gross margin sensitivity to your (inaudible)----

Our gross margin does not fluctuate very much based on revenue. There might be a minor degree of fluctuation, but it is probably less than a half a point.

Okay, great. Thank you.

Steve Smigie, Raymond James.

Great, thank you. I guess a little bit on that last question about the changing gross margin. In a previous - or a couple quarters ago when gross margin went down I believe it was because you ran less wafers through the testing part of your operation. That caused some gross margin issues. Given what is happening here in the guidance for the fourth quarter, would that again create a situation where in the first quarter that might be impacted by that? Or is it just not going through there?

As we said in the comments, assuming we get through this weakness during the fourth quarter - or by the end of the fourth quarter - it should not create an issue. If this market weakness continues beyond the fourth quarter, then we could end up having to do some sort of an adjustment. As I just said, this would have to last several more months before we would even have to consider that.

Okay, great. Thank you.

(OPERATOR INSTRUCTIONS). Shawn Slayton, SG Cowen.

This is actually Deepak Futeraman for Shawn. In the context of the lawsuit against Fairchild, we understand that Fairchild has a monolithic solution and a multi-chip module solution. I know you can't speak about this in great detail. Can you give us some color on whether you believe the infringement is process-related or circuit-related.

One, I can say because it would be public information is that it includes both the multi-chip solution, which is called a hybrid and the monolithic solution. They are in a (ph) number of products.

Fair enough. Also following up on comments from last quarter's call, can you give us an update on Nokia's attitude towards deploying more efficient chargers?

They have signed up to be European Union standard for standby consumption. However, it's a voluntary standard. They can do it at their own pace. I think they have agreed to do a percentage of their products. They agreed that they will meet the new standard, which is effective January 1. Then it will hopefully grow over time. Our hope is that by showing that we can provide at the same cost a much higher performance with our integrated solution, there will be really no reason for them to have the older solution - the linear solution. The biggest problem is inertia to change. I think once they change, then there will be a lot more incentive for them to change across the board. Certainly so far they are still holding onto the linear solution. I believe it will change. We just don't know exactly when.

Thank you very much Balu.

Ladies and gentlemen that does conclude today's question and answer session. At this time I'd like to turn the conference back to (inaudible).

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