Power Integrations Inc (POWI) 2005 Q2 法說會逐字稿

Welcome to the second quarter 2005 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. Mr. Shiffler, please go ahead.

Thank you and good afternoon. I'm Joe Shiffler, director of IRx and Corporate Communications for Power Integrations. Thanks for joining us to discuss our second quarter results, which are outlined in a press release that we issued earlier this afternoon. The release has been e-mailed directly to those of you on our distribution list and is also available on the investor info section of our website, www.powerint.com. With me on the call today are Balu Balakrishnan, president and CEO of Power Integrations, and John Cobb, our chief financial officer. Balu and John each have a set of prepared remarks after which we'll take your questions.

Before we begin, I'd like to caution you that our discussion today, including the question and answer 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," "anticipate," 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.

Thanks, Joe, and good afternoon, everyone. Our second quarter results were very solid with revenues and earnings right in line with our expectations. Gross margin was nearly three points higher than a year ago at the high end of our expected range despite a very tough pricing environment.

We also achieved a 10% reduction in inventories, significantly increased cash flow from operations, and completed our $40 million share repurchase. Most importantly, we had our strongest quarter ever in terms of design wins including significant wins with LinkSwitch and DPA-Switch. Ongoing design activity remains strong with a robust level of early-stage activity on external power supplies, which was made California's new energy efficiency standards by mid-2006.

Second quarter revenues were $35.3 million, up 3% sequentially. Consumer revenues were up 10% driven by set-top boxes, digital cameras, LCD TVs, major appliances, personal care devices. Industrial revenues were also very healthy, up 15% sequentially. Consumer and industrial combined were 43% of our revenue, an all-time high.

These markets are attractive because they are so diverse in terms of applications and customers. As part of our diversification strategy, we have made a deliberate effort to increase our exposure to these markets, and I am pleased with the excellent progress we are making.

Communications revenues, which are primarily from cell phone chargers, were up 1% sequentially. The computer segment was the one source of weakness in the quarter declining about 10%. PC standby, the largest computer application for us was fairly strong, but we saw some weakness in PDA servers and LCD monitors.

As I mentioned at the outset, we had a record quarter in terms of design wins with strength across all markets and all product lines, and we once again widened the range of applications that we addressed. Design wins with TOPSwitch-GX included a UPS power supply for APC, area projection TV for Sharp, a home security system and, believe it or not, an electronic bidet.

TinySwitch-II had a tremendous number of design wins during the quarter in applications as diverse as air conditioners, rice cookers, emergency exit lighting, and MP3 players, and the last, PC standby designs for Dell, IBM, HP, and Gateway and a server standby design for Qanta.

We also won a number of cell phone designs with TinySwitch including designs for Motorola, Kyocera, LG, and several others. Also in the cell phone market, we won a high-volume design for a Motorola charger using LinkSwitch, our low-power product designed to replace linear transformers. This is our largest LinkSwitch design win to date, and a highlight of a very strong quarter for LinkSwitch.

Other LinkSwitch designs include a cordless phone adapter for Sagem, several lighting applications, industrial controls, and a number of consumer appliances. Progress at LinkSwitch has been slower than we originally expected as the product was perhaps a little bit ahead of its time. Now, however, the pace of linear replacements appears to be accelerating, driven by the new energy efficiency standards. As evidence of this trend, we now have plenty of design activity going on with LinkSwitch and we have seen LinkSwitch increase significantly as a percentage of our bookings in recent weeks.

We expect LinkSwitch to continue gaining traction as vendors of external adapters work toward meeting the energy efficiency regulations scheduled to take effect in California next July and Australia next April.

Since our last conference call, Washington State and Arizona have adopted the standards identical to California's effective in 2007 and 2008, respectively. These standards, as well as the voluntary standards implemented by EnergyStar, the European Union, and China, effectively to load [ph] the use of linear transformers in external power supplies.

Based on discussions with OEMs and power supply manufacturers, it is clear that the new standards are having a major impact extending well beyond the state of California. Because external adapters are used with so many products, the new regulations affect a wide range of applications and a huge number of manufacturers all over the world.

The effective date of these deregulations almost a year away, we are still in the early stages of the transition, however, we are very encouraged by the feedback we are hearing from customers, and we even have our first two design wins that can be directly attributed to the CEC regulations.

The cordless phone design that I mentioned earlier, as well as a vacuum cleaner design were both direct results of CEC mandate according to our customers. And number of other linear replacements appear to have been influenced by energy standards as well, including a high-volume design for V-Tech [ph] cordless phones. So the early indicators are very encouraging.

Returning to the design wins for the second quarter -- we had our best quarter so far in the DC to DC market including our largest design win to date with the DPA-Switch. On our last conference call we announced a design win for IP phones at Nortel. In the second quarter, we won a design in Cisco's highest-volume IP phone model. We have additional IP phone designs underway at other OEMs as well as design activity on other Ethernet-powered devices such as security cameras and wireless access points.

The accelerating adoption of power over Ethernet, or PoE, is a very encouraging trend. PoE has essentially become a required feature in network equipment, and the desire of enterprises to deploy PoE is now a key factor driving shipments of new Ethernet ports. As a result, the number of PoE-enabled ports is set to explore over the next several years. This sets the stage for strong growth in Ethernet-powered client devices. This should create a lot of opportunities for us.

In addition, the DPA-Switch family has sufficient power range to serve the emerging PoE-Plus standard, which is expected to address high-power devices such as notebook computers and peripherals.

Earlier this week, we announced that DPA-Switch is now available in a new low-profile package called the S-Pack, which reduces the bold footprint of DPA-Switch by 40% and is height by 55% compared to the standard PO263 package. The new package will further add to the attractiveness of our solution for PoE and other DC-DC applications.

Returning to the second quarter results, a key highlight was our gross margin, which was 48.9%, up nearly 3 points year-over-year and at the high end of our guidance. Over the past several quarters, our margin has improved steadily as significant achievement, considering the intense pricing pressure that we have seen over the past several quarters. Pricing for discrete components and competing integral parts remains extremely competitive and shows little sign of improving. In fact, high-volume prices for some comparative components, such as resistors, have fallen so much over the past few years that the cost of placing the component on a separate board often exceeds the cost of the component itself.

In spite of this challenging environment, we have improved our gross margin by working on both the price and cost sides of the equation. As a single-source supplier, we don't typically raise our prices. However, the increasing level of integration in each new generation of our products, combined with our circuit design expertise enables us to reduce our customer system costs without sacrificing our margins.

On the cost side, we continue to reduce both our test costs and our silicon costs. We have reduced silicon costs through both process implements and price reductions from our foundries, which demonstrates the unique characteristics of our fabless model. And like most fabless companies, we have proprietary production process supported by strong intellectual property, and we continue to evolve the process to reduce cost. However, our process does not depend on leading in geographies, which means that it can be installed in fully depreciated paths with declining cost curves and ample capacity.

We have sufficient cost reductions still ahead of us, so we are optimistic that we will at least maintain our growth margin for the foreseeable future in spite of continual aggressive pricing by our competition.

Thanks to a strong gross margin, earnings for the second quarter came in at the high end of our expectations at $0.16 per share. Operating expenses were in line with that guidance, up 4% sequentially due mainly to patent litigation expenses, which will continue to be a significant expense driver for the next couple of quarters.

We are now expecting litigation costs to be higher in 2005 than our previous estimate, largely because we decided to take our case against System General to the International Trade Commission rather than wait for a jury trial. This decision should bring a quick resolution to the case, but it will pull in some spending forward into this year. John will go through those numbers in more detail in a moment.

While the cost of patent litigation is unfortunately very high, we believe our cases against Fairchild and System General will have a positive return for our business over the long term. Our IP is extremely important to us, and we believe these two companies have done real damage to our business by violating it.

In our case against System General, we received two pieces of good news this quarter. First, the judge in our lawsuit denied a claim by SG that the California code does not have jurisdiction in the case. Also, in June ITC decided to accept our case and go ahead with an investigation. We expect to have a decision from ITC by early 2006, and if they find in our favor, products containing SG parts would be excluded from the U.S.

Our suit against Fairchild in Delaware court is currently in the discovery phase, and the trial should take place in mid-2006. We are seeking both damages and an injunction against Fairchild's infringing parts. As we have said repeatedly in the past, we believe that we have very strong cases in both of these legal actions, and we fully expect to win.

Looking ahead, we remain highly optimistic about the near term and longer term futures of our business. Forecasting our near-term performance remains as difficult as ever, due to the high turns nature of our business, but based on recent design wins and input from the field, we expect strong revenue growth in the second half of the year.

Looking beyond 2005, we are very excited about the opportunities in front of us. The new regulations on external power supplies are forcing conversion of [inaudible] linear adapters and early signs are very encouraging. We have dealt with a range of products specifically to address linear replacement, and we've ordered substantial sales and adding resources to this opportunity. Beyond external adapters, the energy efficiency movement continues to gain steam. Over time, we expect an increasing number of products to be subject to tighter regulations including set-top boxes, TVs, and printers, and we believe that all of these will represent growth opportunities for us.

To help ensure that we capture this opportunity, we are increasing the size of our sales and field engineering staff, and we have a robust product roadmap ahead of us. We will introduce a range of new products over the next several quarters that will expand our addressable markets and improve our competitiveness in the markets we address today. Our R&D efforts have always been our most important growth engine, and that will continue to be the case, going forward.

With that, I'll turn it over to John for a more in-depth review of the financials. John?

Thanks, Balu, and good afternoon. Our second quarter financial results were right on target, and as Balu indicated, we believe the second half of 2005 is shaping up very nicely. Our second quarter net revenues were $35.3 million, up 3% sequentially and down 2% from the second quarter of a year ago. Our reported revenues included an adjustment to our reserve for sales returns, which had the effect of increasing net revenues by about $900,000.

Looking at some of the revenue detail, turns orders were 76% of revenues for the quarter, the highest percentage in our history. Distributors accounted for 61% of revenue in the quarter including Memec and Synnex at 20% and 18%, respectively. As a reminder, we recognize all of our distributor revenues on sell through.

Revenue mix by end market in the second quarter was 33% consumer; 30% communications; 21% computer; 10% industrial; and 6% other. Gross margin was 48.9%, up from 48.3% in the prior quarter and up nearly 3 points from a year ago despite the ongoing pricing pressure that Balu described.

Operating expenses for the quarter were $11.3 million, up 4% from the prior quarter and 12% from a year ago. Patent litigation expenses were the primary driver of both the sequential and year-over-year increases, totaling just over $800,000 in the second quarter or about $0.02 per share.

Note that we are now breaking out patent litigation expenses as a separate item on the financial statements attached to our press release, whereas previously these expenses were included in the G&A line. As Balu noted, our decision to initiate an ITC action against System General will pull a significant portion of our expenses on that case forward into 2005. We are now expecting patent litigation expenses to total approximately $5 million for the full year with $1.3 million spent as of the end of June.

We expect to spend approximately $1.5 million in the third quarter and in excess of $2 million in the fourth quarter. This represents a substantial increase over our original expectations for legal expenses in 2005. However, the majority of the increase is simply a matter of timing, as expenses are being pulled forward into this year, due to the more compressed schedule of the ITC process as compared to the California courts.

Returning to the income statement -- income from operations in the second quarter was $6 million, giving us an operating margin of 16.9%, a slight increase from the prior quarter driven by the improvement in gross margin. Other income was $725,000, a slight increase from the first quarter due to higher interest income. Our effective tax rate was 24.4%, a bit below the 26% that we expected due to a higher percentage of profits from lower tax jurisdictions.

Net income was $5 million, or $0.16 per share including a $0.01 benefit from the adjustment to our returns reserve. Weighted average diluted shares for the second quarter were 30.9 million. We repurchased 373,000 shares during the quarter using just over $8 million in cash and concluding our $40 million repurchase program. Since the start of the program last October, we repurchased a total of 2 million shares, or about 6% of the shares outstanding. Our average price on the repurchased shares was $19.67.

Turning to the balance sheet -- we ended the quarter with $124.2 million in cash and investments, up slightly from the prior quarter despite the repurchase activity. Cash flow from operations was $8.6 million, up 30% from the first quarter. The strong cash flow was due partly to a substantial reduction in inventories, which declined 10% from the prior quarter to $24 million. Inventory turns improve to 3 from 2.7 in the prior quarter. We expect inventory turns to increase slightly as we go through the balance of this year.

Accounts receivable increased $1.7 million to $11.9 million. DSO rose to 30 days, closer to normal than the 27 days reported a quarter ago.

Moving to the outlook -- as Balu noted, our visibility remains extremely limited, and we expect the turns component of our revenues to remain at record levels for the foreseeable future. This is partly a function of the current demand environment in which power supply manufacturers appear to be managing their inventories very tightly and ordering in a hand-to-mouth fashion. However, the high turns percentage in our business is also largely a function of our success in delivering parts to customers on a just-in-time basis and our deliberate effort to keep our channel inventories as low as possible.

For the third quarter, we expect turns to be slightly higher than the 76% we saw in the second quarter. We expect sequential revenue growth in the range of 4% to 10%, which equates to 7% to 13% excluding the adjustments that benefited second quarter revenue. We expect gross margin in the third quarter to be approximately 49%, about the same as the second quarter.

Operating expenses are expected to increase between 7% and 9%, sequentially, driven, once again, by patent litigation expenses, which, as I mentioned earlier, will total approximately $1.5 million for the quarter or around $0.04 per share.

We expect our tax rate to be approximately 24% for the remainder of the year. We expect earnings per share in the range of $0.15 to $0.18 in the third quarter.

Now I'll turn it back to Joe. Joe?

Thanks, John. Before we open the line for questions, I'll do a quick rundown of our third quarter conference calendar. We'll be presenting at the Adams Harkness Summer Seminar in Boston on August 2nd; the RBC Capital Markets Technology Conference in San Francisco on August 4th; and the Smith Barney Technology Conference in New York on September 7th.

And now, Operator, would you please open the line for questions?

[OPERATOR INSTRUCTIONS] Ross Seymore of Deutsche Bank.

This is Tom for Ross. Nice quarter -- a question for you regarding your outlook. Basically, your seasonality is about 10%. I'm wondering if you can help us reconcile how much of that is CEC-related versus regular seasonality?

At the moment, very little of that is related to CEC. The CEC designs are just starting.

Okay, then do you anticipate that really being a larger contributor going into fourth quarter or when will we expect to see that benefit?

It will be a very gradual increase. I think the most significant benefit will be in second half of next year. There are very few people who actually do the design this early in the game.

Okay, I see. And then in terms of your gross margin pickup, how much of that was attributable to the strengthening dollar versus the yen?

None of it during this quarter. The strengthening of the dollar versus the yen could have a mile impact beginning in the fourth quarter, but it had no impact on the second quarter.

Okay, great, and then my last question -- if you could provide a breakout in terms of consumer, how much was DVD and set-top and within communications, how much was handsets?

In terms of percentage of revenues?

Yes.

The handset revenue during the quarter was about 25% of the total revenue. And your question on DVD, what was the revenue?

Correct, yes.

It's about 3% of our revenue. And the other application, I'm sorry, was --?

Set-top box?

Set-top boxes were about 6% of our revenue.

Tore Svanberg of Piper Jaffray.

Good afternoon, this is actually Jeremy calling for Tore. I guess the first question on the CEC -- can you talk a little bit more about what are the main applications that you're seeing that's driving this? I know it's a little bit early right now, but in terms of the design activity.

Well, it's really a very wide range of applications. We tend to focus on cell phones and cordless phones because they are the most concentrated application for replacement. But if you look at our design activity, it stands a large number of consumer applications and also industrial applications including tools, and really a very, very diverse set of applications.

The easiest way to understand that, if you just walk around your house and see how many linear transformers are hanging off your wall and look at all the different applications they power, that will give you some idea of the diverse nature of this standard.

Great, and maybe in terms of the competitive landscape with respect to meeting the CEC standard, has that changed at all and maybe can you still quantify what type of lead do you think you have over some of your competitors?

Well, it certainly takes the linear transformer out of the competition, if you will. It gives us an advantage over our CEC, what you call the discrete solutions, not that you can't design with discrete solutions, it just makes it harder to meet the standard with discrete solutions. We had one instance where a discrete solution could not meet the CEC, and so our solution was chosen over the discrete solution.

Other than that, really, the big benefit is the integrated solution is quite a bit more efficient than a discrete solution. It's an overall cost advantage.

You guys are still the only integrated provider at this point that can meet the CEC?

No, but we have the most comprehensive product family to replace linears, because the linears have certain types of output characteristics, and we have products that cover every kind of linear and to be able to replace them cost effectively.

Great, and just turning to the LCD monitor segment, can you talk about how much the current price as a percent of sales?

That's about 4% of our revenue.

Okay, and the declined share, does it relate to maybe in inventory adjustment that's temporary in the channel or is relating to the patent litigation that's ongoing right now?

Well, it's the decline in the revenue, and, frankly, that's difficult to know. We are not aware that we've lost any share, and as we say with every application, our shipments to power supply makers aren't always going to align with what's going on in the end market. So it's often difficult to know exactly what the reason is.

I guess one final question -- it looks like you guys have started to make some good progress in the cordless phone market. Can you talk about maybe your penetration in terms of the design activity right now what you think that is, and also if this does anything to your seasonality?

Well, we have two significant design wins to date. One is the V-Tech one we mentioned earlier, that's a very high-volume design. That actually has started even before CEC. It was initiated in response to the EnergyStar program, but I'm sure the CEC has tendered that imminent coming up to CEC standard has some impact on the decision to change from linear.

The second one is Sagem [ph] cordless phone, which is a smaller, it's a more of a medium-volume design. We are obviously working with all of the cordless phone manufacturers, and they will keep you updated.

At this point, it's less than a percent of our revenue, so we're just starting to penetrate that market.

Okay, and maybe in terms of the overall cordless phone market, is this maybe like 5% penetration or less than that even in terms of the design volume this represents?

I haven't really calculated that. The entire market is about 100 million units a year, and we would consider more than 100,000 units a month or more than 1 million units a year as high volume. But, in any case, it is less than 5% market penetration.

Shawn Connor [ph] of Waterstone.

Congratulations on a good quarter. I was wondering if you could talk a little bit about your cost of materials? Are you seeing any price increases being pushed on your from your fab partners?

Not from our fab partners. Certainly, in terms of packaging people. There have been some noises made when the copper went up significantly, but as far as I know, there is no change to date.

Steve Smigie of Raymond James.

I was wondering if you could talk a little bit about your growth guidance for Q3? I've seen that last year but the two previous years you had seen something like 16% sequential growth. Would you say you're just being conservative at this point in terms of your guidance?

Well, first of all, I don't know what is normal anymore, because last year was quite abnormal. With the turns business we have, it's really very hard for us to forecast. We do the best we can from the sales forecast we have, the beginning backlog is becoming almost inconsequential with the type of turns business we have. And also it depends on each year, and each year is different in terms of the overall market growth, and so on. So what we've given you is the best estimate.

And just to reiterate, our guidance with 4% to 10% up, but, as I mentioned, we had an adjustment in our Q2 revenue. So if you exclude that adjustment then the guidance, on a more normalized basis, is 7% to 13%.

Right, that's fair. Okay, and if you could talk a little bit about some of the DPA wins. I know you said some already. Did you mention that you did get some wins or just anticipate wins on notebook adapters?

No, all I was saying was there is an emerging standard called PoE plus, which increases the power available on Ethernet ports to significantly higher power levels than the current PoE standard. The current PoE standard can deliver about 12 watts, but there is a lot of activity going on to see how high a power we can deliver on it. Depending on the power level, you can run a lot more devices off of Ethernet, and all of those things will provide opportunities for the DPA-Switch.

I don't know how it's going to turn out, but all I'm saying is the higher the power, more devices will be powered off of Ethernet, and more opportunities we'll have for DPA-Switch.

Okay, but did you also have opportunities on the notebook adapter, as well, you mentioned?

No, not at all. All I was saying was the power is high enough it could actually power the notebook, and we don't know how high it's going to be.

And my last question was just in regards to ASP and what that was in the quarter?

It was $0.45, same as last quarter.

Andrew Huang from American Technologies Research.

First question is can you give us an update on where you stand with Nokia in terms of telephone charger customer?

There is nothing to report at this time. We work with all of the cell phone manufacturers who are currently using linear transformers to convert them, because most of them will have to convert, at least for California. So we are engaged with all of them, and we will report as things develop.

I assume that means that you are at least working with Nokia to try to get in the door?

As I said, we are working with all of the major telephone guys, and I assume you'd consider Nokia as a major cell phone.

Right. The next question is -- can you give us a sense of what percentage of the wafers that you test are done in-house versus outsourced?

Right now, about 30% of -- well, do you mean wafers or the finished IC?

I'm sorry, I guess I meant the finished IC, yes.

Okay, so 30% are currently done offshore, and 70% is done here, and we expect next year to more than double the percent that's offshore.

Is there any way you can put those numbers into perspective in terms of how it impacts your cost of sales?

In total, if you look at our cost structure, about 25% to 30% of our cost relates to the overhead and the testing function. The remaining 70% of the cost structure is the package costs and the wafer cost. From when we did all of our testing here and then taking the majority of it offshore, we expected to reduce our cost of that testing element, about 50%, and, as I said, we're about halfway, maybe a little less than halfway in that transition. So you can probably do the math from there.

Okay. Next question -- can you comment on the inventory levels of your components at your car supply manufacturers, like given any sense as to how the inventory levels are?

I can't quantify it, but all I can say is they only order parts when they need them, because we have done such a good job of delivering products on order that they take full advantage of that. So we know that our customer inventories are very, very lean, and we also know that our distributor inventories are very normal -- about four weeks right now?

Actually, less than four weeks.

But the one unknown is you don't know how much charger inventory is at the OEM?

That's right. That we don't know.

You said the distribution inventory was less than three weeks right now?

Less than four weeks.

Less than four weeks, okay.

It's 3.7, to be exact.

You mentioned two design wins with V-Tech and Sagem. Can you say which power supply manufacturers those are for, respectively, and are they sole source?

I would prefer not to name the possible vendor, but the V-Tech is actually two separate vendors shipping into V-Tech, and that design win actually occurred earlier, but we just came to know that it was for V-Tech, because many times our vendors don't tell us where it ends up. And recently we found out that it was a linear replacement for V-Tech, but that design win actually occurred fourth quarter of last year.

The second one is Sagem, and I don't know exactly who is actually building for Sagem. Again, I'm not sure that we want to disclose the vendors.

And do you know, as a follow-up, whether or not you are sole source for those power supplies or for those chargers -- or -- I'm sorry -- power supplies?

I don't know that for sure. V-Tech, based on the volumes, I would think we -- this is really a speculation on my part based on the volumes; that at least in that particular design, we are probably sole-sourced.

I guess the V-Tech is extremely high volume, would you characterize that as being, like, over 1 million units per year or what kind of magnitude are we talking?

Oh, it's definitely more than that. As I said, 100,000 pieces a month or more we consider as high volume.

One last question, I'm sorry -- in terms of the additional sales, in terms of the reserves, was there a cost of those sales included in your gross margin?

Yes, the adjustment, as I mentioned, increased our revenue $900,000, and obviously increased our gross margin dollars, but it had no impact on our gross margin percentage.

So the cost was included then?

Yes. Basically the gross margin on that adjustment was 48.9%. So it had no impact on our overall margin percentage.

Ray Rund of Shaker Investments.

Just a little housekeeping question -- what percentage or what was the amount of your revenue that came from license and royalties during the quarter?

$400,000.

400? Thank you.

Vernon Essi of Janney Montgomery Scott.

I just wanted to switch gears here, and I missed some of your prepared comments, but I'm wondering if you could elaborate a little bit on this recent announcement for the DC-DC space. What are your plans beyond the PoE market and if you could expand on that?

Currently, the PoE is our largest addressable market for that product, and the recent announcement was a very low-profile package, which makes our DPA product line very attractive to PoE applications and also other DC-DC applications. So it is more of a package option that we had requests from customers.

I don't know whether you heard our design-win announcement with the highest-volume model at Cisco.

Is this going to be a different -- how do I say this -- are you going to spend a proportionate amount of R&D on this effort to expand your offerings in DC-DC beyond this category or this customer -- category, that is?

Well, we have a number of designs at various OEMs including Cisco on other DC-DC applications, but in terms of volume, the PoE application, especially the wider IP application, seems to be the largest volume offered today, whereas the other DC-DC applications are very, very fragmented, even though we have a large number of them, the volumes are relatively low.

I guess that's what I was getting at -- you don't see yourselves going into the big analog space in terms of tackling smaller runs with more part numbers?

Well, our DPA-Switch is applicable to all of those applications, it's just that the PoE is a large part of our SAM, and it is a very high, broad market. So I think in terms of revenue from DPA-Switch, a large portion of it will be from PoE, although our DC-DC design wins are doing really well. We have a large number of DC-DC design wins.

Shawn Slayton of SG Cowen.

Things seem to be tracking nicely here. I do want to delve into your trepidation related to not giving guidance for the rest of the year. Your preamble mentioned that you expect strong revenue growth for the second half, yet we're a little in the dark here as to your thoughts for Q4. I know we're doing high turns here. This is a nice analog business model. There are lead inventories, and we're looking at seasonally strong end markets, so help me out here and maybe give us some of your thoughts on Q4. I'd appreciate it.

Sure. Let me tell you why I said what I said about a strong second half. It's really based on the design wins we had in Q2. We had an all-time record on the level of design wins, which will translate into revenue over the next two to four quarters. It is hard to predict exactly how that ramp would occur over the next four quarters, and that's why aren't comfortable giving you guidance on Q4, although, as I said, generally, when we have a design win, the ramp-up of the design win to full volume can take roughly between two to four quarters depending on the application. If it's an appliance, it could take up to four quarters, if it's a cell phone design or something, it can be a lot faster.

I read that, Balu, as saying that because these aren't new design wins that Q4, if they don't kick in, is flattish, and if they do kick in, there could be some meaningful upside. Am I putting words in your mouth here or no?

Yes, you are. So -- yes, you are putting words into my mouth. I prefer not to say anymore, because we're really not giving any guidance to Q4, but I think I've told you what I know.

Okay, I'll move on for now. John, in absolute dollars, 2006 legal expenses, a lot of stuff got yanked into the second half of this year. I guess we go to trial with Fairchild in the middle of next year. So can you just ballpark, at least as it relates to SG and Fairchild, what legal expenses might be next year?

Yes, obviously, it's too early to be precise, and it depends upon how things progress. One thing that we look at, and we've mentioned before is in our Motorola suit that goes back about five years ago, we spent, in total, about $5 million. So in this case we have the SG, which is a lawsuit and now the ITC action and then the Fairchild suit. So we have two actions that are ongoing, and as I mentioned in the script, we think this year we're going to spend about $5 million. And we also said the ITC action, we expect to get a ruling early in the year, and then the Fairchild case, we expect to go to court the middle of next year, and that will last a while. So probably for most of next year, at least through Q3, we should continue at a fairly higher rate of legal expenses.

So I'm a little confused. So does that mean, like, $5 million on a pro rata basis over four quarters? Again, this is an approximate, but another $5 million next year?

First of all, it's two difficult to tell at this time, but I think there's no reason at this point in time to think that spending would decline much until we get late in perhaps the fourth quarter when hopefully all the suits will be completed.

Okay.

One thing -- it will fluctuate each quarter, because of the activity or lack of activity that occurs in each quarter.

Okay. I want to talk about Fairchild a little bit, too. I know there are certain things you can say and certain things you can't say, but if you were to prevail against Fairchild, obviously, you guys are somewhat enthusiastic about your opportunities there. The injunction -- give us some details about what that might mean. Does that mean they would have to vacate the market entirely for this power converter IC product set?

Well, the injunction will be against the infringing products. So basically they'll be prevented from selling those infringing products.

Help us understand how that works domestically and how that would impact things internationally for Fairchild.

Well, domestically, they just can't ship. Internationally, it can be a little bit more complicated but the net effect is that they will not be able to ship the product to most of the customers. It's hard to say where that powers end up.

Can you give us a little insight as to what you believe -- or let's say how much revenue that Fairchild has caused you guys to forgo in 2005?

We can't discuss that, because that's part of the litigation. So we are not allowed to discuss those subjects.

Sumit Dhanda, Banc of America Securities.

Hi, guys, this is Jason for Sumit. Can you comment a little bit on the bookings linearity through the quarter?

The bookings linearity through the quarter -- in April it was strong, and then it slowed a bit in May, and then rebounded in June.

Okay, and as far as starting backlog, how does that compare this quarter versus last quarter?

It's approximately at the same level.

Okay, and then can you say anything about bookings, thus far, in Q3?

Bookings thus far in July, obviously, we're only 20-some days into it, have been fairly strong and consistent with the guidance that we provided.

Andrew Huang of American Technologies Research.

Just as a follow-on to the booking trends question -- I know this is going to be hard, but in past years do you guys typically see any kind of seasonal slowdown in September quarter in terms of bookings, like, does it tend to slow in the month of August and then pick up again strongly in the month of September?

Generally -- well, generally is difficult to state, because of the last several years. Bookings would tend to pick up beginning in the middle of August and going into September, because the seasonality with Christmas and, as Balu mentioned, the design wins, usually we see an increase in bookings towards the middle to the end of August.

I think you mentioned in your prepared remarks about an increase in sales and then FAEs? I was just wondering, could you give us an idea of -- I mean, obviously, you want to capitalize on the CEC thing as much as possible, so could you give a sense in dollars, like, how much incrementally you expect to spend for those two line items?

Dollars is difficult. I think if you look at our sales headcount at the end of last year and then what we would expect at the end of this year, we could increase our sales force 25% to 35%, predominantly in Asia.

Do you happen to have those numbers handy -- the sales force headcount?

I don't have those with me, but we can get those for you.

That may not directly translate into marketing and sales expenses, because as we grow, we will take some of the customers direct, and that will change the total cost. So if you notice, in the last two or three years, our sales and marketing expenses have been relatively flat, even though we have added -- we have almost doubled our sales and FAEs over the last couple of years.

So where do those costs get included for the sales and FAEs then?

I did include it there, but I'm saying that there are other changes we have done that have compensated for it.

Can you explain those changes?

I have done this in the previous conference calls, like, we are meant -- the sales and the reps and so on in the U.S. We also took some key customers direct. This was done some time ago, like, Samsung and so on, and that gave us net cost benefits that compensated for the people we added. I think somebody else brought up this question, and he said, well, you are adding people. How come your marketing and sales expenses haven't changed? And that's because we are doing it in a very controlled manner.

[OPERATOR INSTRUCTIONS] Ladies and gentlemen, this concludes today's question-and-answer session. At this time, I would like to turn the conference call back over to Mr. Shiffler. Mr. Shiffler, please go ahead.

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