Power Integrations Inc (POWI) 2005 Q4 法說會逐字稿

Good afternoon and welcome to the fourth quarter 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 IR and Corporate Communications for Power Integrations. Thanks for joining us to discuss our quarterly results, which are outlined in the 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 some prepared remarks after which we'll take your questions.

Before we begin, I'd like to caution you 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," "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. Good afternoon everyone. We finished 2005 with our strongest quarter of the year giving us good momentum heading into 2006. Fourth quarter revenues increased 4% sequentially and 13% year-over-year to $37.9 million in line with guidance and a record level of revenues for Power Integrations.

Unit shipments grew nearly 20% from a year ago indicating significant gains in overall market share. Our gross margin improved to 51.1%, up almost 3 points from a year ago. Earnings were in line with guidance at $0.18 per share and we generated $13.7 million in cash from operations.

We had another good quarter of design activity capping a record year in terms of expected dollar value of design-wins. The level of ongoing design activity remains strong. We expect to make significant gains in market share again in 2006. We are especially pleased with the design activity on our LinkSwitch products, which should account for more than 10% of revenues this year. A record year for design-wins and a strong pipeline of ongoing designs give us good reasons to be bullish on 2006.

We also have several additional drivers that should contribute incremental growth this year and give us further momentum for 2007. These drivers include (1) Energy efficiency standards on external power supplies, which are helping us gain share in markets such as cell phone charges and cordless phones. (2) Our expanded sales force, which has more than doubled in size over the past two years. (3) A number of new products such as LinkSwitch-XP, LinkSwitch-LP and TinySwitch-III, which are already winning designs and beginning to generate revenue. (4) New markets such as power over ethernet and LED lighting. (5) Our new direct approach to the Japanese market, which we previously addressed primarily through licensing. (6) The expected conclusion of our two patent lawsuits, which could further center our competitive position. (7) Increasing penetration of tier two and tier three markets, particularly in industrial market, which grew 37% for us in 2005.

All of these factors add up to a favorable outlook for 2006 and beyond. Assuming a healthy macro environment, we expect to grow our revenues this year at a rate of well above the 7% that we have averaged over the past two years. We expect to regain share in cell phone markets this year, achieve significant penetration in cordless phone markets, maintain a gross margin of approximately 50%, and grow our earnings faster than revenues through operating expenses leverage. We have ambitious plans for 2006 and 2007. Our fourth quarter results provide a good platform to start from.

As I mentioned a moment ago, we grew 13% year-over-year in the fourth quarter highlighted by strong growth in communications and industrial end markets. We grew 15% in communications, our second consecutive quarter of year-over-year growth. We expect to grow communications revenues significantly in 2006 to increase penetration of existing cell phones customers as well as penetration at new cell phone and cordless phones customers driven largely by replacement of linear power supplies.

Industrial revenues grew 63% compared to a year ago and comprised 13% of revenue in the fourth quarter, up from just 5% three years ago. Growth came from a large range of applications such as utility meters, motor controls, emergency lighting, and uninterruptible power supply. Our growth in this market proves that we are succeeding in penetrating tier two and tier three customers, which dominate the industrial end market.

In order to address smaller customers, we have developed a robust set of self-service design resources such as our PI expert design software and we have established relationships with a number of small regional distributors. We are very pleased with the results we have seen over the past year and we expect the industrial market to be a good growth driver in 2006.

We had another very good quarter in terms of gross margin, which came in at 51.1%. This was up more than 1.5 points sequentially and almost 3 points year-over-year. We have consistently improved our gross margin over the past six quarters through cost reductions mainly in the areas of wafer prices and technology improvement. We will continue our focus on cost reductions, which should help us maintain our gross margin around 50% for the foreseeable future.

Thanks in part to the improved gross margins, the fundamental profitability of our business is in excellent shape. Our operating margin for the fourth quarter was 14.6% despite an impact of 6.3 percentage points from litigation expenses. This suggests an underlying operating margin of nearly 21%. Net income for the quarter was $0.18 per share including a $0.06 impact from litigation expenses.

Whilst patent litigation is a temporary drag on our bottom line, protecting our intellectual property is critical to maximizing our long-term profitability. As for the timeline for the two cases, we can now see the light at the end of the tunnel. Our ITP trial against System General was completed last week in Washington, DC. We believe we have put forth a compelling case and expect a ruling in May. In the Fairchild case, the [markman] hearing is being held this week with a pre-trial hearing scheduled for early May. The case should go to jury trial sometime this summer with a verdict expected at the end of the trial.

As mentioned earlier, 2005 was a record year for design-wins, setting up strong revenue growth in 2006. Fourth quarter design-wins was strong across all end markets and all of our four product families. TOPSwitch-GX won several consumer appliance designs including a washing machine and coffee maker from Miele; service standby power supplies for Apple and Fuji; and air-conditioners for Mitsubishi; several DVD and DBR designs; and more than a dozen industrial control and metering designs. DPA-Switch continues to gain acceptance in the power over ethernet market as well as traditional telecom and industrial DC-to-DC applications.

Design-wins in the fourth quarter included voiceover IP phones, wireless LAN equipment, and industrial controls. We have a very good pipeline of ongoing design activity for 2006. TinySwitch-II had another stellar quarter with BP standby designs for Apple, Fujitsu, Lenovo, Dell, HP, and LEC; a high-volume DVD player for Toshiba; air-conditioners for Hitachi and Matchusita; several LCD TVs; and numerous industrial applications. TinySwitch-II continues to be our top running product and shows no sign of slowing down. Just this week, we introduced TinySwitch-III building on the success of TinySwitch-II with new features, better energy efficiency, and a wider range of addressable power levels. New features include selectable current limits, which allow designers to optimize the design for either maximum power or maximum efficiency. As a result of early sampling with customers, TinySwitch-III is off to a fast start with first designs likely to go into production late first quarter and several more in the second quarter. Based on the high level of customer interest, we expect TinySwitch-III to contribute significant incremental revenue in the second half of 2006.

We also expect a good contribution this year from LinkSwitch-XT and LinkSwitch-LP, both of which were introduced in the fourth quarter, but have already established strong design momentum. Interest in our LinkSwitch products continues to grow driven by the replacement of linear power supplies. In total LinkSwitch won more than 60 designs in the fourth quarter, including major appliances for Mitsubishi, Whirlpool, and Electrolux; UPS power supplies for American Power Conversion; a couple of cordless phone and cell phones designs; and a variety of lighting, metering, and other industrial applications. The increasing rate of linear replacement is driven partly by the rising cost of raw materials such as copper and iron, but also by energy efficiency standards on external power supplies, which are clearly having an impact on market.

As many of you know, California Energy Commission conducted a hearing this week at which OEMs requested a delay in the implementation of the external power supply standards as well as changes to certain aspects of the standards. While a delay would be somewhat of a disappointment and could potentially have some impact on our revenue in the second half of this year, we do not believe it would do much to stall the overall process of converting to efficient power supplies. This train has already left the station. In addition to California, mandatory standards are scheduled to go into effect later this year in Australia; next year in New York, Oregon, Washington, and Rhode Island; and in 2008 in Arizona. China's external power supply standards are already mandatory for government purchases and may be converted to nationwide mandatory standards in the very near future.

Energy Star started promoting the labeling campaign for external power supplies. In fact Samsung, our largest end customer recently announced that they will be the first OEM to market cell phones with Energy Star qualified chargers. It is clear that manufacturers are already working to comply with the standards. Since the CEC standards were announced a year ago, we have one of our half a dozen cordless phone designs with OEMs such as Panasonic, Sagent, and Sharp. We have a strong pipeline of ongoing activity with other major OEMs. A year ago the cordless phone market was completely dominated by linear power supplies, so this represents significant progress. Likewise, several top cell phone OEMs with significant volumes of non-compliant chargers are in the later of evaluating efficient designs. We have been very successful winning designs at the charger vendors bidding for this business and we are encouraged by the feedback we have received thus far. It is clear that OEMs are serious about complying with the standards and have already set the wheels in motion to make it happen.

Beyond the issue of external power supplies, the overall global trend towards more efficient electronic products continues to gain momentum. In November I attended a forum in South Korea with energy regulators and other experts from all around the world. There is a clear consensus that much more needs to be done to contain the growth of energy demand caused by the proliferation of electronic products. The voluntary programs currently in place are seen as a good start, but regulators are increasingly thinking in terms of mandatory standards. China in particular is extremely concerned about the growth in energy demand and appears ready to adopt mandatory efficiency standards on a number of categories of products, including its cell power supplies as I mentioned a moment ago. Obviously any move by China towards tighter standards would have major implications for the power supply industry, so we will be watching these developments very closely.

We are also very enthused by California's new standards for residential lighting, which took effect late in 2005. The standards require the use of energy efficient lighting throughout all new residential buildings as well as additions to existing homes. In effect, builders must use now – or must install either LEDs for all compact [unintelligible] lights for almost all interior and exterior fixed lighting. The standards allow non-efficient lighting only to a limited extent in kitchens or when used in conjunction with dimmer switches or occupant sensors. We have already observed an increased level of interest in using LEDs for general lighting as a result of these new standards. LED power supplies are a natural application for our chips. We have already begun to address applications such as commercial signage and traffic signals where LEDs are already taking hold. The new California standards promise to accelerate the use of LEDs for general room lighting. This is potentially a very positive trend for Power Integrations.

Before I turn it over to John, I would like to conclude by reiterating that we are very bullish on our outlook for 2006 and beyond. We exited 2005 with a good head of steam growing revenues at double-digit rate, pushing our gross margin above 50%, and delivering strong operating margins. Just as importantly, we had a record year in terms of design-wins, which will translate to strong revenue growth for 2006. We are also excited about a number of other initiatives that point to even stronger growth ahead including new markets like lighting and power over ethernet; new products like TinySwitch-III and others still in the pipeline; and a proliferation of energy efficiency standards around the world. We look forward to reporting our progress to you throughout the year ahead.

With that, I'll turn it over to John for a review of the financials. John.

Thanks Balu. Good afternoon. Our fourth quarter results were right on target with revenue and earnings in line with our expectations and a gross margin of 51.1%. Our balance sheet also remains extremely strong with receivables down from last quarter, inventories at their lowest level in three years, and our cash balance up almost $9 million from a quarter ago. We are extremely well positioned financially heading into 2006 and look forward to a year of strong revenue and earnings growth.

Turning to the income statement detail for the fourth quarter. Net revenues totaled $37.9 million, up 4% compared to the prior quarter and 13% year-over-year. ESP was $0.43, down a penny from the prior quarter and $0.02 from a year ago. Looking at some of the revenue detail, turns orders were 75% of revenue, down from 77% in the third quarter. Distributors accounted for 59% of revenues in the quarter including [Tenex] and [ABNET] at 21% and 16% respectively. As a reminder, we recognize all distributor revenues on sell-through. Revenue mix by end market in the fourth quarter was 29% communications; 28% consumer; 22% computer; 13% industrial; and 8% other. In terms of sequential growth rates, industrial was up 20% quarter-to-quarter. Communications was up 8%. Consumer and computer were down 5% and 3% respectively.

Gross margin for the quarter was 51.1%, up 1.6% from the prior quarter and nearly 3 points from a year ago. The gross margin improvement over the last six quarters has been a function of cost reductions outpacing the measured decline in our ASPs against a backdrop of highly competitive pricing. Also, we have improved our gross margin significantly while achieving substantial inventory reductions. Inventories are down 27% from a year ago while gross margin is up 2.8 percentage points over that same time.

Operating expenses for the quarter were $13.8 million, up 9% from the prior quarter. Patent litigation expenses were a major reason for the increase totaling $2.4 million, up from $1.8 million in the third quarter. This was about $400,000 higher than we had expected or about $0.01 per share. Sales and marketing expenses also increased quarter-to-quarter driven partly by increased sales and FAE headcount and by training expenses related to the significant number of new sales and FAE hires.

Income from operations in the third quarter was $5.6 million giving us an operating margin of 14.6%. As Balu noted however, the operating margin impact of litigation expenses was 6.3 percentage points, which suggests an underlying margin of nearly 21%. Strong operating expense leverage has always been a hallmark of our business model. We consider operating margin to be one of our most critical metrics. We view 20% as a key target. We are pleased to be back above that level, absent the impact of litigation expenses.

Continuing down the income statement, other income was $1 million for the quarter, a slight increase from the prior quarter due to higher interest rates on our cash. Our tax rate for the fourth quarter was 16.9% bringing our full year tax rate to 19.7%. This is about one point lower than we had anticipated and resulted from a higher percentage of profits coming from lower tax jurisdictions. We expect our tax rate for 2006 to be in a range of 20 to 22%.

Net income was $5.5 million or $0.18 per share. Litigation expenses reduced EPS by $0.06. Again, this was about a penny more than we had expected when we gave guidance for the quarter.

Recapping our full year numbers for 2005. Revenues totaled $144.1 million, up 5%. Full year gross margin was 49.5%, up from 47.7% in 2004. Operating margin for the year was 15.7%, including an impact of 3.8% from the $5.5 million in litigation expenses. EPS was $0.68, up about 8% from the $0.63 reported in 2004. We grew earnings per share faster than revenue despite a $0.14 impact from litigation expenses. We expect a similar impact from litigation expenses on our 2006 earnings per share.

Turning to the balance sheet at yearend. Cash and investments stood at $131 million, down about $4 million from a year ago primarily due to significant share repurchase activity during the year. Repurchases in the fourth quarter totaled $5.4 million or about 250,000 shares. Cash flow from operations was $13.7 million in the fourth quarter and $35.7 million for the year, up from $30.1 million in the prior year.

As mentioned earlier, our inventories are at their lowest level in three years at $18.4 million, giving us inventory turns of four. We expect inventories to remain in a range of three to four turns throughout 2006. Accounts receivable at yearend were $13.5 million, down more than $1 million from the prior quarter and giving DSO of 32 days consistent with our recent range.

Looking ahead, our first quarter numbers will reflect the adoption of stock option expensing. However, we have not yet finalized our accounting for options. As a result the following guidance excludes the impact of option expenses. We expect revenues to be approximately flat sequentially in the first quarter with gross margin in a range of 50 to 51%. Total operating expenses should go up slightly with litigation expenses totaling approximately $2.5 million. We expect first quarter EPS of $0.15 to $0.17.

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

Thanks John. Before we take questions, I'll do a quick rundown of our first quarter conference calendar. We'll be at the Thomas Weisel Partners technology conference in San Francisco on February 6; the NASDAQ US small cap conference in London on February 7; the Piper Jaffray analog summit on February 16 in Boston; the Raymond James institutional investors conference in Orlando on March 7; and the Citigroup small to mid-cap conference in Las Vegas on March 14.

Now Operator, would you please give the instructions for the Q&A session.

Yes, sir. (OPERATOR INSTRUCTIONS) Ross Seymore with Deutsche Bank.

Thanks. Just a couple questions for you. First, on the sales side. Balu, you mentioned that you had some new customers lined up in the cell phone space. Can you elaborate a little bit on that and go into when the revenue might be seen from those customers.

We have won a number of designs with our customers. We don't actually consider it a design-win until they win business with the OEM. At this point I really can't discuss the OEMs. When we do win the designs, we will certainly talk about it.

Onto the OpEx side, one for John, with the sales force expansion that got the OpEx and the sales and marketing specifically up a little higher than I had expected in the December quarter, as we look into '06, are you right-sized with the sales force that you need now. So the increase in that line would be mainly driven on variable costs along with sales growth? Or will the growth in sales and marketing continue in absolute dollars regardless of the sales as we go into '06?

We continue to add people. But I think the growth that you will see in sales and marketing expenses in '06 would be less than what you saw in '05. But, as I said, we are still adding some incremental heads.

Finally on the CEC versus the CEA side of things, do you have any better color on when a decision from the CEC side of things may come out regarding any delay or lack thereof in the implementation of the registrations?

Not really. I don't think they have committed to any dates at all. My understanding is they listened to all the presentations, but did not give a specific date.

Okay. Thank you.

Tore Svanberg with Piper Jaffray,

Good afternoon. A couple questions. Balu, you mentioned Samsung now moving forward to use the Energy Star label. Do you think that is now the beginning of a trend? Have you heard some other OEMs moving in that same direction?

Yes. We have heard of one other major cell phone company. I don't think it is public yet. But they are going to be compliant with CEC.

Very well. Looking at the gross margin, you mentioned some cost savings. Can you give us a little bit more color on what types of cost savings that you are seeing. Is it on the front end? On the back end?

Moving forward, there are several areas. The key ones are we will accelerate our transit of test to overseas locations. We expect to double the percentage of testing done overseas in this year in 2006. That will be a gradual change throughout the year. That will give us some cost advantages. We don't expect cost improvements in the packaging itself because of raw materials issues. The raw materials are getting more expensive. However, we still have the cost improvements through new products. All of the new products we have introduced in the recent past and the ones we are going to introduce in the near future, are all more cost-effective at the system level, which means it is also lower cost for us also.

Also looking at 2006, I think your sequential growth rate the last four quarters being in the 2% to 4% range, it looks like you've got a lot of things going on for you in 2006. When do you think we'll start to see the sequential growth trends moving in above the 5% level?

It is hard to predict. We haven't given the forecast for the whole year. What we can say is that 2006 is going to be significantly better in growth rate than the last two years because of all the drivers we talked about specifically related to the CEC standard. We should start seeing significant design-wins in Q2, which should translate into revenue in Q3 and Q4. The even bigger impact will be in 2007 when we'll see the whole year impact.

Finally on the legal expenses. Based on your calendar of events, is it safe to say that legal will probably kick some time in the third quarter?

The fourth quarter should be almost down to nothing. Most of the expense will be the first, second, and third quarters. Other than the first quarter, we are not in the – we don't have enough information to say exactly how it will be split between the second and third quarter. By its nature, it is very unpredictable as to exactly how the sequence of events happen and how the work is done. It is dependent on a lot of external factors. That is one of the reasons we have difficulty coming up with the forecast for actual legal expenses. Although the overall legal expenses still are within the range that we have expected.

So based on that, is there a fair chance you'll then be about 20% operating margin in Q4 of the year?

Based on where we are now, without the legal expenses, I would say that is definitely our expectation.

Very good. Thank you very much.

Andrew Huang with American Technology Research.

Good afternoon. Just a quick question. First, can you give us a rough idea of what percent Japan is of total sales?

Japan – at this point, it's somewhere in the 4% to 5% of revenue.

I was just curious. By using a direct approach in Japan as opposed to using [distee], does that help your gross margin? Or does it reduce your operating expenses by not having to pay the distributors?

I think what you might be referring to is what Balu mentioned in his comments and also what we talked about last quarter when we say a direct approach. Previously we had a licensing agreement that is still, to a certain degree, in place with the Mashusta. They had the non-exclusive right to sell products in Japan using our technology. Then they would pay us a royalty. They no longer have the right to our new technology – to anything that was developed after June 30. So they no longer have the right to that. They will continue to pay us royalty using the old technology for four years at a reduced rate. But now we are going to attack the Japanese market directly entirely. In the past we depended primarily on royalties from Mashusta. I think that what we meant by direct. So direct could be either direct to us or with a distributor. But it would be selling our parts as opposed to getting royalties from Mashusta.

Just to add, most of our revenue in Japan – I would say almost all of our revenue is through distribution.

Okay, got it. The next question. I think in your prepared remarks you talked about revenue growth for calendar '06 being well beyond 7% number. What was that 7% figure?

The average of the last two years – '05 and '04.

The last two years. Got it. At this point, obviously you don't want to provide full year guidance.

But you want it anyway.

Basically. I'll leave it at that. The last question is just a point of clarification. I am looking back. In my model for the December quarter, I had a 21% tax rate. I thought you guided us to 21% for Q4. First of all, I want a clarification on that. Secondly, what tax rate should we be using for calendar '06?

We did guide you to 21%. As I mentioned in the comments, we had more profits in lower tax rate jurisdictions than we were expecting. Therefore our tax rate was lower. As I also mentioned in the comments for '06, for the year we're estimating somewhere between 20 and 22. Because it's difficult to predict which country our profits are achieved, it's a little harder to estimate an exact number. Obviously that tax rate excludes option expense. We haven't figured that part out yet.

One last question, if you don't mind. Do you have any more shares left in your repurchase program? Is it all done?

The board authorized 40 million of the—I'm sorry. The original was 40 and now 25 million. As I mentioned, we purchased 5.4. So we still have 19.6 million left.

Thank you very much.

Shawn Slayton with SG Cowen.

Good afternoon. Could you give us a little more color on this CEC event. The way I look at it, if you go to the website and check this thing out, it says that the appliance efficiency regulations were put into the California Code of Regulations on December 30, meaning they are state law. The standards for power supplies, which pertain to you, are there in the California Code of Regulations. Right now this appliance rulemaking, this committee hearing on the 14th is talking about lighting, refrigerators, freezers, cooking products, and food services equipment. I don't understand how that pertains to standards for power supplies. Can you help me out?

I am not sure what you are referencing in the second part of your question. The first part is correct. The external power supplies was part of a larger standard on appliances that went into effect in December of 2004. For external power supplies, the effective date for compliance as it stands right now is July 1 of 2006.

Right.

The hearing, which happened two days ago, was on the external power supplies. There were a few OEMs who wanted either to delay the standard or get some minor changes or exemptions. That was the hearing. But it is already a law. I understand it is a law. This hearing actually comes very late in the game. I guess the Commission wanted to listen to all of their suggestions or presentations, which they did. We don't know exactly what course of action the Commission will take and when they will take it. What we do know is most of the OEMs – you've got to remember the ones that were represented at the meeting was a very small percentage of the OEMs who are already going full-speed forward to meet the standard. I think Hewlett-Packard specifically said they did not want to extend the effective date because they had already spent a lot of effort in converting all of their power supplies. Apple has also been very supportive. Samsung recently announced that they are going to be compliant with Energy Star standards, which is identical to CEC for the external power supplies. This is not very uncommon for any standard, for that matter. There is always a push-back from usually a certain number of people. What we don't know is what CEC is going to do.

Can you help us – can you put any numbers around the recent design-wins that you believe are directly attributable to the CEC initiative – the new California law.

I think we did mentioned it.

We had a total of 60 design-wins on LinkSwitch. It is difficult to know exactly which ones relate to CEC and which ones don't.

Can you give us just a couple of case studies or a couple of specific examples of design-wins that you know are most likely related to CEC.

The ones that we mentioned in the press release and also in the script was the cordless phone area with Panasonic, Sharp, Sagent. As we've also mentioned, we have lots of design activity, which are not yet design-wins. We define a design-win when we get pre-production orders. As we've said all along, we expect in Q1 and Q2 to get most of the design-wins related to CEC. The ones that we have gotten that we've talked about, would predominately be in the cordless phone area.

Okay, that's all. Thank you.

Gus Richard with First Albany Capital.

Can you talk a little bit about the pricing environment and the impact of that in the quarter on gross margin.

We have read reports and gotten some anecdotal evidence that discrete pricing is forming at medium and small-priced customers. We haven't seen that at tier one customers. Certainly the lead times have gone out, not only on discrete components, but also on integrated components from our competitors. As far their impact on our gross margin, unless it is sustained for a long time, it is not going to have an impact. For one thing, you cannot change over the design quickly. Secondly, we can't raise prices on existing designs. So I don't think it will have any significant impact on our gross margins purely from a pricing point of view unless they continue to stay stable, go up over the long period of time.

Have you been – how has your learning curve pricing been over the last few quarters? Has it been a little more shallow than normal?

You mean in terms of how aggressive our----

You haven't had to take it down as much because you are not getting as much pressure from the discrete guys.

I would say so far we haven't seen any letup on that. If the pricing remains stable or goes up, then over the long term it could help us. But it is not clear that it is going to be a long-term stability in pricing.

So most of the gross margin upside in the quarter is coming from your cost reductions as opposed to any more favorable pricing.

Yes.

Got it. Moving onto the mix of revenue by end market, clearly you are knocking the cover off the ball in the industrial market. And you had very strong sequential growth. Is that a seasonal thing? Or is that just ramp in some power over ethernet designs – well, that probably wasn't in there – but some portion of that that is really driving strong sequential growth.

It's a good question. We have so many fragmented applications, it is really hard to understand the trends in that market. Even if you look at our seasonality – try to figure out whether there is any seasonality on industrial – it is really hard to see a pattern. All we can say is that over the last three years our industrial revenue has grown dramatically from 5%. Even from a percentage point of view it has grown from 5 to 13% over the last three years. Of course, in dollar terms it is even more because we have grown the top line.

One of the areas that we've had the most growth in is uninterruptible power supplies. I have to admit I don't know the seasonal patterns of uninterruptible power supplies.

I can tell you one of the reasons why that is growing. That is because of more computers being purchased in countries like China, Indonesia, India, and Latin America where, when you purchase a computer, you pretty much have to purchase a UPS because the power interruptions are so frequent. You will start losing data if you don't have UPS. The volume of UPS power supplies is equal to the volume of desktop computers sold. That is one of the reasons it is growing so fast.

One final question back to the gross margin. Do you expect to maintain – at the high end historically your range has been 45% to 50% gross margins. You are above your model. Do you expect to stay above that? Or if you continue to accrue benefits from cost reduction, are you going to pass it along to your customer and try to spur elasticity in the market?

As we mentioned, we expect to remain around 50% for the foreseeable future.

Foreseeable future in your business in about a month. When you say that, are you talking about all of '06? Could you be a little bit more clear on that term.

I think in general as we go into '06, we would expect to have our gross margin remain at that level for several quarters.

Yes, several quarters is how I would put it. That makes the assumption that the dynamic in the market remains similar to what it has been in the last year. We are assuming a certain measured reduction in price and also assuming there are no dramatic changes in other factors like yen exchange rate or any other factors that we don't have control over.

Got it. Okay, I appreciate it. Thanks a lot.

Sumit Dhanda with Banc of America Securities.

A couple of questions please. My first question is, can you help us quantify some of the seemingly higher profile design-wins, for example, your cordless phone with Panasonic. Are we talking just one or two models? Are we talking several models? What might be the timing of the ramp into production as it relates to power supplies [inaudible].

I don't have the specifics on all of the customers. I think in the case of Panasonic it's two models. The general impression we are getting from OEMs is that they are going to convert at a tide line over a period of time. Their immediate concern is to take care of California. My guess is they would pick a few models to take care of California and then slowly spread the compliance charges to the rest of US and then to the rest of the world.

Along those same lines, as you are competing for these market – maybe you can use Panasonic as an example or any other OEM that you chose. Typically what is the ratio of designs that you tend to win versus the competition. I am assuming most of the competition is suite-base [inaudible] whatever that might be. Could you elaborate on that.

Yes. In the linear replacement, we are in a very strong position. We have a large number of products that we developed three years ago. We were way ahead of the market. We are in a very good position relative to other integrated competitors. The real competition in the linear replacement are the discrete solutions. We are always competing at the [unintelligible] or system level solutions to be equivalent to discrete. But we have the benefit of fewer components, easier design – a faster design – and easier manufacture-ability. Because of the urgency of implementing these standards, we have an upper hand because they can design better products a lot quicker.

If I were to ask you, are you winning one out of every two designs, one out of every three? Is it higher or lower than that? Could you give us some ballpark quantification.

If you look at the cordless phone market, we already have I think three or four design-wins. If you take the top six, we already have three or four of them. We are also working with the rest of them. We hope to get a very large of this market over a period of time. This won't be a step function on July 1 for reasons I mentioned earlier. They will gradually transfer the rest of the world. We expect to get a very high share of this market over the next couple of years.

Switching gears a little bit back to the cell phone market, you indicated that some of your solutions were in the later stage of evaluation at the OEM level. Can you help us gain a little more granularity in terms of when those evaluations might be done and when you hope to see a full-blown design-win announcement at the cell phone OEM level.

We will get some design-wins in Q1, but probably the bulk of them in Q2 in time for the CEC on July 1. At the moment what is happening is that we have gotten our product design into a number of vendors who are bidding for the business with the OEMs. The remaining vendors are using the discrete solution. When they win the design and place a pre-production order is when we would consider it a design-win. Most of that will occur in Q2, but we should see some in Q1.

Any specific OEM you can allude to where we might see a design-win announcement?

I would say all of the major cell phone OEMs – all of the ones who actually have linear instead of converting. We are going after all of them.

Two quick questions for you, John. First, the inventory is down very significantly. Anything you can attribute that to?

We made a decision a year ago to keep our production levels relatively flat to manage our business. It makes it easier to manage the business. As our revenue grew throughout the year, obviously it brought down our inventory. I think we are at a point now where we are going to take our production levels up throughout 2006. It was a decision to keep production levels at a constant level, which is important as we look to transitioning offshore. We want to keep the testing that we do in San Jose at somewhat of a fixed level. As we move additional production, that goes offshore. To keep the local production flat and at the same time, our revenue was growing. It facilitates management of the operation and facilitates the offshore transfer.

The implied turns guidance for the March quarter?

Implied turns. We expect the turns orders to meet the mid point of our guidance, which is flat, in the mid 60s. We had a higher backlog at the start of the quarter than we had had for quite awhile.

Any reason. This backlog was substantially lower than last quarter. Any reason for the conservatism?

If you look at the backlog, they had longer-term backlog. I think it's because the lead times have gone out on other companies. People are booking ahead of time. So the lead times are longer. Even though we have a larger backlog, that doesn't necessarily indicate that it is a stronger quarter than what we implied simply because of the length of time that it actually goes over.

Because we have such a high turn in this business, we rely more on our sales forecast in developing guidance than the backlog. The backlog is usually a small percent of the revenue compared to other semiconductor companies.

I will ask you just one final question. It is the same question differently. Do you think that the extension with the better backlog coverage is more a function of the cyclical dynamic out there and is not really attributable to the better design-win momentum you are seeing and the resultant ramp in production. Is that a fair way of categorizing it?

Yes. We don't see a fundamental change at this point in time to the overall model.

Okay. Thank you very much.

Craig Hettenbach with Wachovia.

Thank you. You spoke about the industrial market being robust and com with cell phones going to drive some growth in '06. How about if we look at the consumer end market? What are your expectations within consumer?

We also expect that segment to grow, but probably not at the same rates that we might expect in the communication and industrial areas. We expect to get growth in all of our segments.

Yes. I think that 2006 should be a good year for the entire marketplace across the board. If you look at our design-wins, we got a large number of design-wins in PC standby and also a large number on consumer goods like LCD TVs and the appliances and so on. We expect all of the segments to grow nicely in 2006.

If you look at bookings linearity through the December quarter, how did it trend? How have you seen bookings within January?

From a bookings standpoint in the fourth quarter, October was the strongest as is typically the case. People order early in the quarter to build product for the Christmas season. Bookings were the strongest in October. Our actual shipments were the strongest in November, which is also somewhat typical. The first quarter is a little different every year, but it generally is one of our more linear quarters of the year in terms of the orders and the revenue shipped.

Great. Lastly, it looks like R&D as a percentage of sales approaching the 10% level. Do you think if it gets there, does it stay at about that level? Longer term, how should we think of R&D spend as a percent of sales?

All of our operating expenses longer term should come down as a percent of our revenue because of the leverage that we get off of our revenue growth. Sales and marketing increased quite a bit in '05 because we made a conscious decision to increase the size of our sales force. We didn't spend as much on R&D. We will add some spending to R&D in '06. Overall, operating expenses as a percent of revenue should come down over the long term.

Thank you.

Mark [Donahue] with Ferris Baker Watts.

Most of my questions were answered. Just a couple housekeeping. What was your ending headcount for the quarter?

Ending headcount was 342.

Back on the discussion around the backlog, have you seen a change in the amount of weeks of inventory that you had in distribution channel? I think you said 3.6 last quarter.

It was up slightly at the end of December, which is unusual. Usually from September to December it declines. But it was up slightly.

Lastly, off the beaten path a little bit. Have you defined a size of the market for the DPA-Switch and POE given the product offerings you have?

Yes. I do believe we have the market. I am trying to remember the size of the market. It is in the order of, for the POE, I think it was in the order of $50 million in 2007 for our chips.

Okay, great. Thanks a lot.

Steve Smigie with Raymond James.

Great. Thank you. Most of my questions have also been answered. Could you comment a little bit on the development of the sales force. You have doubled that. I was wondering how their progress in terms of getting a pipeline ready, etc., is going. Are things ahead of schedule perhaps?

In terms of hiring the people and training them?

In terms of the training or getting them out on the street or in terms of trying to get design-wins. I was wondering where you were in that.

I think we are on track. We talked about that last quarter that the level of design-wins has increased, especially in Asia, especially in China. We attribute a lot of that to the increase in the sales force. Last year – over the last two years, we've doubled our sales force, but we added to it significantly last year. As we commented, one of the reasons why our expenses were a little higher in the fourth quarter is we spent an extensive amount of time training the sales force and the FAEs to make sure they understand all the products and have all the tools and can work together. We think that we're starting to see the benefits. We expect to see more benefits of not only added headcount, but people that have had more experience and are more mature in selling our products.

As part of that, it sounds like things are progressing well. It was such a significant increase I thought that maybe you are being a little bit conservative in terms of when they could get up and the magnitude – the number of design-wins you could get. I am trying to get at if you are ahead of what you had hoped you can get out of it.

Part of the reason, just so that you understand, is the CEC standard. Because the CEC standard required quite a bit of design support that we had to provide to a large number of customers at the same time. In preparation for that, we added some people. Also, we talked about a large number of other drivers, other than energy efficiency, which also meant that we need people. We have new markets that we are going after. We are going after Japan by ourselves, which has required people in Japan. The power over ethernet and lighting markets require somebody, some people to go after those customers. It was well planned. It didn't happen by itself. It was a proactively planned growth to address all of the drivers we have going forward in 2006.

Just to be clear, our spending was higher in that area than we had originally expected because we did add people a little faster in the fourth quarter than we anticipated and we did extensive training in the fourth quarter, which at the start of the quarter we hadn't fully planned. We made the decision to make it much more extensive than we had originally expected.

Okay, great. Thank you.

[Eric Glover] with Canaccord Adams.

Thank you. Could you talk a little bit about your market share particularly among your primary competitors. How do you think you ended up in 2005? Given your expectation for share gains in 2006, where do you think your market share might end up?

We haven't updated our market share relative to our competitors recently. I think if you remember our presentation, our last estimate was all of our competitors combined in the integrated space had somewhere between 20 to 25% of the market versus us. We had the remaining 75% of the market. I don't think it has changed significantly. In fact, we are growing our market share. Some of it is coming from our integrated competitors. Some of it is coming from discrete competition. And linear transformers – the third category.

Okay, that's good enough. Thanks.

Alright, next question. We'll take two more questions please.

Craig Ellis with Citigroup.

Thanks for that. First a clarification. You identified three or four factors that were going to be beneficial to gross margins this year. Can you quantify the impact of those collectively. I assume the order that you gave them is the order of magnitude that they will benefit your gross margins.

I don't recall giving four factors on gross margin. We mentioned in general that we were going to focus on cost reduction – as we always do – which includes wafer cost; the size of the die; packaging costs; test costs; and operational overhead in general.

Right. That is what I am referring to.

We focused on all of those. We will continue to focus on all of them. In 2005, the cost reductions we achieved were primarily wafer related – either wafer cost reductions or reduced die size. We didn't get as much from packaging or from test costs. I think in '06 – we haven't fully quantified it. I think in '06 we would expect to get reductions from all the pieces – wafers; packaging assembly; test.

Focusing on revenue growth, two items. One, given what you are seeing, you are confident that growth will be better than 7%. Are we talking about growth that is low to mid single digits, mid to high single digits? Any parameters you can put around the growth potential that you see in the business?

No. At this time we are not giving guidance for the year other than to say that we expect it to be significantly more than what we've done the last couple years.

Understanding how that might break out across the various products, whether it is TinySwitch or TOPSwitch, Link, DPA, how would the growth of the various product sets compare to what you might get on average? Link is going to be the biggest growth driver. Is that a correct assumption?

That is a correct assumption. Link will have the largest impact on the growth. DPA should grow nicely as a percent growth rate, but it is coming off a fairly low base. As we also mentioned, in the second half of the year, we expect to get revenue from TinySwitch-III. We expect the good growth to continue with TinySwitch-II and TOPSwitch-GR.

Link might drive 50% or more of your growth for the year?

I haven't done the exact math, but it will be a major driver of the revenue growth, yes.

Alright. Thanks.

Okay. We've got time for one more question.

Shawn Connor with Waterstone Capital.

Most of my questions have been answered. A couple quick ones. Did you see much of a benefit from the yen in your – that helped out gross margins in the last quarter?

No. We estimate the benefit from a weakening yen is no more than 20 basis points. From when the yen exchange rate changes to when we see it in our financial statements is delayed about six months because it is based on when we order the wafers, when the wafers are delivered, and then when it flows through our inventory. It is about a six-month delay. So about a 20 basis point impact. We could see a little more in later quarters. However, overall the yen will have less of an impact going forward because we now have a third foundry that we have been buying wafers from for the last year, a German foundry. Those wafers are purchased in dollars. While obviously the weakening of the yen has some benefit, it's not a significant benefit.

Just real quick – I apologize – on the litigation cost, do you give an estimate of what you think it will be for the entire year.

We – our spending was 5.5 million in 2005. We said we expected a similar level in 2006.

Great. Thank you very much.

Okay, thanks. That concludes our call. A replay will be available shortly on the investor info section of our website at www.powerint.com. There will also be a telephone replay available for one week. The number for that is 877/919-4059 from within the US. From abroad the number is 334/323-7226. The replay passcode is 94327275. Thanks for listening and good afternoon.

Thank you. Ladies and gentlemen, that concludes today's call. You may now disconnect.