Power Integrations Inc (POWI) 2006 Q4 法說會逐字稿

Good afternoon. My name is Brooke, and I will be your conference operator today. At this time, I would like to welcome everyone to the Power Integrations reports selected fourth quarter and full-year financial results. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Mr. Shiffler, director of Investor Relations. Thank you. Mr. Shiffler, you may begin your conference.

Thank you, and good afternoon. I am Joe Shiffler, director of IR and Corporation Communications for Power Integrations. With me on the call today are Balu Balakrishnan, president and CEO of Power Integrations, and Rafael Torres, our chief financial officer. Following Rafael, we'll each have some prepared remarks after which we'll take your questions.

A short time ago we issued a press release outlining selected financial results for the quarter and year ending December 31, 2006, and providing an update on the status of our pending financial restatement. This press release is available on our website, www.powerint.com and has also been e-mailed to those of you on our distribution list.

At this point, I'd like to note 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. Such risks and uncertainties are discussed in today's press release as well as 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. I'd like to begin today with some very good news on the status of our pending restatement. The SEC has very recently completed its review of our stock option accounting and the restatement-related disclosures. With this major hurdle cleared, we should be able to file our 10-K for 2005 in the next week or two.

Once the restatement is behind us, we will work to file our outstanding 10-Qs as quickly as possible. While there is still work to be done in order to get up to date on our SEC filings, our 2006 filings should be more routine than the restatement, which involved multiple audit firms the SEC pre-clearance procedure.

Once we are up to date, it is our understanding that our shares can be relisted in a matter of days.

With the 2006 10-Q still pending and the audit process still not complete, we are not in a position to share complete financial results for 2006. We intend to review the completed financial results on a later conference call once we file our 10-Qs for 2006.

However, at this point, we are providing preliminary revenues and gross margin information for the fourth quarter and the full year of 2006.

Our outlook for the first quarter also includes the forecast of our gross margin and operating expenses. Our preliminary full-year revenue for 2006 was $152.4 million, up about 13% from the prior year. Our gross margin continues to run well above the recent historical levels coming north of 54% on a GAAP basis for the full year including the offsetting impacts of stock option expenses and the one-time shipment debt settlement benefit that we recognized in the second quarter.

Our cash balance increased by $2 million over the course of the year in spite of using approximately $20 million for repurchase of share and spending more than $18 million in total between the restatement efforts and our patent litigation.

Our financial model is in good shape going into 2007, and we expect to deliver strong earnings growth for the year, particularly with the restatement spending nearing its end and with patent litigation costs expected to decrease significantly compared to last year.

Turning to our results for the fourth quarter of 2006, we saw greater-than-expected impact on the inventory correction that has affected the industry over the past several months. At the time of our number two conference call, we had just concluded one of our strongest months ever in terms of bookings. However, conditions can change very quickly given the high turns nature of our business, and that was certainly the case in the fourth quarter.

Bookings in November and December slowed significantly more than normal seasonality would indicate. Fourth quarter revenues came in at $41.3 million, up 9% from a year ago and down 7% sequentially.

The slowdown in bookings were extremely broad-based. Revenues from the computer consumer and industrial end markets were all down sequentially and nearly all of the major applications in these markets were down as well, underscoring the breadth of the downturn.

The communications market bucked the negative trend growing sequentially thanks to growth in cell phones, voice over IP phones, broadband modems, and cordless phones. Given the high turns nature of our business, the upcoming new lunar year holiday and the negative outlooks of many of our analog peers, calling the bottom is an uncertain proposition. However, our bookings have improved significantly since the beginning of the year, and we believe there is a strong likelihood that sequential revenue growth will resume in the first quarter.

With a sense that this downturn is shorter and/or less severe for us than for other analog companies, it is an indication of the penetration gains that we achieved in 2006, which was a stellar year in terms of design wins.

For 2006, the expected revenue contribution of designs won was more than 20% higher than the prior year.

Throughout the past year, we have highlighted a variety of drivers that have contributed to the acceleration in design activity and design wins. Each of these drivers should have an even greater impact in 2007 both in terms of design wins and revenue growth and, as a result, we expect to grow our revenue faster in 2007 than we did in 2006.

Probably the most significant of these growth drivers is the replacement of linear power supplies, which continues to accelerate due to elevated raw material prices as well as the onset of the California Energy Commission's energy efficiency standards for external power supplies.

The mandatory CEC standards are already in effect for a handful of end products, and after a one-year delay, are scheduled to take effect in July for all other products including cordless phones, power tools, and the countless other devices that utilize external power supplies.

Virtually all existing linear power supplies will fail to meet the standards, so we expect to see a continued ramp in linear replacement designs throughout 2007 and beyond. Cordless phones, which, until recently, used linear power supplies almost exclusively are an excellent example of the traction that we are gaining in linear replacement.

In 2006, our cordless phone revenues exceeded $1 million, up from virtually zero two years ago, and we have design wins with many of the major suppliers of power adapters to cordless phone [unintelligible].

With the CEC standards going into effect for cordless phones in July, we have a significant number of additional designs in progress, and we expect to gain quite a bit of market share in this market in 2007.

We look at growth in our LinkSwitch product line as an indicator of the overall linear replacement trend, which includes embedded linear power supplies as well as external adapters.

LinkSwitch remains the only fully integrated product specifically targeted at linear replacement. LinkSwitch revenues increased 125% in 2006 and comprised 9% of our revenues, up from 4% in 2005. Again, this is in spite of the delayed implementation of CEC standards, which clearly slowed the pace of redesigns for external power supplies.

We are excited about the level of ongoing design activity with LinkSwitch and about the impressive range of designs that we won during the fourth quarter. These include a major appliance design for Electrolux, an air conditioner for Samsung, a Remington shaver, a high-volume PDT television design for LG, and a range of industrial applications including metering and lighting controls.

Another key driver for us has been the excellent traction we have seen with TinySwitch III, which we introduced in early 2006. Tiny III has generated more than 5% of our revenues exiting the year, and has already surpassed Tiny II in terms of quarterly design wins.

The fourth quarter was very strong for Tiny III in terms of design wins, including PC standby designs for Dell, NEC, and Lenovo, an ATM machine for LCR, a Sharp LCD TV, and a high-volume DVD design for Philips. The ramp of Tiny III has been considerably faster than we typically see with new products, which gives us a strong indication of the product's cost effectiveness and attractive features.

Other growth drivers that we have focused on over the past year have been two imaging markets for our technology; namely, lighting and power over Ethernet. Lighting-related revenues approached $3 million for 2006, up more than 60% year-over-year thanks largely to growth in all plan LED applications.

LED power supplies are a natural application for our technology, particularly since better efficiency is one of the key benefits of LEDs compared to traditional lighting technology.

Power over Ethernet was the primary driver of growth in our DC-to-DC product line DPA switch. DPA switch revenues tripled year-over-year led by the growth in voice over IP phones due largely to our presence in Cisco's high-volume phone model, we believe we have become one of the top two players in the power conversion market for voice over IP phones.

Another growth driver that we have discussed throughout 2006 is our increased presence in Japan following the expiration of our licensing agreement with the MEI in 2005. Because MEI is no longer able to make use of our latest technology, we now have a technological advantage in Japan similar to our advantages in other markets, and we are seeing the benefits of that in terms of higher shipments to Japan.

For 2006, revenues from Japan grew more than 40%, and we expect another strong year in 2007. All of the drivers I have just outlined are still emerging and should have a bigger effect in 2007 than they did in 2006. In addition, we look forward to the conclusion of our patent litigation against Fairchild as an opportunity to gain market share currently held by infringing products.

As you may recall, a jury found Fairchild to be willfully infringing four of our patents and awarded us damages of approximately $34 million. A patent validity argument in front of a second jury are now scheduled to occur in early June. We expect the validity of our patents to be upheld, and we intend to seek an injunction against the infringing Fairchild parts.

We also plan to request enhancement of the damage award based on the finding of willful infringement.

Our ITC cases against System General has already had a significant impact. We believe that some incremental revenue has flowed to us as SG lost share in the LCD monitor market and several redesign opportunities are currently in progress. Originally, we believed that a number of SG products not covered by the ITC exclusion order also infringe our patent. We are seeking action against these products as well as financial damages in our pending case in the district court of Northern California.

We are very bullish on the growth opportunities ahead of us, and we have built up our sales force in order to fully address them. We have also brought on board a number of smaller regional distributors and catalog distributors to help us increase our presence with smaller customers. This expanded geographic reach is critical in the high-voltage power conversion industry, which is not only fragmented but also highly dependent on strong application support since every power supply is essentially a custom design.

Our expanded reach combined with unmatched expertise in power supply design, battle-tested intellectual property, and cutting-edge products have us well positioned to maintain our leadership in the power conversion market in 2007 and beyond.

At this point, I'd like to turn the call over to Rafael for further comments about the restatement as well as a bit of additional color regarding our financial performance. Rafael?

Thanks, Balu, and good afternoon. I'd like to start by providing a bit more detail on our financial restatement effort, which is essentially complete now that the SEC has completed its review of our stock option accounting treatment and the disclosures related to the restatement.

The restatement period includes fiscal years 1998 through 2004 as well as the first three quarters of 2005. The restatement will be incorporated entirely in the 2005 10-K, which we expect to file shortly. We will not be filing amended versions of past years 10-Ks.

In aggregate, we expect to recognize approximately $44 million in pretax stock-based compensation and related expenses over the restatement period plus an additional 900,000 in the fourth quarter of 2005.

The amount of stock-based compensation spilling into 2006 and future periods as a result of the restatement is not expected to be material.

After tax affecting the stock option expense and taking into account other accounting adjustments, which are not material in the aggregate, we expect that our net income over the restatement period will be reduced by approximately $31 million. About 97% of this amount will be recorded in fiscal years 2003 and earlier.

The completion of the restatement and the filing of the 2005 10-K is, by far, the most significant hurdle for us to clear in order to get up to date on our SEC filings. As you may recall, for the 2005 10-K, we needed to pre-clear our accounting and disclosures with the SEC, and we have had two external accounting firms auditing our restatement.

Going forward, it is difficult to predict how long it will take us to become fully compliant. However, for the remaining filings, no SEC pre-clearance will be required, and only one accounting firm will be involved, which should make things less complicated. We look forward to concluding this process in the near future and regaining our listing status shortly thereafter.

Now turning to our fourth quarter results, we obviously regret that we did not forecast the downturn that hit shortly after we issued our revenue guidance. However, we are highly encouraged by the upswing in orders that we have seen thus far in the first quarter.

While we are not immune to the challenging supply chain conditions currently impacting the industry, it appears that penetration gains are bringing us out of the downturn more quickly than is the case across much of the industry.

With respect to our financial performance for the fourth quarter and the full year, we are yet to complete our customary close and review procedures, and all numbers presented should be considered preliminary and subject to change.

Preliminary fourth quarter revenues were $41.3 million, up 9% year-over-year and down 7% sequentially. Revenue mix for the quarter was 32% consumer; 29% communications; 18% computer; 14% industrial; and 7% other.

Communications revenues increased sequentially in the mid single digits, while consumer revenues were down mid single digits and industrial revenues declined in the low teens. Computer revenues were down approximately 20% coming off a 40% sequential increase in the previous quarter.

Turns orders comprised 63% of revenue down from 65% in the third quarter. Distribution accounted for 64% of revenue in the quarter, all recognized on a sell-through basis, as usual. One distributor, Avnet, was our only 10% customer accounting for 27% of revenue.

For 2006, preliminary revenues were at $162.4 million, up 13% year-over-year. Full-year revenue mix was 32% consumer; 27% communications; 19% computer; 15% industrial; and 7% other. Avnet was, again, our sole 10% customer accounting for 23% of our product revenue for the year.

Gross margin was strong throughout the year driven by a variety of factors including die shrinks, the continuing migration of our testing operations to overseas contractors, a change in customer mix toward smaller, higher-margin customers, and a relatively favorable pricing environment.

Our fourth quarter gross margin should come in at approximately 53% on a GAAP basis, which includes an impact of about one margin point from stock-based compensation.

For the year, GAAP gross margin should be above 54%, again including about one point impact from stock compensation. That GAAP number also includes about a one-point positive impact from the ship and debit settlement benefit that we recognized in the second quarter.

Our fourth quarter operating expenses included $1.7 million related to the cost of the restatement and $1.5 million for patent litigation.

For the full year, these expenses totaled $11.2 million, and $7 million, respectively.

As Balu noted, we intend to provide a full review of our operating expenses and all other financial information for 2006 once our 10-Qs have been filed.

Moving down the income statement, other income for the fourth quarter was $1.6 million driven primarily by interest income. For the year, other income totaled $6 million. We are still working to finalize our tax rate for 2006, however, we expect the effective tax rate for 2006 to come in below 10% due to the high level of U.S.-based expenses for the restatement and patent litigation.

Looking at the balance sheet, our cash balance increased to $132.7 million, up $4 million from the prior quarter. As Balu noted, our cash balance increased by $2 million for the year despite the fact that we spent $18 million on the restatement and patent litigation and used about $20 million to repurchase shares.

Looking ahead, we expect first quarter revenues to be in the range of flat to up 5% sequentially, which would be a year-over-year increase of roughly 17% to 23%. That would give us an excellent start toward our full-year goal of growing our revenues faster than the 13% growth we achieved in 2006.

For the first quarter, we expect gross margin to be between 52% and 53% including an impact of about one margin point from stock-based compensation. Overall, we expect gross margin to remain relatively steady throughout 2007 while we do expect some increased pricing pressures due to the competitive environment and some additional margin pressure from raw material costs, particularly silicon, we think we can largely offset these factors through continue cost reductions and perhaps a slight benefit from the improved dollar/yen exchange rate.

We expect first quarter GAAP operating expenses to total $19 million and $22 million. This range includes $3 million to $4 million in stock-based compensation, $2 million to $3 million in expenses related to the restatement, and less than $1 million related to patent litigation.

In summary, we think that 2007 should be an exciting year for Power Integrations. We are on course to deliver strong revenue and earnings growth. Our gross margin is running well above the recent historical levels, and we should see significant leverage in our model, particularly as some of the elevated spending on litigation and the restatement are put behind us.

Our balance sheet remains in outstanding shape with more than $4 a share in cash and zero debt, and with the SEC review of our option accounting complete, we are now one big step closer to completing our restatement and regaining our listing status.

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

Thanks, Rafael. Before we take questions, I'd like to just mention a couple of conferences we have on the calendar for next week. We'll be presenting at the Bank of America Technology Conference next Wednesday morning in New York, and later that same day, Balu will be participating in a panel discussion at the Piper Jaffray Opportunities and Alternative Energy Symposium also in New York.

Now, Operator, let's open it up for questions.

[Operator Instructions] Ross Seymore, Deutsche Bank.

Hi, this is Suki for Ross. Can you hear me?

Just barely.

Is that better?

Much better, thanks.

Okay, on the margin front, clearly, your gross margins were pretty good for the quarter. Can you talk a little bit about what your operating -- I mean -- expenses were year-over-year at least for '06? I mean, you'd think, on a pro forma or a GAAP basis, your opex increased year-over-year greater than revenue or less than that? Any color on that would be helpful.

We can't give you too much color at this point. I think what we can say is point to what we expect, going forward. Until we close our books and complete the audit, it's just typical to give out those types of numbers. But what we can tell you is what we said earlier is that expenses, going forward, should be in the range that we mentioned, which is 19 to 22.

So, for Q1, Rafael, it seems like your opex will be somewhere in the $12 million to $16 million pro forma basis? That's a big -- there's a big gap -- or variation there. Can you help me understand what the range -- how does that play out?

Yeah, for the fourth quarter it's roughly somewhere between -- I'm sorry, for the first quarter it's roughly $14 million to $15 million, and it will scale, as the year progresses, and we deliver higher revenue growth, so it will inch up towards the higher end or even higher if revenues come in much higher.

Okay.

Does that make sense?

All right, okay, and then you talked about bookings being -- picking up in the quarter or at least at the beginning of this quarter. How is your visibility as you move into the first quarter, and is that any different this quarter than last quarter and anything there?

Well, we don't have a lot of visibility. So it's been the case for as far as I can remember because we have so much turn business. The only visibility we have is on the design wins we get and how much market share we are winning in the process. But as far as the general market issues go, like inventories, and so on, we really don't have any visibility. What we know is that the bookings have been very strong since the beginning of the year.

Okay, one last question -- on the communications side, you said you grew in the quarter -- I guess you said around 7% sequentially. How would you break that down wireline versus wireless?

The cell phone piece was up slightly, and then the remainder of that was up at a greater percentage.

Eric Ghernati, Banc of America Securities.

A few questions for you -- first of all, Rafael, can you -- I missed what you said the patent litigation and option grants investigation expenses were in Q4. Could you just repeat that, please?

$1.7 million for the restatement spending and $1.5 million for the litigation.

In the fourth quarter.

In the fourth quarter.

And then you said 12 for options and 7 for patent?

For the full year, 11.2 for the restatement and 7 for patent litigation.

Your expenses -- going back to the expense question -- it seems like they're scaling up a little more meaningfully than previously thought. Can you give us a rough idea of what's been going fast, or was that SG&A or R&D?

It's a mix between SG&A and R&D, so we have been hiring folks on both the product side to get more products out, as well as investing in sales folks to have a broader reach. So it will be mainly those two line items.

Okay. On your gross margin side, you talked about some component -- some raw material cost per share and then some pricing pressure. Can you just elaborate a little more on the raw material costs? It doesn't seem to have been an issue in 2006.

Actually, we did mention it, I believe, in the previous conference call. There is an increase in the cost of the starting material for silicon wafers, and this is driven by the demand of wafers for solar panels. There is so much demand for solar panels, there is a worldwide shortage of wafers, which has increased the price of the wafers, which will have a negative impact -- slight negative impact on the gross margins this year.

As far as the pricing environment, we had a virtually benign pricing environment in 2006 because of the raw materials going up and the demand being reasonably high, but going into 2007, we are beginning to see the normal price erosion. I don't think it will be unusually high, but I think it will be returning to normal price erosion, which is another thing that would have a negative impact.

Of course, we have some offsetting items, which allow us, to a large extent, offset the negative impact of these two factors.

On your tax rates for 2007, that's -- would you be still expecting 10%?

I think the model should be somewhere plus or minus a couple of points from 20% -- point 4. The 10% --

So 22?

Yeah, it's already --

Plus or minus from 20?

Right, 20. The tax rate that we have today is being affected by the fact that we have a lot of -- the receiving costs are all U.S.-based, so we get benefits there, so it's artificially low for '06.

Yes, both the restatement and some of the litigation costs are related to the U.S. expense, which gives a significant break in taxes.

So the rate will continue to be low as we incur restatement and patent litigation expenses, but as soon as those are out of the way, the tax rate goes back up.

Okay, and then, lastly, what do you expect your turns requirements will be this quarter?

It's in the high 60s.

Craig Ellis, Citigroup.

Rafael or Balu, can you just comment on the comparative strength that you'd expect to see in the outlook across your verticals? Where do you expect to be in the positive range, and do you expect anything to be down in the quarter?

You mean in just other markets?

Yeah, computing, tuner [sp], et cetera.

I don't think I have any specific information that would say one is better than the other. We [inaudible] full speed ahead in all of those markets. We have design wins that are very broadly covering these markets. Do you have any additional comments?

Yes, I think the order rate suggests that it's fairly broad-based in terms of growth as well.

Now, at the end of the quarter we get the POS information, so we'd be able to give you more color on that, but I have no reason to believe it is anything other than very broad market-based improvement.

And is that what you would normally see across your various end markets -- would they normally be all up in the first quarter or would they be more bifurcated than that?

Well, normally, in the first quarter, if you look historically, we are slightly down from the fourth quarter. But this quarter, based on the bookings you've seen, we believe that we'll be flat to up to 5% up in the first quarter related to the fourth quarter. And that's because we had weak bookings in November and December, which made the book order weak, but we are seeing really strong bookings, which is actually different from most other analog companies.

And just following up a little bit on the fourth quarter, computing, down around 20%. Was there something in particular that happened in computing? Are you seeing a different competitive dynamic there, or why would you see computing drop so dramatically in the fourth quarter?

We are almost certain it has nothing to do with us losing share. In fact, it's quite the opposite. We are actually gaining share in PC standby and many of the other areas. I just think the computer market had significant inventory problems, but they were up 40% in Q3, and I think they just bought a lot more than they sold.

And you have to remember, our exposure in the computing market is mostly to desktop PCs, because PC standby is our largest segment in the market, and desktop PCs have not done very well. I think the laptop has done better, but, overall, the computer market has had inventory issues.

Okay, that's helpful, and then just looking at the operating expenses, how should we think about legal expense on a go-forward basis? Not just the first quarter, but should we be thinking that legal expense, given appeals and other cases, is going to be something that runs in the half million to $1 million a quarter? Or how can we think about modeling that?

It's hard to speak from a quarter -- and individual quarter basis, because things happen in different quarters, which we can't predict but, overall, for the year, we are estimating $3 million to $4 million this year as opposed to -- we did, what, about $7 million last year.

Tore Svanberg, Piper Jaffray.

Hi, this is Evan standing in for Tore Svanberg. We were wondering if you can give us an update on the CEC and what to look out for in '07, as well as any other global development energy efforts?

So to answer your first question on the CEC, the CEC went into effect on some products starting 1st of January, and those products are called IT products, or high-tech products mainly include things like PDAs, the cell phones, and printers, and so on. But the remaining products, just called low-tech products, will be effective middle of this year, on July 1st of this year, and the largest segment there is the cordless phones, but that are hundreds and hundreds of fragmented markets where the external [unintelligible].

So we expect to see a continuous increase in the LinkSwitch revenue driven by this, you know, you would think that it would happen in a step-wise action, but what happens is they first take care of California, and then they'll migrate the products to other states and other countries. So we expect to see a continued growth in the linear replacement market for a long time to come, maybe several years to come.

Moving to margins, we were wondering -- your gross margins improved nicely in '06. Do you believe that there will be more room in '07 -- room for expansion in '07, or do you think it will stay around the 53% to 54% range?

Well, what we have given is that 52% to 53% for Q1, that includes the 1% -- approximately 1% impact on stock option compensation. So the pro forma margins will be 53 to 54. So the best we can tell, you know, making a lot of assumptions, it's going to be relatively flat throughout the year, and as I mentioned earlier, there are two factors that actually impact the margin negatively, but there are other factors that help us mitigate that. So the best, I think, we can hope for is we maintain the margins at this level for the rest of the year.

The last year we grew the margin for several reasons, and I think we went through -- Rafael went through those items.

And, lastly, regarding your patent litigation cases, could you just take us through maybe any remaining logistics around the case? Like, could there be appeals? Or what might come after the May trial?

They can always appeal, and there probably will be, in this case. So let's talk about the Fairchild case. We have the validity force of the case, which is now scheduled for June, and after validity, which we believe we will win, then the judge has -- we'll ask the judge to pass an injunction on all the infringing products, so it will be sometime after the trial that would happen, and certainly Fairchild could appeal it, but I will assume that the judge would impose the injunction are some kind of a bond in case that delays the injunction in some fashion. That's the Fairchild case.

In the case of SG, the IDC case is complete. They are appealing the IDC case, and that will take a year or so before the ruling on their appeal is issued. But in the meanwhile, we are continuing the district court case, which is currently stayed for the appeal to be complete. So we don't expect the district court case to go to trial until probably late in 2008 or early 2009.

Vernon Essi, M.S. Howell.

Thank you. I was wondering if you could just go over this booking pattern that you saw, and sort of -- I know this is never easy -- you're sort of flying blind to some extent with the turns that you have, but it seems like you have a little bit of a disconnect relative to the general analog players in terms of when you saw this starting to kick in, and I'm wondering if there is any specific end market that may have contributed to that and discuss the best top side, but is there anything else that we should be thinking about in terms of how you've managed this revenue growth and communicated it to the Street?

Well, you're absolutely right. You know, when we had the conference call on November 2nd, we seemed to be bucking the trend because we had such strong bookings in October. But then in December there was quite a significant drop-off. And then we are announcing a significant pickup -- the rest of the people are not seeing that.

I don't know what to make of it, but we can tell you that the drop-off in November and December was really broad-based. There was no particular market that we saw was worse than the other, although I would say, maybe, PC was worse than the communications and industrial -- I'm sorry -- not communications -- in consumer and industrial.

In the communications, we grew mainly because of some design wins in non-cell phone areas. The cell phone also grew a little bit but the main growth came from non-cell phone communications business.

But if you look at the bookings in the November and February, so far, we have no reason to believe that it's any specific market. It looks quite broad-based, and we will know for absolute certainty once we get the POS data. But just looking at the bookings, it looks very broad-based.

Okay, and in terms of that desktop side, what would you approximate your market share to be, overall, for the standby side of the desktop PC market?

Our market share in PC standby is somewhere in the 20s.

Okay, and, finally -- maybe I misinterpreted this in your comments to maybe another question. You talked about January bookings. Did you make a statement on them? I thought I caught you saying they actually picked up a little bit?

Yes, we saw strong bookings in January, and it continues into February, so far.

Okay, and then the last thing, what was Avnet in the third quarter in terms of sales?

About 26%.

Auguste Richard, First Albany Capital.

Recently Fairchild bought System General. I was wondering if you guys had any thoughts as to how that improves their patent positioning in the new products out of System General. Do you think that those are non-infringing? Have you had a chance to look at them, et cetera?

Well, as far as we are concerned, from a patent litigation point of view, there is really no change, there is no impact whether SG is an independent company or they are part of Fairchild. I'm sorry, what was the next question he had?

Have you seen the new parts out of System General and do you still feel that those -- if so, do those still infringe?

Well, first of all, we won't comment on whether any product infringes or not infringes on our patent. We just don't do that. We certainly monitor our competitors very closely, and that's all I can say at this point.

Okay, and then just looking at the numbers, the difference between GAAP and pro form going forward, is that going to be -- for stock-based comp -- is that going to be about $0.10, $0.11 a quarter? Am I doing the numbers right?

On the expense side, you have to tax-deduct it and so on. It's roughly $3 million to $4 million per quarter, going forward.

Is that -- does that $3 million to $4 million a quarter need to be taxed?

There will be a tax sometime. I just don't know --

So that's before --

Right, that's before tax.

Before tax, okay, all right, I got it. I think I understand.

Craig Ellis, Citigroup.

Earlier you talked about the goal of getting better revenue growth than you achieved in 2006. Would you expect the linearity of that to follow normal seasonal patterns, or would that tend to be more back-end loaded, given the benefit of the July CEC implementation?

The best I can speculate, I think it will be similar to our historical pattern, which is you get some growth in Q3, but most of the growth comes in Q3, and Q4 is usually flat, plus or minus, from Q3. That's the best I can speculate it.

Thanks, Balu. And then, Rafael, can you just help us with respect to the gross margins -- obviously, exiting last year at around 51.1% for the year, averaged on a GAAP basis, I believe, 54%, did we see a step function change up in the second or third quarter and then, if so, I guess it stepped back down a little bit in the fourth quarter. Can you help us just understand the trajectory that you saw on the gross margin line through last year?

It grew somewhat linear quarter-over-quarter. Q1 was up slightly, Q2 was up a lot more, and Q3, roughly, the same as Q2.

Flat?

Yeah, and sustained.

And then it came back in 100 basis points or so in the --

Yeah, it's been relatively steady the last six months or so.

Andrew Huang, American Technology Research.

I just wanted to clarify a couple of things -- first, Balu, I think in your prepared remarks you said that your revenue growth for calendar '07 would be greater than 2006, is that correct?

That is correct. That is what we are forecasting.

And does that including that $2.7 million benefit you got in the June quarter from the distribution credit?

Yes, yes.

Great, and then a second question -- tax rate -- did you suggest that we should use 10% roughly for calendar '07?

No, that would have been calendar '06. The tax rate is coming in much lower in '06 because of U.S.-based expenses related to added litigation as well as restatement. Now, as those expenses go away, the tax rate should go up to roughly 20%, plus or minus a couple of points.

Yeah, just to be clear, I think what we said was less than 10% for 2006.

Okay. Now, just one question on the gross margin -- it looks like, for this December quarter, for the December '06 quarter, it came in at around 54% on a non-GAAP basis.

Roughly.

Roughly, and then based on my calculations -- or -- my estimates, that's up almost 100 basis points sequentially. So assuming -- my guess is around, right, can you talk about where most of that sequential improvement came from or break down the different segments of that improvement?

And is this a question from Q3?

Yes, from Q3 to Q4, right.

But we didn't give the numbers on Q3.

Right, but --

So let me, maybe, if I explain a little bit you'll understand. The Q2 gross margin was unusually high because of that $2.7 million credit, okay? But if you take that away, let's say we remove that from that -- as Rafael is saying, we grew our gross margin in Q1 with respect to the 2005 Q4, and then we grew it again in Q2, excluding this $2.7 million benefit. In Q3 it was, again, slightly up, I think, almost flat; and then Q4 was actually slightly down.

Q4, the gross margin was down?

Yeah, slightly.

Slightly, very slightly down.

Okay, all right. Thank you. And then, I guess, let's see, in terms of this July 1st deadline that's kicking in for the CEC. Is there any way you can quantify what the TAM is for the July 1st deadline versus the January 1st '07 deadline?

That's a good question. I would say the largest single market is not -- there are lots of fragmented markets. The largest single market that will come into effect in July is the cordless phone. That's approximately 100 million units of [TAM], and let's say it's about $30 million worth of TAM. But then there are hundreds of applications, tools and security systems, the global lighting, is going on and on and on. There are a lot of toys and so on.

So I don't know whether that gives you some idea, but I could tell you the total TAM combining both the beginning of the year impact and the middle of the year, that's for the total linear. I take that back -- total linear TAM, we can use both external and internal power supplies for the LinkSwitch is in the order of $250 million to $300 million. Does that help?

Yes.

And I don't know exactly how much of that is external power supplies, whether it's internal. But we are making, I would say, equally good progress on internal power supplies as we are doing on external power supply, thanks to very high raw material prices on linear.

But CEC applies to external alone, correct?

Correct, but there are a lot of other standards that are applied internal power supplies. There are a lot of appliance standards that apply to internal power supplies, also. But the other driving factor is just cost. When they are redesigning an internal power supply, like a washing machine or a micro oven, they are going away from linear transformers.

Okay. Now, in terms of -- I think someone asked earlier in the call about your market share in PC standby, and I think your answer was around 20%, is that right?

Somewhere in the 20s.

Is that for desktop PCs or for servers as well?

That was for desktop PCs. We may have a much higher share on the server market.

Then my question is -- you know, with -- I was just curious, Avista changes anything at all in terms of the power supply design for the desktop PC.

I have no idea. I would say for the first I don't know. I don't see the connection.

All right, and then one last question, if you don't mind, and I apologize. I guess my sense is that if you look at the January 1st deadline compared to the July 1st deadline, that the July 1st deadline is much more far-reaching in terms of the number of power supplies -- or percentage of power supplies that have already been penetrated with compliant solutions. Would you agree with that?

You are absolutely right. The high-tech products, already, to a large extent, use switching power supplies. It is the low-tech products that are predominantly linear, and those are the ones that will be impacted in July. And they are the ones who actually pushed back the most, because the high-tech guys are already comfortable with switchers, whether they're the cell phones or printers or PDAs, they were already predominantly using switches, anyway.

All right. Those TAMs you gave, are those on a worldwide basis or for California alone?

No, that was on a worldwide basis.

[Operator Instructions] Steve Smigie, Raymond James.

I was wondering if you could comment on computing side. Do you know, does it matter whether you're on, say, an Intel machine versus an A&D machine? You have more share in one or the other, or does that really matter, for the desktop and notebook?

I really don't think it matters, because the specification for the power supply is independent of the process, as far as I know. It's the APX specification -- to be honest, I don't think there is any -- I mean -- I can't say with certainty, but I have a hard time believing they'll be any different.

Okay, that's fair. And back to the gross margin for Q1, you got it down, I think, about 100 basis points. You indicated that's because of price and I forgot what the other --

And the silicon -- it's raw material costs.

And those are the reasons for the Q1 decline?

Yeah, and raw material is mainly silicon, but there is also raw material increases due to gold adders and copper adders and packaging. We use very little of it, but there is still an increase.

Okay. I guess, as you mentioned, the 2006 pricing environment out there had been pretty decent, and it seems like most of the competitors in that market seem to have been pretty reasonable in their capex investments and still haven't seen any significant price declines out there. Are you just being conservative in terms of that gross margin, or are you actually -- there's something that's happened that's triggered you to say, "Yeah, that's got to be lower?"

Well, we're just seeing a price erosion coming back, which was relatively benign in 2006. We are seeing the discrete component prices eroding in the last, say, two or three months, whereas, they were stable -- in fact, at the beginning of the year last year they were slightly up for smaller customers.

Okay, so it's actually come back. Okay. I guess -- I think that's it for me.

Kevin O'Boyle, KCO Investments.

Can you tell me at year-end how many shares were outstanding and how many options were outstanding.

I don't have the numbers at my fingertips, but roughly the share count was 28.5 in terms of actual shares outstanding, and options -- I'll give you the number in a few minutes.

Okay.

Do you have another question in the meanwhile?

What is your market share for the cordless segment at this point, would you say?

It's probably still in the low to mid single digits at this point. We're just really getting started penetrating that market.

And how about the cell phone segment of the linear transformer TAM?

It's hard to distinguish that, because many of them have already converted into switchers. So I would say, at the moment, out of the -- let's say out of a billion cell phones, maybe about 100 million to 150 million is still linears. But they are being rapidly converted, as we speak. It was almost 250 million just a year ago.

Okay, and then I guess the last question -- on the DPA switch business, what are your expectations now in terms of if and when that market will really take off for you, and what would drive it?

Well, the power over Ethernet market has grown very strongly, and I think it will continue to grow because it's starting from a very small base. In the long term, how far it will grow, you know, it's really hard to predict. Right now, the main growth is from voice over IP phone and wireless access points. But beyond that, I am not sure how many other products will take advantage of the power over Ethernet. There are arguments on both sides. Some people feel that it's going to grow dramatically, some people feel that it's not going to grow that dramatically, it will grow more linearly.

So I just can't predict how well the power over Ethernet will do.

Okay, and is it fair to say that your DPA switch sales in '06 were about 1% of sales?

Actually, more than 1%. It was 2% of sales.

Okay. Those are all my questions except for the option --

Yes, so back to your options question -- I'll tell you what it was at the end of 2005. At the end of 2005, it was roughly 7.5 million options outstanding. I don't have a number for 2006, but my guess is it's probably closer to 8 million, give or take a couple of hundred thousand shares. So that's just my guesstimate based on some experience that I have here.

Stephen Glass, SPG Capital.

I believe you mentioned some pricing pressure that's come up in the last two or three months, if I remember your wording correctly. I guess I'd like to understand more if that's back-to-normal pricing curve or after pretty benign pricing, or is it accelerated beyond the normal curve.

And then, secondly, if some competitors have been somewhat out of the market, given your winning those lawsuits, why is the pricing pressure accelerating again? Help me understand that.

Okay, so the first question is, to the best I can tell, it's just coming back to normal price erosion. I don't think it's more than normal. It's just beginning to erode again. It's mainly to do with the supply/demand issues with discretes. There was, I would say, a shortage of discretes in the beginning of the year last year, and now I think there are more discretes on the market available.

Now, to answer your second question, if you look at our competition, a large portion of it is discrete, not innovative competitors. So if you take the total SAM, we think we have it lower, 10%. All of our integrated competitors including the hybrid type converters, we believe have about 3% of the SAM, of the market share, and the remaining, what, about 87% or so is either discrete electronic power supplies or linear power supplies.

And that's why when discrete prices go down, it puts pressure on our integrated solutions, ours or our competitors.

Steve Smigie, Raymond James.

Great, thanks, just a quick couple of follow-up ones. The strong bookings you're seeing -- are you noticing that a particularly high percentage of that is coming from what you would consider CEC business, or is it just general strength?

To the extent we can tell at this point, it's very broad-based. Until we get the POS data, we can't tell exactly where those units end up. The only way we can tell is what part numbers are being purchased by our distributors and our end customers. So it's hard to tell exactly where they end up until we have the POS data for the whole quarter.

Do you know if the high mix of LinkSys?

The Link is growing gradually, and I think it will have a bigger impact probably in the second half of this year when the July 1st deadline for the CEC takes into effect. I feel then it will grow gradually. I don't see a significant jump in the LinkSwitch revenue this quarter, if that's what you are talking about.

Yeah, that was it. And, I guess, finally, if you could say what the ASP was for the company in the quarter and maybe specific for LinkSys?

It's $0.41 for the quarter for the company.

And could you tell LinkSys?

I don't have the exact number, but it's on the low end of the spectrum. So my guess is in the 30 range -- 30 plus or minus.

At this time there are no further questions. Mr. Shiffler, are there any closing remarks?

Just to say thanks to everyone for listening and to give the replay information here -- the replay will be available on our website, the Investor Info section of the website. There is also a telephone replay available at 800-642-1687, and the access code for that is 6019321. Thanks, everybody, for listening, and good afternoon.

Thank you. This concludes Power Integration's report selected fourth quarter and full year financial results conference call. You may now disconnect.