Power Integrations Inc (POWI) 2007 Q2 法說會逐字稿

Good afternoon. My name is Stacy and I will be your conference operator today. At this time, I would like to welcome everyone to the Power Integrations Second Quarter Financial Results Conference Call. At this time, all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the conference over to Mr. Joe Shiffler, Director of Investor Relations. Mr. Shiffler, you may begin your conference.

Thank you and good afternoon. I'm Joe Shiffler, Director of IR and Corporate 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. Balu and Rafael each have some prepared remarks, after which we'll take your questions.

Earlier this afternoon, we issued a press release outlining our financial results for the second quarter of 2007. The tables included as part of the press release also incorporate our final results for the first quarter of 2007, which were previously unreleased.

This press release is available on the Investor Info page of our website, which is investors.powerint.com. The release has also been e-mailed to those of you on our distribution list.

I'd like to note that our discussion today, including the Q&A session, will include forward-looking statements reflecting management's current forecasts 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 expression 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 report on Form 10-K filed with the SEC.

In addition, during this earnings call, we will provide certain non-GAAP financial results. The press release available on our website includes text and tables that explain our reconciliation of these non-GAAP measures to our GAAP results.

Lastly, please note that this conference call is the property of Power Integrations and any recording or rebroadcast of this conference call is expressly prohibited without the written consent of Power Integrations. With that, I'll turn the call over to Rafael for an update on the status of our financial reporting.

Thanks, Joe, and good afternoon. Today's earnings report marks an important milestone in our efforts to catch up on our financial reporting after completing the restatement process a few months ago. We are now current in terms of our quarterly close and review processes and we are resuming normal financial reporting beginning with today's earnings release, which includes full P&L statements and balance sheets for the first two quarters of 2007.

The other piece of the puzzle, of course, is to catch up on our SEC filings and then regain our NASDAQ listing. Although the tail end of this effort has been frustratingly slow, largely for reasons beyond our control, we are now very close to the end of the process.

We filed our 10-Qs for 2006 earlier today and I expect to file the 2006 10-K within the next several days. I anticipate filing the first and second quarter 10-Qs and regaining our NASDAQ listing within approximately two weeks.

With that, I'll turn it over to Balu for a discussion of the second quarter. Balu?

Thanks, Rafael, and good afternoon. Our net revenues for the second quarter were $43.2 million, down 5% from the first quarter. The sequential decline was due to the adoption of a competing product at our largest end customer in the cell phone market. As we announced in June, we believe that these competing products violate three of our patents and we have undertaken patent litigation against BCD Semiconductor in order to protect our intellectual property.

We are also in the process of rolling out a highly innovative new product that gives us an opportunity to win back the lost sockets, even against aggressively priced infringing BCD product. We are encouraged by the feedback we have heard regarding the new product, though it will probably be several months before we will know the outcome of the design-in process.

In the meantime, we believe this design loss cost us roughly $2.5 million in revenue in the second quarter and we expect a total impact of $3.5 million to $4 million per quarter going forward.

In spite of this setback, the remainder of our business continues to grow very nicely. Our second quarter revenues came in higher than our revised guidance, driven largely by LinkSwitch revenues, which increased more than 30% sequentially. Overall, our revenue in the first quarter-- first half of the year was up 15% compared to the first half of 2006, in spite of the one-time revenue benefits we had in the second quarter of last year. Product revenues, which do not include the impact of this benefit, grew 20% in the first half compared to a year ago.

This growth reflects the design-win momentum we have seen in recent quarters, driven by our expanded sales force, the replacement of linear power supplies, the successful ramp of our TinySwitch-III products, new markets such as LED lighting, increasing penetration at smaller customers and the impact of our litigation against infringing competitors. Thanks to these growth drivers, the second quarter was a record design-win quarter in terms of the expected annual revenue contribution of designs won.

On our June conference call, we mentioned the significant design wins for Nokia cell phone chargers with LinkSwitch and the Xbox game console with TinySwitch-III. Tiny III has also won a charger design for the iPhone. It is difficult to predict the revenue impact of this design win at this time, because it depends on the volumes of the end product and what share our business-- of the business our customer gets. However, this is, obviously, a design with potential to contribute significant revenue over time.

TinySwitch had an excellent quarter overall, also winning an AC adapter design for Garmin GPS devices, a high-volume charger design for Mobility Electronics and PC standby designs for Dell, H-P and Lenovo. Tiny III has been extremely successful in desktop PCs, due largely to the stringent energy efficiency requirements in that market. Nearly all branded desktops are now designed to meet 1 watt standby requirements and we believe that Tiny III is easily the most cost-effective solution available to meet that standard.

TOPSwitch design wins in the second quarter included a SONY LCD projector, a UPS power supply for [ARIS], several consumer appliance designs and a variety of industrial designs, including utility meters, lighting and control applications.

DPA-Switch, our DC-to-DC product, has won an incremental design at Cisco, increasing our already significant penetration of their (inaudible) IP phone business. We estimate that with this additional design win, we now have roughly 20% share of the worldwide market for IP phones, which is, by far, the highest volume application for power-over-Ethernet technology.

LinkSwitch, our low-power product family, had an excellent quarter, both in terms of revenue growth and new design wins. Notable wins included a high-volume cell phone design for LG, major appliances-- appliance designs for Siemens and (inaudible), a cordless phone adapter for VTech and a high-volume design for DEWALT Power Tools.

Adoption of LinkSwitch continues to accelerate, due mainly to the replacement or carbon and iron linear power supplies. This trend is being driven by a combination of energy efficiency standards and the cost effectiveness of LinkSwitch compared to linear.

In the second quarter, LinkSwitch revenues grew more than 30% sequentially and more than 100% year-over-year. LinkSwitch represented 13% of our revenues in the second quarter, up from 10% in the first quarter, and has accounted for a significantly higher percentage of our bookings thus far in the third quarter.

While we won a number of high-volume designs for well-known end customers in the second quarter, we are equally excited about the far larger number of lower-volume designs, especially in the highly fragmented consumer and industrial market. Industrial revenue, in particular, continued to grow very nicely, up more than 10% sequentially and 20% year-over-year in the second quarter.

Industrial accounted for 17% of our revenues in the second quarter, more than double where it was three years ago. The growth in that market is coming from a diverse range of applications, including uninterruptible power supplies, control applications, utility meters and lighting applications.

Utility meters, in particular, have been an important growth driver for us in recent quarters. Energy efficiency is a critical design factor in this market, due to the 2 watt standard set by the International Electrotechnical Commission. Also, the proliferation of electronic meters and remote meter-reading technology create a demand for advanced power supply technology to power electronic displays, prevent tampering and conserve space.

Our technology is very well suited for this market and we have been targeting it aggressively with (inaudible).

Our revenues from the metering applications are up more than 80% in the past year and we won more than a dozen new metering designs in the second quarter alone.

We're also excited about the traction we are seeing in the LED lighting where, again, efficiency and form factor are critical design criteria. We won about a dozen LED lighting designs last quarter and doubled our LED-related revenue compared to the first quarter.

This market is developing rapidly thanks to the improving cost profile of LEDs, combined with the increasing focus on lighting as a source of potential energy savings. Australia, Canada and Europe have announced plans to eliminate incandescent lighting over the next several years and the cities of Toronto and Raleigh have recently announced plans to install LED toward their infrastructure. It is clear that efficiency is coming to the lighting market in a big way and we think we are very well positioned to participate in this transition over the next several years.

The growth in revenues from industrial applications has been a part of a deliberate effort to diversify our revenue base and improve our gross margins by targeting smaller, higher-margin customers. Over the past three years, our gross margin has risen approximately 10 points, coming in at 56% on a non-GAAP basis in the second quarter.

While cost reductions have been the biggest driver of this increase, the change in mix towards smaller customers has clearly played a role. Our success in executing this strategy gives us greater flexibility to go after higher-volume designs in markets like cell phone chargers and DVD players where margins are inherently lower but there are more total profit dollars available. Our goal is to grow the bottom line as fast as possible and our success in penetrating smaller customers is an instrumental part of that effort.

Before I hand it back to Rafael, I'd like to conclude by expressing my appreciation for the patience that those of you in the investment community have shown with respect to the accounting issues we've been dealing with for well over a year now. This process has taken some unforeseen turns and lasted far longer than we ever imagined, despite a lot of hard work by Rafael and his team. The later stages of this process have been especially frustrating, with delays being more a function of procedure and red tape than any significant accounting issues.

My appreciation extends to our employees, who have also shown tremendous patience. I am proud to say that we have not seen any increase in employee attrition during this very challenging period. This is a testament not only to the loyalty of our employees, but also to the optimism we all share about the future of the company.

And with that, I'll turn it back over to Rafael. Rafael?

Thanks, Balu. I'd like to run through a few financial highlights before we open it up for questions.

Overall, our financial model is in very good shape, with gross margins in the mid 50s and a non-GAAP operating margin north of 20%, despite still material expenses stemming from the restatement project. We also continue to generate substantial cash flow, with $12 million added to our balance sheet in the second quarter.

As Balu noted, our second quarter revenues were $43.2 million, down 5% sequentially due to the lost cell phone socket, but slightly above our revised range of $41 million to $43 million. Year-over-year, we grew 4% but, again, that's compared to a prior year quarter in which we had a one-time revenue benefit of $2.7 million. Looking solely at product revenues, we grew 12% from a year ago.

As you may recall, we had a very strong first quarter this year, with revenues-- revenue growth of 29% over the first quarter of 2006. That growth was driven partially by a surge in turns orders in late March, which indicated that some revenue was pulled forward from the second quarter. Looking at the entire first half of 2007 compared to the same period a year ago, we grew 15% overall and 20% in terms of product revenue.

Looking at the revenue in more detail, the consumer market comprised 30% of revenues in the second quarter. Communication was 26%, computer 20%, industrial 17% and other 7%. 67% of our second quarter revenue went through distribution and 33% was direct.

Avnet, our largest distributor, was our only 10% customer, accounting for 28% of revenues.

Turns orders comprised 65% of revenue and average selling price was $0.39, unchanged from the first quarter.

Our gross margin was 55.4% under GAAP and 56% on a non-GAAP basis, which excludes stock-based compensation. That's down from a year ago, but keep in mind that our gross margin in the second quarter last year was boosted by the one-time revenue benefit, all of which flowed through into gross profit.

Second quarter operating expenses totaled $17.6 million on a GAAP basis, in line with the outlook we provided. Stock-based compensation accounted for $2.2 million of operating expenses and we've broken that out by line item in the tables attached to our press release.

We also incurred just under $1 million in expenses related to the restatement and the effort to complete our SEC filings and patent litigation expenses were approximately $600,000.

Operating expenses, excluding stock compensation and restatement expenses, increased sequentially, driven partly by annual salary increases, which we implemented in the second quarter. However, we also incurred significant expenses on the G&A line for income tax compliance and those expenses should decrease in the next couple of quarters.

Second quarter operating margin was 20.4% on a non-GAAP basis, excluding stock-based compensation. That included a reduction of just over 2 percentage points from the restatement-related expenses.

Other income for the second quarter was $2.4 million, which included a benefit of approximately $700,000, as we were reimbursed for certain legal fees by our D&O insurance provider.

GAAP net income was $6.8 million or $0.22 per share on a diluted basis. Non-GAAP-- non-GAAP income was $9.3 million or $0.30 per share. That includes a benefit of-- from the insurance reimbursement, but that's more than offset by the restatement-related spending.

Looking quickly at the balance sheet, cash and investments increased by $12 million compared to the prior quarter and has increased by $25 million over the past 12 months, despite the considerable expenditures related to the restatement and our patent litigation.

Inventories were $24.7 million at quarter end, down $1.5 million from the end of the prior quarter. Inventory turns were 3.1, within our normal range of 3 to 4 turns.

Receivables were $14.3 million, down $3.5 million from the end of the prior quarter. DSOs were at 30 days, down from 35.

Looking ahead to the third quarter, we expect our sequential revenue growth to be impacted, once again, by the cell phone design loss to BCD. As Balu indicated, we saw an impact of about $2.5 million in the second quarter and we think the ongoing quarterly impact will be in the range of $3.5 million to $4 million or an incremental $1 million to $1.5 million over the second quarter.

That said, we expect third quarter revenue to be between $45 million and $47 million or up roughly 4% to 9%, sequentially. We expect our GAAP gross margin to be between 53% and 55%, including an impact of about 1 percentage point for stock-based compensation.

Operating expenses should be in the range of $19 million to $20 million, including $3.5 million to $4 million of stock-based compensation and approximately $1.3 million in expenses stemming from the restatement project. About $1 million of this amount relates to charges we expect to take in connection with addressing certain tax implications to our employees arising from stock-- from past stock option grants.

Lastly, patent litigation expenses should continue to run between $600,000 and $800,000 per quarter through the balance of this year.

With that, we're ready to take questions.

Thank you. (OPERATOR INSTRUCTIONS) Andrew Huang, American Technology Research.

Hi. Good morning, guys.

Good morning.

So clearly the BCD is impacting into the September quarter, but I just wanted to kind of get some commentary more on LinkSwitch, because it looks like you had very, very good progress in terms of sell-through for the June quarter, but based on what you see in your bookings, is that progress expected to continue into the September quarter?

You're breaking up a little bit, but I think I understood your question. Yes, the LinkSwitch will continue to grow as a percentage of the business in the third quarter, based on the bookings so far. It is growing very nicely.

Great. And then maybe a question for Rafael on the gross margin. If you look at the gross margin over the past six quarters, it looks like it's basically at an all-time high if you exclude the June quarter of '06.

Right.

So what's driving that sequential improvement? How are you able to continually squeeze out more gross margins out of the business?

Well, there's been a couple of drivers, but the main one has been just cost-- just normal cost reduction efforts. The other one is just moving some of our testing offshore, which is part of our cost reduction effort, as well, which has been-- And also, increasing our penetration into tier two, tier three, tier four type customers where the margins are generally a little bit higher than tier one customers. So that's-- those have been the main reasons why they've been higher than they have historically.

But to add, in the second quarter the loss of the Samsung business actually helped us in terms of increasing the margin, although it was offset by other tier one businesses that got into production.

Got it. And can you comment on whether or not your power supply or power-- your charger manufacturers that are manufacturing for Nokia, have you started shipping for those chargers yet?

Yes.

Okay, great. And then one last question, if you don't mind. I guess September tends to be your seasonally strongest quarter and I understand that some of it's being taken away from the Samsung business, but is there anything that could potentially drive, I guess, revenue to the upside, towards the high end of the guidance, like, for example, Xbox or maybe more Nokia ramp?

Well, we have taken into account everything we can forecast at this point, including the bookings to date, the bookings at the beginning of the year, the sales forecast. So this is our best estimate. Now could it be higher? Yes, it always could be higher. It's hard to predict any more accurately than we have done.

Okay. Thank you very much.

You're welcome.

Sumit Dhanda, Banc of America Securities.

Sumit, we're having trouble hearing you.

Oh, is this better?

Sumit, I'd like to answer-- or clarify our guidance before we take the next question, so I'd like to take the opportunity now. The guidance for operating expenses should be $18.5 million to $20 million OpEx, which would include $3 million to $4 million of stock-based compensation and approximately $1.3 million in expenses stemming from the restatement project.

Sumit, we'll take your question now.

Okay. I just wanted to followup on the comment on your-- for your revenue outlook. So I understand that relative to Q2 you're seeing about, call it $1.5 million in terms of an impact from the Samsung business declining, but aren't you seeing it relatively offset by Nokia and/or Xbox? Because my recollection is, you thought Nokia would be a couple of million this year and Xbox would be about $0.5 million a quarter. So if it all washes out, roughly speaking, then shouldn't you see sort of better growth in this space than normal seasonality?

Well, if you-- if you add back the Samsung to our forecast-- We are saying $45 million to $47 million. If you take the midpoint, which is $46 million and add $3.5 million to $4 million of the lost Samsung business, we'd be very close to $50 million, which would have been a very significant growth.

But this is not an additional $3.5 million to $4 million, it's an incremental $1.5 million versus your Q--

Versus the $2.5 million that we lost in the second quarter.

Correct. But I'm just saying that we would have been close to $50 million with the Samsung business. So your question is why is the growth not as high from Q2 to Q3? Is that your question?

That is my question.

Well, I think overall the growth is very good. If you look at our first half, our growth was-- the product growth was 20% compared to the first half of last year. So we got a pretty big jump in the first half and that is in spite of the fact we lost $2.5 million to Samsung. So part of the reason, I think, it is somewhat muted in Q3 is that we got a much stronger first half.

Well, let me just ask you a different question. In terms of July 1st deadline on replacement in California and its coming into effect, again, my assumption was that those designs that fall into the category associated with this, call it the second phase of the implementation, would see a bigger ramp third quarter. Are you seeing that? Is that encapsulated in your guidance? If not, why not?

We are seeing that. If you look at the LinkSwitch revenue, it grew 30% and I believe it'll grow significantly in Q3 and become a larger percentage of our revenue, reflecting the impact of the energy efficiency standards and the cost of linears, which are now higher than LinkSwitch-based solutions. So I think we are definitely seeing the impact of that.

And in terms of-- if you can share with us any-- any trends on your-- on your backlog or the turns requirement for the September quarter to hit the midpoint?

Yes, so backlog going into the third quarter was roughly to what backlog was going into the second quarter. As we mentioned, turns for the second quarter were roughly 65%. So to get to the middle range of our guidance, we need turns in the high 60s, something like that.

Any trends on bookings, which--?

Yes, in terms of trends, what I can point out is that the order rate in July has been slightly higher-- a bit higher than what the order rate was in June, so it's all going in the right direction.

Okay. And then-- and then back to my original question, is the expectation for the Nokia business and the Xbox business still consistent with your original forecast, whatever it was, about a month ago?

Yes. We saw some Nokia business in the current quarter and I think we'll-- that that should continue for the rest of the year.

The range we gave you is still the best number we have.

Okay. One-- a couple of housekeeping questions, Rafael. The patent litigation of $600K to $800K, is that included in that $18.5 million to $20 million number?

It is, yes.

And then how should we think about your ESO expense over the next couple of quarters? Does that go up once your filings are done and--?

It's artificially low because we haven't been able to grant stock options, but we expect that once we gain-- regain relisting here in a couple weeks that we're able to do our annual grant as well as employee grants. So the expense, as I mentioned, should be somewhere between $3 million and $4 million in the upcoming quarter and probably at that range to slightly lower-- not on the high end, going forward.

Okay. Thank you very much.

You're welcome.

Craig Ellis, Citigroup.

Thank you. First with a clarification -- Rafael and Balu, typically the second quarter is a strong one for consumer but consumer was down about 10%. What was the driver for the weakness there?

That's a good question. We have been scratching our heads on that. We have looked into the major programs and really can't tell anything significant other than just a quarterly variation. We had a very strong Q1. We grew from Q4 significantly in Q1 and Q2 was not as strong. It is a-- I would say it's just a quarterly-- quarter-to-quarter variation.

So you're not seeing anything at an application level or at a geographic level that you could attribute to the 10% decline?

That's correct.

Okay. Switching gears to the outlook, I wasn't clear if you were saying with the incremental headwind that you're facing in the handset business if you're expecting that business to be flat or down sequentially or if, in fact, you're expecting that to grow. Could you clarify that?

And then, as you look at your different end markets, can you just identify where you expect relative strength versus relative weakness in the outlook?

Yes, I mean, we didn't provide that type of color in terms of where the strength comes out, but the way that we forecast here, we basically look at every market, every application and we roll everything up. I would imagine that it's fairly broad-based in terms of the growth going forward with tier-one-type cell phone business probably coming back, to some extent, a little bit more than the others.

Well, in the cell phone we will lose more next-- next quarter from Samsung, so $1.5 million more. But that will be offset, to some extent, by Nokia growing and also we're gaining share at LG cell phone division, also. So it's hard to predict exactly what it will be. The Samsung reduction will be, to some extent or to a large extent, offset by those two.

And have you seen any evidence that the inroads that your competitors made at Samsung is underway at either other large handset companies or in other application areas that you're competing in?

As far as BCD goes, we have not seen them anywhere else.

Okay. And then there was a gross margin question earlier, Rafael. When I look at the incremental gross margins over the last seven to eight quarters, the quarters where you've grown, your incremental gross margins have been quite high, oftentimes in the 70% to 90% range. So with self-help and mix shift to lower, smaller customers that pay you an admittedly higher price, how much gross margin help is still in front of you here from things that are within the Company's control? Is all of the low-hanging fruit behind you or are there still some things that you can do to drive gross margins higher?

Yes, so just a clarification -- margins have actually been in the mid 50s the past couple or several quarters.

Yes, but the incremental gross margins have been a lot higher than that for the last five to seven.

So, yes, I don't know that there's-- there's still room in front of us in terms of cost reductions, but I think that'll be muted by tier-one-type applications customers going into production. So overall, I think margins will start trending down in the last half of the year.

Yes, there will be continuing cost reductions in different areas, but that will be offset by competitive pressures we are seeing, especially from the Chinese controller manufacturers, and we think for the foreseeable future we'll be north of 50%, but we probably will be trending lower than where we are now.

Okay and then lastly for me, as you look at inventory, where do you expect to end the quarter with inventory, Rafael?

Yes, I don't have a specific number for you, but we have decreased production to some extent, so, in general, inventories have been coming down. My best guess is they're probably flattish to where they're at now.

Okay. Thanks, guys.

Steve Smigie, Raymond James.

Great, thank you. So in terms of the operating expense guidance, if I look past this quarter where you have all the restatement stuff, et cetera, do I basically back out the $1.3 million as I get into the December quarter and further quarters? Is that how it should-- do I just take it out-- mostly out of SG&A? Is that how I should think about it?

I'm not sure of your question. I imagine you're trying to get to expenses excluding restatement, as well as FAS-123R?

Not so much FAS-123R. I mean, I'll exclude that, anyway, but you've already given us some guidance on that. I just meant more from the restatement stuff.

Yes, you're right. Yes, ongoing-type expenses I would just carve out the $1.3 million.

Okay. So in that-- that'll happen in Q4?

That should happen in Q4. Correct.

Okay. And then just to sort of followup on the gross margin, Balu, you mentioned that you're expecting to or you're going to attempt to try to really accelerate revenues in these smaller accounts. Is that going to-- is that acceleration going to come at the expense of a little bit of gross margin? I know in the past you've said your primary goal is to grow the gross margin dollars rather than the percentage. Is that another factor here in maybe bringing the gross margin down a little bit over the next few quarters?

I think what I said was that we have a number of tier-one design wins that will be going into production, including the Nokia design, which are below the corporate average gross margin. So to the extent we ramp up those customers, our gross margin will trend lower.

Okay. All right. And any update on the-- on the Fairchild litigation?

Well, I think we updated the date of the trial, which is September 17th.

Right, okay.

And these last about four days, so by the end of that week, there'll be a jury decision.

Okay and then with the exception of the BCD stuff, we would see some litigation expense come out after that?

Yes, I don't think we'll see any-- any material expense related to BCD this year. If at all, it'll be early part of next year when the discovery process starts.

Okay, great. Thank you.

And just to add to that Steve, we did say we've spread the cost of the Fairchild case evenly throughout the year. So we've said $600,000 to $800,000 a quarter for the balance of this year in total litigation spending.

Okay. All right, thank you.

You're welcome.

Ross Seymore, Deutsche Bank.

Hi, guys. Balu, you went through a pretty long list of the vertical design wins, as well as the horizontal. How should we think about that as a percentage of sales between those two markets currently and going forward?

Yes, we normally don't give out the dollar value of the design wins, mainly because it could be very misleading, because it doesn't account for the end of life on some of the existing designs. That's why we give you only qualitative information that the value-- dollar value of design wins in Q2 was a record number, but we don't quantify it.

I was actually referring a little bit more towards kind of the percentage of revenue. Is the easiest way to think about it just the industrial business and then maybe some of the wireline computing tends to be more of the horizontal stuff? Just so we can monitor the mix, going forward, between those big vertical guys and horizontal guys. Is there either an end-market way to do it or just a percentage of sales you can give us?

Okay, I understand your question now. So what you're saying is you want to know the-- how the tier-one-type customers grow versus tier two, tier three. Is that your question?

Yes, exactly.

Well, the tier two and tier three tend to grow gradually. You don't see significant changes because it's a very large customer base. We've been growing that consistently for the last four or five years now and we're very, very happy about that. The tier one is very different. Tier one can go up and down quite significantly. Just like we saw in the last quarter, just losing one customer -- it just happened to be our largest customer in this case -- caused a significant change in the tier one revenue.

So that one, we expect it to grow nicely because we have a number of tier one designs, including Nokia, going into production over the next several quarters, but that is the subject of more-- a lot more volatility.

And so it's hard to define that, but at the moment, our tier two, tier three revenue is approximately 40% of our total revenue. Does that help?

Yes, that's kind of what I was getting at. And then seasonally, is it fair to think of that tier two and tier three stuff to be more first-half-centric and then second half would be more the tier ones, just as seasonality comes in? Or will the pace of the design wins and the ramp timing kind of overwhelm any sort of more normal seasonal pattern?

Yes, that's a hard one, because it really depends on the market. Industrial, for example, doesn't have the seasonality that overall revenue has, but certainly consumer does and so does computer. So I haven't really studied that enough to give you an intelligent answer.

Okay. And the final question, you guys have looked like you're coming out of the restatement process. You have a lot of cash on the balance sheet. Can you just talk about a couple of the potential uses for that?

Well, there's really three potential uses. One is an acquisition. The other one is stock repurchase. The third one is dividends. And the Board looks at it periodically to determine whether we should-- what we should do with the cash.

Nothing conclusive at this point.

Yes.

Okay, thank you.

You're welcome.

Gus Richard, First Albany Capital.

Hi, guys. A quick housekeeping question to start off with. What was the average selling price in the quarter?

$0.39.

$0.39? Okay. And when I take a look at your forecast for Q4, your guidance, it looks like, if I back out Samsung, you're going to grow 8% to 12% sequentially and that is normal seasonality for you all. And I kind of look at the turns in the high 60s and looking over the last few years, that's a little bit lower than normal. I'm assuming you guys feel real comfortable with the guidance you're handing out here?

I hope so.

Well, that's the best guidance we can come up with.

Okay. Well, I mean, given the acceleration of LinkSwitch, I would expect that to add, add a little bit to your normal seasonality. Is there some mitigating factor, I mean, other than ex-Samsung that would cause-- cause that to be the case?

To be honest, it's really hard for us to predict the quarters, simply because of the amount of turns business that we have. If you remember, last quarter we gave a guidance of $41 million to $43 million, almost at the end of the quarter, and we ended up at slightly higher than $43 million by the time we were done, because we don't get the POS information until after the quarter.

Right.

So it is really difficult to predict. We do the best we can, given the data we have. So could it be higher? Yes, it could be higher. But it is harder-- hard to say that at this point in the quarter.

Okay. And then the last one for me, you just mentioned briefly in your-- your opening remarks about the-- the new product family that you're coming out to compete with BCD. I know you've been sampling for a while here. Is there any updates as to how you're going? Any more color you can add there?

Well, we have actually sampled some customers, but it's still-- the product is still not in production yet, but the feedback we have gotten has been extremely positive from most of the subcontractors. But we are still in the early stages of designing with the product and we will have, probably, a better feeling in the-- at the end of the fourth quarter or some time in the fourth quarter we'll get a much better feeling for how well we are doing in terms of getting some share back.

Okay. And then to move the product into production, what needs to happen? Design done, what kind of test program? Sort of a little color there?

Well, we-- we expect to be in production with that product by the end of this year, which will-- about the time it takes for them to do the design and get it qualified at Samsung. So it's unlikely we'll get anything until first quarter of next year in terms of revenue.

Right and then just again, as it pertains to the new product, this is a new architecture but not a new process?

That's correct. It's not a new process; it's a new architecture.

Okay. And any color on that architecture? I know it's not Tiny; I know it's not Link. It's something a little new.

Well, we haven't said what it is and we are not prepared to say what it is at this point. We don't usually talk about new products until they come out.

Okay. All right. All right. That's enough for me. Thank you.

Okay, thanks.

Kevin Cassidy, Piper Jaffray.

Hi. Thank you for taking my call. What's-- can you tell me what the trends are in distribution's inventory, say, second quarter over-- or first-- in the second quarter going to the third quarter?

Yes. So distribution inventories generally came down slightly between the second quarter and the third quarter. That's as much information as I have.

Yes, it's in the range of four weeks, which is fairly typical for us.

It's usually in the four to four-and-a-half weeks. We are closer to four weeks right now.

Okay. And what are your lead times?

On most of our high-volume products, it's four weeks.

Okay. All right. Thank you very much.

You're welcome.

Kelly Pan, Pantheon Capital.

Hi. Yes, I wanted to know whether those patent costs that you talked about, $600K to $800K, was that included in the $18.5 million to $20 million OpEx estimate?

Is it included.

Oh, it is included? So I shouldn't add that. Okay and then I wanted to know why the OpEx is heading back up, because you just had a quarter with $17-something and at your high end you could increase $2.5 million again.

Right. So the main driver there is that we're expecting higher stock-based compensation, in the order of $1 million to $2 million more. And the reason for that is the fact that we have not issued stock options in over a year and we typically do what's called an annual grant that's pending. So when we do that, depending on the stock price and depending on the amount of shares that we issue, it will just-- it will obviously increase your stock compensation expense. So that's the number one reason.

The number two reason is we do plan on issuing a tender offer related to fixing certain stock option grants and making employees whole on the tax implications around those stock options. So that's about $1 million worth. That's a one-time cost.

I see.

So the stock charges in Q2 are unusually low, because we have not been able to issue any stock options over the last year.

Right.

Got you. The second thing that I had was, you talked about some of the LED lighting and some of these other applications. Is that in the industrial line? Because I noticed that's the line that's been increasing nicely.

Yes, it is.

Yes.

Okay, thank you.

You're welcome.

(OPERATOR INSTRUCTIONS) Sumit Dhanda, Banc of America Securities.

Hi, Balu. I had a couple of followups. First the KSR case got some brief media attention. Any thoughts there on how that might impact your trial with Fairchild?

Yes, we have discussed that with our attorneys and they believe that the ruling on the KSR case will have-- will not have any impact on our situation, because our patents are not obvious.

Okay.

So it doesn't change the merits of our case, according to our attorneys.

Okay. And then, Rafael, a couple of quick ones for you.

Sure.

Not to beat a dead horse here, but it seems like, for reasons beyond your control, it got harder and harder to get filings or, at least, get rid of the delinquencies on the filings.

Right.

This two-week timeframe, you're thinking, again, if you had to attach a probability to it relative to the other forecasts you've had to make, how do you feel about it?

Well, I'm a lot more optimistic and the reason is, the filings are effectively done from our perspective and there's obviously some red tape and loopholes to get through there, so you never know what can happen, but I couldn't say that before, right? So those were all forecasts based on the deliverables that we expected to have and at this point our deliverables on the Company side, for the most part, have been completed. So I'm a lot more optimistic this go-round than I would have been otherwise.

Is there a holdup, potential holdup, on the auditor end which could persist here?

Well, there's always that possibility. You can't control that. But we did file the first three Qs this morning. We did say that we expect the 10-K to be filed over the next several days. So that's the lion's share of the filings. And when you get into Q-7-- or Q1, Q2 of '07 type filings, they don't go through the same process as the previous filings, so it's a little bit-- it's easier to get it through the process than the others.

Is that reviewed only at the local as opposed to the national auditor?

That's correct.

And then on the interest income line, do we just back out the insurance reimbursement and then effectively model only a slight uptick in interest to come over the next several quarters?

Yes, that's what I would do. I mean, there's a potential there to get other recoveries, going forward, but I couldn't predict those. So for now, that's all I would do.

One final question for you, Balu. On the-- on the new product that you're targeting to hopefully gain back the share versus BCD, any comments you could make on the margin profile? I mean, I'm assuming it's a cheaper product and so the margins get impacted and in the outside chance that your other tier one telephone OEMs also demand similar solutions, how should we think about gross margin impact?

Well, the reason we are offering a new product rather than cutting price on the existing product is to maintain margins. We have done that for many, many years. That's our operating model. That's how we maintain margins, is through more integration and innovation.

And we certainly offer all of our new products-- new products to all of our customers. So we will offer it to everybody else.

Okay, but the point here being you don't expect gross margin erosion associated (inaudible)--?

The only impact it will have is any tier one design, by definition, is below our corporate average, simply because they're much higher volume designs so they have lower pricing. But this product should not be that different from anything else we have done in the past for the same volume.

Okay, thank you.

You're welcome.

Thank you. And with no further questions, I'll turn the conference back over to Mr. Shiffler for any additional or closing remarks.

Okay. Thanks. That concludes the call for this afternoon. A replay will be available shortly on the investor section of our website or you can access a telephone replay for one week-- sorry, for 48 hours, by dialing 888-203-1112 and the replay code for that is 4083413. Thanks for listening and good afternoon.

Thank you, ladies and gentlemen. Once again, that will conclude today's call. We thank you for your participation and you may disconnect at this time.