Power Integrations Inc (POWI) 2007 Q3 法說會逐字稿

Good afternoon and welcome to the third quarter financial results conference call for Power Integrations. As a reminder, today's call is being recorded. At this time I would like to turn the conference over to Mr. Joe Schiffler; Mr. Schiffler, please go ahead.

Thank you and good afternoon. I'm Joe Schiffler, 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 third quarter of 2007. This press release is available on the investor page of our website, which is investors.powerint.com. The release has also been emailed 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 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 report on Form 10K 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 that explains our use of these non-GAAP measures, as well as tables that reconcile these 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 Balu.

Thanks Joe, and good afternoon. Power Integrations delivered an outstanding third quarter with revenues up 15% sequentially to a record $49.8 million, well ahead of our guidance of $45 million to $47 million. The upside came primarily from strong production ramps on a variety of high volume programs, including cell phone and PDA chargers, as well as video game consoles.

We also saw considerable strength in desktop PCs driven by market penetration and strong end market demand. This kind of performance is precisely what we are aiming for with the strategy we have been executing over the past several quarters. As you know, in recent years we have made a deliberate effort to increase our penetration of smaller power supply customers in order to diversify and add customers in the Tier II and Tier III area to our revenue base and enhance our gross margin.

Our success in targeting these small accounts, combined with substantial cost reductions, helped drive a 10 point increase in our gross margin between the second quarter of 2004 and the second quarter of 2007.

As we first told you a couple of quarters ago, we believe that our improved gross margin gives us flexibility to pursue additional high volume business in certain price sensitive end markets such as cell phone chargers, DVD players and LCD monitors. While margins are inherently lower in these applications than in some of the more fragmented end markets, there are significant profit dollars available and we think that pursuing these opportunities on a selective basis is the right way to maximize our revenue and earnings growth.

We are very pleased with the results this strategy is yielding so far. Our third quarter gross margin was down sequentially as expected, but within our guidance despite much higher than expected Tier I revenue. And our non-GAAP operating income grew 16% sequentially, despite higher restatement expenses in the third quarter. This is a good demonstration of the leverage in our financial model, and exactly the kind of results our strategy was intended to produce.

I want to emphasize that we are taking a very deliberate approach to this strategy, targeting the key opportunities where we see the most potential for top and bottom line growth. Our broader approach to the business has not changed. Our products and our power supply design expertise add tremendous value for customers and our gross margin is a reflection of that value. We expect gross margins to remain significantly above the 50% mark for the foreseeable future, even as we pursue further growth in some of the more price sensitive applications.

We intend to balance this growth with the further expansion of our Tier II/Tier III customer base, and we think we have significant cost reduction opportunities ahead of us in a number of areas that will help offset the margin impact of additional Tier I growth.

As stated in our press release, we are expecting fourth quarter revenues to be similar to the third quarter. That would translate to roughly 18% growth in product revenue for the full year despite the loss of substantial revenues to an infringing competitor earlier this year.

Clearly our Tier I strategy is a major reason for this momentum, but a number of other drivers that we have talked about over the past several quarters are also helping fuel our growth. These include our expanded sales force, emerging markets like lighting and power over Ethernet, recent product introductions like TinySwitch-III and LinkSwitch-LP, our expansion in Japan, and perhaps most importantly, the increasing focus on energy efficiency in the electronic industry.

The best example of the impact of energy efficiency is the replacement of linear power supplies driven by efficiency standards, as well as elevated raw material prices. The (inaudible) and Energy Star standards on external power supplies are now in effect and the growth of LinkSwitch products shows the impact those standards are having.

LinkSwitch targets low power applications where linear transformers have historically dominated the market, so LinkSwitch delivers a pretty good representation of the linear replacement trend. LinkSwitch revenues were up 75% sequentially in the third quarter and 150% from a year ago. LinkSwitch accounted for 13% of revenues in the second quarter and jumped to 21% in the third quarter.

The biggest driver in the third quarter was our recent design win for Nokia cell phone chargers. Over the past year or so Nokia has made a wholesale transition away from linear chargers to electronic power supplies, single handedly taking a major bite out of the linear transformer market.

As we reported last quarter, we have won a substantial piece of that business through two of our power supply customers. That business has ramped very quickly and accounted for a significant portion of the upside to our guidance in the third quarter. We also won a wide range of new LinkSwitch designs in the third quarter, including two cell phone designs for UT Starcom, a walkie-talkie charger for Motorola, a cordless phone design for Uniden, several LED lighting designs, and a high volume digital camera design for Samsung.

Energy efficiency is also an important driver in the applications served by our AC to DC product lines. For example, the Federal government's one watt standard for stand by consumption, which President Bush signed in 2001, is now met by a very high percentage of branded desktop PCs. Also the standby power supply in PCs is now increasingly being used to deliver power for additional functionality such as USB ports and LAN wakeup capability.

Tiny-III is by far the most cost effective way for designers to meet these demands while adhering to efficiency standards, which is why it has become a dominant solution in the branded PC standby market. Thanks largely to our success in desktop PCs, revenues from the computer market grew more than 30% sequentially in the third quarter. We also won significant new PC standby designs for Dell, HP and Acer.

Other TinySwitch design wins in the third quarter included appliance designs for [Hire] and Fisher and Paykel, and LCD TV designs for Vistron, a UPS power supply for APC, a variety of LED lighting and industrial applications.

At the higher end of the power range we have just introduced TOPSwitch-HX, our fifth generation TOPSwitch. TOPSwitch-HX offers significant efficiency improvements over previous innovations and enables best in class efficiency at all load levels, including standby. Because TOPSwitch-HX is highly efficient at light loads, it will enable designers to forego a separate standby power supply all together in some high power applications, which is a significant cost savings.

TOPSwitch-HX also gives designers a highly cost effective option for complying with CEC standards on high power external adapters, which are scheduled to become tighter next year.

In July 2008 CEC's limit on normal consumption is scheduled to come down by 33% for all adapters above 10 watts. Energy Star is also now proposing dramatically tighter no load standards across the entire power range, including higher powered adaptors for applications such as wireless access points, POS terminals, stereo systems and many others.

The European Commission is also now considering a mandatory standard for external power supplies similar to CEC standards, which could be implemented as early as 2008.

In condition with the larger TOPSwitch-HX, we have announced a series of design seminars being held this fall in more than 40 locations around the world. We have already trained 1,500 engineers in the seminars that have taken place already, and we have another 1,700 or so scheduled to attend future sessions. Teaching engineers to design energy efficient power supplies cost effectively is one of the key themes of the seminars, and the strong response is a good indication that efficiency is a key concern for power supply engineers today.

We expect energy efficiency to be a significant driver for our business for a long time to come. As we all know, the sense of urgency about limiting carbon emissions continues to build, and with clean energy sources still providing only a small percentage of the world's needs, efficiency is the best and the most cost effective way to reduce emissions.

And I'm proud to say that our products are having a real impact on the environment today. In the third quarter alone we estimate that EcoSmart technology saved 1.4 billion kilowatt hours of electricity, resulting in an estimated savings of nearly 1 million tons of carbon dioxide emissions or the approximately quarterly output of more than 600,000 automobiles. And these savings are really just the tip of the iceberg. Electronic products still have a long way to go in terms of efficiency and over time we will undoubtedly see tighter standards on a wide range of end products.

But the potential savings in electronics are dwarfed by the opportunities in the lighting industry. There are an estimated 4 billion installed lighting fixtures in the U.S. alone and the incandescent technology used in most of the fixtures is less than 5% efficient. The Lighting Efficiency Coalition estimates that a conversion to efficient lighting technologies could save $18 billion a year in electricity costs, an amount equal to the annual output of 80 coal burning power plants.

Australia, Canada and Europe have already announced plans to phase out incandescent lighting over the next several years, and similar measures are now being considered here in the U.S. As LEDs continue to come down in cost and go up in terms of practice and efficiency, we think it's only a matter of time before they become the technology of choice for replacing incandescent lights.

While still in the very early stages, we think lighting should be a significant growth driver for us in the years ahead. We won more than 15 LED lighting designs in the third quarter, and should begin to see a meaning revenue contribution from LED contributions in 2008.

In conclusion, we are very pleased with the momentum we have built throughout 2007, and we are excited about our prospects for 2008 and beyond. We have a strong product portfolio with a good pipeline of new products in the works, our sales an application support team is now not only larger, but also highly experienced, and we have developed a robust set of tools and services to help smaller customers design cost effective production ready power supplies in far less time than it takes to design with competing products.

We also have a strong intellectual property portfolio with 192 U.S. patents issued as of the third quarter. Our IP is the foundation of our company and we have repeatedly proven our ability to protect it when we have to. In September a jury upheld the validity of all four patents being validated by Fairchild, and we are now seeking an injunction against infringing products and also because of the willful infringement, we are asking for an enhancement of $34 million in damages that were awarded to us last year. Obviously we are very pleased with the outcome of the trial and we look forward to getting this case behind us.

And now for a review of financials, I'll turn it over to Rafael. Rafael?

Thanks Balu. Good afternoon. We are very pleased with our third quarter financial results, which featured record revenues of $49.8 million, strong growth on the bottom line, and more than $22 million in cash flow from operations. Our financial model is in excellent shape and stands to improve going forward as spending related to the restatement project tapers off.

Looking at the revenue in detail, our sequential revenue growth of 15% was led by the computing end market, with over 30% quarter to quarter, driven by strength in PC and server standby, as well as PDAs, which we include in the computing segment. The communications market grew in the low teens sequentially, driven mainly by cell phone chargers. The Nokia ramp was a primary driver in cell phones but we also saw strong growth related to LG, helping to further offset the expected decrease in Samsung-related revenues.

Cell phone chargers accounted for just under 20% of our total revenue, similar to the levels we've seen for some time now. However, in recent years, half to two-thirds of this revenue has been tied to a single OEM. In the third quarter, our cell phone business was much more balanced with three OEMs, each comprising 20% to 30% of the mix and a number of other OEMs making up the rest.

Looking at the other end markets, revenue from the consumer market grew roughly 10% sequentially, led by strong growth in appliances, video game consoles and digital cameras.

Industrial revenue grew in the mid single digits with control applications, tools and LED lighting all contributing to the sequential growth.

61% of our third quarter revenue went through distribution and 39% was direct. Avnet, our largest distributor, was our only 10% customer, accounting for 24% of revenue. Turns orders comprised 71% of revenue and the average selling price was $0.36, down $0.03 from the prior quarter, reflecting the strong ramp for LinkSwitch, which serves the lower end of the power range and therefore has a lower ASP by definition.

Our gross margin in the third quarter was 53% on a GAAP basis, within our expected range. Non-GAAP gross margin, which excludes stock-based compensation, was 53.7%. As Balu explained, we are taking advantage of the recent expansion of our gross margin by selectively targeting certain key high-volume opportunities to accelerate our revenue and earnings growth. We will continue this strategy going forward and we expect to see further growth in Tier I programs over the next several quarters.

However, we also expect to see incremental margin benefit over the next several quarters as the result of ongoing cost reductions, including better wafer pricing, lower cost packaging and efficiencies in product testing. We should also see some unit cost improvement begin to flow through next year as a result of the higher volumes we are currently experiencing, particularly on LinkSwitch.

While we expect to see typical quarter-to-quarter variations in our gross margin, depending on the timing of the cost reductions and the ramping of key design wins, overall we expect our cost improvements to roughly offset the margin impacts of any changes in the customer mix. As a result, we think our gross margin should remain significantly above 50% over the foreseeable future.

Third quarter operating expenses totaled just over $20 million, including $3.6 million of stock-based compensation. Op Ex, excluding stock compensation, totaled $16.5 million, including $1.7 million in expenses related to the restatement project.

The restatement expenses were driven by the work to complete our SEC filings, which concluded in August, as well as legal costs associated with derivative litigation and charges for the 409A tax cure that we explained on last quarter's call.

While the restatement expenses in third quarter were higher than we expected, we anticipate that a substantial portion of that overage will be recovered through reimbursements from our DNO insurance carrier in either Q4 or Q1. We also expect to recover a substantial portion of our fourth quarter restatement expenses, which should be around $500,000.

Non-GAAP operating margin for the quarter was 20.5%, with an impact of 3.5 percentage points from the restatement expenses. This suggests a strong level of underlying profitability and demonstrates the leverage that our strategy is intended to produce.

GAAP net income was $6.8 million, or $0.22 per diluted share. Non-GAAP income was $10.1 million, or $0.32 per share, including an impact of approximately $0.04 from restatement expenses. That compares to the second quarter in which we earned $0.30 per share, with a minimal impact from restatement expenses. This suggests strong underlying earnings growth, again showing the leverage in our financial model.

Looking quickly at the balance sheet, cash and investments increased by $28 million, compared to prior quarter, driven primarily by strong cash flow from operations of just over $22 million.

Inventories decreased by nearly $5 million sequentially, ending the quarter at $19.9 million, or 4.7 turns. We have increased production in response to the sharp increase in unit volumes that we've seen over the past few months and we expect inventories to return to our normal range of three to four turns over the next couple of quarters. Receivables increased to $14.7 million, while DSOs decreased to 26 days, down from 30 days last quarter.

Looking ahead to the fourth quarter, we expect revenue and gross margins to be similar to third quarter levels. We expect operating expenses to be between $18.5 million and $19 million on a GAAP basis, which is down $1 million, to $1.5 million from the third quarter. This total includes approximately $3 million of stock compensation expense, plus about $500,000 related to the restatement, which again, we expect to recover, for the most part, through DNO insurance reimbursements.

The expense guidance also includes $800,000 to $1 million in patent litigation expenses, which is a bit higher than our run rate in recent quarters, due to the beginning of discovery activities in the BCD lawsuit. And again, we expect our tax rate to be similar to the third quarter levels, with a longer-term rate probably a point or two higher as our restatement related expenses become immaterial.

With that, we're ready to take questions.

(OPERATOR INSTRUCTIONS).

We'll take our first question of the day from Ross Seymore, Deutsche Bank.

Thanks guys and congratulations on a strong quarter. Balu, overall with the guiding for flat revenue in the fourth quarter, can you talk a little bit about the dynamics, either by the end markets or by the order book that you're seeing, heading into the fourth quarter? Whether orders are slowing, if it's normal seasonality, etc.?

Yes. Our normal seasonality is basically flat from Q2 through to Q4. It could be plus or minus a couple of percentage points. So there's nothing special and, since we have, usually, quite a large turns business, we do the best we can to estimate what the forecast is. Our best estimate is it's relatively flat.

Are you looking for an increase in turns, quarter-over-quarter? Or just about in the normal range there too?

The turns this quarter will be lower because the fourth quarter is usually front end loaded. So, we expect the turns, this quarter, to be between the low 60s.

Okay and then, the last question for me; on the cash usage side of things your cash keeps going up. You guys, before going into that restatement process, had a couple of share buyback plans, I believe, or at least one. Can you talk a little bit about what you might do with that cash?

Yes. Until now, we really couldn't do very much because, first of all, we couldn't do it until we were compliant with the SEC. Then, after we got compliant, we had to go through this tender offer for the 409A, the tax issue, which we completed. And, I'm sure this will be discussed in the upcoming board meeting and the earliest, of course, that we can do anything is when the window opens. But, just quickly, the board will look at all the options as to how to use the money.

Great; thank you.

You're welcome.

(OPERATOR INSTRUCTIONS).

Next, we'll hear from Andrew Huang, with American Technology Research.

Good afternoon. Can you hear me okay?

Yes.

Yes, very well.

So, I just had a quick question. First, with respect to design win activity, I wanted to know if you're seeing - if you're still seeing design win activity as a result of CEC. And then secondly, are you seeing any, maybe, incremental design win activity from potential customers that used to work with Fairchild?

Let me answer the first one. Yes, we are, seeing CEC activity. Sometimes, it's difficult to distinguish between CEC-driven activity and cost-driven activity, because, as you know, the linear power supplies have gone up in price, driven by the cost of copper, iron and plastics.

And so, there are a number of customers, who are not even affected by CEC, who are switching for pure cost reasons. There are a lot of customers who are switching, driven by both CEC and by the cost issues. So, what we do as the best way to monitor the linear conversion, is to look at our linear replacement product, which is the LinkSwitch, which covers the power range the linear power supplies are used in.

And that's actually a pretty good indication. And, as you saw, that has grown dramatically to 21% of our revenue. And in terms of unit volume, it's even a lot higher because it's on the lower end of our ASP.

Got it. And, the following was the Fairchild?

Fairchild? Yes, we are seeing a number of customers who have decided to discontinue the use of infringing products and we are actually one in front of them. Obviously, any time they decide to redesign, they look at all options.

But we are definitely seeing the benefit of getting some of those design wins. In fact, we have already won one major one, in the DVD area.

Excellent. Now, I guess, along the lines of competition, I guess, you know, with your gross margin coming down to 53%, I know it's still well above 50%. But do you have an idea, like, where your competitors are, that compete with your business, specifically for that business? Like, for example, (inaudible) Semi or ST Micro?

I haven't looked at them recently but I believe they are all much lower than ours.

Okay. And, I guess the last question is, it looks like Energy Star is going to do, I guess, another draft of the criteria for the power supplies, external power supplies. And does that -- now maybe you could elaborate; does that help you even more? Or does it, like, further drive more design win activity?

Absolutely. In fact, the Version II, as they call it, for (highly accented language) adaptors, is significantly [tighter], both in terms of (highly accented language) conception and also in terms of average efficiency over the entire load range. And higher efficiency always benefits us because that means that our products bring additional value to customers. So, we are really looking forward to that.

And I believe it's scheduled to become effective in July. We don't know whether that date is going to hold but certainly, a lot of customers are now asking for these new designs to meet the standard, even though it's not effective yet.

Excellent. Just so I'm clear, you're still seeing new customers coming in to meet the July 1, 07 deadline. Is that correct? Even though the deadline, you know, passed?

That's true and the reason for that is it's a relatively soft deadline. They are allowed to ship anything in inventory. They only can't manufacture beyond July 1st, for California. So, especially in cordless phones, which seem to be the slowest to change. They seem to be dragging their feet a little bit.

Most other areas have already moved quite fast. The cell phone and the computer area more the first and then slowly the other areas are moving, like tools and so on. But cordless phones are lagging behind a little bit but what we are hearing from customers is 2008 is when the cordless phone market is going to transition because it is an additional thing that's happening in 2008, which is the European Union is planning to implement mandatory standards for (inaudible) power supplies that are similar to CEC. And it is the European voltages being higher, it is even harder to meet those specs with linear. So I think that the cordless phones really, they won't have a choice, they have to switch.

Got it. Thanks very much.

You're welcome.

We'll take our next question from Steve Smigie, Raymond James.

I wonder if you could talk a little bit about what the Op Ex is going to look like this quarter with the improvements you've made. So is it basically R&D is similar dollar wise, but you're going to see a big drop in SG&A, is that the way to think about it?

Well the way that I would look at it is that expenses overall remain relatively flat with a shift across all the major buckets, so those slightly down in the fourth quarter, but with IP litigation slightly up, so that's kind of the mix. So it's actually down somewhat in the coming quarter, offset by increase in IP litigation.

Okay. I was wondering if you could talk a little bit more about the new TOPSwitch product in terms of timing, when that will hit. Is it going to cannibalized existing products, and the gross margin you expect to get on it?

There will be always a little bit of cannibalization, because there's an overlap between TinySwitch-III and TOPSwitch-HX. But really TOPSwitch-HX was designed for certain specific feature set, if you will, to address certain types of markets, which tend to be medium to high power areas. So I think the overlap is relatively small.

In terms of when we'll see the revenue from it, we just introduced the product so we won't see any revenue this year, but we should start seeing revenue, I would say from Q2 onward that is material.

And the gross margin?

It's not very different from -- the gross margin across our product line is very similar at the same volumes, it's just that when you go to very high volume applications, like any other semiconductor company, we offer lower prices.

You mentioned it was best in class, and certain specifications that were better. Can you give me some sense of the difference between it and what your point is to the competition, and if it's significantly better? I'm just trying to understand, is it hugely more efficient? Can you help me understand that a little better?

The easiest way I can explain that is it has very flat efficiency all the way from a very light load, a few hundred milowatts, all the way up to full power, which could be 100 to 200 watts. And that's actually pretty difficult to achieve in a large power supply, it's easier to do in a very low wattage power supply. And we have managed to do that through a way of implementing the power, we call it the multimode operation that gives a very flat efficiency.

Now the actual efficiency itself is a function of how big a [mosfit] do you use. Obviously that's a cost issue, the higher the efficiency requirement is, the larger device you have to use. But the challenge is maintaining that efficiency across the entire range. Now the reason that's significant is most of the new standards define the efficiency over the entire range. They don't just say you have to be 87% efficient at full load, they say that the average efficiency at 25%, 50%, 75% and 100% needs to be 87%.

And so that makes it very challenging for different designs to meet that.

Okay. On the Nokia business, you had some targets on what you thought that might be in '08. Is that pulled forward, was there just more opportunity now than you originally anticipated? What are you thinking now in terms of your targets for the Nokia business, and are there potential new design wins that you could get?

Well we haven't really received a forecast from the customers for 2008, but if I were to assume the current run rate, we'll be north of our original prediction of approximately $10 million I think is what we projected, but we'll be north of that. So we are doing better than we thought.

All right, thanks a lot.

You're welcome.

Moving on, we'll hear from Tory Sandberg, Thomas Weisel Partners.

Evan Wang calling in for Tory Stromberg. I was wondering if you could take a couple of questions on the general market here. Are you seeing any effect from the weakness in the housing market in your order rates, or any market data that you might have?

Well that's very hard to say. We did see in Q2 our consumer revenue went down, which we thought may be related to the housing market, because a significant portion of our consumer revenue comes from appliances, and appliances are obviously used in homes. Did we see anything in Q3?

The appliance business, Evan, actually bounced back pretty nicely for us in Q3, so it's hard for us to perceive any real weakness related to housing.

Okay, and along the same line, are you seeing any indications of maybe pullings from Q4 that you might also be factoring into your guidance?

There's nothing that is apparent to us so far. Our booking rates in October are slightly lower than September, but that's not unusual, because September and October are the strongest months so we booked a lot in September for October. In October we're booking for November and December, so that's not unusual at all. But we haven't seen anything unusual that would indicate that there was a pull in to Q3 for Q4 business.

Okay. Let me switch tracks to another subject. You just announced your foundry partnership with Epson. I was wondering if you can clarify that decision, your rationale behind the decision, and why you're spending the capacity at this time.

Well first of all it's a very long term plan; we didn't decide to do it yesterday. It was decided three years ago I think, three or three and a half years ago. It is really to make sure that we have enough capacity for the next five years, and also to have more leverage in pricing. The more foundries you have you have more leverage, some of them are hungrier than others and so on and so forth, at any given time. So there is nothing that is in the short term that prompted us to do that. It was really a long term strategy.

But it's important to us in terms of cost reductions, it's important to us in terms of having a lot of capacity for us going forward.

Okay, thank you very much, and congratulations on a great quarter.

Thank you.

And next we'll hear from Sumit Dhanda, Banc of America Securities.

Hi Balu, I hope you're doing well. I had a couple of questions for you. Just in terms of the Nokia ramp again, you said north of your original projection of $10 million. Can you give us any more granularity? Are you talking more than $3 million a quarter, or 2.5, or is it even higher than that?

I think, again I don't have the numbers for 2008 yet, but again if I were to extrapolate from the run rate right now it will be north of the $3 million.

North of the $3 million, okay. The other question I had, as it relates to BCB and any more progress that you could share with us in terms of potentially winning back that socket? I recall you suggesting that the field trials for that product hadn't worked very well for Samsung. How, in any way has that helped you make any inroads back to Samsung?

Yes, absolutely. So they continue to have manufacturing problems at BCB and most of the subcontractors pretty much I think have decided that they want to move away. So they're looking at our new product and, of course, Discreet Solutions. They always look at Discreet Solutions. We have sampled our new product, we have gotten good positive feedback, we are working with all of the subcontractors at this time, but we don't expect any revenue from the new product in Q4. The earliest will be Q1, I think I mentioned that in the last conference call, because it takes time to get it designed and qualified.

But are you fairly convinced that you will get back some of the revenue then? If so do you think you'll get back a fourth of the revenues you lost, less, more?

I'm very confident that we'll get back some business, the question is how much of the business we'll get back and that we won't know until further down as we work with the subcontractors. So hopefully sometime in the first quarter we'll have a pretty good idea.

I wanted to follow up as it relates to the Fairchild, completion of the Fairchild litigation, any reason why a potential injunction is taking longer than anticipated? And then sort of the follow up to that is, have you seen any activity come your way post the completion of that litigation? Something that was previously in Fairchild's pocket coming back your way?

I believe I answered the second part of your question earlier, you might have missed it. We did win a large DVD design win where we directly replaced Fairchild. We are seeing a number of customers discontinuing Fairchild concerned about the injunction taking effect in the near future, and they're looking at our designs and other designs obviously. And to the extent we can tell, Samsung has gone away from Fairchild after the trial was over.

But we think that most of this volume is being supplied by BCB at this time although you'll get (inaudible) and bookings on our older product. But there is no trend in that respect. So yes, we are seeing the benefit of the Fairchild trial. I think you have one more question as to why it's taking so long. First of all, it's not taking any longer than it normally takes. After the trial is over we filed what's known as briefings to the judge, asking for the injunction, asking for enhancement of damages based on willfulness and so on, and they'll file their own briefs, basically putting their positions forward.

Then it's up to the judge, as to when he is going to make decisions on those, and that's totally up to the judge. I've asked this question to our attorneys many times over, they said it could take a couple of months. There is a very high likelihood we will hear from the judge sometime by the end of the year or the beginning of next year.

One final question for you. Balu you and Rafael talked about the fact that gross margins will stay comfortably above 50 and you highlighted the fact that despite a hard Tier I mix you will aggressively pursue cost reductions to offset any erosion, at least offset some of the erosion. What are the specifics you can highlight, factors which could drive further cost reductions?

I think we did talk about the specifics. One of them is the wafer cost reductions, the other one is packaging, and the third one is manufacturing efficiencies in testing. We have identified ways to make the testing more efficient, reduce the test times and so on, which has a pretty significant impact. So all of those I would say have a relatively equal amount of impact on the gross margin that we are pursuing, and again, depending on how successful we are in getting these Tier I opportunities, margins could go up. It could fluctuate, but even in the most optimistic case, meaning that we get all the revenue we're going after, we think we'll be well north of 50%.

Okay, thank you.

Next we'll take a question from Vernon [Effie], Needham and Company.

Thank you. I just wanted to, maybe you discussed this already, but I wanted to go over the inventory level on your balance sheet, it's down nicely, haven't seen it down this low in quite a while. I'm wondering how you're going to contend with that going forward, and if there's anything we should be thinking about on your manufacturing front?

Well it's down for a reason, it's down because demand is obviously up quite a bit in the third quarter and we were able to fulfill those needs. So going forward I would expect inventories to come up slightly, but nothing too dramatic. Obviously as we plan for an optimistic future.

Okay are there any other thoughts to keep in mind though on the cost side, with your foundries, anything changed on that front, or should we be looking at the cost bundle being pretty much stable?

No, I think we explained that we see a significant cost reduction in a number of areas, in fact almost all cost areas. We have three big components, the silicon, the packaging and tests, and we see opportunities to reduce costs and give positive impact on margins through reduction in costs in all three of those areas.

Okay, and then just on the market segment side, you obviously had some very strong growth there on the PC front. And you had indicated -- is that just desktop? Or is that a combination of -- I see you don't make a notebook adaptor itself but that's primarily desktop that drove that delta growth?

It's primarily desktop but we also had a very strong growth in PDAs. We supply to two major PDA - we don't directly supply. Our customers supply to two major PDA manufacturers. One is RIM; the other one is HTC. And both did very well last quarter, the Q3. And, of course, PC standby, we not only had very strong end market demand, we also increased our market share significantly, driven by energy efficiency standards.

Okay, so if we look into the fourth quarter, it's fair to say that your market share is probably going to be growing sequentially into that timeframe, because that's usually a seasonally tough environment you're entering into.

Yes.

Okay. And then, just finally on that front, if you were to look at the guidance, which is very nice, going into -- or at least sequentially, for this time of year, what would you say, out of your market segments, will be the best grower, on a sequential basis? Or where do you see the most visibility right now?

That's a good one. We don't have a lot of visibility. We usually depend on you to tell us.

Yes, you know, we are so far removed from the end markets because, you know, our customers supply to the OEMs, who supply to the retail chains and so on. We don't have any intelligence about end markets other than what we read in the press.

Okay; well, good luck with that and thanks for taking my call.

Thanks.

Moving on, we'll take a question from Craig Ellis, Citigroup.

Thanks, guys; good afternoon. I missed part of the call so I apologize if my questions have been asked already but LinkSwitch was certainly stronger in the quarter than I would've [liked], so congratulations on that. But, what drove the strength, sequentially, and were you expecting it to be up 75%? And if not, what was the upside to your expectations?

From the bookings, we still see the LinkSwitch growing as a percentage of our business. And how far it will grow I really don't know. It depends upon how much of the market we have already converted, you know, that's driven from CEC and the cost of linears.

I'm afraid I don't have an exact number for you but for the foreseeable future, meaning the next quarter or two, the LinkSwitch revenue should continue to grow. Do you have that?

For Q3, Craig, the big driver on the upside on LinkSwitch was the Nokia RIM.

Well, I think you were expecting to pick up Nokia as a customer so that just ramped more significantly than what you thought?

Correct.

Okay and I think you had been designed in at one of their charger suppliers? Are you designed in at more than that now?

No. We said that we had design-in at two of the charger suppliers.

Okay, got it. And you're expecting that LinkSwitch can grow as a percent of revenue over the next couple quarters. How do you think about first quarter seasonality here? It looks like you've got strong design-in (inaudible). You mentioned a number of things early in the call. Are you seeing enough design-in strength off of LinkSwitch that you're going to be able to grow sequentially in the first quarter? Or, would we expect to see that seasonality would overpower some of the design-in momentum that you're getting?

It's hard to tell. It all depends upon how much overhang there is in the retail chain after the holiday season. If there is no inventory in the retail chains then the Q1 tends to be a strong quarter. But if there is overhang, usually Q1 is down slightly. Not a lot, but I think we have had, in some years, it would be a bit down, like 5%. Some years have been flat; some years have actually grown.

So, (highly accented language) is a little bit difficult to predict because it depends upon how good the sell-through has been in the retail markets.

Okay, that's helpful, Balu. And then, Rafael for you, can you just provide us with a breakout in the gross margin sequentially, from 56% to 53.7%? How much of that was just product mix shift towards LinkSwitch, vs. pricing dynamics inter-quarter or anything else that emerged? Can you just break that down into the contributors that caused the decline?

Not quite, but I can tell you that, for the most part, the majority of the shift related to the ramp in Tier I type businesses, predominantly Nokia.

Okay.

Yes, if you take out the new Tier I businesses that we have selectively gone after, the rest of the business had been flat, in terms of margins.

Right.

Okay and so the pricing dynamics that -- I think you said that ASPs were down in the quarter. Does that include what you're seeing at Nokia? Or, how do we (inaudible) the ASP trend?

The $0.39 to $0.36, the majority of the decline is because of Tier I type businesses, once again, mainly Nokia.

Yes. The Nokia design is a very low power design. It's actually about 1-1/4 watt charger, which is at the low end of our power spectrum, in terms of our products. And the lower the power, you know, the less expensive the chip is. And so it's not an indication of price erosion necessarily. It is more of a mix in the different products. And basically this product is a lower priced product because of the power. It's also lower priced because it's very high volume.

Okay, that's clear. Thanks for the help, guys.

(OPERATOR INSTRUCTIONS). Next, we'll hear from Andrew Huang, American Technical Research.

Thanks for the follow up. I just wanted to make a couple clarifications. When you said that PDA was very strong, did you say that was RIM and HTC?

That's correct.

Okay. And then, I guess, just to clarify on that last question, basically all the gross margin pressure you saw was basically product mix. It wasn't you aggressively cutting prices for your products, correct?

That's correct.

That's correct.

Okay, and then, I guess the last question is about, for the tax rate -- oh, two questions. Tax rate, going forward, what should we use?

I would say that, out in '08, once restatement expenses are out of the way, it starts to approach 20%.

And you guided litigation expense, $800,000 to $1 million for the December quarter.

Right.

Could you give us kind of an initial pass for '08?

Sure.

It's kind of early to tell but, depending on what happens, in terms of trials and so on and so forth, it could be anywhere in the $3 million to $5 million range. I'm not saying we would be in the high end until we know when the trials are going to occur.

But that is the best I could tell you right now, $3 million to $5 million.

Okay. Thanks very much.

You're welcome.

Operator, I think we have time for one more, if we have anymore questions in the queue.

And we'll take that final question from Donald [DeSant], Evergreen Investments.

Thanks, hey Balu; real quick. Depreciation and amortization in Cap Ex for the year, can you give us a little help with that?

Yes. For the quarter--.

Yes, for the quarter, that's fine.

Cap Ex was just over $2 million. And DNA was just under $2 million. And that's been pretty consistent at those run rates throughout the year.

Beautiful; thanks.

Okay, well, we'll make that our last question. Thanks everyone for listening. A replay of the call will be available shortly on the Investor Info section of the website, which is investors.powwerint.com. Or, you can access the telephone replay for 48 hours by dialing 888 203 1112, from within the U.S., or 719 457 0820 from outside the U.S. And the replay code is 4381032.

Thanks for listening and good afternoon.

And once again, that does conclude today's conference. We thank you all for joining us.