Power Integrations Inc (POWI) 2009 Q4 法說會逐字稿

Good morning and welcome to the fourth quarter 2009 financial results conference call for Power Integrations. Today's call is being recorded.

At this time, I would like to turn the conference over to Mr. Joe Shiffler. Mr. Shiffler, please go ahead.

Thank you and good morning, I'm Joe Shiffler, Director of IR and Corporate Communications for Power Integrations. With me are Balu Balakrishnan, President and CEO of Power Integrations and Bill Roeschlein, our Chief Financial Officer.

During today's call we will make reference to financial measures that are not calculated according to generally accepted accounting principles. Please refer to today's press release which is available on our website at www.powerint.com for an explanation of our reasons for using such non-GAAP measures as well as tables reconciling these measures to our GAAP results.

Also 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 of future business. Forward-looking statements are denoted by such words as will, would, believe, should, expect, outlook, estimate, plan, anticipate, suggest, project, forecast and similar expressions to 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 statement. Such risks and uncertainties are discussed in today's press release, and under the caption item 1A risk factors in part two of our most recent Form 10-Q filed with the Securities and Exchange Commission on November 5, 2009.

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.

Lastly, I'd like to note that this coming Monday, February 8th, we'll be attending the Thomas Weisel Partners Technology and Telecom Conference in San Francisco, followed by the Deutsche Bank Small and Mid Cap Conference on February 10th in Naples, Florida. With that I'll turn the call over to Balu.

Thanks, Joe and good morning. Power Integrations completed an outstanding year with another strong quarter delivering record revenues, a significant increase in our gross margin and record net income. Fourth quarter revenues were $66.1 million, up 56% from a year ago, and 23% higher than our pre recession peak, which compares very favorably to the analog peer group. For the full year we achieved our eighth consecutive year of top-line growth with revenues of $215.7 million, an increase of 7%. We believe our ability to grow through the downturn reflects an acceleration in our market penetration over the past couple of years including record design wins in 2009. We also finished the year strong in terms of gross margins, coming in at 51.1% on a GAAP basis, up 260 basis points sequentially, and above our forecast of 49% to 50%. Fourth quarter operating expenses were higher than anticipated due primarily to unexpected jump in patent litigation expenses, specifically related to the discovery phase of Fairchild case scheduled for trial later this year. Now that discovery is essentially complete, we expect litigation expenses to be not only lower, but also more predictable throughout 2010.

We also elected to accelerate some spending on upcoming product introductions in response to customer feedback indicating strong demand for ultra high efficiency power supplies. We beta sampled five products during the later part of 2009, some of which enable efficiency levels that are not expected to be in demand for at least a couple of more years. However, customers have told us that OEMs want these higher efficiency as quickly as possible, and we have accelerated our efforts to get new devices into production in order to seize this opportunity.

Overall we expect 2010 to be a banner year for us in terms of the number of new products. We have as many as eight new IC families on track to be introduced this year with the majority targeting high-power applications. Just to put that in perspective, we typically introduce only one or two new product families each year reflecting our highly focused business model and the broad applicability of our technology. However, as we have discussed on previous conference calls, we have made a number of breakthroughs that enable us to bring unprecedented levels of integration and efficiency to high-powered markets, just as we have done for many years at the low power end of the market. The drive towards higher efficiency makes this an opportune time for us to enter the high power market and the early response from customers gives us confidence that we are making the right investments.

As I mentioned a moment ago, much of the demand for high efficiency is coming directly from OEMs and many manufacturers are already going beyond the regulatory standards. In addition, policy makers continue to be extremely active in setting new and tighter standards on a wider range of end products. Europe's eco design program continues to expand with a mandatory cap on standby consumption taking effect last month. On April 1st of this year, eco-designed programs will adopt the current US standards on external power supplies which originated in California a few years ago. Additional standards covering computer monitors -- computers, monitors, set-top boxes, and appliances, appear to be on track for approval in Europe during the first half of this year.

Meanwhile, the California Energy Commission has passed new standards in November that limit the energy usage by flat-panel TVs beginning in 2011 and then reduce the limits further in 2013. These mandatory requirements complement Energy Star's new voluntary TV specs scheduled to take effect later this year and then tighten further in 2012. Other Energy Star specs are pending for set-top boxes, audio video equipment, game consoles, and home networking equipment among others.

In December, Energy Star also issued requirements for LED light bulbs, covering not only efficiency, but also a wide range of performance specifications including minimum lifetime, lumen maintenance and labelling. The specs also require manufacturers to offer a three-year warranty in order to use the Energy Star label. Clearly, Energy Star wants to ensure a positive consumer experience with the LED lighting in contrast to the experience with early days of compact fluorescent bulbs which have never fully recovered from the bad reputation they earned with consumers as a result of inconsistent quality and performance.

We remain very bullish on LED lighting opportunity which has created not only a fast-growing new market for us, but also a market where customers place a great deal of value on the key benefits of our products, efficiency, reliability, and ease of design. We continue to win more designs in LED lighting than any other application and we expect this market to be a significant growth driver for us in 2010 and beyond.

Just to conclude before I turn it over to Bill, I would say we are extremely proud of our 2009 results which rank among the best in the analog semiconductor industry in terms of top-line growth. 2010 is off to a promising start with record monthly bookings in January, and we expect another significant increase in revenues in the first quarter. Predicting revenues in the future quarters is, of course, very difficult given our limited view into cyclical dynamics, and end market demand. However, we believe our ability to grow through the downturn demonstrates a strength of our secular growth story and we think the story has a long way to go with the energy efficiency trend still in the early innings and incremental opportunities like high power and LED lighting just getting started.

Now I'll turn it over to Bill for more color on the Q4 financials and the outlook. Bill?

Thanks, Balu, and good morning. I'll quickly recap the fourth quarter financials, briefly touch on the outlook for Q1, and then we'll take your questions.

Revenues for the fourth quarter were $66.1 million, just above the high end of our forecast, and up 56% year-over-year.

Consumer revenues led the way with growth of nearly 70% year-over-year, with broad based strength in appliances and consumer electronics.

Industrial revenues also grew in excess of 60% year-over-year, with strength across the board, but most notably in LED lighting and smart metering applications.

Communications revenues grew better than 50% year-over-year with mobile phone chargers being the primary driver, but also big contributions from cordless phones, wireless access points and a number of other applications.

Computer revenues grew by nearly 40% year-over-year driven by desktop PCs and LCD monitors.

On a sequential basis, fourth quarter revenues were up 10% led by the communications market where revenues were up more than 20%. That reflects the recent share gains in the cell phone market, but also reflects better than 20% sequential growth in other communications applications.

Industrial revenues grew more than 10% sequentially driven mainly by LED and process control applications.

Computer revenues were up mid single digits, while consumer revenues were flat sequentially.

Turns business accounted for just over 20% of revenues for the quarter, obviously a much lower level than normal, due to longer lead times on certain products, as we discussed on last quarter's call.

Average selling price for the quarter was $0.29, down $0.03 from the prior quarter and driven primarily by higher percentage of revenues from the cell phone market.

We had two 10% customers during the quarter, including of Avnet, our largest distributor with 15% and one direct customer with just over 10%.

Direct sales accounted for 38% of revenues during the quarter, while distributors accounted for 62%.

Our channel inventory stood at 5.3 weeks at year-end, up slightly from last quarter, but consistent with the higher range we've seen over the past few quarters as our lead times have extended. As a reminder, 100% of our distribution revenues are recognized on sell through. The fluctuations in channel inventories are not a significant indicator of future revenue performance.

Our gross margin was higher than expected at 51.1% GAAP and 51.4% non-GAAP, which excludes stock-based compensation. Both numbers increased sequentially by 260 basis points. About 60 basis points of the increase came from the absence of the nonrecurring items that impacted us in the third quarter. The remaining 200 basis points of sequential improvement was primarily driven by higher production volumes with some help also coming from unit cost improvements on LinkSwitch-II, which continues to work its way down the cost curve as discussed on last quarter's call.

As Balu noted, we came in higher than expected on operating expenses with non-GAAP expenses of $19.5 million. Litigation expenses were $2.3 million, well above the rate we've averaged in recent quarters, reflecting the unpredictable nature of the discovery phase of a lawsuit. However, discovery related to the upcoming trial is now essentially complete, so litigation expenses should be both lower and more predictable throughout this year. We expect total litigation spending for the year to be in the $4 million to $4.5 million range, down from $5.6 million in 2009 and we expect that to be spread fairly evenly across the four quarters.

The other big expense driver in the quarter was our accelerated product rollout efforts which cut across all three expense lines with test wafers and other materials expenses impacting R&D, application-related expenses hitting the sales and marketing line and patent filings impacting G&A.

I would also note that we reinstated 401(k) contributions in the fourth quarter, and recognize the entire year's worth of expense during the quarter rather than accruing for it throughout the year as we would normally do.

Despite the higher than expected operating experiences our non-GAAP operating margin expanded by 120 basis points sequentially to 22%.

GAAP operating expenses were $22.6 million, which included $3.1 million of stock-based compensation. That amount includes a $600,000 charge to correct errors made by a third-party software that we and many other companies use to calculate stock-based compensation. The error has caused stock-based compensation to be understated slightly beginning in fiscal 2006, up through the third quarter 2009, and the charge represents a catch-up for that. Going forward, we expect quarterly stock-based compensation expenses to be about $2.5 million per quarter.

Our GAAP and non-GAAP tax rates for the quarter were 19% and 17% respectively. Getting us to full-year tax rates of 23.8% GAAP and 20.3% non-GAAP.

Non-GAAP net income was a record $12.2 million, or $0.42 per diluted share, up $0.06 per share on a sequential basis and up more than 160% from a year ago.

GAAP net income was also a record at $9.2 million or $0.32 per share.

Looking at the balance sheet, accounts receivable increased by $1.3 million sequentially with days sales outstanding holding steady at just under 30 days. Inventories increased by about $6 million to $26.2 million, or about 74 days of inventory, compared with the unusually low level of 60 days last quarter.

Cash and investments increased by $19 million during the quarter to $196 million, or about $6.75 per share. For the year, cash and investments increased by $21 million driven by cash flow from operations of $46.2 million, which was up 28% from the prior year.

Reflecting the strength of our balance sheet, our board has doubled our quarterly dividend to $0.05 per share beginning with the first quarter which will be paid out on March 31st.

Turning to the outlook, we expect first quarter revenues of $70 million to $74 million which would be up 79% year-over-year, and 9% sequentially at the midpoint. Although we have ramped production dramatically over the past several months, lead times on many products remain extended and customers continue to order further out than we would normally expect. As a result, our turns requirement remains unusually low at roughly 30% to reach the midpoint of our projections. Based on our current mix of backlog, we expect first quarter gross margin to be similar to the fourth quarter level, which again was just over 51% on a GAAP basis, and 30 to 40 basis points higher on a non-GAAP basis. GAAP operating expenses should be in the range of $21 million to $21.5 million including $2.5 million of stock-based compensation expenses. That implies non-GAAP operating expenses of $18.5 million to $19 million, including about $1 million of litigation expenses. We expect our GAAP tax rate for the quarter and the year to be roughly 20% and our non-GAAP tax rate to be in the high teens.

With that, we're ready for your Q&A.

Thank you. (Operator Instructions) We'll pause for just a moment. We'll take our first question from Vernon Essi with Needham & Company.

Thanks very much, congratulations on the strong guidance.

Thanks.

Just a question, I've asked this a lot in the past, but on the LED lighting front, it looks like you had some obviously some pretty good growth there sequentially, and I don't want to state this as sort of a break out, but I'm curious if you have seen any -- you've always talked about how there's a very broad mix of customers. Is there any particular customer or area that's standing out in terms of where you're seeing stronger dollar content or do you still qualify it as just being very well spread out?

As far as we can see, it's pretty broadly spread out. We have a lot of customers. We have, I think, about 200 opportunities in design. Production actually. So I really can't see any specific customer standing out.

Okay. On the higher power products, you have obviously a lot of designs that are rolling out. Is there any up-front costs that we should be thinking about going into 2010 that might be unusual for that relative to the lower product introductions you've had in the past or how should we think about that from a modeling perspective?

Well, as we mentioned, we decided to accelerate some of the introductions. Approximately middle of the quarter we decided to do that based on customer feedback that they wanted these products earlier than we originally planned to roll out. Which meant that we had to add both fixed and variable costs earlier than we expected, and that will continue into Q1 and onwards. I don't think there's any big bubble that occurs in any particular quarter, because we think we'll have up to about eight product families introduced, but with introduced throughout the year. So I don't see any particular quarter having a huge impact in terms of cost.

I guess I was -- to be specific, more on the marketing side, do you anticipate that your sales and marketing might actually run a little bit higher than historical norms on a percent of fills basis or not?

Yes, yes, absolutely. And that's included in our Q1 guidance.

Okay. And then finally, one other number question I have, and I'll pass it on. Taxes look to be lower next year than what we've typically been guiding. Am I correct on that, Bill? Is it a 20% rate now?

That's correct, 20% on GAAP and a couple points lower on non-GAAP. We get -- there is some benefit to having a larger percentage of our sales occurring offshore and there is some leverage in that tax rate.

Okay, great, thanks a lot.

And we'll take our next question from Tore Svanberg with Thomas Weisel Partners.

Yes, thank you, and great quarter. This is a question I typically don't like to discuss, but it's a topic that's out there, so I'll bring it up anyways. So your lead times are still long. So can you maybe just address potential double ordering and if you feel that the bookings you are currently getting is for true demand?

To the best we can tell, most our customers are still clamoring for parts, and so we don't think there's a lot of -- that the customers, I think, really have the demand, but it's much harder to tell if the OEMs are double ordering into our customers. That's the hard part.

So I -- it's also possible that some of our customers are building some inventory because they've been really -- they're short of parts for a long time.

Having said that, if I look at the last six to nine months, we've been thinking that there might be some over ordering, but so far we have not seen any sign of that, and that doesn't mean there -- it won't be in the future, but it certainly looks like at least to the extent it's visible to us at our distributors and our customers, they're maintaining relatively low inventory and, as I said, even on a daily basis, we have customers asking to move in the orders. But we really can't see beyond our customer into the OEMs.

Okay. Very good. And Bill, you mentioned that channel inventory was up a little bit. Can you just repeat that number and where does that stand relative to the historical norm?

Well, it was at 5.3 weeks, and it's been in the 4 to 5 range when we had shorter lead times. So I think 5.3 is still a pretty conservative number and, if anything, we would expect that in dollar terms the disties would probably seek to get -- to increase their levels at this point.

You have to remember that our lead times used to be four weeks, and at that point our distributors used to carry somewhere around 4.5 weeks of inventory, 4 to 4.5 weeks. But now our lead time on most of our products is eight weeks, and there are a handful of products where it's even longer than that. So it's not at all surprising that our distie inventory is around 5.3 at this point, it's been that way for the last couple of quarters.

Okay very good. And obviously you're ramping some capacity here to try and meet demand. When would you expect your lead times to start coming back into the four-week range?

Well to some extent it will depend on how the demand continues. As it stands right now, we think that by the end of this quarter, we would be able to reduce the lead times to some extent. We are certainly producing more, significantly more products than the actual ship-out. So we are hopeful that we would be caught up and we'll be able to reduce our lead times by the end of this quarter.

Great. And lastly, I assume the 30% turns requirement was at the beginning of the quarter. So where is that turns requirement based on February 4?

As of today, our bookings are just below our minimum, that is just below the $70 million, the lower end of our guidance.

Excellent. Thank you very much.

You're welcome.

And we'll take our next question from Ross Seymore with Deutsche Bank.

Hi, congrats on the strong quarter and guide. On the quarter itself were -- was there any capacity limitations that -- it was a strong quarter, but you're pretty much at the high end of the range and you didn't beat it despite the turns requirements being so low.

You're talking about the last quarter?

Correct, fourth quarter.

Fourth quarter, yes, we could have shipped a little bit more if we had the part -- the right products.

Got you. So just to be clear, you basically don't need any more turns to make the low end of what you just guided for the first quarter, is what you just answered to Tore's question?

Yes, but let me put a little bit of color around it. You have to remember what we can see at this point is what we ship out. We don't know -- about 60% to 65% goes towards distribution. So when I say we are slightly below the low end of the guidance, I am making assumption on a slight increase in distribution inventory consistent with our growth. If the distribution inventory grows a little higher, then the numbers will be slightly different. But overall, you're right, we are very close to the low end of the guidance already.

Got you. And I know you don't guide any further out, but can you just remind us what's normal seasonality for the second quarter, and if you were thinking about the puts and takes involved with lead time shrinking and kind of new products launching, things like that, what would be the puts and takes for how you would view second quarter this year?

It's really hard to predict because we don't know whether all of what we're shipping is actual demand or whether there is some level of inventory replenishment going on at this time. So it's very, very hard to predict what the second quarter is going to be this year. However, normal seasonality in the past years has been a slight increase in revenue in Q2.

The last question on my side, Bill, can you just walk us through the puts and takes from kind of a high level for the gross margin in 2010, from a yen perspective, production costs -- whatever the big metrics are? Not specific guidance of course.

Sure, well, the two headwinds which we've often talked about are the yen being one of them, and compared to maybe two years ago, it was at 105 and today's at about 90. And that's given about a point and a half of impact to our current levels.

On the flip side, the utilization that we're getting with the percentage of our cost of goods sold that is fixed, we're getting a lot more -- a lower -- more absorption per unit -- or lower absorption per unit, that's allowing us to increase our gross margin. And then just again for the rest of the year, some of this is going to -- there's always a mix impact that we take into consideration. And raw materials, there's been some impact we've had with particularly gold, and that can work either way. As we look through the year, that's something, again, I wouldn't prognosticate on, but those are the big-picture items on our margin.

Again, I can add a little more color. We have ramped up our production quite significantly. So going forward, I don't see any additional improvement in absorption, but we continue to reduce costs in several ways. We are continuing to move our production into six-inch wafers, about 40% of our production currently is still five-inch. So that will give us some cost benefit.

We are also looking at some technology improvements that will allow us to shrink our dies, in fact, we're already doing that as we speak, but those things will go into production throughout the year, converting some of our high end and our volume products into smaller dies.

And that will be to some extent offset by increasing raw material costs, specifically gold. We do use gold bond wires that has impacted us over the last few months due to increasing gold price. So I would say net-net, if the yen rate remains where it is right now, the gross margin is likely to stay approximately where it is right now. Obviously there are a lot of variables that could change it a little bit, but I feel reasonably confident that we'll stay about a 50% range, exactly where it will be is hard to tell.

Perfect, thanks for the detail and congrats again.

Thank you very much.

We'll go next to Arnab Chanda with Roth.

Yes, thank you. A couple of questions. First of all, if you look at your -- the contribution of the business that's coming from LEDs, could you talk a little bit about what the trajectory has been on a yearly basis even during the downturn and what you expect to see after, in 2010 and beyond?

That's a good question. It's very clear from everything we hear in the press and from the Department of Energy and so on, that LED lighting is the lighting of the future. It just has the right attributes. It has very good color relative to compact fluorescents, it's got a very long lifetime, it's instant on, it's very easily dimmable. So there's many, many things going for LEDs, it's almost a perfect lighting technology.

The question is how quickly is the -- is it going to convert the existing technologies. And unfortunately, I'm unable to answer that other than to say that I think for the next 10 years or more, LED will continue to grow very rapidly. I don't think it's going to be hockey sticks, because the cost of LEDs are still pretty high. So it is converting markets where the benefit is so significant that it's an immediate payoff, like street lighting, for example. But I think it will gradually replace existing technologies over the next 10 to 15 years.

This is Joe. In terms of the numbers we communicated a target of about $6 million to $8 million in revenue for the year last year and we were well within that range for 2009, and that was up from about $3 million to $3.5 million the prior year.

You think that trajectory continues, nearly doubling year-over-year?

It's very possible.

Okay. I have a question maybe for Bill on the backlog. Could you talk a little bit, it seemed like your backlog was up a lot in Q3 and then you're assuming kind of high turns. Do you think your backlog is increasing given higher visibility faster than your revenues or qualitatively where do you see that?

The backlog, it was roughly equal in both quarters, but we're continuing to see demand remain strong, and as we ramp capacity to meet that demand.

With the lead times where they are, I am not surprised that the backlog is very, very strong. And the beginning backlog was comparable to Q4, but we have certainly booked a lot in January. January was a record booking month for us. So that's why we are already close to the minimum and the low end of our guidance, because of strong bookings in January. So it's not surprising. I don't know whether there is as much visibility as the lead time. I don't think our customers have a lot more visibility than they had before, but they are essentially forced to forecast further out in time because of lead times. Not only our products. We have heard that most semiconductor vendors have increased their lead time, in fact quite a bit further than us.

So last question maybe for either Balu or for Bill or Joe. If you look at the effect of the California energy mandate for LED TVs, I'm sorry, TVs in general, digital TVs, as well as, I think the energy department is undergoing an experiment about what the lifetime is for LED lighting. Do you see that most of the effects of the first really already happened or do you see that sort of continuing? And is there an acceleration from either the first or the second trend? Thank you.

I don't think it's happened yet. I think it's happening as we speak, and it will continue for many years because the California requirements take effect in two stages. There is a Tier 1 requirement, and then two years -- was it two years or three? -- two years later, there's a Tier 2 requirement, which is tighter. So this is not a one-time event, it's going to be a continuous improvement in energy efficiency.

And then if you look at Energy Star, they also have a two-tier program, but Energy Star's specs are much tighter than California specs because it's a voluntary spec. But many of the brand names are already shooting for Energy Star. So again, it's a continuum of improving energy efficiency over time. I wouldn't be surprised that after the Tier 2, if California adapts the Energy Star specs, the Tier 1 and Tier 2, which will make it, again, tighter as time goes on.

Thank you.

And we'll go next to Gus Richard with Piper Jaffray.

Yes the name is [Ronway Feldman]. Hi, nice quarter, you are doing a great job.

Thank you.

Let's see. You are supply-constrained, I'm assuming it's test and assembly or do you have issues getting more wafers?

I'm not sure it's as much a supply constraint as knowing exactly what products to build. If you look at our run rate right now, we're -- in terms of products we are producing each month, it's significantly about what we are shipping. And so it's an issue of -- and also if you look at our inventory, we have built some inventory last quarter. So if we have it in the inventory, we can ship right away. Having said that, as I said last quarter, we could have shipped a little bit more if we had the right products. So I don't know, I don't know whether you can call it a supply constraint.

It's a production-control issue, you just running a little bit leaner than normal and, A, just can't quite figure out what package and what die you need and you're just getting randomly short on various and sundry things and it circulates depending on the undulation of demand?

Yes. Just to give you an idea, we have something like about 150 to 200 products, and just a handful of them is where we have the problem, and that handful changes all the time depending upon the month. Each month it changes because you just can't get the right mix when the demand is this high and we don't have enough -- we don't have the normal inventory level. Normally we would have four to five turns. Right now, we are at just about five. So we are just getting into that area where it will get comfortable.

Historically, you have run your production hard in the first quarter -- or first half when demand is down, and then as demand came up in the second half, you don't really adjust your production output, just level the factories and keep things running at a sustainable pace. Is that the plan this year or do you feel like you're just going to have to keep adding production as you go through the year? What's your thoughts on that?

It will all depend on how the rest of the year turns out. It's possible we will stay at the same rate, or we may have to increase if the demand continues to increase. We do have additional capacity that will allow us to increase our production in Q2, and then even more in Q3. So we will have plenty of capacity for significant upside if that happens, but I just don't know what's going to happen.

Right. And you have the testers in shrink wrap, if I'm not mistaken; correct?

No problem at all, because the testers are very short lead times, and short meaning relative to fabs. So, yes, it's really not a problem.

Just switching topics, you mentioned you're gaining market share in the cell phone side of things. Is that coming from other integrated controllers or is it finally the end of the ring choke controller here?

It's certainly coming from our competitors, we're gaining share against pretty much all of our competitors, and not just in cell phones, in all areas. It's very clear to us that trend is happening. And in cell phones certainly we have gained share from a number of competitors. And in one case, we have gained share because of redistribution of volume among the vendors of the OEM.

Oh, okay. But specifically I'm -- just because ring choke controllers have always had such a high market share in the low powers, are you finally -- is it finally at a point where the energy efficiency requirements exceed the capability of those controllers?

The answer is absolutely yes. In fact, I think the ring choke controller is very close to dying in the cell phone area. You might have already gone to close to zero at this point because of energy efficiency specs.

Okay. So did that transition happen last year or is there more of that to go?

It's happening as we speak.

Got it. Okay. And just remind me, the -- as I recollect, the percentage of the cell phone market that was RCC was something like 35%, 40%. Is that about the right number?

That was some time ago, but at this point, I think -- I can't tell you exactly when it's happening, when it's going to happen, but to the best of my knowledge, nobody's designing RCC going forward.

Oh, wow. Okay. Got it.

Because of the low-load consumption requirements and efficiency requirements.

Okay. So basically there's zero going forward?

Yes, again, to the best of what I (multiple speakers)

I understand.

-- OEMs, yes.

Right. No, I understand. Okay. Very helpful, Balu, congratulations, you guys are doing a great job.

Thanks.

We just need smarter analysts. Thanks.

We'll go next to Steve Smigie with Raymond James.

Great. Thanks. I was wondering if you could talk a little bit about operating expense. Even with the accelerated spending it seems, I'm doing the math right here, that percentages here are definitely lower than historical levels. Do those percentages continue to trend down as revenue moves up?

We would expect to have significant operating leverage as we ramp revenues. It's always been our target model to grow OpEx that's at or below the growth rate of revenue growth rate. So that would be our expectation. But we did put in the guidance here in Q1 a little bit of extra OpEx to reflect what we're doing with our product rollout plans, but, again, we're having -- it's not in excess of what we're anticipating for revenue growth.

Just to restate what he said, next year -- this year, I'm sorry, 2010, our expectation is that our operating expenses will be roughly increasing by half the amount of revenue increase. That's based on our internal model for what we think we'll be able to do this year.

Okay. And is there a particular -- your Q3 is normally a huge quarter, and 8% to 16% sequential growth, will we see a step function drop in percentage there, is that the right way to think about it, or is that going to happen?

Are you talking about whether there will be an increase in operating expenses? I'm not sure I understand --

Your Q3 revenue typically is a pretty big jump. So if I were to look at your OpEx as a personal of your revenue in that particular quarter, I guess I would expect it to step down pretty significantly if you're controlling your operating expense dollars. Is that the right way to think about it, or will the percentage sort of remain the same so you will see have a jump up? Will you make the decision that, hey, we're getting much better revenue, so let's keep the R&D dollars cranked up? Or something like that?

There's a lot more volatility in the revenue in the -- and being able to see into the revenue is a little more difficult, obviously the OpEx is a lot more under our control. But we do our best to manage our OpEx and our OpEx forecast and budget to some expectation of where we're going to be in revenues. So, yes, you wouldn't see OpEx in revenue moving together correlated one-to-one, rather you'd probably -- we are making the investments that we're making now in anticipation of where we believe revenues are going to be.

We look at the entire year rather than a quarter because the OpEx doesn't change that quickly each quarter. So what we're saying is based on our internal revenue models, our goal is to keep the OpEx increase approximately half of the revenue increase, and as the revenue grows, our OpEx as a percentage will reduce. And that will also apply to R&D expenses, which is really the nice thing about our model. It's got a lot of leverage.

Okay. And since you're accelerating the spending, I guess this year, all else being equal, say we'd think that, hey, we get to 2011 and that just steps down again? Or would that accelerating spending continue the next year?

Then the last question is just turning back to gross margin, I think in the past you've done something like 54% gross margin. With the increasing mix of stuff like handsets or just with your mix overall, do we have a way back to 54%?

Well, on your second question, from where do we go from here on margin is going to be dependent upon what we do internally, which we're doing -- which we are working on, which is cost reduction, as Balu mentioned, and changes -- packaging changes, and moving to larger wafer sizes and looking at transitioning different wire bonds, et cetera.

A couple things that are out of our control is -- in the macro picture, is raw materials, yen, is somewhat out of our control, and we are somewhat limited in our ability to gain more margin from absorption at this point. We've gotten most of the benefit to date.

And in terms of mix, we've been -- you've seen historically that the mix with link and cordless telecommunications will have some effect on our overall margin, but when we look at all of those variables together, that's why you heard Balu mention earlier, we're comfortable above the 50% range, but it's really difficult for us to predict if and when we would be 54%, 55% because there are a couple variables that are simply out of our control.

Okay. And then the spending drop-off in 2011, is that the right way to think about it or --

Well, it's not like we add operating expenses just to add operating expenses. It's really driven by new products. But the good news is we always have more new product ideas than we have resources to implement. And obviously in 2009, we were constrained in our operating expense because of the recession. And now that we are doing well, and there's significant demand for the new products based on the feedback we've received, we've decided to accelerate our spending. And again, based on our model, we believe that it will still have significant leverage in 2010, and whether that will continue to increase in 2011 will depend on, again, how many new products we want to introduce and so on and so forth.

Thanks a lot.

And we'll go next to Christopher Longiaru with Sidoti & Company.

Hi, congratulations on the guidance. So my big question is, could you give us a little more color on the -- you have eight new launches come in, in a high-power arena, when do those start to ship, and how does this play out from a revenue standpoint, how does it ramp, where are they specifically? Can you give us a little more color on that?

Just to clarify, not all eight of them are related to high power.

Okay.

The majority of them are related to high power. So roughly speaking, it takes about nine months to a year after we introduce a product to a customer before we see any revenue, production revenue. And we mentioned that about five of those products, we sampled some key customers in late 2009, which means that the earliest we'll get some revenue from that will be in the fourth quarter of 2010. It's -- we'll have some revenue in 2010, but we'll have material revenue from those products, those five products, in 2011. The remaining three products will be introduced sometime during 2010 and we shouldn't expect any revenue from them until 2011.

Can you give us some -- any idea what these products are, where they -- what the target market is?

Well, as I said, the majority of them are related to high power, particularly for very high efficiency power supplies, and in terms of the applications, the applications we're going after are TV main power supplies, PC main power supplies, video game power supplies, high-power printers, like laser printers and copiers, and notebook adapters. So those are the big ones that we're going after.

Got it. All right, thank you.

You're welcome.

And we'll go next to Sumit Dhanda with Banc of America.

Good morning, a couple of questions. Bill, could you give us a sense, as you have ramped up production here over the last couple quarters, how much has the increase in production contributed from an absorption perspective in terms of gross margin benefit? Is it a point? A couple of points?

Well, certainly in the last quarter, as I mentioned in my opening remarks, much of that 200 basis-point increase was absorption with some being cost reduction in Link II. We also had another benefit in Q3. So cumulatively we may be three, three points or so of benefit from these higher levels of utilization.

Okay.

There's -- is it less than that amount available to us going forward given where we are in the -- in our production curve and how much we're able to leverage there. And that's what I was referring to in terms of not just drawing a line and assuming you can just gain more and more absorption with producing more and more, but rather margin expansion would have to come more from our cost reduction efforts in 2010, which is what we're focused on.

Okay. A second question, Balu, this relates to a comment you made about the fact that it's not clear sometimes where the component shortages will be going forward, and hence the need to build a lot of inventory. I guess one of the things that struck me as I looked through your press release was that on a percentage basis, definitely, but even so on a dollar basis, most of the growth seems to be coming, incremental growth seems to be coming from LinkSwitch. So I guess my question is why is it so hard to ascertain what the right mix of inventory build should be given that so much growth has been driven by LinkSwitch? Or I am I missing something in the analysis?

No, you are not but even within LinkSwitch you have many products. Even though we have something like 150, 200 products, most of the volume comes from probably about 50 products. Among them, the volume can change quite dramatically, depending on somebody getting higher share or somebody ramping up new design and so on. And so normally we would have enough inventory to manage that. In the last two or three quarters, we have had very little inventory, so when we get the surprise order on a product that has not been forecast, we could have a long lead time to get that out. That's where the problem is. Now, once we build sufficient inventory and bring our turns to, closer to four, that problem to a large extent will go away.

Okay. Two more questions. One, Bill, it seems like entering the quarter your dollar backlog was similar, but as a percentage of the turns coverage, it was a little lower this time, 30% versus 20% last quarter, and you obviously had a strong month of January. Do you think there's any risk that you're extrapolating the strength in January here to continue through February, given that it could be a slow month given where load [in a new year] falls? Or do you think you've adequately accounted for that?

In our guidance, we are -- we typically see the Chinese New Year result in a holiday on bookings for us, and so we've taken that into account. And we're also taking into account some level of expectation that there's usually more -- higher levels of just the inventories in Q1 seasonally than there are in Q4. And so we've done the math on that and reflected that in our guidance to you.

Okay. Last question, a little longer term in nature. Balu, my recollection is that as LEDs started to emerge, there was a regulation passed in California about commercial lighting and use of LEDs. Any more regulations down the pipe or things that we're not necessarily aware of which you think could be catalysts in the near term to drive adoption of LED lighting?

Well, certainly California has a efficiency regulation which would require people to use either LED or compact fluorescent lamps in all new residential construction and any remodeling of residential buildings. So that's already in place. I don't know of any other activity in terms of efficiency of lighting.

However, people are doing it on their own. Like for example, many cities in the US and in other countries have decided to transition over to LED lighting simply because the return on the investment is relatively short period of time, and it comes in multiple areas. One is it immediately reduces energy consumption because you can dim the lighting so that it has constant brightness, so you don't have to run it always at full brightness. Number two, which is the biggest advantage, is that you don't have to replace the light as often, which is very expensive to do for street lighting.

So I would say more driven by the user, the end user than by regulatory agencies at this time.

Okay. Thank you so much.

You're welcome.

And we'll go next to Brian Piccioni with BMO Capital Markets.

Thanks for taking my question, and of course congratulations.

Thank you.

As you can imagine, most of the questions that I would have asked have been answered already. However, if we look at the pattern of revenues on a per-product basis, we've just been through -- well, hopefully through anyways, a pretty brutal recession, you've had tremendous growth. It's kind of hard to figure out on a, let's say, an end-market basis what a normal seasonality would be, given all of these factors. Is there any way you could maybe give us a sense for modeling purposes, what you expect again assuming some sort of a steady state, what peak would be, and trough would be for each of the end markets?

Oh, that's a tough question. Again, if you look back many years (technical difficulty) [our seasonality] is that you get some increase in Q2 and a more significant increase in Q3. But this year could be quite different because we don't know whether all of what we are going to ship in Q1 is end demand or some of it is going into replenishment of inventory. So depending on how you -- what the end demand is, you may or may not see the normal seasonality. So that's what is very difficult.

Now, the last two or three quarters, we have been thinking that there's some replenishment of inventory and possibly some over ordering, but so far we haven't seen any of that. But this quarter it could be different. It's possible that because they've been so low on inventory, they might be building some inventory. So that's why it makes it difficult to project what Q2 and Q3's going to be this year.

I really wasn't trying to draw a forecast for Q2 and Q3, although it would have been nice if we would have gotten one, I was more thinking along the lines of, for example, consumer. There's -- there would have been, one could imagine, a significant push in the consumer business leading up to Christmas and Thanksgiving and all of that, and maybe we'd see an ebb followed by a recovery going into the summer.

Industrial is a little more opaque. Does that generally show some level of seasonality? Computers -- well, we can work that out ourselves, I guess. Communications again is something that's a little harder to figure out.

Yes, there is some seasonality. Consumer is usually strong in Q3 in anticipation of the holiday season and we had a very strong Q3 on consumers. And Q4 is also reasonably strong for us, although this time it was flat. But if you look into the consumer market, we actually grew very well in certain areas, so it was not flat on a broad basis, there were some areas that were weak, but the same areas were much stronger in Q3. So it may be just a quarter-to-quarter variation.

You're right, industrial has less variation, although it does have some seasonality, but that's changing as we speak because of our penetration of the LED market and the smart metering market. Those two are two of the largest, fastest growing markets in industrial, and that is actually distorting the normal seasonality we have seen in the past because of the rapid growth of those two areas.

So, I don't have a very clear cut answer on the seasonality of those two areas, and again, computers are relatively strong in Q3 and Q4 for the, again, related to the holiday season and the Chinese New Year.

Okay, great, thank you very much

You're welcome.

Operator, we'll take one final question, if we have one.

We'll take a follow-up from Tore Svanberg with Thomas Weisel Partners.

Yes, thank you. Just looking at your guidance for the March quarter, you have been operating at the high teens on the operating margin line the last couple quarters, it looks like now you're going to be in the mid-20s, is that the way I should look at it?

That's right, Tore, on a non-GAAP basis we were 22, and at the midpoint, based on guidance we've given, that would put us in the mid 20s, just like you said.

Very good. Finally, Balu, the R&D efficiency has always being pretty high, with some products generating a lot of revenue, or some product families generating a lot of revenue. Now you have eight new coming this year. Should I think of those eight families as having a similar revenue opportunity as, let's say, the TOPSwitch family or the LinkSwitch family?

That's a good question. I haven't thought through all of them. Yes, I believe all of those products are extremely promising long term. Obviously, it takes several years for the volume to ramp up, but just to give you a perspective, the high-power market, we're estimating to add about $400 million to $500 million in addressable market. And with the products we plan to introduce, we should be able to cover that entire market, and plus the products we've already introduced. So that gives you kind of a relative perspective of how significant the high-power products are. But that's -- in addition to the high-power products we'll be introducing a number of low power products in a number of different applications which are also new product families.

Great. Thank you very much.

You're welcome.

And with no further questions in the queue, I'd like to turn the conference back over to Mr. Joe Shiffler for any additional or closing remarks.

Thank you, that concludes the call for this morning, we'll have an archive of the webcast of this call available shortly on the Investor info section of our website, which is investors.powerint.com. Thanks for listening and have a great day.

That does conclude today's presentation, we thank you for your participation.