Power Integrations Inc (POWI) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Power Integrations first quarter 2010 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Joe Shiffler, Director of Investor Relations.

Thank you. Good afternoon, and thank you for joining us to discuss Power Integration's quarterly financial results. With me on the call today 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 investor website at investors. 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 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 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 and under the caption, "Item 1A Risk Factors" in Part 1 of our most recent Form 10-K filed with the SEC on February 26, 2010. 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 achieved record revenues for the third consecutive quarter, growing our top line 77% year-over-year, and 8% sequentially, coming in at $71.5 million.

We surpassed $70 million in revenue, just two quarters after our first $60 million quarter, and came in 33% above our pre-recession peak, well ahead of the broader semiconductor industry and our analog peer group. Our non-GAAP operating margin expanded for the fifth straight quarter, to 23.6%, resulting in record non-GAAP net income.

Non-GAAP earnings were $14.3 million, or $0.49 per share, up 18% from the prior quarter. On a GAAP basis, we exceeded 20% operating margin and earned $0.42 per share. We also generated $16.8 million of cash flow from operations during the quarter, and returned more than $7 million to stockholders through repurchases and dividends.

2010 is off to a good start and we believe we are well positioned for the second quarter and beyond. Bookings were strong throughout the quarter, increasing more than 30% sequentially, and our starting backlog for the second quarter was more than 25% higher than Q1. Orders have remained strong in April, already surpassing the record monthly bookings we received in March.

As other companies have pointed out, this backlog expansion is partly a reaction to extended lead time, both our own and those of competing and complementary parts. In this environment, it's difficult to know with certainty how well orders will ultimately align with end demand. However, with the possible exception of some business that we may be picking up because of supply issues at competitors, we believe that our revenue growth is being driven mainly by end market demand and market share gains, particularly the record number of designs we won in 2009.

As we discussed on previous calls, we believe that our market penetration has accelerated as a result of manufacturers efforts to improve energy efficiency of their products, either of their own volition or in response to mandatory standards like EU Ecodesign directives or voluntary incentive programs like Energy Star and 80 PLUS.

The growing focus on efficiency makes this an ideal time for us to enter high power end of the AC-DC market, which we believe represents at least a $400 million expansion of our addressable market. During the first quarter, we achieved our first high volume design wins for the high-power market, winning multiple designs for our high-efficiency PC power supplies for a top tier OEM.

These designs use two brand new, yet to be announced members of our Hiper family of high-power PLCs including a highly integrated power factor correction product with a built-in MOSFET and a power conversion shift that combines the main and stand-by converters, including three built-in MOSFETs. These two innovative products bring an unprecedented level of integration to the high-power market, eliminating as many as 100 components from a typical discrete design, including several MOSFETs, a drive transformer and up to three controllers, enabling very compact designs.

They also enable extremely high efficiencies in a very cost effective fashion, allowing PC OEMs to comply with 80 PLUS, bronze, and silver efficiency specifications. We are very pleased by the initial reception of these products, which we expect to begin shipping this quarter to our first customer before introducing them to the broader market later this year.

We are also delighted with the customer reaction to our brand new CAPZero product family, which is unlike any product we have ever brought to market. CAPZero is an extraordinarily simple, easy to use chip that eliminates the power losses created by the resistors used to safely discharge the so-called X-capacitors, which are used in power supplies to reduce electromagnetic interference.

In high-power applications, these capacitors can store considerable high voltage energy for several seconds before the device, after the device is unplugged, creating a hazard should the user touch the prongs of the plug. To eliminate this hazard, bleed resistors are used to discharge X-capacitors when the device is unplugged.

However, these resistors consume power as long as the device is plugged in, significantly decreasing the stand-by efficiency of the power supply. CAPZero is a smart switch that detects the presence of AC when the device is plugged into the wall outlet and blocks current flow through the bleed resistors eliminating this power loss.

When the device is unplugged, CAPZero allows the bleed resistors to do their job, safely discharging the X-capacitors. CAPZero is a simple two-terminal device that is extremely easy to use, requiring very little effort and know-how on the part of the designer and can easily be retrofitted into existing power supply designs. We think CAPZero is an extremely elegant, cost effective solution for manufacturers looking to minimize power consumption in high-power applications, and we are very pleased with the reception it's getting so far in the market.

We have already received our first orders and expect to begin volume shipments this quarter. In March, we also introduced TOPSwitch-JX , our sixth generation TOPSwitch which brings an even higher level of integration and efficiency to a wide range of applications. TOPSwitch-JX enables no-load consumption as low as 85 mW and provides high (inaudible) efficiency across the entire load range as required by many of the new efficiency specifications currently in place around the world.

We are well on our way to introducing the eight new product families that we committed to on the last quarter's call, a record number for power divisions. As we discussed last quarter, we accelerated the rollouts of several of these products in order to satisfy customer demand for the high levels of efficiency they enable.

Clearly, many OEMs have seized on the energy efficiency as a way not only to differentiate their products in the marketplace, but also to demonstrate their corporate social responsibility. Earlier this month, Sony announced its Road to Zero plan, which includes a goal of achieving zero environmental footprint by the year 2050.

Among the targets included in the program is a 30% reduction in the energy consumption of Sony products within the next six years. Also this month, LG Group of Korea announced a major corporate initiative to reduce greenhouse gas emissions, which includes the development of more energy efficient appliances and consumer electronics. And Verizon Communications announced a range of environmental initiatives, including a partnership with Motorola to deploy energy efficient set top boxes for their TV customers.

These examples, which are referenced in the latest edition of the Mr. Green blog on our website helped demonstrate the sea change that has occurred in the electronics industry, which is now embracing energy efficiency and in many cases going well beyond the requirements. Manufacturers have learned that the cost effective solutions like EcoSmart technology significant energy savings can be had at essentially no cost and that the change in mindset is creating opportunities for us in the power supply market.

Another encouraging development is the announcement last month by EPA that they are aggressively strengthening the testing and verification of products in order to ensure that the Energy Star label remains a dependable way for consumers to identify energy saving products. The changes include ending the practice of self-certification by manufacturers, instead requiring qualification by an approved, independent test lab followed by ongoing third party verification.

Details on the new requirements can also be found in our Mr. Green blog, which resides in the Green Room area of our website. While our traditional AC-DC power supply business has clearly accelerated because of energy efficiency, our design pipeline is being further augmented by emerging green technologies, such as LED lighting and smart metering.

Because these technologies are intended to save energy in the first place, it obviously makes sense for them incorporate efficient AC-DC power converters. And because they are designed to be in service for a long time, they also require highly reliable power supplies, which is another key benefit of our highly integrated approach.

We have devoted considerable resources to these two emerging markets over the past several years and those investments are now paying off in significant revenue growth. We are winning more designs in LED lighting than any other application and our products are now in use to some extent by most of the major meter manufacturers around the world.

We expect to generate well over $20 million in combined revenues from LED and metering in 2010, and with both applications still relatively nascent we think there's a lot of potential for growth in the years ahead. In closing, 2010 is off to a promising start.

Our financial model and our balance sheet are in very good shape, and our key areas of strategic focus, energy efficiency, high-power, and emerging markets like LED lighting and metering are solidly on track. And with that, I'll turn it over to Bill for more details on financials and the outlook.

Thanks, Balu, and good afternoon. I'll do a quick rundown of the Q1 financials and then touch on the outlook before we move to Q&A. Revenues for the first quarter were $71.5 million, in line with our forecast and up 77% year-over-year. Industrial revenues were up more than 100%, with strength across a wide range of applications, including LED lighting, metering, power tools, and industrial controls.

Consumer revenues grew by more than 90%, driven primarily by appliances, air conditioning, set top boxes, and digital cameras, all areas where we have made significant market share gains in addition to the underlying growth in the end markets. Communication revenues were up more than 70% year-over-year, with mobile phone chargers being the primary driver, but also with major contributions from cordless phones and networking equipment.

Computer revenues, which are mainly comprised of desktop standby and LCD monitors were up more than 45% year-over-year. On a sequential basis, revenues grew 8%, well above first quarter seasonality, which has been essentially flat over the past decade.

Industrial and consumer revenues drove the growth, increasing in the mid-20s and high teens respectively. Computer revenues were down slightly, while communications declined in the mid-single-digits. In terms of sales channels, distribution sales grew 16% sequentially and accounted for 66% of total revenues, while direct sales were down 4% sequentially and accounted for 34% of total revenues.

Two distributors, Avnet and ATM, were our only 10% customers during the quarter, comprising 13% and 11% of sales respectively. Inventories in the channel were about six and a half weeks at quarter end, up a little more than a week from the prior quarter, as distributors more closely aligned their inventories with our longer lead times.

Because we recognize distribution revenue on a sell-through basis worldwide, fluctuations in channel inventories are not a significant factor impacting future revenue performance. Turning to gross margin, we came in at 50.2% GAAP and 50.5% non-GAAP, each down 90 basis points sequentially, but within our target range of 50% or higher.

The sequential decline was primarily due to product mix within the cell phone business, driven by a transition at multiple cell phone OEMs from earlier generation LinkSwitch products to our newer LinkSwitch-II product line, which is earlier in its lifecycle and, therefore, carries a lower gross margin. Also contributing to the lower gross margin for the quarter was the absence of any significant absorption benefit, as production volumes were constrained during the quarter due to unexpected downtime at one of our assembly vendors.

Going forward, product mix is likely to be a continued headwind, as demand for LinkSwitch-II continues to ramp. However, we expect the impact to be offset by higher production volumes, as well as cost reductions that should come into play gradually over the next several quarters.

These include the launch of our next generation, higher density process technology, as well as the addition of new 6-inch wafer capacity, which should result in a lower percentage of volumes coming from 5-inch fabs. Net-net, we expect our Q2 gross margin to be between 50% and 51% on a GAAP basis, compared with 50.2% in the first quarter.

Non-GAAP gross margin should continue to be about 30 to 50 basis points higher than the GAAP gross margin. Operating expenses on a GAAP basis were $21 million, coming in at the low end of the expected range, due to lower than expected stock-based compensation expenses, which totaled $1.9 million.

Non-GAAP operating expenses were $19.2 million, down from $19.5 million in the prior quarter, but slightly above the high end of our implied forecast, which was $19 million. Litigation expenses were $1.1 million for the quarter, but would have been substantially less if not for a lawsuit filed against us in March by Fairchild in China.

We believe the suit is without merit and are contesting it vigorously, having already filed invalidation proceedings for the asserted patent with the China Patent Reexamination Board. Start-up costs for the lawsuit impacted our earnings by about $0.01 a share in the first quarter. Otherwise, expenses were in line with our forecast, with slight increases in R&D, sales and marketing, and G&A, generally reflecting slight head count growth and the resumption of payroll taxes as of the first of the year.

The impact of higher sequential revenues and lower expenses more than offset the decline in gross margin, resulting in higher operating margins. Our non-GAAP operating margin expanded for the fifth straight quarter to 23.6%, an increase of 160 basis points sequentially.

GAAP operating margin exceeded 20% for the first time since the inception of FAS 123R, coming in at just under 21%. Our GAAP and non-GAAP tax rates for the quarter were 19.9% and 17.6% respectively, and reflected no benefit for the R&D tax credit, which has yet to be renewed.

Non-GAAP net income was a record $14.3 million, or Non-GAAP net income was a record $14.3 million, or $0.49 per diluted share, up $0.07 per share on a sequential basis. Again, that included the unforeseen impact of the new Fairchild litigation, which is about $0.01per share. GAAP net income was also a record, coming in at $12.3 million, or $0.42 per share, up from $0.32 in the prior quarter.

Cash flow from operations was $16.8 million for the quarter, subtracting CapEx of $3.4 million resulted in free cash flow of $13.4 million. We utilized $6 million for share repurchases during the quarter, buying back 171,000 shares at an average price of $35 and change.

We also paid out $1.4 million in dividends, after doubling our quarterly dividend to $0.05 per share in the first quarter. Cash and investments on the balance sheet increased by $14 million to $210 million, or a little over $7 per diluted share.

Looking at other items on the balance sheet, accounts receivable increased by $5.8 million sequentially, with days sales outstanding at 35 days. Inventories increased by $5.2 million sequentially to $31.4 million, or about 79 days of inventory. That's an increase of five days from the prior quarter, but still below our comfort level given the continued growth in orders and unpredictability of product mix.

Accounts payable increased by $9.2 million, primarily reflecting the timing of payments on capital equipment purchased during the quarter. Turning to the outlook, we expect second quarter revenues of $74 million to $78 million, which would be up 54% year-over-year.

On a sequential basis, that would be up more than 6% at the midpoint, which is consistent with our historical average seasonality. As I mentioned earlier, we expect gross margins to be between 50% and 51% on a GAAP basis, including an impact of about half a point from stock-based compensation.

We expect second quarter GAAP operating expenses to be approximately $23 million, plus or minus $0.5 million. This forecast includes litigation expenses of approximately $1.3 million, and non-cash stock-based compensation expenses of about $3 million.

We expect our tax rate to remain consistent with first quarter levels, assuming no changes to the current tax law. However, should Congress renew the now-expired R&D tax credit, which appears likely, we would expect our tax rates to decrease to about 18% GAAP and 16.5% non-GAAP on an annual basis.

Lastly, for modeling purposes beyond the second quarter, I would like to point out that on or around July 1, we expect to close on the acquisition of an early stage R&D company for a total purchase price of about $12 million, about $3 million of which has already been paid as an advance. We expect our results in the third quarter to include $300,000 to $400,000 in one-time transaction costs related to the acquisition.

On an annualized basis, we expect the acquisition to add approximately $3 million to $3.5 million to our operating expense run rate, a portion of which will be non-cash amortization of intangibles. With that, we're ready for your Q&A.

Thank you. (Operator Instructions) Our first question comes from Tore Svanberg of Thomas Weisel Partners.

Yes, thank you. A few questions. First of all, can you talk a little bit about the turns in the quarter and how much turns you're expecting for 6% growth next quarter?

Yes, hi, Tore, it's Joe. The turns for the quarter was -- I think we had told you at the beginning of the quarter we needed somewhere around 30% and that's roughly where we came in.

The turns requirement for the upcoming quarter, as of the beginning of the quarter we needed something in the 15% to 20% range. We give it as a range, not knowing exactly what the change in distribution inventory will be.

Great, and how have turns bookings been so far this quarter?

Well, so far it's been less than in the past primarily because of the longer lead times. We are seeing more bookings ahead of time. But the actual number is not as indicated because of the -- we don't know exactly how much will be sold through.

Okay, fair enough. And did have you any delinquencies in the quarter?

Nothing to speak of, no.

Okay, and where are your lead times now and how do you expect those to track in Q2?

We have actually asked our customers to give us a 12-week forecast, primarily because we want to make sure that we have the mix correct. And this way we'll know what parts are required and we can make sure that we can build the right mix of products.

Okay, and as far as growth drivers in Q2, is it going to be broad based or any, any given market you expect to see some more growth from?

So before I go to that, Tore, I misspoke, you asked for delinquencies, I was thinking of something else. [Delinquencies-wise], we could have shipped some more in Q1, a little bit more, maybe $3 million to $4 million more. But we don't know how much of that would have shipped through. So I want to correct my answer.

Okay, I appreciate that. So follow-up to that question then, will that then ship in Q2?

Yes.

Okay, and then my previous question was about growth in Q2 by end market. Where do you expect it to come from?

Well, it's hard to tell. I mean, until the quarter's over, we don't know exactly where the parts go. I don't see any specific area that I could say will do better than others, other than the normal seasonality.

As you know, in Q1, we normally do very well in industrial. And in Q3 and Q4, we normally do better than communications and consumer. But I don't have any other insight.

Okay. Last question is, where are we in the transition from LinkSwitch to LinkSwitch-II in the cell phone market? And by when would you expect that transition to start to be accretive again to your margins?

You mean from LinkSwitch-I to LinkSwitch-II?

Correct.

I would say right now it's about, what, half of the cell phone market uses LinkSwitch-II. And before the first quarter, it was more like one third.

Okay, and when do you expect the gross margin to be more normal in LinkSwitch-II?

It will take us a few more quarters. We are a little bit behind, primarily because we, we -- our demand was so high, we weren't able to get the new process technology ramped in Q1. However, we just started ramping it this quarter. You'll see a very slight benefit in Q3, but you'll see a much more significant benefit in Q4.

And on top of that, we are also continuing to expand our 6-inch capacity. We were hoping that we would get away from the 5-inch capacity, but because of the demand, we have to build every wafer we can get.

So we will continue to use the 5-inch capacity to the full extent for the foreseeable future, but, however, we will improve the 6-inch capacity, we'll increase the 6-inch capacity over the next three quarters. That will help our overall gross margin. But the actual cost reduction will, will take, for the LinkSwitch-II, maybe about three to four quarters.

Sounds good. Thank you very much.

You're welcome.

Our next question comes from Ross Seymore of Deutsche Bank.

Hi, guys. Kind of continuing on the LinkSwitch question a little bit, but as far as the mix implication on gross margins, not so much by the products, per se, but by the end markets, how should we think about what happens in the back half of the year when we kind of get away from industrial and we get to more consumer sides of things? Do we have LinkSwitch-II margins going up finally by then so that will offset some of it, or is it more consumer and less industrial a headwind?

Well, at the moment, primarily the LinkSwitch-II is going into cell phone market. Some of it will also go into consumer market and so on. But in general, our lowest margin is in the cell phone market. The consumer is actually pretty good margin, although industrial is the highest margin for us.

So going -- looking into Q3 and Q4, my expectation is that the gross margin will gradually improve if everything else remains the same, meaning the yen, exchange rate, so on and so forth, and pricing remains relatively stable.

So some of the cost reductions should help by then. Otherwise I would think the fact that cell phones are a little bit more of a back half phenomenon, that that increasing as a percentage of your mix would be a headwind, you can offset with cost reductions by then, I guess, is what you're saying?

Absolutely. We think we can offset it and improve margins slightly through cost reductions.

Great, and then on the inventory side of things, you guys are still lean relative to any sort of normal historical level. What do you think is your expectation for what your own inventories do in the second quarter, as well as what you expect the channel to do?

Well, it's always hard to forecast what the channel's going to do, but as far as our inventory, we expect inventory to improve -- increase slightly, because we are building at a higher rate than our shipments. And as far as the (inaudible) inventory I would expect to go up a little bit more because of the lead times. Because compared to the lead times, the (inaudible) inventory is still pretty low.

Great, and then the last question, I guess, is there any other color you can give us as to what the acquisition was, what it's targeted at, et cetera, that you guys are going to conclude in the middle of this year?

I can give you a little bit more information. It's a small East Coast company. It's an early stage R&D company. It has about 11 or 12 employees and it comes with some IP, intellectual property, and it has a small fab. Beyond that, we prefer not to discuss our long-term R&D efforts.

Okay, great. Thank you.

One more thing I would add, it is related, directly related to our high voltage technology.

Perfect, thanks.

Thanks, Ross.

Our next question comes from Vernon Essi of Needham & Company.

Thank you very much. I wanted to go back to some of the prepared comments you made on these new product developments. It sounds like you've got a couple of unnamed products that are already -- I wanted to make sure the timing is straight here.

Are they sampling with customers, or are you already in a production ramp with customers on these new products?

We actually sampled the customers with those two products last year, and we have won the design, the production has just started and we will be shipping production, pre-production volumes in Q2 and they will be in full production in Q3.

Okay, and any sizing as to what kind of revenue stream this could look like incrementally to the model?

It will be definitely higher than $1 million, well over $1 million. It could be as high as $2 million this year, based on the designs we have won.

Okay, and obvious question here, but is this going to be run through a lot of the same fabrication supply chain that you already have, or is this going to be using a separate source? In other words, is there a capacity constraint that might be on top of this one as well?

To a large extent, it is the same capacity.

Okay.

Yes, it's the same capacity. Just to be clear, we are not capacity limited at this point. We were a little bit mix limited, because, of course, as I said, we could have shipped a little bit more if we had the right mix but we are not capacity limited.

Okay, and then you had made some comments about the EPA, I guess, going in and becoming the green police are these Energy Star stickers. I mean, what is your impression of how many products are out there that are noncompliant in terms of meeting those standards?

Actually, I don't have that information. All I know is there were a couple of incidences where the products did not meet the Energy Star, even though it said Energy Star. And I assume the Energy Star thinks it's a big enough problem that they will change the rules.

Okay. So obviously it sounds like -- I'm just trying to gauge if this could be a very interesting demand-driven situation for you or do you think this is just more of a compliance situation that might boost demand near term? I'm just trying to figure out if you think there's a lot of product out there that might need to be redesigned?

Well, I would say this is just a continuum of developments that point towards high efficiency for future products. I don't expect this particular change to have any direct impact on our revenue.

Okay, and then finally, and this is a pretty obvious question here, but you've got a little bit of revenue that looks like it's going to be pushed into the June quarter from the March quarter. And then also discussing the guidance being sort of seasonally normal, but it isn't if you include that revenue.

I'm trying to gauge, is that just sort of a conservatism on your part or do you feel that there's reasons to believe that things could be a little bit less than seasonally strong in the June quarter?

Well, you have to remember that even if you had shipped those, let's say $3 million or so, it's not clear that all of it would have gone, passed through to the end customer. So we don't know that for a fact.

So as far as forecasting this quarter, we are doing the best we can in terms of estimating how much increase in (inaudible) revenue we think is going to happen, and also how much turns business we think we are going to get for the rest of the quarter, which is really hard to predict because we are in the situation we have not been in in the previous history of the Company.

Even last quarter, as you saw, we were very close to the low end of the guidance, but we ended up just below the middle of the guidance and interestingly enough, we actually shipped $78 million worth of parts. But because the (inaudible) inventory went up, we recognized $71.5 million at sell-through. So you can see the challenge in being able to predict what revenue is.

So last quarter we expected more turns business than we got. We also increased the (inaudible) revenue more than I expected. So this quarter we are being a little bit more conservative in that regard. Having said that, our lead times have gone out further and, therefore, it is natural to assume that you'll get less turns business this quarter.

Okay. Well, it's a high class problem, nonetheless.

Yes, I think, yes, it's a great problem to have.

Right, right. Okay. That's all. Thank you very much.

Thanks.

Our next question comes from Brian Piccioni of BMO Capital Markets.

Hello. Thank you for taking my questions. You remarked in your earlier comments that you were going to expand new products, higher power products, were going to expand your total available market by about $400 million, I believe, the figure was. How would you quantify your TAM currently, and based on your announced product development strategy, how would you characterize -- what would you characterize the TAM to be a few years from now?

Our TAM, the addressable market, for low-power products, less than 50-watts, we estimate to be $1.6 billion. And with the addition of the high-power products, which is -- which covers from 50 to 500-watts, we expect to add at least $400 million to our SAM, service addressable market.

That puts the SAM at $2 billion. The TAM is, of course, higher than that. I don't have the TAM number. But we normally only focus on the SAM.

Okay. So now, the -- you had remarked earlier on a very significant number of design wins in the LED application space. Now, it would seem that those wins would translate into voluming. Prices are still quite high on those, the end products, as the customer sees them. When would you expect to see a material impact on revenues associated with the LED design wins that you currently have?

Well, I -- this year, our expectation would be that LED revenue would double from last year and that will be in the range of $12 million to $15 million. That's our forecast for this year for LED revenue. And you can see that that is getting to the point where it is becoming material.

And I wouldn't be surprised if it continues to grow strongly through next year and the following year because it's still in very early stages.

Right, and following on on that, if we were to look at, say, as a model, the penetration of compact fluorescents, which really exploded when prices got to a more reasonable level, would there be a significant impact in particular being concerned about a negative impact on gross profit margins on those products?

Actually, the profit margin on the LED product is higher simply because of the very fragmented market. There are many, many -- I think we have more than 1,000 customers we are working with on LED lighting. It tends to be fixture manufacturers rather than light bulb manufacturers, if you will, because unlike light bulbs, we don't have to replace LEDs.

LEDs last a very, very long time. So it is -- I think, if at all, it will have a positive impact on the gross margin.

So the thinking being that whereas light bulbs are intended to be low cost consumables, fixtures are expected to have a long life, likely to be more expensive and, therefore, the significance of your contribution not resulting in a lot of pricing pressure because there's a lot of other things, like mechanical things and this sort of thing going into a fixture, is that correct?

That is absolutely correct. The LED is so expensive and then you have the mechanical, the heat sinks and so on to keep the LED cool. Power supplies are a relatively small portion of the fixture costs, but because the power supplies don't last as long as LED, they want to have the highest reliability power supply they can build, so they are actually willing to pay more money to build a power supply that lasts whatever, 30, 40, 50 years. Typically power supplies don't last beyond 10 years in continuous use.

So there is a significant emphasis on the reliability of the power supply and that's, that's a huge advantage for us because integration brings higher reliability.

Thank you very much for your answers.

Thank you.

Our next question comes from Gus Richard of Piper Jaffray.

Hey, guys, thanks for taking my questions. Nice quarter, guys. Could you just talk a little bit about the opportunity of the CAPZero family, sort of what's the ASP and sort of what do you think the overall market is for that?

Sure. Anything I would say roughly about 50-watts of consumption, of any appliance would require a large enough input filter capacitor that you would have to have these resistors, these bleed resistors. So they are candidates for our CAPZero chip.

At the moment, people who are interested in the CAPZero are the ones who want to meet the EUP Ecodesign standard which has a half a watt standby, which is very difficult to meet in many applications where you have to have some parts of the system alive. Like for example in a TV you need to have the remote control alive. So we think the primary targets for that are PC power supplies, TV and large appliances, like dishwashers, washing machines and so on.

So in terms of the selling price, we have 16 different products, depending on the size of the capacitor, and also depending on the transient voltage you have to meet and if I take the median price, the list price will be somewhere in the $0.40 range.

Got it.

Okay. So I would say the overall TAM of that market is probably in the $80 million to $100 million.

Got it. Thank you, and then just to be clear, you got a couple of designs in your new product that's unannounced in a PC, PC main power supply, correct?

Correct.

Okay, got that. And then on the Link-II, I mean, I've seen the movie before. You guys usually roll out with low gross margins and over time they go from, wherever you start up to the high end of the range as you get maturity and test times come down.

Same deal with LinkSwitch, and just your, last year you had some increased competition from some ankle biters and basically rolled that out to drive the share and that started to catch in Q4 and ramped in Q2 and that's -- I'm sorry, Q1, and that's the margin issue here?

Yes, and some of our cost reduction efforts have been a little bit slower than we would like, primarily because of the demand. The demand is so high that we are focused on maximizing capacity rather than transferring products into this new technology.

Got it.

If you have a higher density technology that's ready now, but we just have to ramp it up.

Got it. And then just on the acquisition, Bill, could you just give a little bit better color on how much -- how much is SG&A and how much is OpEx so we can get a little bit better idea how to model?

It's mostly R&D, within the R&D, $3 million to $3.5 million annualized. And out of that, maybe $600K would be amortization of intangibles with the rest being pure R&D expense.

Okay. No SG&A here?

No SG&A.

Perfect. And will that slow your hiring for the rest of the year? I've seen you do that in the past.

It's actually part of our hiring, meaning that we had certain number of people who are going to add to R&D. Instead we are actually just acquiring a group that comes ready-made.

Got it, okay. That makes complete sense. And then on the JX, that's just better efficiency across the load line. Same power range as like the GX or FX? Is that the right way of thinking about that?

Yes, it's the same power range as GX and HX. But you got it. The main advantage is the no-load consumption is much lower, but on top of that, you have extremely flat efficiency from full load to very, very light load.

Got it. And any particular market that that's targeted towards, appliances, industrial, lighting?

Several different markets. For example, in very high efficiency PC standby, JX can provide 90% efficiency for gold PC applications. It will go into set top boxes, monitors, some TVs. So there's -- and printers and so on.

Okay, got it. And then my last question sort of, can you characterize the LED business, just are you seeing an acceleration here given some of the push in China for general lighting or -- just sort of if you could characterize that business in terms of region and power levels, what sort of light bulbs [you're lighting]?

I would say that in the last three years, the businesses have been doubling for us and I think the, the TAM is also probably doubling, roughly. So I don't think I have seen a change in the acceleration. It's been, it's been going pretty rapidly over the last few years. In terms of the power range, the sweet spot is around about 12-watts, which replaces the 60-watt incandescent lamp, but we have design wins that range from, like 3-watts all the way up to about 150, 200-watts. The 150 to 200-watts being the street lights.

Got it, got it. Okay. And you're starting to appear in Edison bulbs?

Sorry?

You're starting to appear with the bulbs with Edison sockets, the regular light bulbs?

Yes. Yes. If you go to, for example, Wal-Mart or Home Depot, purchase LED replacement, screw-in replacements, you'll find that a lot of them use our chip.

Great. All right. That's it for me. Thanks so much.

You're welcome.

Our next question comes from Steve Smigie of Raymond James.

Great, thanks. Congratulations on the nice numbers and orders there.

Thank you.

On the -- just to clarify, on the extra R&D from the acquisition, so you're saying we shouldn't sort of take the annually adjusted number there and just paste it on what our original assumptions were.

It's sort of like if you were going to spend those dollars, it would be there, instead of, as the previous questioner said, about the hiring. So it's not just an addition to, let's say, this year or next year's R&D?

That's correct. For example, if you remember, in the last conference call, we said that our operating expenses should be -- should increase no more than half the, half that of revenue increase. And we are still well within that this year.

And we were in conversation at that time, so we knew that we were going to add a few people from that company if everything went through. And after our conference call, the deal was signed. And the -- so we're going to purchase them as of July 1.

In some ways, the people we are adding were already part of our expenses that we originally planned. But, of course, you also have one-time expense, or transaction expense of about $300,000 to $400,000 in Q3. And there's also some level of amortization of intangibles that's in the range of about, what, about $150,000 a quarter?

Yes.

Roughly.

Right.

And any option expense?

There will be some, but it's only about 11 employees. We have 400 employees, so it will be relatively immaterial, if you will.

Okay, great. And then on the LED business, so as you mentioned, you have the part on the actual bulb itself, if you go buy it at Wal-Mart, but you're also putting a part on the fixture as well, so you're putting parts in both locations?

Yes, usually our part is right behind the LED. So if you have a screw-in replacement, it will be in the base of the bulb where the threads are, inside the base. But if you have a, like a table lamp or a, let's say a can light in the ceiling, it will be, again, just behind the LED. LED will -- behind the LED will be heat sink and behind that would be our power supply.

Okay. On the CAPZero product, is that -- would you necessarily have to sell that in conjunction with another high voltage part, or could you sell that separately as well?

It will be sold independently. And the reason is, it can be retrofitted into existing designs very quickly, because all you have to do to insert that, it's just a two-terminal device. Just insert it and fit it with the bleed resistors and you immediately get the benefit of normal bleed consumption.

Okay, and last question, is if you could just comment on the new relationship or the upgraded relationship with Avnet that you announced yesterday? Thank you.

Absolutely. We just recently signed an agreement with Avnet to expand their geographical reach for us. The first one we have signed is for U.S. We, we didn't have a very strong distribution coverage in the U.S. and we are very thrilled now to have Avnet. And we think that it's going to make a big difference, especially in the LED and metering areas, which is quite, to some extent, U.S.-centric.

And we also are discussing with them some additional geographies. We already have them in Asia, and several countries in Europe. But we are trying to cover most areas of the world with them. It just gives us much broader reach.

So would we see a little pop in revenue, as you sort of start to load the channel? I guess you don't recognize until you ship out, so wouldn't necessarily impact--

We'll see a pop in bookings, but not revenue because we don't recognize until they sell through.

Right, right, cool. All right, thanks. And congratulations again.

Thanks.

(Operator Instructions) Our next question comes from Arnab Chanda of Roth.

Thank you. Couple of questions. First of all, it seems like this is the first time that you've actually not exceeded your expectations and it sounded like you were talking about some issues on your back end. Could you talk a little bit about that? You said you could have shipped more, does that, what was exactly going on and has that been fixed?

Let me explain the first one, first question. We have done much better than most companies. In fact, I think of our peers, we are, we are ahead of pretty much everybody we follow (inaudible) to the previous peak in third quarter of 2008.

So it's not that we are -- we're not doing well. We are doing very well, we're doing actually better than most companies. But our forecast was slightly higher. I mean it's hard to forecast it any more accurately. We're only within $0.5 million of midpoint.

So I would say if at all, we were a little bit more than forecast because we simply didn't know how much turns business we would book. I mean I expected to book a little bit more turns business than we booked. On top of that, I didn't expect the distribution inventory to go up as much as it did. I was accounting for some of it, but not all of it.

So that was the issue, not how well we are doing. We are doing great, as you can tell. So what was the second part of the question? I lost my track.

Well, you talked about some kind of issues at your back end. Could you discuss what it was and whether that's been corrected or not?

Okay. So that was nothing to do with our ability to ship because, as you know, we built additional inventory so the fact that we could have shipped a little bit more has purely to do with the mix, whether we had the right mix. In terms of parts we produced in Q1, we produced more parts than we shipped. That was not a capacity issue.

However, we expected to build even more parts than we built, and we had a little bit of a hiccup in one of our assembly plants where one of the tools had to go into maintenance. It got damaged and it had to go into maintenance, so we lost like three or four weeks of that tool. It was kind of unexpected.

But all that did was, it put more of our inventory in die form than in finished goods form. But that was not the limiting factor. Our limiting factor was that we didn't have the right mix to ship a little bit more.

Okay, great. Couple more questions, if I could. First of all, could you talk a little bit about -- you were saying that you are starting to ship your high current business. Could you talk a little bit about what sort of end markets or what kind of products that you're seeing early success in, and is that, is that going to accelerate your growth as we go into sort of next year, kind of qualitatively speaking? Thank you.

Yes, we hope so. The first high volume design we have secured is in the PC power supply area. So we have two yet-to-be announced Hiper family products that will implement both the power factor correction stage and the main converter stage, which -- it so happens our chip includes the standby with the main converter.

We have a two-chip solution to the entire primary site of the power supply. And so we are very excited and pleased that we won with one of the top tier power supply manufacturers selling into a top tier PC OEM.

But the same chipset can go into other applications like video games and, of course, the power factor part of the chip, the power factor chip can go into pretty much any power supply that is about 65, 70-watts, because as soon as you go about that power level, you will need a power factor correction stage.

So that could be like TV, it could be in appliances, it could be in laser printers, of course, PCs and video games. So there's a lot of applications for the power factor chip.

Great, and then one question maybe for Bill about the gross margins. I know there's a couple of factors, obviously, with your kind of the great demand for the LinkSwitch-II product, as well as what's happening with the yen/dollar exchange rate.

Can you talk a little bit about sort of what type of timeframe do you expect to get back in your -- I think your previous peaks were somewhere in the low to mid-50s. Is that possible, given the mix you have today, or what's happening with the exchange rate? Thank you.

Well, mix is always a wild card, but as we mentioned in our prepared remarks, we are undergoing cost reduction efforts and that has been taking somewhat longer than expected because of this increased demand for our product.

That being said, as Balu had mentioned, we expect over the next several quarters to make some gradual improvements in our cost reduction efforts and that our movement from 5-inch to 6-inch should have a more material impact on our gross margin as we look at Q4 and 2011. Does that help?

Thanks, Bill. Hello?

(Operator Instructions) We'll pause one moment to see if there are any further questions. I'm not showing any further questions. Would you like to continue with any further remarks?

No, thanks. We'll leave it there. That concludes the call this afternoon.

And we'll have an archive of the webcast for the call available shortly on the investor page of our website, which is investors.powerint.com. Thanks for listening, and have a good day.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.