Monolithic Power System Inc (MPWR) — Q3 2017 Earnings Call Transcript

Thank you very much. Good afternoon and welcome to the third quarter 2017 Monolithic Power Systems conference call. In the course of today's conference call, we will make forward-looking statements and projections that involve risks and uncertainty which could cause results to differ materially from management's current views and expectations. Please refer to the Safe Harbor statement contained in the earnings release published today. Risks, uncertainties and other factors that could cause actual results to differ are identified in the Safe Harbor statements contained in the Q3 earnings release and in our SEC filings, including our Form 10-K filed on March 1, 2017, and Form 10-Q filed on July 31, 2017, both of which are accessible through our website, www.monolithicpower.com. MPS assumes no obligation to update the information provided on today's call. We will be discussing gross margin, operating expense, R&D and SG&A expense, operating income, interest and other income, net income and earnings on both a GAAP and on a non-GAAP basis. These non-GAAP financial measures are not prepared in accordance with GAAP and should not be considered as a substitute for or superior to measures of financial performance prepared in accordance with GAAP. A table that outlines the reconciliation between the non-GAAP financial measures to GAAP financial measures is included in our earnings release which we have filed with the SEC. I would refer investors to the Q3 2016, Q2 2017 and Q3 2017 earnings releases as well as to the reconciling tables that are posted on our website. I would also like to remind you that today's conference call is being webcast live over the Internet and will be available for replay on our website for one year, along with the earnings release filed with the SEC earlier today. This was a record quarter for MPS with revenue of $128.9 million, up 14.9% from the previous record set in Q2 of this year and up 21.1% from the comparable quarter in 2016. In addition to the continued strong sales momentum in cloud computing and automotive, this quarter's results included the first full quarter of revenue from our power management solutions for gaming consoles. Looking at revenue by end market. Revenue from consumer markets increased 26.8% over the third quarter of 2016 to $55.3 million. The year-over-year revenue increase reflected sales gains in high-end consumer applications. Consumer revenue accounted for 42.9% of our total Q3 revenue compared with 41.0% in the prior year. Third quarter automotive revenue of $12.9 million grew 48.8% over the same period of 2016 as a result of increased sales of infotainment, safety and connectivity application products. Automotive is MPS' largest SAM opportunity at $6 billion and we are in the early stages of penetrating this market. In the years ahead, we plan to offer a number of new products for applications in body controls, lighting, infotainment and ADAS. Automotive revenue was 10.0% of MPS' total Q3 2017 revenue compared with 8.1% for Q3 2016. In our computing and storage market, revenue of $29.0 million increased $5.6 million or 23.7% year-over-year, reflecting strong sales growth for cloud computing. MPS has experienced a significant increase in product sales reflecting both new design wins and increased dollar content. Computing and storage revenue represented 22.5% of MPS' third quarter 2017 revenue compared with 22.0% in Q3 2016. Third quarter 2017 industrial revenue of $16.3 million increased 12.6% from the third quarter of 2016, primarily due to increased sales for AC/DC power applications. This market represented 12.7% of our total third quarter revenue versus 13.6% for the prior year. GAAP gross margin was 55.0%, 30 basis points higher than the second quarter of 2017 and 60 basis points higher than the third quarter of 2016. Our GAAP operating income was $23.8 million compared to $15.0 million reported in the second quarter of 2017 and $15.0 million reported in the third quarter of 2016. For the third quarter of 2017, non-GAAP gross margin was 55.7%, 10 basis points higher than the second quarter of 2017 and 40 basis points higher than the third quarter of 2016. Our non-GAAP operating income was $38.9 million compared to $31.2 million reported in the prior quarter and $29.4 million reported in the third quarter of 2016. Let's review our operating expenses. Our GAAP operating expenses were $47.0 million in the third quarter compared with $46.5 million in the second quarter of 2017 and $42.9 million in the third quarter of 2016. Our non-GAAP third quarter 2017 operating expenses were $32.9 million, up from the $31.2 million we spent in the second quarter of 2017 and up from the $29.4 million reported in the third quarter of 2016. The year-over-year increase in operating expenses primarily reflects investment in new product introductions and staff additions in support of targeted sales and marketing efforts. On both a GAAP and a non-GAAP basis, third quarter litigation expenses were $327,000 compared with a $290,000 expense in Q2 2017 and a $55,000 expense in Q3 of 2016. The differences between non-GAAP operating expenses and GAAP operating expenses for the quarters discussed here are stock compensation expense and income or loss from an unfunded deferred compensation plan. Total stock compensation expense, including $453,000 charged to cost of goods sold for the third quarter of 2017 was $14.0 million compared with $15.1 million recorded in the second quarter of 2017. Switching to the bottom line. Third quarter 2017 GAAP net income was $23.6 million or $0.54 per fully diluted share compared with $0.35 per share in the second quarter of 2017 and $0.34 per share in the third quarter of 2016. Q3 non-GAAP net income was $36.6 million or $0.84 per fully diluted share compared with $0.68 per share in the second quarter of 2017 and $0.66 per share in the third quarter of 2016. Fully diluted shares outstanding at the end of Q3 2017 were 43.5 million. Now let's look at the balance sheet. Cash, cash equivalents and investments were $305.0 million at the end of the third quarter of 2017 compared to $283.0 million at the end of the second quarter of 2017. For the quarter, MPS generated operating cash flow of about $33.7 million compared to Q2 2017 operating cash flow of $24.9 million. Third quarter 2017 capital spending totaled $4.6 million. Accounts receivable ended the third quarter of 2017 at $50.8 million or 36 days of sales outstanding compared with the $42.0 million or 34 days reported at the end of the second quarter of 2017. Days of sales outstanding in the third quarter of 2017 were eight days higher than the 28 days reported in the third quarter of 2016. Our internal inventories at the end of the third quarter of 2017 were $99.9 million, up from the $92.7 million at the end of the second quarter of 2017. Days of inventory decreased to 156 days at the end of Q3 2017 from the 166 days at the end of the second quarter of 2017, but were higher than the 133 days reported at the end of the third quarter of 2016. I would now like to turn to our outlook for the fourth quarter of 2017. We are forecasting Q4 revenue in the range of $123 million to $129 million. We also expect the following: GAAP gross margin in the range of 54.4% to 55.4%, non-GAAP gross margin in the range of 55.2% to 56.2%, total stock-based compensation expense of $13 million to $15 million including approximately $500,000 that would be charged to cost of goods sold, litigation expenses ranging between $250,000 to $350,000, GAAP R&D and SG&A expenses between $44 million and $48 million, non-GAAP R&D and SG&A expenses to be in the range of $31.5 million to $33.5 million. This estimate excludes stock compensation and litigation expenses. Other income is as expected in the range from $600,000 to $700,000 before foreign exchange gains or losses. Fully diluted shares to be in the range of 43.7 million to 44.7 million shares before any share buyback. In conclusion, thanks to acceptance of our new product offerings and with our shareholder support, we will continue to invest and deliver outstanding products to our customers and consistent results to our shareholders. I will now open the phone lines for questions.

Good evening Michael and Bernie and congrats once again. It looks like it's in auto mode and looks pretty exciting. Now a couple of questions. So obviously, you are talking about the data center and some of these design wins, Michael. But can you give us some update on kind of the pipeline of design wins and kind of the opportunity that you have here.

We have many of them and some are small, some of them big. Of course, the bigger ones now, we don't want to disclose that on the Internet or to anybody. Overall, I can tell you that everything is doing well. We are performing as expected or better than what we anticipated.

And on the e-commerce platform, I know this is something that you guys have been looking at a little bit longer term. But any updates here?

On the e-commerce? Well, it's a bigger project and obviously you haven't seen our new website launched yet. But we still expect that at the end of the year. The key is all the content. We are working very hard with the limited resources. But it's going to be some time next year. So maybe you will see something new.

And again, Anil, here. Just to set expectations: we are probably most excited about developing the new sales and marketing channel through this e-commerce platform, particularly as it relates to our field programmable power modules. But we want to keep expectations at a realistic level. In the initial stages here, we will be taking customer feedback regarding their user experience and how valuable they find the content. We will integrate the website to take that feedback into account. We are really looking for sales to ramp up probably about another two years from now, but we believe that we will be able to go live with this by the end of this year.

Well, that's well said. I think user experience is everything, and we don't want to have things crippled out just to put it out there. We approach this very cautiously. I think to enter this market with the breadth of product behind it, user experience is everything. But I think we are still on time. Next year, you will see the first line of products we put out there and then we will gradually launch the other products. The first line of products that we talked about before is programmable DC-to-DC converter modules.

Great. Congrats once again from my end.

Thank you, Anil.

Hi. This is Jerry Li on behalf of Ross Seymore. Thanks for letting us ask a question. Just a few from me and the first one, just want to go into a little more detail about your recently disclosed automotive group. So the year-on-year growth appears to be declining every quarter. I just want to get a sense of what you think the rate of growth for this business could be over the next two or three years?

I think, as Bernie said, we are addressing this. The current product serves a market of about $60 billion. So we are at the very, very beginning. I can't quantify exactly what that number is. However, the growth rate will be somewhat similar to the current growth rate, perhaps slightly higher over the coming years. These numbers are estimations.

Actually, he's got a good head of hair, too.

I do have a lot of hair.

To add to that, the exciting part for us is that we are able to work across many different verticals within automotive and certainly across different geographic areas with various OEMs. We see this as an opportunity that has growth potential for the next several years.

Got it. That makes sense. It's only 10% of your revenues anyway. So you would think that other guys are at 20%. So there's definitely room for growth.

I think, yes, well said too. In our other market segments, growth has been fairly consistent over the last five or six years, and the automotive side has slightly faster growth, but it starts from a very small number. Once you get to the $100 million to $200 million range, I think the growth rate will align more closely with the overall average.

Yes.

That makes sense. Thanks so much. Moving onto storage and computing. The segment, at least for the third quarter, came in slightly below our model. Could you talk about how the Purley ramp is trending and its impact on your company and how long you expect that trend to last?

Yes. I think the opportunities for us in compute and storage are very exciting. I don't think you should look at an individual quarter as a milestone for success. We have made it clear that we have two significant opportunities driving new growth in cloud computing: increasing the number of design wins and adding significant dollar content to sales in the second half of the year. From our perspective, the rollout has been almost exactly as planned, and the prospects for the next two years seem similarly positive.

Well, it's not quite exactly that planned. I think it will likely be delayed by a year or two or so. But overall, cloud computing is very similar to the automotive business, except we have only a few players in this market. Other competitors dominate, and we are just entering. Our customers have only accepted our product in the past couple of years. This year, particularly, is a good year for us with a new product introduced into this market segment. We are ahead of our competitors, which gives us strong growth prospects in the next couple years.

I appreciate the responses. Thanks, guys.

Okay.

Thank you.

Yes. Thank you and I think we are all excited about the growth, but I actually want to congratulate you on your 30% operating margin. So, well done there.

Thank you.

You are the first to notice that. That was why we did it.

Well done. So my first question, Michael, you said your design win pipeline is better than expected. Could you elaborate a little bit on that? Are you starting to see more customers coming to you? Or is it just because you have been able to introduce more new products?

I think each segment is slightly different. In automotive, we are more recognized and engaged with all the top-tier companies. Before we had meetings, and now we engage on the product level. They have opened up for MPS to quote on new product development, which is for revenues in 2019, 2020, and 2021. In cloud computing, I believe we are ahead of many other players. We introduced products and exceeded all the order requirements, and our products are very simple to use. This is attracting customers, particularly among the top-tier server makers.

That's very helpful. Could you update us a little bit on your new foundry partner? I know you probably don’t want to mention who it is, but maybe just give us an update on how that's going? Are you up and running? Is it starting to contribute to revenues yet?

Yes. I think you are familiar that we began to invest with this partnership back in late 2015 and early 2016. The following 18 months were a period of investment for us. Actually, the results from this partnership have been quite good, and we are pleasantly surprised. This partnership came at a time when there were concerns about industry capacity, but we are not experiencing that at all. So I think that as far as the partner, it was very timely regarding our long term relationship and our ability to develop new technologies together, and we are very encouraged.

Very good. Just one last question, back to Michael. I know you don’t want to talk too much about your process technologies, but you must be working on the next one. Obviously, you have been integrating more and more capabilities with that process. So is there anything you care to share with us as far as what you are working on for the next-generation process?

Yes. We are moving on to a 12-inch fab. That obviously will not be ready for production next year. We are looking for 2019 or 2020, which will also include most of the bandwidth circuitry and not just those bands including CMOS. We will continue to upgrade MPS capabilities.

Very good. Thank you very much and congratulations again.

Thank you.

Hi guys. I want to add my congratulations on returning to a 20% growth rate for the first time since, I think, early 2015. Good to see that percentage back. I wanted to ask first, looking at the automotive business, it looks like you have been hovering in a range of the low $12 million to the higher $12 million per quarter range. It seems like it's seeing a little bit of flattening on a sequential basis over the last few quarters. On a year-over-year basis, it's still growing nicely. How should we think about the growth in that business? Does it come in phases? Or should we think it can be a more steady quarter-to-quarter grower?

I would describe it as steady state. However, it is true that we are somewhat flattening out and didn’t grow as much. I haven’t looked into it deeply; perhaps Bernie could answer that question.

Yes. We have discussed in the past that while we are not immune to macroeconomic factors, given that we are so small and new to the market, we have seen a step function in growth here. We will have a series of new product introductions that may be timed around a specific model year, resulting in a step change in growth followed by quarters where we do not see the same rate of increase. However, year-over-year, we have been generating results in excess of 40% annual growth. So while it’s not a perfect linear equation, we believe a step function moving in the upward direction is the best way to view it.

Okay. So last year, it seems like you hit that step function in the December and March quarters. Is that fair to think that you see that step function up with each new model year, and expect to see a little better sequential growth from December into March? Or is it not necessarily timed to the same seasonality each year?

Yes. I think the behavior of the product line is important. Last year or the year before that, revenue was generated from non-automotive products that we retrofitted for automotive use. Starting this year, the new revenue generated is specifically designed for automotive applications. Moving forward, all the new revenues will come from these specially designed automotive products, which I would say will lead to more consistent growth.

Great. And just looking at the sequential growth, you had a nice jump in consumer revenues as well as compute. Just confirming, is that game console revenue included in the consumer segment? And similarly, on compute, was that mostly driven by cloud computing, or the server power management launch? Did you see broader growth in the compute segment in the September quarter?

Yes, you are correct that the power management solution for gaming consoles is part of the consumer group. As for the growth in compute and storage, most of that was led by servers and workstations which broadly falls under cloud computing.

Great. Thank you.

Hi guys. I want to add my congratulations on a solid quarter. I have a couple of follow-up questions on topics raised earlier. The first is just on your e-commerce site. Could you provide a sense of how big that small and medium-sized business opportunity is for you? Is there a framework or guidepost we could use to think about its potential size?

I think it will be a few billion dollars. Considering all these companies, that market size is largely about underserved markets. It really requires Field Application Engineers (FAEs) to provide hands-on support. It's a fast-time-to-market segment. Initially, I think that we will trickle down the initial design; that won't sustain it. However, our e-commerce model and our modules will have open bills of materials. Customers will initially buy our modules for plug-and-play purposes, and later on, they can buy our chips and source their own components. So, by adding everything together, I think that total market for MPS is a few billion dollars. As we add programming capabilities and bring it to the Internet, I think we have a very good chance. I am quite optimistic about it.

Okay. Should we think of the ramp there, once it starts, as a linear ramp? Or do you think there's any sort of step function there, particularly as new features come online or adoption takes hold? Or is it too soon to know how that will unfold?

Well, we have already launched, but it's not on the Internet yet. We just sent out some early materials. It's been well received. However, once we introduce it on the Internet, I wish for the step function, but it's too early to call.

Okay. Just a quick follow-up on the automotive business. If I rephrase the question differently, you have mentioned in the past that your auto SAM is roughly $200 per car today. Is that correct?

Actually, it's a little less than that, about $145 or $150.

Okay. So how does that compare with your actual average content now? And what is that going to look like in the next year or so based on your anticipated design wins?

When you assess the potential of analog and sensor electronics in each automobile and win an individual application or socket, it’s not that you achieve 100% adoption. In the areas we have been launching, especially with infotainment including USB ports, we have seen strong penetration, though it's spread out across just a few dollars per individual automobile. As we launch additional vertical product releases and venture into lighting, body controls, and ADAS, I believe you will see opportunities for multiple adoptions which will, by nature, increase the dollar content per car.

Got it. Lastly, you have been growing cash nicely. Bernie or Michael, could you discuss your top uses of cash? Are we more likely to see a rise in dividends sometime soon? Are you leaning more towards buybacks? Or how are you thinking about cash usage?

We are considering all scenarios. As we always stated, we are also looking for some small tuck-in type complementary technology company opportunities.

Got it. Thanks, guys.

Okay.

Thank you.

Hi. Thank you. Good afternoon, gentlemen. Thanks for letting me ask a question. Bernie, just a quick follow-up. With inventory increasing sequentially each quarter in 2017 to support your strong second half product ramp, when do you expect inventory levels to start to normalize? Would that be in the March quarter of 2018?

Yes. Let me process this. The reason we have invested in inventories is that there have been very unique new business opportunities for developing power management solutions for cloud computing, gaming, and high-end PCs. During a time when capacity was uncertain, we have done a good job of meeting our customers' demands. However, our intent is not to stay at an elevated level but to normalize. As you stated, we have tried to target a range between 135 to 155 days for inventory, and I expect us to bring that range back, probably not to historic levels, but within that range, likely in Q2 or Q3 of next year.

Okay. That's helpful. As a follow-up, you are guiding toward strong year-over-year growth in the December quarter. Is that driven more so by the Purley product ramp? Or more by the Kaby Lake processor transition? Or is it mostly the new game console business? Or is it a combination of all three or something else?

A combination of all of the above that we mentioned in this conference and also that Bernie said in his script. Don't forget about consumer. We are growing considerably percentage-wise, and on the revenue side, they are pretty sizable.

Okay.

I think it's about time. The new game console work is exciting.

Thank you.

Great. Thanks for squeezing me in. Congrats on the great results and outlook. I joined a little late, so I apologize if this was already asked. But I would love to get an update on e.Motion. If you could remind us how big that business is for you now? Are there design wins that are currently generating revenue, or is that expected to roll out in the next couple of quarters? Any elaboration on that business would be helpful. Thank you.

Yes. Okay. Thanks for raising the question. In the last few earnings calls, I mentioned that it didn't grow as expected because I didn't monitor it closely. In reality, this product line is growing quite well, and we will have more than a few million dollars in business next year. We have fully integrated products and we are launching. We are aiming to partner with several model companies and provide models aligned with our modules. As we introduce more, we will secure more design wins since the March timeframe. I believe this will revolutionize the replacement of stem models, replacing all BSP controls, along with optical sensors. Acceptance will be critical for specific applications, but once we start with larger segments like robots and warehouse robotics, it will spread widely.

Maybe just one level deeper on the same topic. The somewhat unusual go-to-market approach is you are trying to get these components designed in by OEMs who would have otherwise gone to motor companies to buy a motor. Correct me if I’m wrong, but I believe you are telling them basically, to build their own motor or a better motor using our components. Is that right? Are you seeing acceptance based on performance, pricing, or both?

I think our go-to-market segment is similar to the way MPS sells DC-to-DC converters. We are now selling modules for underserved customers and for fast-tracking to market. Once the volumes reach a certain height, they can source our ICs. You can purchase MPS ICs. In the case of the e.Motion product line, we will adopt a very similar approach, but we will also focus on modules alongside our partnerships with model makers. Ultimately, it depends on customers’ needs, whether they can buy our modules or our chips. The crucial aspect right now is that customers are having difficulty understanding this change, as we are moving away from using optical encoders. We help them design their modules and always support them through our model maker partners.

Great. Thank you.

Okay. All right.

Thank you.

Thank you. I would like to thank you all for joining us for this conference call, and I look forward to talking to you again during our fourth quarter conference call, which will likely be in early February. Thank you. Have a nice day.