Monolithic Power System Inc (MPWR) — Q2 2018 Earnings Call Transcript

Thank you very much. Good afternoon and welcome to the second quarter 2018 Monolithic Power Systems conference call. Michael Hsing, CEO and founder of MPS, is with me on today's call. In the course of today's conference call, we will make forward-looking statements and projections that involve risk 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 Q2 earnings release and in our SEC filings, including our Form 10-K filed on March 1, 2018, and Form 10-Q filed on May 8, 2018, 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 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 Q2 2017, Q1 2018, and Q2 2018 releases as well, 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. In the second quarter of 2018, MPS set a new high watermark in quarterly revenue and non-GAAP earnings per share. MPS’s Q2 revenue of $139.8 million was 8.2% higher than revenue in the first quarter of 2018 and 24.6% higher than the comparable quarter in 2017. MPS’s sales momentum continues to build as we generate superior results from our R&D investments targeting the computing, automotive, and industrial markets. Looking at our revenue by market: In our computing and storage market, revenue of $37.0 million increased $12.5 million or 51.1% year-over-year. Growth in this market was broad when compared to the year ago quarter, with all applications: cloud computing, storage, and high-end notebooks increasing at a rate well above the market. Computing and storage revenue represented 26.4% of MPS's second quarter 2018 revenue. Second quarter automotive revenue of $20.3 million grew 58.2% over the same period of 2017, fueled by product sales for infotainment, safety, and connectivity application products. Automotive revenue was 14.6% of MPS's total second quarter 2018 revenue. In our consumer markets, revenue of $47.8 million increased 8.9% over the second quarter of 2017 and represented 34.2% of our second quarter 2018 revenue. The year-over-year revenue increase reflected gains in home appliances, IoT-related applications, and specialty lighting. Second quarter 2018 industrial revenue of $19.1 million increased 27.2% from the second quarter 2017 due primarily to increased sales of industrial power supplies. Industrial represented 13.7% of our total second quarter 2018 revenue. GAAP gross margin was 55.5%, 10 basis points higher than the first quarter of 2018 and 80 basis points higher than the second quarter of 2017. Our GAAP operating income was $24.9 million compared to $22.0 million reported in the first quarter of 2018 and $15.0 million reported in the second quarter of 2017. Non-GAAP gross margin for the second quarter of 2018 was 56.0%, 10 basis points higher than the first quarter of 2018 and 40 basis points higher than the second quarter from a year ago. Our non-GAAP operating income was $41.4 million compared to $37.2 million reported in the prior quarter and $31.2 million reported in the second quarter of 2017. Let’s review our operating expenses. Our GAAP operating expenses were $52.7 million in the second quarter of 2018, compared with $49.5 million in the second quarter of 2018 and $46.5 million in the second quarter of 2017. Our non-GAAP second quarter 2018 operating expenses were $36.9 million, up from $35.0 million we spent in the first quarter of 2018 and up from the $31.2 million reported in the second quarter of 2017. The differences between non-GAAP operating expenses and GAAP operating expenses for the quarters discussed here are stock compensation expense and income or loss on an unfunded deferred compensation plan. For the second quarter of 2018, total stock compensation expense, including approximately $480,000 charge to cost of goods sold, was $15.9 million, compared with $15.0 million recorded in the first quarter of 2018. Switching to the bottom line. Second quarter 2018 GAAP net income was $24.2 million or $0.55 per fully diluted share, compared with $21.9 million or $0.49 per share in the first quarter of 2018 and $15.0 million or $0.35 per share in the second quarter of 2017. Q2 non-GAAP net income was $40.0 million or $0.90 per fully diluted share, compared with $35.0 million or $0.79 per share in the first quarter of 2018 and $29.5 million or $0.68 per share in the second quarter of 2017. Fully diluted shares outstanding at the end of Q2 2018 were 44.4 million. Now, let's look at the balance sheet. Cash, cash equivalents, and investments were $318.7 million at the end of the second quarter of 2018, compared to $312.5 million at the end of the first quarter of 2018. For the quarter, MPS generated operating cash flow of about $25.4 million compared with Q1 2018 operating cash flow of $16.3 million. Second quarter 2018 capital spending totaled $5.6 million. Accounts receivable ended the second quarter of 2018 at $53.5 million, representing 35 days of sales outstanding, which was 1 day higher than the 34 days reported above that at the end of the first quarter of 2018, and at the end of the second quarter of 2017. Our internal inventories at the end of the second quarter of 2018 were $128.9 million, up from the $111.9 million in the first quarter of 2018. Days of inventory increased to 189 days at the end of Q2 2018 from the 177 days at the end of the first quarter of 2018. The increase in inventory days was due to a buildup in advance of seasonally high Q3 revenue, changing customer requirements, particularly in automotive, computing, and gaming applications, and hedging for potential upside in the second half of 2018. I would now like to turn to our outlook for the third quarter of 2018. We are forecasting Q3 revenue in the range of $155.5 million to $161.5 million. We also expect the following: GAAP gross margin in the range of 55.2% to 56.2%; non-GAAP gross margin in the range of 55.6% to 56.6%; total stock-based compensation expense at $15 million to $17 million including approximately $500,000 that will be charged to cost of goods sold; GAAP R&D and SG&A expenses between $52.3 million and $57.3 million; non-GAAP R&D and SG&A expenses to be in the range of $37.8 million to $40.8 million. In anticipation of higher revenue in the next two to three years, we are stepping up investment in our foundry capabilities. We're actively qualifying two 12-inch fabs and are in the process of developing advanced technologies. Other income is expected to be in the range from $600,000 to $1 million before foreign exchange gains and losses. Fully diluted shares to be in the range of 44.0 million to 45.0 million shares before share buyback. We are continuing to execute our long-term business strategy, which we believe will maximize long-term shareholder value. I'll now open the phone lines for questions.

Thanks for allowing me to ask a question. I want to focus on the auto business for a moment. It has grown from being the smallest segment to now surpassing both communications and industrial. At the analyst day, you mentioned that you expect the auto sector to grow at a 40 to 50% compound annual growth rate. It experienced approximately a 60 to 65% compound annual growth rate from 2013 to 2017. Is it reasonable to anticipate auto growing at around a 40% compound annual growth rate through 2021? How do you view the growth moving forward?

Sure. At the Analyst Day that was on June 7th, we characterized growth for the next three years as being in the range between 40% to 50% in any given year. And on a quarterly basis, because there's sort of a step function with how revenue increases here that it could be between 30 and 60%. So, I think that you're in the right ballpark for your CAGR.

All right. I appreciate that. And next, I'd like to ask about the inventory dynamics you guys had this quarter. I understand you guys had prepared remarks, but I'd love to hear you guys elaborate a little bit more on this. Inventory is up 39% year-on-year, that's ahead of revenues for actually the sixth straight quarter. Maybe there's some mix dynamic there, I understand with the auto, maybe some of your parts have a longer life cycle and maybe require more of a build. But is there anything else that you'd like to elaborate on why inventories continue to be outgrowing revenues?

Actually, you gave a pretty complete answer for me there.

What we really said in earnings is that we're hedging the potential future growth. And I can give you more color is that we have so many products introduced in the market, they start to ramp. A lot of them we still haven’t seen the revenue yet. And during the ramp, you don’t want to see any hiccup, either in the number of products or in quantity issues, and we don't have any history of it. And so, we would be very cautious. We use the cash wisely. And in terms of MPS in history, we don’t carry a lot of inventory. And so, if you want to talk about inventory, this is how we manage it. And we have long life cycles. And as long as we see growth in the top line and in EPS, I don’t care about the rest of it.

Hey guys. Congratulations on the nice results for June and a particularly strong guide for September. I just wanted to start with the September quarter. Is there anything in particular, any one end market where you’re seeing particular strength leading to that guide, or is it pretty broad-based? And I’ve got a couple of follow-ups.

It’s pretty much broad-based; all the growth areas we cover. In the last few quarters, the story remains the same; we’re very much at the very beginning. And all the product ramping is across the board.

Do you guys still feel pretty comfortable with hitting that 8% to 10% share of the server power management market for all of 2018?

Yes. Our expectations for the server market have really not changed in the 18 months since we started discussing those terms. We’re seeing very positive results and very good acceptance and continuation of good volume.

And I just wanted to ask if some others in the industry have been constrained by the supply of ceramic capacitors and passive devices. And just wondering, if you’ve seen those same constraints. If so, are you doing anything to try to avoid some of those constraints, possibly purchasing passive devices that you can sell as part of your solution to the customers or any thoughts on the supply of passives and whether it’s impacting your business?

Yes. It does impact our business. And a lot of products ramping are just not as high as we expected. And we’re looking heavily at design around without using the capacitors.

And then lastly for you, Bernie, you mentioned the step-up in spending here to qualify two 12-inch fabs. It sounds like that might be a two to three-year phenomenon. Does that take you above the OpEx as a percent of sales in that range of 50% to 60%, or do you still think you can kind of target that 50% to 60% OpEx growth as a percent of revenue growth?

I think for a brief period of time here, and I don’t know how many quarters necessarily that's going to be. But while we’re ramping and qualifying the two fabs, we will be beyond what our model is. But we’re very conscious of the need to get operating leverage and return spending down to the 50% to 60% of revenue growth. But I’d say that probably for the next four to five quarters, maybe six, we’ll probably be above that level.

I’d like to begin with the ecommerce question and get an update on the progress of that effort. I see you are already acquiring some customers, and I’m interested in the feedback you’ve received. Could you also provide some insight into the potential opportunity for your business in the coming years? I understand that this might be difficult, but if you could quantify it in some way, that would be helpful. What is your view on the total addressable market?

I can address your initial question. The website is operational, although it currently doesn't look great, but we have plans to improve it in the future. We are receiving orders through our website. The growth of our programmable modules is hard to predict since we are starting from scratch. However, the numbers from the past few months have exceeded my expectations. We will continue to evaluate the situation, so please stay tuned.

Okay. But for now, I assume we are keeping it out of the model for now I guess?

Yes. We…

Yes, keep it out of that model.

We kept revenue expectations, maybe a conscious effort to keep them low for ‘18 and ‘19. And really, what we're trying to do is get up to speed and what it takes to market and successfully manage the ecommerce experience. And during this time, we will also be adding more products and getting traction with customer acceptance.

Got it. Then, maybe switch gears to 48 volt core power. I know, in the next couple of years, you guys have talked about 48 volt coming to GPU and CPU. I guess, maybe if you could walk us through what the timing looks like of that? Who you are likely to compete with there? I think GPU probably ramps before CPU. So, maybe what has to happen for that to go?

Yes. We anticipate reaching the mainstream in early or mid-2019. We have been working on that product for the past three years, and we view this as a near-term solution for the future of servers. I cannot specify our competitors, as there isn't a comparable solution available currently, though there may be a couple. Our solution will be mass produced and user-friendly. In recent years, we have secured many design wins.

And just to add real quickly, as Michael said, we’ve had this project under development for three years. I think there are a couple of data points in the market today that validate the timing of having our solution released in 2019 was a good set of circumstances for us. We're in the right place at the right time with the 48-volt solution.

Got it. And then, just a quick clarification question, if I could, on 300 millimeter. Where do you guys stand today? I mean, do you have any design wins on 300 millimeter or is that still on the commercial side? And then, maybe if you could update us on the ramp of any design wins at 55 or 65 nanometers?

These are some of the stuff we're hitting the market very, very soon, and I don’t know if it is the first shipment or we are certainly sampling it.

Slightly different development track where the 55 effort will probably have design wins early in 2019 and the 300 millimeter will probably be more out in 2020.

Great, thanks for taking my questions. Congrats on the very good results and outlook. I wanted to return to the comment about hedging for potential upside in the second half. Is there a particular end market that that's weighted towards? And likewise, would you anticipate a sort of variability in potential upside to be more of a Q3 event or is there something special in Q4 that we should think about? And then, I have a follow-up, if I can.

Yes. I think that as we said on the call that there's really three or four key areas that are driving a lot of our business. And within that, what we've tried to do is we're working within a range of expectations for any one of those. Generally, what we’ve done is we've modeled in our revenue expectations the midpoint or below, but we've provided the inventory at the upper end of the range that has been provided to us by the OEM or from the end customer. So, it really could be any one of the opportunities in computing and storage or automotive in particular where we could experience a pop.

Thanks, Bernie. I appreciate that. And maybe backing up, you offered initial take on e-commerce. I wonder if there's any change in the customer traction relative to the E Motion product.

It's a family of E Motion products that I see, and we are primarily focused on selling the integrated circuits and the complete solution. This approach is significantly better and easier for generating revenue and servicing our customers, a lesson learned from the past couple of years. I view this as a similar type of ramp-up.

And on E Motion, that is starting to ramp very nicely right now, and we've seen a lot of design wins that we have, not just in ‘18 and ‘19 but even ‘20 and ‘21 that we're already going to be benefiting from. So, that is an initiative that we started in earnest about four years ago, and that's how long it takes for these things to ramp, whereas the e-commerce platform and the field programmability offered on it, we're just in the very early stages of that.

Great. Thanks for that clarification and congrats again on the good results and outlook.

Thank you.

Thank you. Congratulations on hitting all those records. First question, the 12-inch fab, I understand the OpEx on top of it. But how should we think about that impacting your gross margins over time? Because I would think that that could potentially be pretty accretive to your gross margin.

Yes. Tore, you covered us for a long time, and you know that our patterns are that we move from early days to go to 16-inch and then we go to 8-inch, with the first 8-inch being a 0.35 micron fab. And until these are 180 nanometer fabs, depreciated further, then we moved there. So, each step we move to a new foundry or new advanced fab that doesn’t impact the margin immediately. And so, those 12-inch fabs are still expensive. But three, four years later, that will be cheaper. So, we just follow our history; we repeat the same thing. By that time, we will have the superior technologies and good cost.

Very good. And I believe last quarter your ASPs were sort of in the high single digits. Is there a number you could share with us for this quarter?

Not at this point. But what I can tell you is that the ASP delta has a lot to do with our mix of business. Many of these new opportunities that we’re going into have ASPs that are 2, 3, and 4 times what some of our legacy products, particularly in consumer used to be. So, I think that you're going to see missing bias as the higher percent of our businesses is with these newer opportunities.

And just one last question on automotive, it seems like there could be significant potential there in the second half of the year. Considering your confidence in the car, it seems that so far it has mainly been in lighting and some of the USB power aspects. Are there any new additional opportunities in other areas that could emerge in the second half of this year?

Actually, as far as the technology that we’ve introduced in the automotive, it really is centered around the infotainment, the USB-C ports, and the body controls. Interestingly, lighting, we’re just at the very early stages of that. And so, over the course of the next 12 months, I think you’re going to see the ramping in the body control and then a little bit after that in lighting.

I want to revisit the increased expenses related to the fabs. Bernie, you mentioned that these would continue for four to six quarters, and during your analyst day, you provided a target for operating margins in 2021. I assume those targets remain unchanged and that the increased expenses were intended at that time.

Yes. We have been aiming to provide some guidance regarding both the timing and scale of our investments. We are beginning to see these investments reflect in our financial statements. However, our main focus remains on managing our core business. While I won't necessarily label these as one-time costs, they are related to specific projects. These project-related costs will decrease over time, enabling us to reach the targets we have set for ourselves.

We see a significant opportunity for growth in the next two to three years. We have made the decision to increase our expenditures and investments in a new facility to avoid any capacity issues. I will also ensure that our technology continues to advance. Looking back at last year and early this year, MPS did not face any capacity constraints and we grew as expected. We are being judicious with our spending. My primary focus is on top-line growth and earnings per share, while other aspects are less of a concern to me.

And then, as far as characterizing what we provided at the analyst day, those are guidelines. So, for example, in revenue, we want to be able to grow at 20%. In this case, with the midpoint of the guidance that we’ve offered for Q3 as well as what we've done in Q1 and Q2, we are several percentage points above that this year. So, you really have to look at the guidelines that we've offered in the business model as sometimes it will be above it, sometimes it will be below it. The thing to focus on is we only provide guidance one quarter ahead at a time.

To be fair, if our growth is lower, our spending will also decrease. However, we are currently accelerating our growth, and we cannot achieve growth without a solid foundation.

Understood. Are you guys seeing sort of the seasonality of your business change as you become more broad-based? I mean, obviously, your Q3 is sort of in line with normal seasonality. I know you don’t guide Q4. But given some of the upside opportunities you guys have been describing, how should we think about seasonality as we look out into the out year as well?

Yes, I would say that overall, we intend to maintain the seasonality we've historically observed. However, Q1 exceeded our expectations; the decline from Q4 to Q1 was less significant than usual. Consequently, the increase from Q1 to Q2 was also lower than our historical average by about three percentage points. Looking ahead to Q3, our guidance aligns closely with past performance.

Yes, our seasonality has changed. Over the past year, as the business evolved and we entered a higher growth phase, we experienced four consecutive quarters of growth for the first time since 2004-2005. Therefore, I can’t predict what our seasonality will look like moving forward.

Hi. This is Josh Buchalter on behalf of Matt. Thanks for taking my question and congratulations on the great results again. Firstly, I'd just like to dig a little bit more into the storage and compute bucket. Is there any more granularity you could provide on some of the moving parts within the quarter and maybe the guide, given your large socket wins there?

We have an abundance of success as all our major product lines in computing and storage are performing exceptionally well. The guidance for Q3 indicates that this trend will continue. Much of the technology we focused on developing is now entering the market. For instance, the deployment of our servers has unfolded almost exactly as we anticipated. Currently, we don't foresee any challenges; instead, we are experiencing ongoing advantages.

And you provided an update on E Motion and ecommerce. I was hoping you could provide the same on field programmability.

No. This is tied together; the ecommerce, of course, is wider than we do some of the products that are not programmable. Currently, I think we sell most of the products that are kind of fixed, because the website was late. Now we have the capability to reprogram the product, reconfigure the product. These are the things to me; ecommerce and field programmability are tied together.

I think that as we look at the continuing demands in this area is that we're going to take an even larger number of our product catalogue today and reengineer it around field programmability, which offers our customers the best ease of use and time to market.

I'd like to thank you all for joining us on this conference call and look forward to talking to you again during our third quarter conference call, which will likely be at the end of October. Thank you, and have a nice day.