Monolithic Power System Inc (MPWR) — Q2 2019 Earnings Call Transcript

Thank you. Good afternoon. And welcome to the second quarter of 2019 Monolithic Power Systems conference call. Michael Hsing, Founder and CEO 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 risks and uncertainties, 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, 2019, and Form 10-Q filed on May 10, 2019, which are accessible through our website. 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 2018, Q1 2019 and Q2 2019 releases, as well as to the reconciling tables that are posted on our website. I'd 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. MPS achieved record second quarter revenue of $151 million, 6.8% higher than revenue in the first quarter of 2019 and 8% higher than the comparable quarter in 2018. Looking at our revenue by market. In our computing and storage market, second quarter revenue of $41.6 million increased $2.4 million or 6.1% from the first quarter of 2019. Computing and storage revenue represented 27.5% of MPS's second quarter 2019 revenue. Storage revenue was down from the first quarter of 2019 with computing revenue increasing. Nevertheless, the growth in computing was slower than what we'd planned for back in the second half of 2018. The slower than anticipated growth rate was primarily due to customers delaying product launches or absorbing overcapacity. Having said that, our design activity in the first half of 2019 with top tier customers reached an all-time high in server, storage and AI applications, positioning MPS for long-term success in these critical markets. In our consumer markets, revenue of $43.8 million increased 14.8% from the first quarter of 2019, and represented 29% of our second quarter 2019 revenue. The sequential quarterly revenue increase reflected improved sales of products for wearable applications and a seasonal increase in certain legacy consumer market. Second quarter 2019 industrial revenue of $22.4 million increased 5.2% from the first quarter of 2019 due primarily to increased revenue for smart meters and point of sale systems. Industrial represented 14.9% of our total second quarter 2019 revenue. Second quarter automotive revenue of $21.2 million grew 3.5% over the first quarter of 2019. Similar to computing, revenue growth in automotive was lower than we had anticipated three quarters earlier due to a slowdown in the broader market. And like computing, our superior technology in design activities both in standard and custom products have been widely accepted by tier one customers. The range of applications MPS encompasses includes infotainment, smart lighting, ADAS and autonomous driving. Again, we believe MPS is well positioned to accelerate growth in automotive when the market returns. Automotive was 14.1% of MPS's total second quarter 2019 revenue. Second quarter 2019 communications revenue of $22 million was essentially flat with the first quarter of 2019. Sales for our legacy router and wireless applications decreased sequentially, while infrastructure sales, including 5G networks increased. As 5G spending ramps, MPS is well positioned to benefit as existing design wins move to revenue. Communication sales represented 14.5% of our total second quarter 2019 revenue. GAAP gross margin was 55.1%, 10 basis points lower than the first quarter of 2019 and 40 basis points lower than the second quarter of 2018. Our GAAP operating income was $20.1 million compared to $21.7 million reported in the first quarter of 2019, and $24.9 million reported in the second quarter of 2018. Non-GAAP gross margin for the second quarter of 2019 was 55.6%, matching the gross margin reported in the first quarter of 2019 but 40 basis points lower than the second quarter from a year ago. Our non-GAAP operating income was $43.7 million compared to $39.6 million reported in the prior quarter, and $41.4 million reported in the second quarter of 2018. Let's review our operating expenses. Our GAAP operating expenses were $63.1 million in the second quarter of 2019 compared with $56.3 million in the first quarter of 2019, and $52.7 million in the second quarter of 2018. Our non-GAAP second quarter 2019 operating expenses were $40.3 million, up from the $39 million we spent in the first quarter of 2019 and up from the $36.9 million reported in the second quarter of 2018. The difference 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 2019, stock compensation expense, including approximately $663,000 charge to costs of goods sold was $22.7 million compared with $16 million recorded in the first quarter of 2019. Switching to the bottom line. Second quarter 2019 GAAP net income was $20.7 million or $0.45 per fully diluted share compared with $26.2 million or $0.58 per share in the first quarter of 2019, and $24.2 million or $0.55 per share in the second quarter of 2018. Q2 non-GAAP net income was $41.9 million, or $0.92 per fully diluted share compared with $37.9 million or $0.84 per share in the first quarter of 2019, and $40 million or $0.90 per share in the second quarter of 2018. Fully diluted shares outstanding at the end of Q2 2019 were $45.5 million. Now, let's look at the balance sheet. Cash, cash equivalents and investments were $369.7 million at the end of the second quarter of 2019 compared to $362.3 million at the end of the first quarter of 2019. For the quarter, MPS generated operating cash flow of about $44.1 million compared with Q1 2018 operating cash flow of $38.8 million. Second quarter 2019 capital spending totaled $19.3 million. Accounts receivable end of the second quarter of 2019 at $55.4 million, representing 33 days of sales outstanding, which was five days lower than the 38 days reported at the end of the first quarter of 2019 and two days lower than the 35 days at the second quarter of 2018. Our internal inventories at the end of the second quarter of 2019 were $143.6 million, up from the $142.5 million at the end of the first quarter of 2019. Days of inventory of 193 days at the end of the second quarter of 2019 were 12 days lower than at the end of the first quarter of 2019. As we've said in the past, we are comfortable carrying a higher than normal level of inventory during a downturn, given that most of our products are not customer or application specific and carry minimal obsolescence risks. Having said that, we do not expect meaningful reductions in the near term, and inventories are likely to remain elevated through the second half of 2019. I would now like to turn to our outlook for the third quarter of 2019. We are forecasting Q3 revenue in the range of $162 million to $168 million. We also expect the following: GAAP gross margin in the range of 54.9% to 55.5%; non-GAAP gross margin in the range 55.3% to 55.9%; total stock-based compensation expense of $18.3 million to $20.3 million, including approximately $600,000 that would be charged to cost of goods sold; GAAP R&D and SG&A expenses between $57.1 million and $61.1 million; non-GAAP R&D and SG&A expenses to be in the range of $39.4 million to $41.4 million. We are continuing to invest in our new 55-nanometer process technology on 12-inch wafers, and are selectively adding headcount despite slower revenue growth; litigation expense should range between $400,000 to $600,000; interest income is expected to range between $1.4 million to $1.6 million; fully diluted shares to be in the range of 45.3 million to 46.3 million shares. In conclusion, for the remainder of 2019, we remain cautious amidst the market uncertainty. I believe MPS is well positioned for long-term growth. I will now open the phone lines for questions.

Congratulations guys on results. And I know it's not easy to achieve this in this environment. So maybe my first question is if you could just give some more color, or maybe parse out the areas of relative strengths heading into 3Q, which segments, I mean just at a high level. Which segments you expect to grow and maybe which segments might be lagging a little bit?

They're kind of all lagging a little bit.

Well, if you look at sequentially. Automotive is expected to probably contribute, both in terms of dollar and also percentage gain. Likewise, I'd say that industrial, which you know can be rather lumpy business, should show some improvement from Q2 to Q3. Again, when you look at the comparison against last year's Q3, to Michael's point exactly, consumer usually is the bellwether and in fact that has remained down from last year. And industrial would be flattish. But we do expect to see continued improvements in both automotive and communication year-over-year.

Can you provide some insights into the automotive situation in China? It seems like there might be some signs of improvement. Could you also discuss the design win momentum with automotive OEMs and tier ones? How is the pipeline looking during this downturn? I assume there is still a good amount of design activity happening?

Yes, our auto as that goes up slightly, I don't know this is from noise. It is from noise or just on certain projects, we're still very small in the entire auto segment, our market share is very small. And in terms of engagements and the designing activities, and we actually surprised ourselves and again after we qualified from first tier suppliers including OEMs, and the level of engagement and the level of meetings that they requested cannot be better.

And just as a finishing point there, I think that the results that we saw in the first half of the year were colored mostly by the soft demand, particularly in the China market. And then the uptick that we expect to see in the second half of the year is a result of the new model years being rolled out, particularly in North America, Europe and Korea.

I have a quick housekeeping question regarding your exposure to Huawei. I understand it's minimal for you, probably in the low single digits. Some companies have mentioned that they can still ship products that aren't linked to national security concerns. Could you provide some insight into what you are able to ship to Huawei and how much of that low single digit exposure is actually being sent to them? Thank you.

Sure. There's a couple of points there. I mean, obviously in the middle of May, that's when the Department of Commerce added Huawei to the entity list. And so like our peer companies, we did an evaluation of how the ban would affect us and how to implement it. After we completed that review, we concluded that the MPS ICs are really now subject to the entity list prohibitions. We basically determined that certain components working in compliance within the sales band framework. And so we have resumed shipping. One thing to add is that, historically, Huawei has been a very small percentage of our business. And I'm not talking through them in total here, but I am saying that in China, in particular with the level of uncertainty related to tariffs and trade that we did see a step up in volumes in Q2 as certain customers built inventories in advance of any further bans.

We are not depending on Huawei to grow.

Great, thanks for taking my questions. Normally, downturns in my experience tend to trigger an increased pace of innovation. Customers sometimes look to use the weak demand environment to leapfrog competitors. And I'm wondering if you're seeing this trend now, and how it affects your view to your future revenue growth?

Will, I think that is a very accurate observation. And particularly when we look at areas that really are exciting for our future. In particular within computing, we've talked about cloud-based server and AI, even storage, which has been down now for about three to four quarters. We're seeing a very high level of engagement. And the same can be held true for automotive, in particular. And a point that Michael made earlier that I do want to emphasize is that in the past, we've had to go out and really get them excited at MPS. And now that engagement is starting to occur where they're calling us and setting up meetings at the executive level. So we're not going to try and tell you the timing of when the market is going to turn around. From a theme for this quarter, we really believe that we're well positioned to take advantage of it.

Maybe one more if I can squeeze it in. The Q3 guide is remarkably in line with consensus. But I think, at least in my analysis, it looks slightly above typical seasonality. So still, not as robust year-over-year growth as we've come to expect from Monolithic but looking like maybe we're passing through the bottom in terms of year-over-year growth. When we think about Q4, while you're not guiding it, I think normal seasonality is up mid to high singles. Any reason to think that would be better or worse than typical?

I usually think of Q4 as being slightly lower, not reaching single digits. In the last few years, we've had unclear seasonality, especially with growth rates of 16%, 17%, and 20%. For Q4, I believe we'll be either flat or slightly down, and I can't recall last year's exact number, but it might have been slightly up. Last year, we did see a decline.

Last year it was down, a year before we were actually up and that was after we've started to get traction in the server business. And we're actually continuing the theme. Well that in both Q1 and Q2, however, however you define our historic norms, we're underperforming in Q3 by about 2 to 3 percentage points. But I think that Michael's point is spot on that we've had a lot of volatility, particularly in the last two years as we've had the change in sales mix. So it's not as predictive as it once was. But I do feel good, to add to your point, that we basically stayed in a good position relative to expectations for the quarter.

Yes, I completely agree with you. This year, we don’t have clear insights into industrial growth. The only thing we can do is put forth our best effort to secure design wins and closely engage with our customers.

Yes, thank you. And congratulations on the results in this environment. First question, the consumer revenue, the year-over-year declines continued to improve. And as we look through the September quarter, should we expect that trend to continue? So again, I'm not asking for that to be up. But I think it does seem like the year-over-year declines are certainly moderating in each quarter and year?

Thank you for your kind words earlier, Tore. The consumer landscape is somewhat challenging to assess. We categorize it into three main groups: high value, gaming, and traditional or legacy. Traditionally, the legacy market exhibited specific seasonal patterns that were relatively reliable. However, that has changed as we observe a significant decrease in demand, particularly in Asia, and specifically in China, though it isn't limited to that region. On the other hand, the high value sector, which heavily involves home appliances, has shown a solid recovery and remains strong. Additionally, as we approach the holiday season, we expect gaming to see an uptick. Therefore, I would advise caution in labeling the situation as having reached a low point; instead, we have a slightly different distribution within these three categories.

And as we start to look at your design activity, it sounds like you're getting a lot of traction with what we'd referred to as really high-end processors and AI engines and servers, maybe even in 5G equipment. Could you elaborate a little bit on that? And should we start to see some revenues already from those high-end processors this year? Or is this more of a 2020 growth goal?

I believe that as long as they are commercially available, they are still in very early stages. We do not have enough momentum to clearly identify a trend. For example, with 5G, our technology is well positioned across various platforms and companies in different regions. The diversification of our technology and entry points gives us confidence in our success, but developing that market will take time. Initially, some of the high-end processing, which includes AI, may experience fluctuations before we see a consistent ramp-up.

Just one last question. You mentioned 55-nanometer on 12 inch. I assume you're not getting any benefit from that yet. They're probably more 2020. But would that be more of an enhancer to gross margin? Or will you use that process node to basically continue to accelerate the growth?

I am not sure if 55 nanometer is sufficient. Yes, we are utilizing 12-inch wafers and are beginning to incorporate them. We will always rely on advanced equipment, and when this equipment becomes available, we will adopt it. This development is consistently solid, not delayed by two or three years, and it will benefit our costs and the features we can provide to our customers.

And I think an example of that is, if you look at how our fifth generation rolled out. We're now getting the benefits of that, even though that that has been in the market for about the last 3.5 to 4 years.

Congratulations on a strong quarter. I have a question about the gross margins, which have been relatively flat over the past few quarters. Looking ahead to next year, what changes do you anticipate that could lead to a return of that 20 basis points of sequential improvement? Is this primarily a matter of product mix, or is it mostly driven by demand?

The one we get to the other. We need to see an increased ramp in overall demand. That really if you look at each of the last four or five quarters, we've actually seen sequential decreases in the sales mix.

We've built our productions for much higher capacities, and now we see the growth slower. So that has partially also impacted the gross margin.

No, that makes perfect sense. And then just expand on Tore's comments or question with regards to some of the strong first half design wins ramping in the second half, or starting to go in, I should say. On the AI front, are you predominantly talking about the 48 volt product? Or how should we think about how you play in AI on the processor front?

Yes, we have secured design wins, including a design win for 48 volts, which we believe is a necessary solution as power requirements continue to increase. We began developing these types of solutions a few years ago, and they are becoming widely accepted. We anticipate a revenue ramp soon, but we are uncertain if customers will postpone their projects. However, we are still expecting growth in the near future over the next few quarters.

I wanted to know about your channel inventories and your current perspective on that. It seems that the inventory issue with appliances has improved somewhat. Regarding other markets, could you provide insight into your inventory levels there? Additionally, how do you expect those levels to change over the next quarter or two?

And again, I just want to clarify, you said channel inventories?

Yes.

Yes. So I think at the end of Q1, we acknowledged that we were above our normal range for channel inventory. Some of that had to do with a backend loading of the quarter where sales that we made in the last month of the quarter did not go out to the final end customer. In Q2, we had much more balanced sales on our side by month. And the channel responded and actually, particularly in China and Taiwan, we've seen a significant reduction. We're back down within our comfort zone with the channel inventories. It's a little bit hard to call out by necessarily end market application. It's easier we have greater visibility as it relates to geography.

Great, thanks. Bernie, you previously mentioned that you believed you could maintain revenue growth of 10% to 15% above the industry average. Do you still feel that way? Considering your performance this year, do you think you can achieve even better results, or is that still the benchmark you aim for?

As I mentioned earlier, this market is quite uncertain right now, and our customers are not providing us with clear feedback. These factors are beyond our control, and our focus remains on product design. Ultimately, this will lead to revenue generation.

And just to agree with Michael's point there is that it's just very difficult for us to project further than one quarter out. And there's sort of an interesting, we have the elements in the business that are within our control and then we have other elements that aren't necessarily directly within our control. And to the extent that we can continue to secure design wins and get customer engagement, I think that we're doing a very good job both in execution within the quarter but also as far as securing our longer-term future.

Yes. We're performing well because we focus on what we can control instead of the overall macroeconomic environment, and we excel when we take charge of our situation.

Okay, great. And then one last one from me, if you don't mind. Just kind of look at the computing and storage. How are you seeing, I guess, the demand for the hyperscale data centers? And I guess if you're thinking about that segment, in particular, where do you think you see that the greatest degree of demand today and how do you think that plays out for the rest of the year?

I think that I can acknowledge that somewhere about Q4 and certainly in Q1 and for a portion of Q2, that we saw a dip in demand by hyperscale. We believe based only on our experience, as it was broad-based, it was not just related to an individual company. However, if you look particularly at the long-term demand forecast for e-commerce, eventually, we believe that a lot of it has to do with just absorbing excess capacity or inventory that is built on their shelves, and that the demand for e-commerce based solutions is going to expand and will have to be renewed investment. I don't know exactly when that's going to start to pick up and it might be not even across the board. For example, we might see a little bit more on the server side before we see it in storage. But I think that some time in the next few quarters it will return to building momentum again.

This is Michelle on behalf of Quinn. Thanks for taking the question. So I guess the first one is, consensus estimates for 2020 as far as revenue growth, it looks like the consensus has you at 19%. So given these macro uncertainties going on, just wondering if you could give us revenue growth drivers in 2020? What would be driving towards?

So let me restate the question, if you don't mind. You had two there. The one is that currently the consensus has us growing at just under 19% for 2020. And within that, what growth drivers we believe are significant in those assumptions. Is that correct?

Yes.

I don't know, it's up 19% now?

Yes, I believe we are committed to achieving growth that exceeds the industry average by 10% to 15%. That is what we are promising. Looking at our historical performance, that’s what we have accomplished in the past. This year feels uncertain, similar to 2012 and 2008, which were also unpredictable years. Nonetheless, that is what we have achieved. And I think that as far as the growth drivers, and again, Michael is right, there’s too much uncertainty to sort of affirm or even not say that we can't live up to the expectations. But I think you're going to see continue increased demand for our products, particularly in computing, automotive. And we're also going to see the initial uptick in the communications markets.

I would like to ask about the project delays. Have you seen an increase in these delays since our first quarter call, and how have the delays changed over the past quarter?

It's challenging to assess, as some projects are significantly delayed while others are making progress. We do not have a clear method for tracking the impact of each project. The company has evolved and now manages thousands of products, with several thousand projects active at any given moment. Consequently, we are uncertain about the overall situation.

And just one clarification. For 3Q computing as far as did you say what was the trend that you set for that end market?

Yes. So overall, we see a delayed launch and delayed project and we see overall slowing down. And starting from earlier this year and even now the similar conditions.

And one thing to add there is the second half of 2018, actually we did very well with computing and storage. So we're going into a situation where we see some signs of improving momentum. But we have more difficult comps in the second half of the year.

Hey guys, this is Josh Buchalter on behalf of Matt. Let me echo my congrats on some solid results in a tough backdrop. I guess I wanted to circle back to industrial. It took a step down compared to last year but it's still growing solid double digits in a notably weak environment. I realized it's fragmented, but are there any verticals in particular that you'd like to call out that help insulating you here?

Yes, I think that if you're looking at sort of sequential growth, I think we called out the fact that smart meters and point-of-sale systems picked up to a degree that, frankly, we hadn't fully anticipated. And when you look at the year-over-year comparisons, remember, our industrial tends to be a little more fragmented. We've got like four verticals that we depend on. And in fact, power sources and security in addition to smart meters seem to be continuing with good momentum right now.

I think that Bernie said is, our industrial market fragmented, our entire company is fragmented, and the beauty is, one segment slows down, another will pick up. And so, nothing's more than a bigger percentage of total revenues. And when we look at it overall, MPS will grow this year. And will grow at the same pace as last year, we cannot say it.

Understood and appreciate the color. And then as I follow up, I think it's been a couple of quarters and I was hoping maybe you can provide an update on e-commerce and e.Motion. If there’s anything to share there? Thank you.

We are still in the early stages and are trying to understand why some people say we have a good solution but aren't buying it, at least not in large quantities. We're in the process of figuring this out and are committed to finding a way forward. As long as our customers affirm that our solution is good, we will continue to explore ways to enhance our offerings. Overall, while I don't have a specific figure, customer requests and revenues have increased significantly, which presents challenges for us but is also encouraging. Once we feel more confident in our approach, we will share a revenue commitment.

And again, most of the comments is related to the e-commerce platforms actually in e.Motion we're seeing very good engagement this year with products that are beginning to ramp in revenue. And there’s a pretty broad and diverse number of end-state applications that we probably wouldn't have anticipated even as recent as two years ago. But I think that, that is holding up to expectations for the current year and also as we look ahead into the next year or two.

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