Monolithic Power Systems, Inc. (MPWR) Q4 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by for your Monolithic Power Systems, Incorporated, Q4 and Full-year Fiscal 2011 Earnings Conference Call. [Operator Instructions]. As a reminder, today's conference is being recorded. And now I will turn the program over to Meera Rao. Please go ahead.

Thank you. Good afternoon and welcome to the Fourth Quarter and Fiscal Year 2011 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 uncertainties. These statements will cover a number of areas concerning our business outlook, including our business and financial outlook for the first quarter of 2012, our expectations for first quarter litigation, stock-based compensation and GAAP and non-GAAP operating expenses, our target operating ranges for gross margins and inventory, our expectations for revenue growth and gross margins beyond Q1 2012, our belief regarding the outcome of our pending IRS audit, our belief that MPS is well positioned for future growth, the expected seasonality of our business, our expectations for future product cost reductions, new product introductions for 2012, potential customer acceptance of our products and the opportunity these present, and the prospects of diversification and expanding our market share. Forward-looking statements are not historical facts or guarantees of future performance or events and are based on current expectations, estimates, beliefs, assumptions, goals and objectives, and involve significant known and unknown risks, uncertainties, and other factors that may cause actual results to be materially different from the results expressed or implied by these statements. Risks, uncertainties and other factors that could cause actual results to differ are identified in our SEC filings, including but not limited to our Form 10-K filed on March 4, 2011, and Form 10-Q filed on October 27, 2011, which is accessible through our website, www.monolithicpower.com. MPS assumes no obligations to update the information provided on today's call. We will be discussing operating expense, 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 Q1 to Q4 2010 releases and Q1 2011 to Q4 2011 releases, as well as 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. We would like to start this call by reviewing our fourth quarter business highlights. Following this update, I will discuss our operating results. We will conclude by discussing our expectations for the first fiscal quarter of 2012. We will then open up the call to your questions. Let's start with the business highlights. 2011 was an exciting year for MPS. We successfully executed our plan by introducing many innovative products, expanding our sales and marketing team and winning designs in many new high value markets. These actions will diversify and sustain our future revenue growth. In the process technology and product arena, MPS had a stellar year. We've set a goal to leapfrog our competition by developing multiple generations of process technologies. We are happy to report that the MPS proprietary BCD3 process has been released which offer higher efficiency and up to 50% reduction in die size compared to our previous BCD Plus process. We are qualifying our proprietary BCD4 process which further reduces die size 20% to 50% from BCD2. We introduced many innovative products and scored key design wins in the following market. For industrial and automotive, we had our first wide [ goods ] design-in. Our high voltage DC/DC parts enable the customer to meet new energy requirements. Our high voltage small footprint solution was successfully designed in by a major part manufacturer opening the door to a new market. We continued gaining traction in automotive markets. MPS products are now designed into 6 models at 5 major European car makers and we scored our first design win in Asia. In the networking and service space, we won our first server design-in as a major U.S. company. This has opened the door for future design activity, utilizing our Intelli-Phase family of products. Our new BCD3 DC to DC product, which offers very high performance in a small footprint, won MPS the first design-in as one of the largest networking companies in the world. In addition, we are sampling a high current fully-integrated module for the networking and cloud computing market. In lighting, we won a key A19 incandescent bulb replacement based on the unparalleled performance of MPS's White LED solution at a large lighting company in Japan. We introduced the first of our new flicker-free White LED dimming family of products. The ability to dim to very low levels is generating interest at various large customers. Finally, in high volume consumer market, our newly introduced cool power family of AC/DC products have gained traction in high volume markets. The cool power series are replacing the older generation devices designed on BCD Plus. Our new White LED backlighting architecture solutions is now ramping as a major Japanese TV manufacturer. Easy configuration and the lower system cost empower the customer to design the solution in multiple models. Now we turn to the financial summary. Strong demand activity in December boosted Q4 revenues above the midpoint of guidance to $47.5 million. Enterprise storage revenues ramped up in the fourth quarter. For the year, our revenues came in at $196.5 million, down $22.3 from 2010, mostly due to the Korean TV business loss from 2010. In the manufacturing area, fourth quarter gross margin was 52.5% consistent with the prior quarter and improved by 2 percentage points over the same quarter a year ago. Our internal base of inventories remain well below our target range coming in at 81 days, while inventory at our distributors was lean. Bottom line, non-GAAP net income in the fourth quarter was $5.2 million or $0.15 per fully diluted share. 2011 was also a good year for IT litigation activity. We successfully enforced our rights against a Chinese company that infringed our patent. In the cases against O2 Micro and Linear Technology, the court granted us multi-million dollar attorney fees award against the other parties. Moving to the profit and loss statement. Q4 revenues were slightly above the $47.1 million in the same quarter a year ago and declined $5.5 million or 10% from the prior quarter, largely attributable to seasonal softness in consumer and notebook market. Looking at the fourth quarter revenue by product type. DC to DC revenues were $41.3 million, down 7% or $3.2 million from the prior quarter. Lighting control revenues were $5.7 million, down 29% from the third quarter, mainly due to higher than seasonal slowdown in notebooks and tablets. While Q4 revenues declined in most end markets, enterprise storage revenues were up quarter over quarter, and gateways and set top boxes were relatively flat to the prior quarter. Let's move down to the gross margin line. Our fourth quarter gross margin of 52.5% was above the high end of our guidance range. Product mix was richer than expected. Fourth quarter gross margin was flat with the prior quarter and grew from 50.5% in the same quarter a year ago, largely due to improved revenue mix. Let's review our non GAAP operating expenses. Excluding stock compensation, our non GAAP operating expenses for the fourth quarter of 2011 were $19.5 million, same as the prior quarter. Our non-GAAP operating expenses were up $2.7 million from the $16.8 million we spent in the fourth quarter of 2010 largely due to higher spending on new products and market diversification initiative. Our non-GAAP operating margin was 11.6% in the fourth quarter of 2011 compared with 15.9% in the prior quarter and 15% in the fourth quarter of 2010. Moving on to our reported expenses and operating margin. Our GAAP operating expenses were $22.5 million in the fourth quarter compared to $22.8 million in the prior quarter and $19.8 million in the same quarter a year ago. The only difference between non-GAAP operating expenses and GAAP operating expenses for these quarters is stock compensation expense. Stock comp expense of $3 million in the fourth quarter was flat with the same quarter a year ago and down from $3.3 million in the prior quarter. GAAP operating profit was 5.1% in the fourth quarter of 2011 compared to GAAP operating profit of 9.5% in the prior quarter. Looking to the bottom line, on a GAAP basis, our Q4 2011 net income was $2.5 million or $0.07 for fully diluted share. On an non-GAAP basis, fourth quarter 2011 net income was $5.2 million or $0.15 for fully diluted share. On the tax front, we have an update on the IRS notice of proposed adjustment, or NOPA, that we discussed in the first quarter of 2011 conference call. We recently received a revised notice of proposed adjustment, or NOPA, from the IRS regarding our returns for the years ended December 31, 2005, to December 31, 2007. In the revised NOPA, the IRS reduced its proposed adjustment substantially. This represents a potential income tax liability of $10.5 million plus interest and penalties if any. We continue to believe that IRS position is incorrect and that our cash returns for those years are correct as filed. We expect to contest these proposed adjustments vigorously. Now let's turn to the balance sheet. Cash, cash equivalent and investment were $187.9 million at the end of 2011, up $11.3 million from the $176.6 million at the end of the prior quarter. In Q4, MPS generated operating cash flow of about $13.3 million and used $2.3 million to purchase capital equipment. Cash, cash equivalents and investments were down from $196.9 million we had on the books at the end of 2010. In 2011, we generated $42.7 million of operating cash flow and $6.5 million from ESPP purchases and option exercises by employees. In the first half of 2011, we bought back approximately 2.5 million shares for a total $38.5 million. On August 5, 2011, we purchased as a new corporate headquarters a property located at 79 Great Oaks Boulevard in San Jose for $11 million. We also purchased other capital equipment in 2011 for $8.7 million. Accounts receivable ended the year at $15.1 million, compared with $16.4 million at the end of the prior quarter and $18.3 million at the end of 2010. Day sales outstanding were 29 days in Q4, slightly up from 28 days in the prior quarter and down from 35 days in Q4 2010. Our internal inventories at the end of the year were $20.1 million or about 81 days of inventory on a historical basis, which we managed to less than our inventory model of 100 to 110 days given the slowdown we saw entering the quarter. This compares to the $23.6 million or 85 days of inventory at the end of the prior quarter. Inventory in our distribution channels decreased in both dollars and days. Total days of distributor inventory are lean and at a lower end of the target range of 30 to 45 days, largely due to higher than anticipated re-sales in December. I would now like to turn to a discussion of general business condition. As we entered the first quarter of 2011, inventory in the channel is lean. So all the momentum that we saw in December continued and storage demands continued to ramp. Turning to our outlook for the first quarter of 2012. We are expecting Q1 revenue in the range of $46 million to $50 million. We expect gross margin to be similar to those reported in the third and fourth quarters of 2011. Stock based compensation expenses are expected to be in the range of $2.5 million to $3 million. In 2011, we expanded our sales and marketing team in support for diversification strategy. Expected non-GAAP, R&D and SG&A expense are in the range of $19.5 million to $20.5 million. This estimate excludes the stock compensation estimate mentioned above. We expect litigation expense in the $500,000 to $700,000 range. Our fully diluted share count is expected to increase as the average quarterly stock price goes up. At current levels, the estimated fully diluted share comps were approximately 35.3 million. In conclusion, as we said a year ago, 2011 was a transition year. We successfully executed our plan. We introduced many innovative products, expanded our sales and marketing team, won designs in many new high value markets and effectively increased our serviceable market. We believe that these successes will lead to a growth here in 2012 and beyond. I will now open the microphone for questions.

[Operator Instructions] Our first questionnaire in the queue is Patrick Wang with Evercore Partners.

Just 2 quick questions for Meera, right up front, on gross margins. You had really, really nice gross margins. As we think about the rest of the year as revenues keep ramping here, I know that you guys had under-loading charges from your facility in Chengdu and you used to pay higher wafer costs. Just curious to know, what is the trajectory we should be thinking about margins kind of over the course of the year?

Let me hope the best. I think I will forecast on what we have seen in the region and in quarters that we have seen similar levels. And although we had design wins in the last year, it is difficult for us to project when these revenues will take and have significant effect on the gross margin.

I see. But there is no reason that this is temporary uptick in gross margins. This is structural improvement that we see today?

If you look in the past, in the past several quarters, and the margins continue to improve, improving.

Yes, we expect it to stay at these levels, Patrick.

Okay. Great. And then just a quick one on OpEx before I ask a more interesting question. OpEx is up a bit here in the first quarter. I know you guys said you did a lot of hiring at the end of the year. How should we think about that, again, as you guys continue growing over the course of the year?

We expect it to be just have a little growth from these numbers, but pretty much the impact of the higher annual pay raises are all already baked into these numbers. So there will be a small uptick, but it's going to be small.

Got you. Okay. And then, Michael, I wanted to ask you about process technologies, this is something that I am really happy to hear you guys are kind of going back towards BCD3 coming out, and then of course you guys mentioned BCD4. Can you talk about some of the competitive advantages that you are seeing there, and maybe perhaps the timing of when we will see products based on these processes?

BCD3 all the products are out now and so we see a lot of good results, as Meera said it a while ago. And BCD4, we are trying to rollout by the end of Q3.

By the end of third quarter, okay. And with the products that you've seen out there based on BCD3, can you talk about the kind of customer feedback you've seen, the die shrink and the better performance, something that customers are really flocking towards, or are they kind of pushing back, what are you hearing?

Well, it's all high current products, and without BCD3 we wouldn't be able to do it. And these are very high current products in a very small package that enable us to open the volume of major networking and industrial accounts. And high volume business with the BCD3 out, that price reduction will reduce a significant amount, and that enable us to compete effectively in the high volume market again.

Got you. And then just last question. Can you talk about how your product pipeline and design pipeline looks today based on your new technologies coming out?

As we said it before, we planned the release of our 70 products every year, and these are products we really believe that will further diversify our -- it's a game change, and the seed that we planted in the last couple of years.

Our next question in queue is Vernon Essi with Needham & Company.

I was wondering, Meera, if I would just dive in, and I apologize, maybe you answered this. But your OpEx looks to be going up about $1 million sequentially on this guide. What exactly is driving that and where we will be seeing that? Between R&D and SG&A, or weighted towards one or the other?

You will be seeing the impact of pay raises will be across both R&D and SG&A. But the impact of the hires that we have had is largely going to be in the sales and marketing area. And most of the hires have been done, we will just have a few more as we go through the year.

And then also, will this -- just to follow on that point, will this impact your stock-based comp in the out quarters? Will you be granting more options on the sales side, or what -- should we be expecting it to kind of be in this level through the remainder of the year?

We will have annual repurchase and grants for new hires as we go through. I think the bigger factor that's going to impact our share count for fully diluted shares is going to be our average stock price for the quarter. As the average stock price goes up, we expect that the fully diluted share count would be higher. This just reflects the impact of underwater options coming into the money.

Okay. And just moving over to sort of product front, you -- it's probably more Michael's front here. You have made some comments about the enterprise storage area. Obviously there has been a lot of turmoil in that market of late. How do you see that playing out, I guess, through the remainder of the year. It sounds like you've obviously got an incremental customer on-board. It's ramping. Are you prepared for any other, I guess, disruptions that may happen. I think there is some consolidation also going on, perhaps, with this customer. If you sort of vetted that out, you're confident that your pipeline is pretty strong all the way through 2012?

We have been working with a storage company for over a year. And last year the Thailand event didn't affected us and actually our product went according to schedule and always ahead of the schedule. And in 2012, we have a many more design win in the last year which will grow in 2012.

Okay. So I guess, just to rephrase that then, you are obviously, at this point, confident that this was probably -- I mean and it sounds to me like this was probably your best horse in all the diversification efforts you've made. This is the one you're probably seeing the most demand through 2012 on a year-over-year basis?

This is a first horse, in effect.

That said, this is the first horse, and we have other ones. And we have a set top box, LED lighting, industrial market, and especially control and safety. In all of these, and we will see a significant growth in this year and also in the next year.

Okay. And this is my last point. You brought up the other horse, I'll stop using that analogy. On the LED front, you had an A19 incandescent win out of Japan. How do you feel about that market broadly, are you engaged with some of the top customers that are penetrating more on the western hemisphere, or are you sort of going to be playing more in the Asia-centric vendors?

No. Just the way we probably just to have a significant wins in A19 incandescent bulb replacement, we just reported that was large win. And other ones that we have, of course, in the Northern America and Europe, we engage with all of these traditional light bulb makers. And we have many, many design wins. We haven't really been in the production yet.

Okay. So you have got the design wins with some of these vendors, but none of them except this Japanese one is going into sort of a material production ramp?

That's right, yes.

The next questionnaire in queue is Steve Smigie with Raymond James.

Just some quick housekeeping items. What will the tax rate look like, I know you're going to this -- all these things -- how should we just draw a model, how should we be modeling this year?

In terms of the tax rate, I would say continue to use something like 5% to 10% tax rate, like you have used in the past. Our U.S. revenues are fairly low, so we have a certain amount of volatility from the discrete items, so, but somewhere like in the 5% to 10% range, I think sounds right.

Okay. Great. And then as we look out to the June quarter, typically I just take a mean of the June quarters in the past you guys hit a large number. I know you probably won't give guidance, but just how should we think about the seasonality for June and for September?

Typically Q2 is higher than Q1 and Q3 is higher than that, and it comes down in Q4. Beyond that, I don't want to give any color as to how high it could be, because the last few years have taught us that the seasonality patterns, other than directionally, we cannot predict it.

And at the same time, the MPS business has sort of as we planned it last year, as a transition to higher value market, and we really don't know what's our seasonality, and we'll have to wait, and will play out.

Okay. So I mean, if you have maybe somewhat less consumer and more storage networking type products, should we maybe be a little bit more cautious on that, or am I going to shoot myself in the foot if I model that in an environment where it seems like everybody is sort of turning here and starting to ramp back up?

If you look at our design win activity, then although that's not really a strong indicator of future revenue, but there is more reason for us not to believe we have a significant change.

Okay. Can you just give the 2011 breakout by end market? I think you guys may typically sort of give a year-end number.

Sure. The end markets were, consumer was about 39% to 43%, computing was -- actually let me rephrase that. Let me start again. Communications was about 39% to 43%; computing was about 17% to 21%; consumer was about 31% to 35%; and industrial and others were about 6% to 8%.

Okay. And within lighting, how much, at this point, is White LED, sort of general illumination, and CCFL?

We don't have a CCFL any -- I mean, a very, very small portion of our revenue.

Less than a million.

Yes.

Everything else is White LED.

Okay. Then how much would you say is sort of maybe the higher voltage, streetlight stuff versus sort of a lower voltage, maybe lightbulb replacement type stuff?

I would say it's about, it is in the single million of dollars. And we expect that to increase in 2012, as the decline we talked about it kick in.

Our next questioner in a queue is Ross Seymore with Deutsche Bank.

In general, in the first quarter guidance, is there any big delta between the 3 main segments and how they are going to perform in your guidance as a whole?

We expect it to be roughly along the same lines that we have talked about.

Okay. And then on the gross margin side of things, it's kind of coming out of a prior question, but perhaps in a different angle. Thinking about the fixed cost coverage and utilization, under-utilization charges, et cetera, is the general math that we talked about before that once you get back upward to the 60 million in revenue range that's kind of what we should equate to roughly 55% in gross margin? And then on top of that, as this year progresses, what general sort of mix impact do you think we should be considering with all the new products, kind of higher value add, industrial networking, et cetera, as that blends in, does that kind of round thing to up, or will the consumer side snap back and make mix potentially even a little bit more of a negative?

We expect gross margins overall for this year to stay around 52.5% range. In a quarter, if our revenues were to go up, if it were to go up to around $65 million range, then we would see some improvement in that quarter coming in from better absorption. So we still think, since we are targeting revenue growth, I would say that for the most part of the year, we will be at current levels of 52.5%.

Well, let me add from that angle. Our consumer business, the percentage in revenue stream went down significantly, and I don't see this year it will increase and will keep going down. So the product, and also the high volume business, we reduce the cost significantly. So but at the same time, we still have older generations. So looking into the future, we don't see a significant reduction on the gross margin. We see it in the last 3 or 4 quarters, and we keep it steadily increase slightly. But we don't forecast a big improvement.

Okay. I guess, the one part I am little confused on, I guess the fixed cost coverage to Meera's answer. But from your answer, Michael, it sounds like the mix component to the equation should be positive not only from the new products that you have but the cost down version of the older products. Shouldn't that mean that the mix is a positive contributor to gross margin along with the fixed cost coverage side?

Yes. And I think the mix is the most, is the biggest contributor for the margin expansion.

Great. And then I guess the last question, a little bit more housekeeping. On the litigation side of things, with the cases that you still have outstanding whatever those maybe, the kind of 600,000 you talked about for the first quarter. Is that kind of a new quarterly run rate, or would you expect that to change much with what you know today as the year progresses?

Yes, roughly, I think that's the levels that it's going to be at for the rest of the year.

Next question in our queue is Rick Schafer with Oppenheimer.

Lot of questions have been asked and answered, but one I have is, is there any way for you guys to quantify your design win dollars? I know you have a lot of design win activity over the last 12 months. Is there any way kind of -- for us to think about those dollars that are sort of on the com over the next year or 2?

We try to do that. And we certainly, we have set a criteria what is called design wins. And some of the highly probable and the ones less probable. And we still try to figure out how to comment. And probably by next year this time, we can give you a better forecast based on the design win. At this time, it's difficult for us to say it.

Okay. Okay. Understood. And then I know a lot of guys have asked the utilization question. I am going to ask you in a slightly different way. I am just curious, what is the drag, maybe Meera knows, if you know off the top of your head, but sort of per every 5 basis points of under-utilization equates to a percentage point or half a percent of gross margin drag. Is there a way for us to kind of think about that as we kind of look at you guys ramp towards that $65 million quarterly...

Sure. It is same as what we have said in the past. If you look from $48 million to go up to the $65 million, $70 million, there is 300 basis points that you could get as a pick up from just cost absorption. And so if I think every 2 or 3 -- we may not see it for $1 million or $2 million different, but every $2 million or $3 million of it, we'll see a pickup, a linear pickup, I would say that's the best way of looking at it.

Great. That's super helpful. And then just maybe kind of a housekeeping question. But what are your turns requirement, at this point in the quarter, how does it compare to the same point last quarter, to make the midpoint of your guidance?

Usually, we don't give our turns business in numbers. But recognize that this is an unusual quarter. So we came in with very strong bookings into the quarter and -- so all I am going to say is that, at the beginning of the quarter, we needed less than 20% turns business to hit the midpoint of our guidance.

[Operator Instructions] Our next questionnaire in queue is Tore Svanberg with Stifel Nicolaus.

Maybe some more specific questions. First of all, when you talk about storage being now a nice revenue contributor, are you talking specifically about for management to SSD, or is it something else?

Both, HDD and SSD.

Very good. And when we think about BCD3, and you mentioned you can now go up to really high currents, what types of current are we talking about? And as you launch BCD4 in Q3, how much higher will you be able to go?

We are now at a 40m curve single chip now. I don't remember the size, 3 by 4 package, millimeter package.

And with BCD4?

With the BCD4, we haven't really released any product now. And the chip size will be, as Meera indicated and said earlier, about 20% to 15%, for the high current, and probably will be another 30% reduction from the size. And but we haven't released any product yet.

Very good. And maybe I -- either I misunderstand it or maybe you guys are just being conservative, but your inventory seems pretty depleted at this point, which probably means that you are going to have to build some inventory this quarter to keep up with demand. I mean, why wouldn't you already get some gross margins upside just from that alone regardless of mix?

It is, the inventory is pretty low, but as you know, that the world is very -- in the recent periods, is very high, so we are play it very safe.

Very good. And Michael, I don't know if there is a way to measure there, or if you have this number, but just thinking about the diversification efforts, is there a way to put a percentage of revenue that's not coming from, let's say, new products introduced over the last 2, 3 years?

Well, frankly, at this time, I don't have the numbers. And I am glad to answer you -- Meera, if you have -- okay, Meera, okay.

If you look in Q4 about 30%, 32% of our revenues came in from new products that we launched in the last 2 to 3 years.

And at this time, I am showing no additional questionnaires in the queue. I would like to turn the program back over to Ms. Rao for any closing remarks.

Thank you for joining us on this call, and thank you for your many questions. We look forward to talking to you in the next quarter. Bye-bye.

Thank you.

Thank you. Again, ladies and gentlemen, this does conclude today's conference. Thank you for your participation, and have a wonderful day. Attendees, you may disconnect at this time.