Bernie Blegen - VP, CFO Michael Hsing - Chairman, President and CEO.

Anil Doradla - William Blair Rich Schafer - Oppenheimer & Co. Ross Seymore - Deutsche Bank Quinn Bolton - Needham & Co. Tore Svanberg - Stifel Nicolaus David Wong - Wells Fargo Securities Steve Smigie - Raymond James.

Good day, ladies and gentlemen, and welcome to the Monolithic Power Systems' Third Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand the floor over to Bernie Blegen, Chief Financial Officer. Please go ahead..

Thank you, Karen [ph]. Good afternoon and welcome to the third quarter 2016 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 Form 10-K filed on February 29, 2016 which is 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, 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 2016 and Q3 2016 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. Revenue for the third quarter was $106.5 million, up 16.7% from a year ago.

Non-GAAP gross margin at 55.3% was 20 basis points higher from the prior year, and non-GAAP operating income was $29.4 million, up 24% year over year.

Our growth in third quarter revenue over the prior year was due primarily to a 30% gain in computing and storage revenue and continued growth in our industrial market segment where revenue increased 22.8%.

In our computing segment, revenue increased to $23.5 million compared with the $18.0 million reported in the prior year, reflecting strength in high-performance notebooks and servers.

In our computing and storage market segment, much of the revenue increase is attributable to market validation of our power management solution based on MPS's digitally designed quantum state modulation or QS Mod.

Digital design allows our power management module to deliver the precise amount of power even as processor requirements go from peak to minimal in as little as a few nanoseconds. This is critical as cloud computing servers include a number of power-hungry features such as quad-core processors.

The increasing power requirements of these features introduces difficult trade-offs for OEM power supply designers. In order to meet these dynamic power requirements while maintaining a small form factor, designs must be extremely energy efficient and plays a premium on reducing component count, complexity and size.

We believe these characteristics, characteristics which are specific to our proprietary digitally designed QS Mod products are valuable to OEM designers.

As the server market transitions from Intel's Grantley family to Purley in about one year's time, we expect this significant design win activity we have enjoyed to date to translate into market share and revenue gains.

In our industrial segment, sales rose to $23.2 million, compared with $18.9 million reported in the prior year, fueled by increased product sales for automotive and smart meters. Over the past few years, MPS has been recognized by tier 1 OEM automotive customers as a high-quality and reliable supplier.

We expect our future growth in automotive will be supported by the attractiveness of our superior efficiency and ease of use. We will continue to invest in our quality and customer support capabilities as we enjoy gains within this market segment.

In our consumer segment, revenue increased 10.5% to $43.6 million, compared with $39.5 million in Q3 of 2015. A majority of this increase was driven by sales gains in IoT and home appliances. As we look ahead, we see continued improvement in IoT, home and appliances, gaming and other selective high-value consumer opportunities.

In our communication market segment, revenue of $16.2 million rose $1.4 million from the year-ago quarter, reflecting gains in gateway revenue. Finally, development of our E.MOTION product family is continuing, with customers evaluating our single-chip prototype.

We are further refining the software and firmware and optimizing its performance based on specific customer demand. We remain positive about this game-changing E.MOTION technology. Turning back to the financials.

Compared with the prior quarter, Q3 2016 revenue increased $12.4 million or 13%, reflecting revenue gains in computing, consumer and communications. Revenue mix for the quarter was 41% consumer, 22% industrial, 22% computing, and 15% communications.

Q3 non-GAAP net income was $27.5 million or $0.66 per fully diluted share, compared with $0.55 per share in Q3 2015 and $0.54 per share in the previous quarter. This result is computed with an estimated tax rate of 7.5%. Let's review our operating expenses.

As indicated on last quarter's call, we expect an increase in operating expenses this quarter as we ramped investment in new product development, incurred costs associated with the development of our fourth fab, and capitalized on new business opportunities through strategic sales and marketing investments.

As such, our non-GAAP third quarter 2016 operating expenses of $29.4 million were $1.7 million higher than the $27.7 million we spent in the second quarter of 2016. Our third quarter 2016 GAAP operating expenses of $42.9 million were $3.5 million higher than GAAP operating expenses reported in the second quarter.

The difference between non-GAAP and GAAP operating expenses for these quarters is stock compensation and an unfunded deferred compensation plan. Stock comp expense increased $1.8 million between quarters, reflecting a catch-up adjustment for the performance-based element of our MPSU program. Now let's look at the balance sheet.

Cash, cash equivalents and investments were $264.4 million at the end of the third quarter of 2016, up $15.2 million from the $249.2 million at the end of the prior quarter. Third quarter cash flow from operations was $33.3 million, compared with $12.8 million reported in the prior quarter.

This increase in cash flow reflected a decrease in net working capital and other long-term assets. Spending on capital equipment and office-based totaled $11.1 million. We paid $8.2 million in dividends in third quarter. Accounts receivable ended the third quarter at $33.3 million, up from the $31.4 million at the end of the prior quarter.

Days of sales outstanding were 28 days -- days of sales outstanding were 28 days in the third quarter of 2016, which was 2 days lower than the year-ago quarter and 2 days lower than the 30 days reported in the second quarter of 2016.

Our internal inventories at the end of the second quarter were $70.7 million, higher than the $69.9 million at the end of the prior quarter. Days in inventory at the end of Q3 of 133 days decreased 14 days from 147 days at the end of Q2.

Inventory in our distribution channel decreased from the Q2 2016 level, reflecting an overall increase in end-customer demand. I would like now to turn to our outlook for the fourth quarter of 2016. We are forecasting Q4 revenue in the range of $101 million to $105 million. We also expect the following.

Non-GAAP gross margin will be in the range of 54.8% to 55.8%. GAAP gross margin will be in the range of 53.9% to 54.9%. Total stock-based compensation expense will be between $11.8 million to $13.8 million. Litigation expenses will be between $100,000 to $200,000. Non-GAAP R&D and SG&A expense will be in the range of $27.3 million to $29.3 million.

This estimate excludes stock compensation and litigation expenses. Interest and other income should be between $200,000 to $300,000 before foreign exchange gains and losses. Fully diluted shares will be in the range of 42.0 million to 43.0 million shares.

In conclusion, thanks to acceptance of our new product offerings and with our shareholder support, we will continue to invest and deliver outstanding products for our customers and consistent results to our shareholders. I'll now open the phone lines for questions..

[Operator Instructions] Our first question comes from the line of Anil Doradla from William Blair..

Hey guys. Good job and congrats. So I had a couple of questions.

So, can you go over the compute strength, especially in the context of Purley and what's going on? Has there been any change? And if so, what are the key reasons here?.

Thank you, Anil. So as far as the current quarter performance, we really saw the growth drivers to be sort of evenly split between our performance in high-end notebooks as well as in the server model. And as we look out ahead, those should be continued sources of strength, well into next year, before the Purley cycle transitions.

So at this point, as far as the adoption rate and the ramp activity that we've been expecting, we don't see any changes..

Okay, great. And on automotive, can you give some qualitative idea of the contribution? I know you've had somewhere, anywhere between I think one-third or something like that.

How much of -- is auto as part of the industrial today?.

Sure. So I usually wait until I get a full year of activity before we sort of break out the segmentation. So you are correct that, at the end of last year, automotive accounted for about a third of industrial, which would represent about 7% of our total.

It has been growing at an attractive double-digit rate, high double-digit rate, albeit not as fast as it had in 2014 and 2015 when it doubled..

Great, guys..

This is Michael. This is Michael..

Hi, Michael..

Yeah. Both automotive and computing segments are -- where MPS just entered only two or three years in the market. Three years ago we have a zero revenues and now we have a fraction of the total market size. So the opportunity for growth is very big..

Excellent. Congrats guys, and looking forward to a great 2017..

Thank you..

Thank you..

Thank you. And our next question comes from the line of Rich Schafer from Oppenheimer..

Thanks guys, and great quarter. I had a couple of questions. Maybe the first one, I haven't asked this one before, but I know we focus a lot on your opportunities with all your new products, your new markets you're getting into and penetrating.

But if we look at your business by customer, can you comment on any significant new opportunities there? Any sort of potential 10% type customers that you see over the next year or two?.

We don't see it. We have -- we gained more than 10% of number of -- 10% of customers. As a matter of fact, we don't have any. And in the last few years we tried to hard to diversify the company product portfolio and also customer portfolio -- customer profile.

And we found out in the last few years that we expand our customer base by, I don't have exact numbers, by four, five times. And probably even more. And so it's a lot more than diversified now. And I will continue our -- in the future, I will continue to see the same trend..

Okay..

And probably add to that, very quickly, is that we're able to demonstrate in a lot of different market segments where we've been introduced to new customers and we've started out with some relatively low-end offerings and then we've been able to incorporate their feedback into our design and sort of go up as far as the amount of dollar content that we sell into them.

So I think that in addition to just the pure acquisition of new customers that Michael referenced, we've also been able to do a good job of capitalizing on those relationships and growing them..

Okay. And then just a follow-up on storage, I mean it's up very big again for you guys.

I mean, are we already beginning to see the benefit of the ASP bump you guys enjoy with the new PCIe and SAS PMICs, or is this something else that's driving the growth and that's still going to be an incremental leg-up?.

I think that in storage, and again I referenced this in the previous call, is that, you're exactly correct that we have very good opportunities there and it is as we increase the dollar content. The real story in the segment has to do again with the notebooks and servers.

In storage we have sort of a mixed view as you've got some gains accruing in SSD and then some sort of mixed signals in the HDD market. So I think that you're going to see a very positive trend for that segment that's going to be at or just below our corporate average, but really the near-term growth drivers are in the servers and in the notebooks..

Got it. And then my last question, and I know Michael will laugh [ph], I know he says he can't grow the company out of thin air, but fourth quarter OpEx seems a little higher than we expected. I mean, what drives that in 4Q? And when can we expect OpEx growth to probably drop closer to your target range, closer to 50% of top line? Thanks..

Well, I'll let Bernie to answer that question..

I'd be happy to. Thank you very much, Michael. So as far as the operating expenses, I think that two of the big growth drivers there have been our investment in new products as well as an increase in investment in sales and marketing. And much of this has been achieved through headcount acquisitions.

While the pace of those headcount additions is probably going to slow, we'll need to annualize those costs next year, and then on top of that, we will continue to make selective net headcount additions.

So the punch line in this is that we're probably going to look at a flattening in our rate of growth and returning to, you know, our expense model, but we don't expect to go, you know, see a decrease in the growth of -- the rate of growth of the operating expenses..

Got it. Thanks guys..

All right. Thank you..

Thank you. And our next question comes from the line of Ross Seymore from Deutsche Bank..

Hey guys. I wanted to ask a little bit of a longer-term question. On the last call you talked about getting your revenue growth maybe at or above even 20% the back half of next year. It sounds like you have a lot of good drivers just from tonight's call that you've already talked about.

But if we put it in a 2017 as a whole perspective, what do you think will be the biggest tailwinds from a product cycle point of view? And are there any headwinds?.

I don't see any headwinds and all these products, like servers and like power modules and among the other things, okay, we talk about it, and a lot of them, especially from a computing side, is not really up to MPS, okay? We did what we can and all the seats are planted [ph]. And we see the initial results.

And the higher growth, okay, as we expected -- high growth rate and we expected next few years, is all depending on the whether the adoption rate of new models. And this is the same as in all the other area.

We have many design win activities and many projects under qualifications, and whether it's -- if we're going the same trend and the growth rate will be much higher than the corporate average in all the segments..

And just to add to that, is that I think you did a good job of saying that the two near-term growth drivers are firmly in place and we're seeing good execution.

And then as we look to next year, we believe that the ramp of new product introductions, in particular with the new server opportunity, as well as the modules start to ramp, will be additive to that..

I guess that's a perfect lead-in to my follow-up. When you were talking about the near-term trends, the positive trends in the computing side of things, you mentioned a good roadmap of growth up until Purley.

Talk a little bit about what happens again when Purley launches? Because, correct me if I'm wrong, but I believe that actually should be a further acceleration as opposed to what could have been perceived in your answer prior as something changing to the negative..

Exactly right. Thank you, giving me the chance to clarify that point. Is that, as we looked at the last two to three years, we've developed relationships with many of the tier 1 and tier 2 server providers. And in the Grantley, the current version, we've sold low dollar content for point of load and for e-fuses [ph].

And as we looked to the transition to the Purley sometime in the fall of next year, we expect also to be able to complement those sales with our V-core [ph] solution. So our dollar content per server will go from $13 per box up to $49 per box.

So we're very optimistic with the design wins that we've already seen converting into market share and revenue gains..

Great. Thank you..

Okay, let me, okay, add on this. I don't have -- in terms of a high growth rate in the 2017, okay. As I said it earlier, we expected that. In this near term, and I don't have any crystal ball as everybody else, but I'm very firmly believe and in the future, 2017, 2018, 2019, when everything is in place..

Great. Thanks again..

Thank you. And our next question comes from the line of Quinn Bolton from Needham..

Hi, Michael; hi, Bernie. Just wanted to ask one on the OpEx. You guys have been ramping or spending on ramp in a fourth foundry. And I think on the last call you had said that most of those incremental expenses would be wrapped up by the third quarter.

Just wanted to see if you could give us an update on the fourth foundry spending?.

Sure. The fourth foundry has been developing quite nicely and in fact almost entirely according to plan. So we're actually very pleased with the development.

Now the news that's additive to that is that we've made the decision to be able to transfer more new products into the fourth fab because we find that it's -- the capacity is there to take advantage of, as well as there are certain cost advantages that we've been able to take advantage of.

So on that basis, we would see that we're going to continue to invest into next year, albeit at a lower rate, but still there'll be, you know, additional wafer spend and map sets as we bring the new products up in the next two to three quarters..

Yeah. Overall we just do it as we promised. We grow revenues, okay, and we grow the OpEx, less than 60% of the revenue growth. And so last year, everybody criticized us, we go 61%, okay, [inaudible] just 1%. Next year we'll be in the model..

Great. Okay. And then I was wondering, I think you guys -- you talked about your high-value consumer opportunities for a while. I think one of those being gaming. It sounds like you guys have had some success on that front. Just wondering if you could provide a little bit more color as you look into 2017, how important gaming could be next year..

Sure. I think that we've been consistent there as far as once again it's an area where there's three primary gaming companies and we've been developing relationships primarily with two of them, although not to the exclusion of the third.

And once again I think we've seen that we've started out with sort of lower-value content and then been able to further develop those relationships and increase the content. So as we look ahead to design wins that we have solidified for next year, we seem very positive for continuing growth in gaming..

The gaming is just like any other segment. We have -- we clearly see our advantage in being, as a matter of fact, in all computing segments. Gaming is a part of it and use a lot of computing power and it's very opportunistic, and we will get the market..

Great. Thank you..

Thank you. And our next question comes from the line of Tore Svanberg from Stifel..

Yes, thank you, and congratulations on another record quarter. You want a trick-or-treat question? Sorry, bad joke. So, first question, can we dig into automotive a little bit more? You talked about your dollar [ph] content in server. But if we look at automotive, my understanding is so far most of the growth has been coming from LED lighting.

At what point do you start to see really an inflection point as far as dollar [ph] content in automotive and what are some of the technologies or components that would come from?.

Sure. I think that I'm going to answer this from the inverse as far as some of the areas that were probably not as receptive to go into, and then I can develop the more optimistic form of the answer, is that automotive is an area that we want to be measured where we invest our technology.

We're doing a very good job as far as developing our QA and our reliability, but there are areas in the automobile such as the powered train and the ADAS that may not be as high a value to us when you take into account what the risk potential could be.

So we'll continue to expand in our areas that we have much more strength as far as the infotainment, as in the body lighting and audio systems, and in certain aspects, both safety as well as in the networking.

But we're also making sort of a cautious approach to automotive so that we make sure that we are able to uphold what's best for the company as well as for our shareholders..

Yeah, the automotive, we will be criticized that if we spend money to build up the infrastructures for all these safeties [inaudible]. And now we just play what we can. And we're not explaining the budget..

Okay, that's helpful. And a question on the quantum state modulation technology. Obviously that's giving you great success for design wins in the server market.

Is there any other areas out there that we should keep an eye on as far as where that technology is applied and you're gaining some design wins?.

Yeah. As we said -- as I said the last quarter, we didn't do well in the communication area. So, although we gained some high-value targets and we exchanged with low to more in the high value content in the revenue stream.

I said we will release some good killer products in the market segment, and that's a quantum state, QS Mod, like we'll have a series of products we're going to announce in this quarter. And if you go to Electronica, we will show it there..

Very good. One last question, you've obviously talked in the past about programmable power modules. I was just hoping to get an update there, because that technology is sort of thought of being used to go after the industrial market. And just want to understand your success there so far, especially with the sales strategy..

It is slow process, okay. We gain market -- many segments of the market accepted it, that from IoT, from industrials, autos and communication segment, even computing, that's in the service, right? And the revenue is ramping but it's still small. It's not that small anymore, but it's ramping.

It hasn't really moved the needle yet, the entire company's revenue. That, I expected that will be next few years you will see a significant revenue contributors..

And just to sort of complete the thought, what differentiates us is both the power management technology, but as importantly, it's the energy efficiency and the ease of use. And we think that, as we look forward to the adoption rates, particularly as we convert from the predesigned modules into field programmability, we see significant opportunities.

We're very committed to this market..

The product that we're going to announce is -- we'll have any current up to 500 amp current, up to 500 amp. And everything can be modulized and require a very or no -- very minimal or no design work..

Very good. Congratulations again guys..

Thank you..

Thank you. And our next question comes from the line of David Wong from Wells Fargo..

Thanks so much.

Can you give us a rough idea of what proportion of your storage division, storage and computing division, is servers? And was the year-over-year growth in server in the September quarter?.

Sure.

The servers, again using the full year numbers, the -- I'm sorry, did you say storage or servers?.

Servers.

Yes, what proportion is servers?.

Okay. So again using last year as sort of the baseline for it, servers only accounted for between 10% and 15% of the market segment, and the growth of servers is not quite triple digits but it's in the very high double digits this year..

Great. Thanks very much..

Thank you. [Operator Instructions] Our next question comes from the line of Steve Smigie from Raymond James..

Great. Thanks guys. I was hoping you could talk a little bit about computing in Q3 and Q4 or all storage and computing, in the sense that, thinking what we saw with Intel, had a very strong quarter, but then the guidance is a little bit below expectations.

It sounds like overall the business is looking really great, but I just want to try to make sure I have expectations right for Q4.

Would it be fair to say that Q3 is maybe a little bit stronger than expected and so Q4 might be down a little bit more than seasonal or something like that?.

So if you look at Intel, they're looking at the desktop and the notebook market in total, both the high end and low end. And we're benefiting from sort of an upswing that's occurring currently with both the adoption of our technology into the high-end notebooks, as well as the development of pretty strong performance in the high-end notebook market.

So that's what differentiates ourselves I think from their story. And we did have a good performance in Q3 which actually fell in line with our expectations, and we don't necessarily see that same falloff in Q4..

Okay, great. And then within industrial, you guys mentioned the strength in metering as you did last quarter. Can you talk about how big that is? And I'm assuming overall industrials is still pretty disperse and that's just kind of one example, but I was kind of wondering how impactful metering is to that overall business at this point..

Sure. Metering has actually been growing very, very well. And while we tend to focus primarily on the automotive part of the story of industrial, meter is growing at a rate that is significantly above our corporate average and it's not from an insubstantial base.

So when you look industrial, again, as you said, we are very diversified because we also have sources coming -- revenue sources coming from meter as well as security and point-of-sale systems, and all three of those lines are developing quite nicely..

Okay.

And last question was just, could you give some sense sequentially how you might expect each of the segments to perform?.

Sequentially, I think if you look at our guidance here, revenue is decreasing in Q4 a little less than normal seasonal average. And really that reflects the diversification because we're seeing sort of flattish performance in the communications and computing.

You have a normal sort of seasonal down in consumer and we still see good growth in industrial..

Okay, great. Thank you..

Thank you. And our next question is a follow-up from the line of Tore Svanberg from Stifel. He just left the queue. With no additional questions at this time, I would like to turn the conference back over to Bernie Blegen for closing comments..

I'd like to thank you all for joining us on the conference call and look forward to talking to you again in the fourth quarter conference call. Thank you and have a happy Halloween..

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a great day..