Good day, ladies and gentlemen. And welcome to the Monolithic Power Systems Inc. Q2, 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will follow at that time [Operator Instructions].

Also as a reminder, this conference call is being recorded.At this time, I'd like to turn the call over to your host, Bernie Blegen, Chief Financial Officer. Please go ahead..

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 Web site, 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 2018, Q1 2019 and Q2 2019 releases, as well as to the reconciling tables that are posted on our Web site.

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 end 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 sales 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 have 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 $22million was essentially flat with the first quarter of 2019.

Sales for our legacy router and wireless applications decreased sequentially, while sales -- 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 $168 million.

We also expect the following; GAAP gross margin in the range of 54.9% to 65.5%; non-GAAP gross margin in the range 65.3% 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..

Thank you, sir. [Operator instructions] Our first question comes from Rick Schafer from Oppenheimer. Please go ahead..

Congratulations guys on results. And I know it's not easy to it 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..

And maybe on that topic to, Michael or Bernie, maybe just a little color on what's happening with China auto. There's -- it doesn't sound like it. But if there -- I mean I guess you did mention auto is picking up a little.

So is China specifically is -- are you seeing signs of pick up there? And maybe as part of your answer on auto, I'm curious just if you could talk about some of the design win momentum you guys have there with auto OEMs, tier ones.

How the pipeline is stacking up through all this downturn? I assume there's still a fair amount of design activity going on?.

Yes, our auto as that goes up slightly, I don't know this is from is it noise. It is from a 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 and including OEMs, and the level of engagement and the level of meetings that they requested, and it 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 result of the new model years being rolled out, particularly in North America, Europe and Korea..

And then just as a quick housekeeping question, if I can, I'll sneak it on. Just on your Huawei exposure. I know it's small for you guys. I think you said low single digits. I mean, some companies have talked about being able to ship that there's not -- basically everything -- because they're not national security.

Can you give some color on what you're able to shift to Huawei, how much of that low single digit exposure are you able to actually to ship out to them? Thanks..

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.

And 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 level of uncertainty related to tariffs and trade that we did see a step up in volumes in Q2 as certain customer build inventories in advance of any further bans..

We are not depending on Huawei to grow..

Thank you. Our next question comes from William Stein from SunTrust. Please go ahead..

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 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 think of Q4 usually is that we are slightly lower and not up to single digits. And in the last few years and last two or three years, the seasonality -- we don't know what's our seasonality is. When you grow 16%, 17%, 20% some percent, and so the seasonality is not very clear to us.

But the Q4, I think is that we are either flat or slightly down, and I don't know what the -- I forgot the last year number, maybe slightly up almost. Last year it was down..

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, one more thing. So I very much agree with you. This year it's -- we don't have a clear views in how the industrials growth. And only we can do is do our best effort to have a design win and to engage with our customer closely..

Thank you. Our next question comes from Tore Svanberg from Stifel Nicolaus. Please go ahead..

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 at 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?.

Tore, thank you very much for your earlier compliment. Yes, the consumers are little bit hard to handicap. I think that you're aware that we parsed it into three general groups, high value, gaming and traditional or legacy. And historically, I think that legacy has had a certain seasonality, it was relatively predictable.

But even that's gone out the window as we've seen a softening of demand more clearly in Asia, China, but not exclusively there.And actually the high value, which has a lot of exposure to home appliances, actually has rebounded nicely and is continuing strong.

And I think you're also aware that as we start to go into the holiday season that gaming is going to pick up. So it's not clear that -- I would be cautious in using any term like bottomed out or that, it's more that we have a different -- slightly different mix within those three buckets..

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 server, 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 think those are, to the extent that they're commercially available, they're very early stage. And we don't have enough momentum to clearly identify a trend line, as we said that if we -- take 5G, for example.

We're very well positioned with our technology on any number of different platforms with any number of different companies in any of the representative geographies. So we think that, again, the diversification, both in for the technology and what our point of entry is, gives us a lot of confidence that we'll do well.

But again, it's going to take time for that market to develop. I think initially that and some of the other high end processing, which you can include AI in, are going to start out a little bit lumpy before a true ramp becomes apparent..

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 don't know there's a 55 nanometer is the accurate enough, okay. Yes, we do use a 12 inch. And we starting to 12 inch wafers. And those are, as you said that these use -- we'll always use a trading edge of advanced equipment. And when we build -- these equipment available then we moved in.

And those are with solid development always, not two or three years or two or three years later that will benefit our costs and also the features that we can offer 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..

Thank you. Our next question comes from Alessandra Vecchi from William Blair. Please go ahead..

Hey, congratulations on the good quarter. Just a quick question on the gross margins, it's not a surprise that they've been trending flat over the last few quarters.

So if we look out into next year, what do you need to see happen to resume that 20 basis points of sequential improvement? Is it really -- is it a mix situation, or is it predominantly an in-demand situation?.

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 build our productions for much higher capacities, and now we see the growth slower. So that has partially also impacted in 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?A - Michael HsingYes, we have a design wins, and we have a design win of -- 48 volts we believe is a inevitable solution as power goal keep going up.

And so we started a few years ago we developed that kind of solutions. And it's kind of a widely accepted and we expect to have revenue to ramp now. But we don't know if the customers push out the projects but we're still expecting a ramp in the near future in the next couple of quarters..

Thank you. Our next question comes from David Williams from Loop Capital. Please go ahead..

First, I guess I wanted to see if you could talk maybe about your channel inventories, and how you're feeling about that. It sounds like maybe some of the appliance over inventory has been digested a bit.

But throughout the other markets, how do you -- I guess, can you give a sense on how your inventory levels are there? And just how you expect those to trend 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 acknowledge 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. And then Bernie you had noted prior that you thought that you could maintain kind of revenue growth that was 10% to 15% above what the industry was averaging.

Do you still feel comfortable with that? And just kind of looking at where you are this year, do you think you can do better? Or how do you -- I guess is that still I guess stick to measure by?.

As I said earlier, this is a kind of uncertain market now, and our customers will not give us a very clear feedback. So that's all -- these are out of our control and what we do the best is have a product designing. And one way or the other, they will turn into a revenue..

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 the 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 doing a good because we ignored all the macro -- total macroeconomy, and we do -- we can do the best when we can control it..

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..

Thank you. Our next question comes from Quinn Bolton from Needham. Please go ahead..

This is Michelle on for 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 Street 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 Street 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 think we’re kind of a committed we can grow better than the industry average by 10% to 15%. That's all we’re committing that. And even that -- I look at our history, that's what we have done in the past. And this year, I think is the same, this year it’s kind of not very certain. And we'll look back the same as like 2012 and 2008.

And those are very uncertain years. And that's what we have -- what we 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..

And then one just on the project delays. I think you guys kind of touched on that.

But I was just wondering, if there's an update as far as it's been -- if you've seen an increase in these delays or how the delays you saw since our first quarter call, have changed over the past quarter?.

We don't -- it's difficult, some are big project delays and some small project advance. So the weight of each project, we don't have a very clear accounting -- method of accounting and the company is in a way migrated, we’ve become like a 3,000, 4,000 products. And we have again -- at any given time we have a few thousand projects going on.

And so we don't know..

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..

Thank you. Our next question comes from Matt Ramsay from Cowen. Please go ahead..

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 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 slow down, other one 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 quarters I was hoping maybe you can provide an update on e-commerce and e.Motion. If there’s anything to share there? Thank you..

Still very early, early stage. We try to figure out the why people don't -- or why people tell us have a good solution but nobody buys it, okay. And at least not selling like hotcakes. And we're still in the midst of figuring out why and how we can. But we’re committed.

And as long as people say our customers this is a good solution and we'll keep figuring out. But overall revenues and also design -- customer request is -- I don't have a clear number but increases tremendously and we have difficulty to handle that. And that's a very good encouragement.

And once we feel we have a handle on it we will give you 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 two expectations for the current year and also as we look ahead into the next year or two..

Thank you. [Operator Instructions]. I am showing no further questions in the queue at this time. I'd like to turn the call back to Bernie Blegen, Chief Financial Officer for closing remarks..

Great. I'd like to thank you all for joining us to 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..

Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may all disconnect. Good day..