Good day, ladies and gentlemen, and welcome to Monolithic Power Systems Incorporated's third quarter 2018 earnings conference call. At this time, all lines are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will be provided at that time. If anyone should require operator assistance during today's call, please press star then zero on your touch-tone telephone. As a reminder, this conference is being recorded. I'd now like to turn the conference over to Bernie Blegen, Vice President and Chief Financial Officer. Please go ahead.
Thank you. Good afternoon, and welcome to the third quarter 2018 Monolithic Power Systems conference call. In the course of today's conference call, we will make forward-looking statements and projections that involve risk and uncertainty, which could cause results to differ materially from management's current views and expectations. Please refer to the safe harbor statement contained in the earnings release published today. Risks, uncertainties, and other factors that could cause actual results to differ are identified in the safe harbor statements contained in the Q3 earnings release and in our SEC filings included in our Form 10-K filed on March 1st, 2018, and Form 10-Q filed on August 2nd, 2018, both of which are accessible through our website, www.monolithicpower.com. MPS assumes no obligation to update the information provided on today's call.
We will be discussing gross margin, operating expense, R&D and SG&A expense, operating income, interest and other income, net income, and earnings on both a GAAP and 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 2017, Q2 2018, and Q3 2018 earnings 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. Let me start by telling everyone that our Q3 2018 quarterly revenue of $160.0 million established another record for MPS, our fifth high-water mark for quarterly revenue in the last six quarters. Likewise, non-GAAP gross margin grew ten basis points sequentially, representing the twelfth consecutive quarter MPS' non-GAAP gross margin has either expanded or matched the prior quarter's performance. As expected, we reached the $160 million revenue milestone, reflecting strength in each of our targeted market segments. Q3 revenue for Computing and Storage up 64% year-over-year, Automotive up 54%, and industrial up 52%.
During the quarter, MPS did experience some unexpected softness in high-volume consumer-related businesses, especially in the Greater China region. However, we still see high demand for these products and remain optimistic in our prospects for high-end consumer products. We also gained market share in low-end communication segments. We will stay opportunistic in these high-volume businesses and focus on growing higher-margin products. Looking at our revenue by end market. In our Computing and Storage market, revenue of $47.7 million increased $18.6 million, or 64.2% year-over-year. Growth in the market was broad-based when compared to the year-ago quarter, with all applications, high-end notebooks, cloud computing, and storage increasing at rates well above the market average. Computing and storage revenue represented 30% of MPS' third quarter 2018 revenue, compared with 23% in Q3 2017.
Third quarter 2018 industrial revenue of $24.9 million increased $8.5 million, quarter of 2017, primarily due to increased sales for applications in power sources, meters, and security. This market represented 16% of our total third quarter revenue versus 13% in the prior year. Third quarter automotive revenue of $19.8 million grew $6.9 million or 53.9% over the same period of 2017 as a result of increased sales of infotainment, safety, and connectivity application products. Automotive is MPS' largest SAM opportunity at $7 billion, and we are in the early stages of penetrating this market. In the years ahead, we plan to offer a number of new products for applications in body control, lighting, infotainment, ADAS, and battery management. Automotive revenue was 12% of MPS's total Q3 2018 revenue, compared with 12% for Q3 2017.
Third quarter Communications revenue of $19.2 million increased $3.8 million, or 24.6%, over the same period of 2017. This represents a combination of share gains in our legacy markets and initial ramping in products for the 5G network. Revenue from consumer markets of $48.5 million decreased $6.8 million, or 12.4%, from the third quarter of 2017. Consumer revenue accounted for 30% of our total Q3 revenue, compared with 43% in the prior year. While loss of revenue in these high-volume consumer markets is likely a reflection of geopolitical or trade policy changes, we did not lose projects and continued to gain market share. GAAP gross margin was 55.6%, 10 basis points higher than the second quarter of 2018, and 60 basis points higher than the third quarter of 2017.
Our GAAP operating income was $33.5 million, compared to $24.9 million reported in the second quarter of 2018, and $23.8 million reported in the third quarter of 2017. For the third quarter of 2018, non-GAAP gross margin was 56.1%, 10 basis points higher than the second quarter of 2018, and 40 basis points higher than the third quarter of 2017. Our non-GAAP operating income was $49.2 million, compared to $41.4 million reported in the prior quarter, and $38.9 million reported in the third quarter of 2017. Let's review our operating expenses. Our GAAP operating expenses were $55.5 million in the third quarter, compared with $52.7 million in the second quarter of 2018, and $47.0 million in the third quarter of 2017.
Our non-GAAP third quarter 2018 operating expenses were $40.5 million, up from the $36.9 million we set in the second quarter of 2018. Up from $32.9 million reported in the third quarter of 2017. On both a GAAP and a non-GAAP basis, third-quarter litigation expenses were $343,000, compared with a $639,000 expense in Q2 of 2018. A $327,000 expense in Q3 2017. The difference between non-GAAP operating expenses and GAAP operating expenses for the quarters discussed here are stock compensation expense and income or loss from an unfunded deferred compensation plan. Total stock compensation, including $471,000 charged to cost of goods sold for the third quarter of 2018, was $14.8 million, compared with $15.9 million recorded in the second quarter of 2018.
Switching to the bottom line, third quarter 2018 GAAP net income was $31.6 million or $0.71 per fully diluted share, compared with $0.55 per share in the second quarter of 2018. A $0.54 per share in the third quarter of 2017. Q3 non-GAAP net income was $47.3 million or $1.06 per fully diluted share, compared with $0.90 per share in the second quarter of 2018. A $0.84 per share in the third quarter of 2017. Fully diluted shares outstanding at the end of Q3 2018 were 44.7 million. Let's look at the balance sheet. Cash, cash equivalents, and investments were $353.1 million at the end of the third quarter of 2018, compared to $318.7 million at the end of the second quarter of 2018.
For the quarter, MPS generated operating cash flow of about $52.2 million, compared with Q2 2018 operating cash flow of $25.4 million. Third quarter 2018 capital spending totaled $5.1 million. Accounts receivable ended the third quarter of 2018 at $59.9 million, or 34 days of sales outstanding, compared with the $53.5 million or 35 days reported at the end of the second quarter of 2018. The $50.8 million or 36 days reported in the third quarter of 2017. Our internal inventories at the end of the third quarter of 2018 were $136.8 million, up from the $128.9 million at the end of the second quarter of 2018. Days of inventory decreased to 175 days at the end of Q3 2018 from the 189 days at the end of the second quarter of 2018.
Days of inventory are in our new range, reflecting changing customer requirements, particularly in automotive and computing. Our new product introductions. Turning to our outlook for the fourth quarter of 2018. We are forecasting Q4 revenue in the range of $151 million-$157 million. We also expect the following: GAAP gross margin in the range of 55.2%-56.2%. Non-GAAP gross margin in the range of 55.6%-56.6%. Total stock-based compensation expense of $13.5 million-$15.5 million, including approximately $500,000 that would be charged to cost of goods sold. GAAP R&D and SG&A expenses between $50.6 million and $55.6 million. Non-GAAP R&D and SG&A expenses to be in the range of $37.6 million-$40.6 million. This estimate excludes stock compensation and litigation expenses. Other income is expected to range from $1 million-$1.2 million before foreign exchange gains or losses.
Fully diluted shares to be in the range of 44.6 million to 45.6 million shares. In conclusion, as expected, we continued to execute according to our plan of diversification in both products and geographical markets. We grew in greenfield segments while gaining share in high-value products in consumer and communications amongst the uncertainty in the market and geopolitical environment. I will now open the phone lines up for questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question at this time, please press star then 1 on your touch-tone telephone. If your question has been answered or you wish to remove yourself from queue, you may press the pound key. We also ask that you please place your line on mute once your question has been stated to prevent any background noise during response. Once again, that is star then 1 to ask a question. Our first question comes from Matthew Ramsey with Cowen. Your line is now open.
Good afternoon, guys, and congratulations on a strong set of results with a lot of uncertainty out there. The question that we've been getting the most often is, there's a lot of new content growth and market share gains that are embedded into the long-term forecast that investors have for your company across a number of businesses. Maybe, Michael, you could talk about at a high level how you're progressing there, and then just juxtapose that against a lot of concerns about a weaker macro environment. Just I know that folks have an expectation of 20% growth for your company over the next couple of years, and we're just trying to understand the risks associated with that versus the opportunities for share gains. Thank you.
All right. Okay. As you know, in here, we're not in a position to answer what the macro position is. We only heard from you guys. We have a very small percentage of a market share, particularly in those greenfield market segments, such as autos and data centers, as well as.
Industrial
The industrial side. We have a very little market segment. Those segments should be relatively immune to what the market condition is. We expect it to grow according to our plan. In the next few years, we're all set.
No, got it.
I think one point to add to that is that we're continuing to be very aggressive as far as securing new design wins, that as we said in our prepared comments, that while there has been a downturn that's reflected most in our consumer business, we didn't lose market share, in fact, we continue to make gains.
No, that commentary is really helpful. I guess as a follow-up, I've spent a decent amount of time with my team digging into the programmable aspect of MPS Solutions as you sort of bring programmability into the portfolio. Michael, maybe you could talk a little bit about at a high level what % of the products that you're shipping now, and then I guess second, winning designs with are programmable in nature today and how you might see that trend going forward and what that might mean for market share. Thank you.
All right. Okay. At this point, still probably a single-digit percentage of our total revenues. We expect a quadruple in the next couple of years. Probably most likely in the four or five years, 100% of our product will be programmable.
Got it. That's really helpful. I'll jump back in the queue if you don't mind. Congratulations and well done. Cheers.
Thank you.
Thank you. Our next question comes from Rick Schafer with Oppenheimer. Your line is now open.
Thanks, and I'll add my congratulations, guys, on a nice quarter. Obviously auto and industrial, each up 50% plus in the quarter. I think the auto business is tracking to something north of $80 million this year. Mostly it's been infotainment, I think now you're starting to see lighting and motor control start to ramp. Maybe you could walk us through what that next leg of growth there looks like. I know, Michael, you talk a lot about having two, three years of really solid visibility there. I'm curious, as ADAS and BMS wins ramp, what the timeline looks there, what we could see for a margin impact. When would we start to see a noticeable margin impact within that auto business?
Even I talk about infotainment, we still scratch the surface. We just start at the periphery, as we just went through all the business, the deep dive in all those segments, we just started on even in the infotainment. For next couple years, we have all these products designing, such as the lighting, including headlights, also as Bernie said earlier, the body controls, like motors, any kind of moving pieces in a car, we have an electronic control. We have those product designing. ADAS, I see it in three years out. All these activities, we have to pick and choose which product we want to do. We just don't have enough people.
Our name is out, our product reputation is out, we are proven to be a quality supplier, the margin will be stay same as now or even be higher.
Got it. Thanks. Switching gears to e-commerce, I know it's something that I think a lot of people care about with you guys. Maybe start with any customer feedback or what the feedback has been from customers so far. I know you've talked about adding hundreds of customers there. I know you've also talked about, I believe, first revenues or material revenues in 2020. I'm curious, do smaller customers, that e-commerce would be targeting, do they need to go through a full qual like some of your more established, larger customers? What I'm getting at is could we see revenues in e-commerce pull forward? Could we see those start to hit before 2020?
Very possible. Particularly those are smaller customers in the industrial shops. They buy 10 to 20,000 units a year, and those are the customers. If we prove to be a quality supplier, and they will stay with us for years. Those ones just starting it now. In terms of how their feedback is, so far our website still is not, and we still have a lot more to do, and particularly under the e-commerce market segments. Okay. How do we do digital marketing? We start to do this year and early next year, you will see some significant changes. In terms of our current feedback, so far, we hand them a floppy disk, and they download it. Almost every one of them, they're very happy. They want to see more of these type of products.
Well, I can't say every one of them, and we have, in recent months, we gained more than a few hundred customers. Most of them, they wanted these kind of products. Okay.
Have you seen any competitive response from some of the larger HPA guys?
I think that these are. We address the very segment of the market, and we don't see any other players, and that they do a similar thing as we do.
Okay. Thanks a lot, Michael. Thanks.
Thank you. Our next question comes from Quinn Bolton with Needham. Your line is now open.
Hi, guys. Congratulations again on the very steady execution. Michael, Bernie, just wanted to sort of address, I guess one of the biggest investor fears I hear is kind of the order rates declining in the China region. Can you give us any sense whether those order rates, which sound like they started to decline late summer, whether that's stabilized or are they still sort of on a downward trend? And maybe just address the sort of where you are in terms of starting backlog looking into the fourth quarter of 2018. I think the last few quarters, you'd gone in to the quarter with nearly 100% of plan in backlog, and then maybe a couple of product follow-ups. Thanks.
Sure. I think that you can see from the Q3 numbers that, and again, the comments that we referenced, that in the Greater China market, that we did see a downturn in demand, particularly for consumer. As a result of that, we are sort of monitoring to see if that branches out into our other end markets, or if there are any changes in ordering pattern. You referenced also our last three quarters as far as what our experience has been with backlog going into the quarter. In fact, what we've seen in this quarter is that we've sort of returned to a more normalized level, where we're not at the accelerated pattern that we've been experiencing previously, but is really, again, returned to a more normalized backlog for this time in the quarter.
It's something that we have to continue to monitor and certainly as there are different developments, we have demonstrated the ability to respond to that. I think the thing that is most encouraging for us is that the targeted areas that we focused on, again, the automotive, the computing and storage, and the industrial, where they have long ordering visibility, that those remain very solid and that we're just seeing gains that are significantly better than market.
Great. Michael, could you just address, as we look into the end of 2018 and 2019, Intel will be launching their Cascade Lake platform by the end of the year, and then the new Whitley or Cooper Lake platform, maybe second half of 2019. I know Purley was a big uptick for you in terms of server content. How do you feel you're positioned with Cascade Lake and Whitley or Cooper Lake over the next 12 months?
I think I expected it. I think that we grow, we don't expect it to have anything different, okay? In all the designing activities and all the new product release, we expect it as the same as the last couple of quarters. I think it even grow faster. Most of the revenue is going to grow in the next 2019 all the way to 2022.
Sort of a steady ramp in server power management over that 2019 to 2022 timeframe?
Yes. Yes. They are in a similar rate of growth.
Got it. Okay. Thank you.
Yeah.
Oh, go ahead, Bernie.
No, I was going to say that, what you were referencing is that Intel has been adjusting their product release schedule around a couple of different issues. Obviously, that's something we need to adapt to. We don't see it as a negative to it or an impediment to the growth that Michael's referring to.
I care less about plus, minus couple of quarters.
Yeah.
That's out of our controls, but the direction of the growth, and that we cover not only from traditional servers, all these new AI systems and the new type of servers, we cover all of them.
Great. Thank you.
Thank you. Our next question comes from Ross Seymore with Deutsche Bank. Your line is now open.
Hi, guys. Congrats on the result and guide in a tough environment. Just wanted to get into the inventory and the channel side, and dovetail that into the backlog question that was asked a bit ago here. While Bernie, you said that the backlog coverage has returned to normal. Over the course of this year, correct me if I'm wrong, have you guys been shipping to the elevated backlog? Have you been controlling it? Where does channel inventory stand today?
Sure. The reference that you're talking to is between Q1 and Q2, that we'd actually had a decline in terms of channel inventory in terms of days. As we look ahead here, both as far as how we finished Q3 and in Q4, a lot of the sales commitments that we have for both quarters are related to commitments that were made upwards of four to six months ago. We are continuing to deliver against that. With the amount of uncertainty that is in the market, the timing of when that gets drawn from the channel is a little bit changed. We went up a little bit in Q3, and I don't know, I don't have a forecast for how Q4 is looking, whether it'll go up or down a little bit. Again, it's something that we have to continue to monitor.
I guess similarly to that, as the backlog falls, the fear people have for the whole market and companies like yourself is that what goes from 100% coverage plus to something that's normal, then the next step is a further step down. I know you guys have a great secular trend over the course of a number of years, how do you guys mitigate that risk as we look into, say, the first half of next year?
Yeah. Okay. The inventory became my favorite questions now, Ross. We have a lot of growth in the new market segments, it changes the pattern how we do inventory. In auto, industrial, and telecom, now the 5G networks, although the revenue is small, it start to ramping. Also, as well as data centers and the cloud computing, we really need a lot of inventory to cover the ramp. Regarding to all these traditional high-volume business, those businesses we can go in and out within a half years. We're not worried about the inventory.
We're basically prepared to be able to service the targeted markets. We believe that as you look at the first half of 2019, that they are less impacted by the price sensitivities that might occur as a result of the tariffs or geopolitical trade policies. Then, as Michael just said, that on the areas that are more affected, we have the ability to course correct, and as we demonstrated in Q3, even within the quarter, to be able to achieve our revenue goals.
Yes. A high inventory, again, is my favorite now. High inventory in a company like MPS, we have to build the reputations. Irregardless the condition, we will ship. We will ship our product. We're the newcomer, we have to have a record of reliability as well as a continuation of a delivery. We never have that kind of problems. Any one glitch that cause a lot more problems, a much bigger market cap hit than a few million dollars in a few days of inventory.
Great. I guess as my last question, as you guys look back to the last cycle in late 2015 and early 2016, it was barely a blip for MPS. You still in 2016, grew, I think, 16%-17% year-over-year, way above the analog market as a whole. If you're just to compare and contrast the positioning of MPS today versus what it was looking like back three years ago, can you just walk through some of the puts and takes as you see it?
Sure. I think that, obviously with all of the new product releases that we've had that really started to ramp beginning in the second half of 2017 and now are in full swing, we have a much different portfolio that we're able to manage. From that regard, I think that the diversification, both in terms of products and markets and geographies, allows us an awful lot of flexibility that we didn't have back at the second half of 2015. Having said that, I would hate to try and draw a parallel between 2015, which ended up being a rather short-term and pretty much an issue specific to the semiconductor industry, and what we're observing today. I don't think that people have enough visibility or confidence as to how long this current environment might last.
Great. Congrats, guys. Thank you.
Thank you.
Thank you.
Thank you. Our next question comes from William Stein with SunTrust. Your line is now open.
Great. Thanks for taking my question. I just want to make sure I understand the narrative around end markets and demand trends. Consumer came in light as customers backed off orders in that end market that you think is attributable to tariffs, but you made up more than the difference in the comms end market. Want to make sure I have that right, and also understand better about what drove that upside in comms. Is that something that perhaps if the consumer end market would've been fine, that you would've posted meaningful upside to the quarter, or was this something that sort of came and surprised you to the upside or was there a lot of extra work that it took to drive this to allow you to deliver good results, as you usually do? Helping me understand that would be great. Thank you.
Thanks, Will. There's a couple of observations. If you look at consumer sequentially from Q2 to Q3, this was a lower increase than we historically experienced. It was fairly broad-based as far as the number of areas that were impacted. Interestingly, that's in traditional consumer or high-value consumer end markets, we actually performed pretty well. Then as far as the ability to course correct within a quarter, even with relatively short lead time, we play opportunistically in a lot of different markets. Historically, we have not taken on the comms business, this is referring to our legacy gateway and router business, because it tends to be lower margin and in this quarter, we were able to really just pivot.
It was not a lot of effort in order to be able to accept opportunities that we have an opportunity to quote on and bring that in within the quarter. As I look ahead, I think the most encouraging thing is that we can have that opportunity. We see the comms business is actually lining up in very good shape for Q4. I think one of the most encouraging things that might have been a slight upside surprise is that we started to see some very initial sales on the 5G side.
Yeah. The comm business is, in the last few quarters, we are flat or slightly down. They have a refresh, okay, and we gained some market shares. There's a significant portion of it, we see the 5G network start to ramp. Those product we designed it back in a couple of years ago.
A follow-up, if I can. When people ask about what's perhaps something that investors don't understand about Monolithic, one of the answers I've heard you give is that, well, consensus for next year is up 16%, and we think long-term growth's at 20%. Would you still endorse a 20% growth number for 2019, or would you think that's too optimistic given the geopolitical and other risks?
I think that we will clearly beat whatever your forecast is for the next year industrial growth. We will beat about 15 points or higher.
I think that when we look at next year, as far as our confidence in 20%, that remains very consistent and solid. Again, one of the things that we want to be known for is our consistency of execution, and that we can support that, again, with the amount of visibility we have, particularly in these targeted areas that have the longer design cycles and longer ordering patterns. Now, having said that, we're not immune to the macro and certainly in the first half of the year, we feel reasonably confident that we have the shots on goal to be successful. We don't have clear visibility on how that's going to play out in the early stages of the year.
Okay, thanks.
Thank you. Our next question comes from Tore Svanberg with Stifel. Your line is now open.
Yes, thank you, and congratulations on the record operating margin. A few questions here. First of all, I know you have some operations in China, and certainly your supply chain is there. Any changes to that strategy at all? I know it's really early days, right? Just given some of the macro political turmoil, any changes to the thinking at all about your operations in China at this point?
We need to diversify. We have a lot of resources from in China. Two years ago, we started to diversify in the different political regions. In terms of R&D, mostly all these are development jobs. All these other geo-political issues, we thought about our controls, if we see the one region down, the other region's up, okay? That's the area we really want to focus on and diversify our presence.
Okay. Very good.
Tore-
Go ahead.
No, no, go ahead. Finish the answer, yeah.
Yeah, I was just going to say that on the supply chain issues right now, Michael's exactly right. We don't have control or visibility as far as what the next steps in the process. Again, to the extent that we diversify in the end markets that we sell into, and the different customers we have, we would probably adapt a similar profile longer term for our supply chain as well.
That's very fair. A question on 5G. You're starting to see some revenue contribution there. Is that power management that's based on Intelli-Phase or QSMod, just like in the data center market, or are these different types of power products?
There are other types of products in the different network segments. As well as the way you said it, that it is based on the Intelli-Phase, and those product in the high power computing segment of 5G.
Okay. Very good. I think you may have already answered this question, Michael, but as far as your lead times, since you obviously are so focused on making sure the deliveries are there, I assume your lead times are still very stable. They were stable the first half. They're stable now?
Yes. The lead time is very stable.
Yeah. We've had no change in the lead times in all phases of production, whether it's wafer packaging test, everything's going very consistently.
Okay, very good. Just one last question. You generated almost $50 million in free cash flow this quarter. I know sort of your approach to capital management, but just kind of based on where the stock price is, any thought about how to put that free cash flow to use?
Well, either we're going to increase the dividend or looking for some technology company we are buying. In a way, I'm not going to buy another company for revenue increase.
Sounds good. Congratulations again on all the record results this quarter. Thank you.
Thank you.
Thank you. Our next question comes from Alessandra Vecchi with William Blair. Your line is now open.
Hi, guys. Congratulations on a great quarter.
Thanks, Alex.
Just to go in a little bit more on the consumer side and the weakness you've been seeing there. I think historically you guys have said that of your consumer revenue, about 50% of it is traditional, I think 30% of it is high value, and 20% of it is gaming. Are you seeing the weakness in gaming as well, or is it only in that 50% traditional bucket? If it's in the traditional bucket, should we consider the whole 50% weak, or is it only parts of that? Just sort of trying to quantify where consumer could go from here, given that seems to be the one bucket that's the most at risk in the short term.
Yeah. I hate to say that, when the last couple of times we talked about gaming, our customers were not happy. Okay?
All right.
The one time I said it wasn't my favorite topic, and our customer heard that. There's a lot of money to be made, and we 100% support it. Go ahead. Here is that, for that regard, and we see high volumes, and we're not talking about what kind of gaming, and we see a bit softness, and it needs high volume ones. Other than that, and we see the connected device or the IoT, if you will, okay, and the variety of other gadgets, and we see in our designing, or we see the market demand is still very similar.
Okay.
Okay.
Similarly, just in terms of the Q4, you guys traditionally don't give us any sort of granularity on the directional segment or the direction of the different segments. If you had to say on the segment from Q4 what's strongest to weakest, should we still think about Computing and Storage as the strongest and then maybe Industrial and Optical, or how has that shifted?
Yeah. Again, I think if you look at the results, clearly, what we saw in Computing, Storage, Automotive, Industrial, those weren't one-time drivers. This is all about the secular expansion that we've been discussing now for several years, we're now seeing the results come in full term. I don't see anything in the outlook that would indicate a diminution of those growth rates. As far as how we manage the margin with the consumer, that's something that we're adept at being able to do. I think that as we look at Q4, we feel very confident, not just in the number in total, but also the individual markets as far as that are going to source that growth.
Understand. That's very helpful. I think that's it for me.
Thanks, Alex.
Thank you.
Thank you. Our next question comes from Chris Caso with Raymond James. Your line is now open.
Yes. Thank you. First question with regard to inventory levels. Can you talk about what your visibility is, both to the distribution channel and to OEM inventories? I know that through the year, you guys have been taking steps to try to discourage customers, to prevent customers from building excess inventory. Could you speak to some of those actions and your level of visibility and confidence in the inventory levels?
Yeah. That's my favorite question, Chris. Inventory, I tried to convince you, all of you guys, okay, it's good for us to increase it. Now I think we are pretty normal.
As far as inventory in the channels, again, I'll just refer to an earlier response, is that in the prior three quarters, we had experienced a pattern of over-ordering, and this is reflected in higher than normal historic backlog levels at certain points in the quarter. While we've seen a moderation of that is changed because there is a certain level of uncertainty. We want to make sure that we're really satisfying real demand as opposed to creating a problem for us down the road. Having said that, with the channel, and we did a very thorough assessment of it at the end of Q3, as well as what we expect to be the sell-through in Q4, and that all got taken into account as we gave our guidance for Q4 in total.
Right now we're feeling that we're getting timely feedback, and we're managing it accordingly.
All right, great. I guess, just following on from that, could you talk about what you consider to be normal seasonal patterns in Q1? I know there's not a lot of visibility right now, and I know you're probably doing a lot of work on that, but are there any aspects that we should take into consideration with regard to Q1 based on what you're seeing right now?
Yeah. We only provide guidance one quarter ahead. I don't want to overreach with any comment. If you traditionally look at, with the exception of last year, which was an unusual set of circumstances because we had greenfield opportunities, particularly in the compute and storage that were introduced, that we've traditionally had a step down from Q4 to Q1 of between 3% to 4%.
Got it. Okay. Thank you.
Thank you. Once again, ladies and gentlemen, if you'd like to ask a question, please press star then one on your touch tone telephone. We do have a follow-up from Quinn Bolton with Needham & Company. Your line is now open.
Hey, Bernie, you kind of addressed it answering Chris's question, just I guess wanted to ask specifically, as you look into your distribution channels, I think there's, especially in uncertain environments, a tendency for the distributors to reduce their inventories into calendar year-end. I guess when you look at your fourth quarter forecast, you said you took into account sort of the supply chain and the disti channel. Are you expecting them to reduce their days of inventory in the fourth quarter, or do you expect them to sort of keep a constant days inventory on hand? Any guidance you could provide us would be helpful.
Yeah. The formula sort of works that the channel tries to reduce the dollar value of inventory in Q4, the denominator as far as the quarterly revenue in Q4 is less than Q3. My expectation is that the dollars will be at or below the Q3 level, and the days may be at or maybe even a little above in Q4, and it's really a arithmetic exercise rather than anything that we're concerned about.
Okay. Thank you.
Thank you.
Thank you. I show no further questions in queue, so I'd like to turn the conference back over to Bernie Blegen for closing remarks.
Thank you. I'd like to thank you all for joining us for this conference call, and I look forward to talking to you again in our fourth quarter conference call, which will likely be in February. Thank you and have a nice day.
Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.