Good day, ladies and gentlemen, welcome to the Monolithic Power Systems second quarter 2018 earnings conference call. At this time, all participants are on a listen-only mode. If anyone should require assistance during the call, please press star then zero on your touch-tone telephone to reach an operator. Later, we will conduct a question and answer session, instructions will follow at that time. As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Mr. Bernie Blegen, Chief Financial Officer. Sir, please go ahead.
Thank you very much. Good afternoon and welcome to the second quarter 2018 Monolithic Power Systems conference call. Michael Hsing, CEO and founder of MPS, is with me on today's call. In the course of today's conference call, we will make forward-looking statements and projections that involve risk and 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 Q2 earnings release and in our SEC filings, including our Form 10-K filed on March 1st, 2018, and Form 10-Q filed on May 8th, 2018, 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 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 2017, Q1 2018, and Q2 2018 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. In the second quarter of 2018, MPS set new high water marks in quarterly revenue and non-GAAP earnings per share. MPS's Q2 revenue of $139.8 million was 8.2% higher than revenue in the first quarter 2018, 24.6% higher than the comparable quarter in 2017. MPS's sales momentum continues to build as we generate superior results from our R&D investments targeting the computing, automotive, and industrial markets. Looking at our revenue by market. In our computing and storage market, revenue of $37.0 million increased $12.5 million or 51.1% year-over-year.
Growth in this market was broad-based when compared to the year-ago quarter, with all applications, cloud computing, storage, and high-end notebooks increasing at a rate well above the market. Computing and storage revenue represented 26.4% of MPS's second quarter 2018 revenue. Second quarter automotive revenue of $20.3 million grew 58.2% over the same period of 2017, fueled by product sales for infotainment, safety, and connectivity application products. Automotive revenue was 14.6% of MPS's total second quarter 2018 revenue. In our consumer markets, revenue of $47.8 million increased 8.9% over the second quarter of 2017 and represented 34.2% of our second quarter 2018 revenue. The year-over-year revenue increase reflected gains in home appliances, IoT-related applications, and specialty lighting. Second quarter 2018 industrial revenue of $19.1 million increased 27.2% from the second quarter of 2017, due primarily to increased sales of industrial power supplies.
Industrial represented 13.7% of our total second quarter 2018 revenue. GAAP gross margin was 55.5%, 10 basis points higher than the first quarter of 2018 and 80 basis points higher than the second quarter of 2017. Our GAAP operating income was $24.9 million compared to $22.0 million reported in the first quarter of 2018 and $15.0 million reported in the second quarter of 2017. non-GAAP gross margin for the second quarter of 2018 was 56.0%, 10 basis points higher than the first quarter of 2018 and 40 basis points higher than the second quarter from a year ago. Our non-GAAP operating income was $41.4 million compared to $37.2 million reported in the prior quarter and $31.2 million reported in the second quarter of 2017. Let's review our operating expenses.
Our GAAP operating expenses were $52.7 million in the second quarter of 2018, compared with $49.5 million in the second quarter of 2018 and $46.5 million in the second quarter of 2017. Our non-GAAP second quarter 2018 operating expenses were $36.9 million, up from the $35.0 million we spent in the first quarter of 2018, and up from the $31.2 million reported in the second quarter of 2017. The differences 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 2018, total stock compensation expense, including approximately $480,000 charged to cost of goods sold, was $15.9 million, compared with $15.0 million recorded in the first quarter of 2018.
Switching to the bottom line, second quarter 2018 GAAP net income was $24.2 million or $0.55 per fully diluted share, compared with $21.9 million or $0.49 per share in the first quarter of 2018, and $15.0 million or $0.35 per share in the second quarter of 2017. Q2 non-GAAP net income was $40.0 million or $0.90 per fully diluted share, compared with $35.0 million or $0.79 per share in the first quarter of 2018, and $29.5 million or $0.68 per share in the second quarter of 2017. Fully diluted shares outstanding at the end of Q2 2018 were 44.4 million. Now let's look at the balance sheet. Cash, cash equivalents, and investments were $318.7 million at the end of the second quarter of 2018 compared to $312.5 million at the end of the first quarter of 2018.
For the quarter, MPS generated operating cash flow of about $25.4 million compared with Q1 2018 operating cash flow of $16.3 million. Second quarter 2018 capital spending totaled $5.6 million. Accounts receivable ended the second quarter of 2018 at $53.5 million, representing 35 days of sales outstanding, which was one day higher than the 34 days reported both at the end of the first quarter of 2018 and at the end of the second quarter of 2017. Our internal inventories at the end of the second quarter of 2018 were $128.9 million, up from the $111.9 million in the first quarter of 2018. Days of inventory increased to 189 days at the end of Q2 2018 from the 177 days at the end of the first quarter of 2018.
The increase in inventory days is due to a buildup in advance of seasonally high Q3 revenue, changing customer requirements, particularly in automotive, computing, and gaming applications, and hedging for potential upside in the second half of 2018. I would now like to turn to our outlook for the third quarter of 2018. We are forecasting Q3 revenue in the range of $155.5 million-$161.5 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 $15 million-$17 million, including approximately $500,000 that will be charged to cost of goods sold. GAAP R&D and SG&A expenses between $52.3 million and $57.3 million. Non-GAAP R&D and SG&A expenses to be in the range of $37.8 million-$40.8 million.
In anticipation of higher revenue in the next two to three years, we are stepping up investment in our foundry capabilities. We are actively qualifying two 12-inch fabs and are in the process of developing advanced technologies. Other income is expected to be in the range from $600,000-$1 million before foreign exchange gains and losses. Fully diluted shares to be in the range of 44.0 million-45.0 million shares before share buyback. We are continuing to execute our long-term business strategy, which we believe will maximize long-term shareholder value. I will now open the phone lines for questions.
Ladies and gentlemen, if you'd like to ask a question at this time, please press the star then the number one key on your touchtone telephone. Again, that's star then one if you'd like to ask a question. Our first question comes from the line of Ross Seymore with Deutsche Bank. Your line is now open.
Hi, this is Gabriel Ong on behalf of Ross. Thanks for letting me ask a question results guide. Just want to focus in on the auto business a little bit. It's kind of grown from being your smallest business line to now larger than both comms and industrial. At the analyst day, you guys detailed that you could see auto growing at a 40%-50% CAGR. Auto grew about a 60%-65% CAGR from 2013-2017. Is it fair to think of auto growing at about a Anyone from, what, maybe 40% CAGR going forward through 2021? I guess, how do you guys think about the growth going forward?
Sure. At the analyst day that was on June 7th, we characterized growth for the next three years of being in the range between 40%-50% in any given year, and on a quarterly basis, because there's sort of a step function with how revenue increases here, that it could be between 30% and 60%. I think that you're in the right ballpark for your CAGR.
All right. Appreciate that. Next, I'd like to ask about the inventory dynamic that you guys had this quarter. I understand you guys have some prepared remarks, but I'd love for you guys to elaborate a little bit more on it. Inventory's up 39% year-on-year. That's ahead of revenues for actually the sixth straight quarter. Maybe there's some mix dynamic there. I understand with auto, maybe some of your parts have a longer life cycle and maybe require more of a build. Is there anything else that you'd like to elaborate on why inventories continue to be outgrowing revenues?
Actually, you gave a pretty complete answer for me there, in that, we're experiencing-
Well, Bernie already said it in the earnings, right? One of it is that we're hedging the potential future growth. I can give you more color, is that we have so many products introduced in the market. They start to ramp. A lot of them, we still haven't seen the revenue yet. During the ramps, you don't want to see any hiccup, either the number of the product or the quality issues. We don't have any history of it. So we have to be very cautious. We use the cash wisely, and we never intend to do, in MPS, in the history, we don't write off a lot of inventory. So if you want to talk about our inventory, okay, this is how we manage it. Okay. We have long life cycles. Okay.
As long as we see the growth, grow the top line, grow the EPS, I don't care the rest of it.
Okay. Appreciate that. Thanks.
Our next question comes from the line of Quinn Bolton with Needham and Company. Your line is now open.
Hey, guys. Congratulations on the nice results for June and the particularly strong guide for September. Just wanted to start with the September quarter. Is there anything in particular, any one end market where you're seeing particular strength, leading to that guide, or is it pretty broad-based? Then I've got a couple of follow-ups.
It's pretty much broad-based, all the growth areas that we covered in the last few quarters, the story remains the same. We're at the very beginning, and all the product ramping is across the board.
You guys still feel pretty comfortable with hitting that 8%-10% share of the server power management market for all of 2018?
Yeah. Our expectations for the server market have not changed in the 18 months since we started discussing it in those terms. We're seeing very positive results and very good acceptance, and continuation of good volume.
Great. Then just wanted to ask, some others in the industry have been constrained by the supply of ceramic capacitors and passive devices and just wondering if you're seeing those same constraints. If so, are you doing anything to try to avoid some of those constraints, possibly purchasing passive devices that you can sell as part of your solution to the customers, or any thoughts on the supply of passives and whether it's impacting your business?
Yeah, it does impact our business. Lot of product ramping are just not as high as we expected it. We are looking heavily at the design around, without using the capacitors.
Okay. Then lastly, for you, Bernie, you mentioned the step-up in spending here to qualify two 12-inch foundries. Sounds like that might be a two to three-year phenomenon. Does that take you above the OpEx as a percent of sales in that range of 50%-60%, or do you still think you can kind of target that 50%-60% OpEx growth as a percent of revenue growth?
Yeah, I think for a brief period of time here, I don't know how many quarters necessarily that's going to be, but while we're ramping and qualifying the two fabs, we will be beyond what our model is. We're very conscious of the need to get operating leverage and return spending down to the 50%-60% of revenue growth. I would say that probably for the next four to five quarters, maybe as long as six, we'll probably be above that level.
Okay, great. Thank you.
Your next question comes from the line of Rick Schafer with Oppenheimer. Your line is now open.
Okay, thanks. You guys, congrats on a nice quarter.
I guess maybe I'll start off with the e-commerce question. Maybe an update on the progress there with that effort. I know you're already adding some customers, I'm just curious what feedback has been, maybe if you could quantify what that opportunity looks like for you guys over the next couple of years or put some kind of, I know that's tough, but put some kind of, quantify it somehow, I guess, give us a TAM, kind of how you guys look at that.
Well, okay, I can answer you the first question first. The website's up. It still looks pretty shitty, but we will improve it later. We do have orders come from our own website, and the programmable modules, we push them out there. This is at trajectories, and okay, it can be what we cannot even predict. Because this is from nothing to something. We look at the numbers, and in the last couple of months, it's better than I expected. We keep evaluating. Stay tuned.
Okay. For now, I assume we're keeping it out of the model for now, I guess.
Yeah.
Yeah. Keep out of the model now.
We've kept revenue expectations, made a conscious effort to keep them low for 2018 and 2019. Really what we're trying to do is get up to speed on what it takes to market and successfully manage the e-commerce experience. During this time, we'll also be adding more products and getting traction with customer acceptance.
Got it. Maybe switch gears to 48V core power. I know in the next couple of years, you guys have talked about 48V coming to GPU and CPU. I guess, maybe if you could walk us through what that timing looks like of that, who you're likely to compete with there. I think GPU probably ramps before CPU, so maybe what has to happen for that to go.
Yeah. We expected hitting the mainstream in the early or mid-
2019
2019. We've been looking at it. We've been developing that product for the last three years, we see this as imminent in solutions for the future servers. I can't answer who do we compete with because there's no such solution out there. Maybe there's a few. Our solution will be mass-produced and easy to use. In the last few years, we have many design wins.
Just to add real quickly, as Michael said, that we've had this project under development for three years, I think that there are a couple of data points in the market today that validate the timing of having our solution released in 2019 was a good set of circumstances for us. We're in the right place at the right time with the 48V solution.
Got it. Just a quick clarification question, if I could, on 300 millimeter. Where do you guys stand today? Do you have any design wins on 300 millimeter, or is that still on the come? Maybe if you could update us on the ramp of any design wins at 55 or 65 nanometer.
These are some of the stuff we're hitting the market very soon. I don't know, is the first shipment, or certainly we start sampling it.
Okay. Thanks.
Slightly different development tracks where the 55 effort will probably have design wins early in 2019, and the 300 millimeter will probably be more out in 2020.
Great. Thanks.
Your next question comes from William Stein with SunTrust. Your line is now open.
Great. Thanks for taking my questions. Congrats on the very good results and outlook. I wanted to return to the comment about hedging for potential upside in the second half. Is there a particular end market that that's weighted towards? Likewise, would you anticipate sort of the variability and potential upside to be more of a Q3 event, or is there something special in Q4 that we should think about? Then I have a follow-up, if I can.
Yeah. I think that, as we said on the call, that there's really three or four key areas that are driving a lot of our business. Within that, what we've tried to do is, we're working within a range of expectations for any one of those. Generally, what we've done is we've modeled in our revenue expectations, the midpoint or below, but we've provided the inventory at the upper end of the range that has been provided to us by the OEM or from the end customer. It really could be any one of the opportunities in computing and storage or automotive in particular, where we could experience a pop.
Thanks, Bernie. Appreciate that. Maybe backing up, you offered an initial take on e-commerce. I wonder if there's any change in the customer traction relative to the eMotion product.
It's the same eMotion products and a lot of them I see, we're rather selling the ICs, and we're selling the total solutions. It's a lot better way, a lot easier way to generating revenues or to service our customers. I learned it from the last couple of years. I see this is the same kind of it'll lead me to the same kind of things.
On the eMotion, that is starting to ramp very nicely right now. We've seen a lot of design wins that we have, not just in 2018 and 2019, but even 2020 and 2021, that we're already going to be benefiting from. That is an initiative that we started in earnest about four years ago, and that's about how long it takes for these things to ramp. Whereas the e-commerce platform and the field programmability offered on it, we're just in the very early stages of that.
Great. Thanks for that clarification. Congrats again on the good results and outlook.
Thank you.
Thank you, Will.
Your next question comes from Tore Svanberg with Stifel. Your line is now open.
Yeah, thank you. Congratulations on hitting all these records. First question, the 12-inch fabs, I understand the OpEx element of it, how should we think about that impacting your gross margins over time? I would think that that could potentially be pretty accretive to your gross margin.
Tore. You covered us for a long time and you know that our pattern is that we move from the early days, the good 6-inch, then we go eight-inch. The eight-inch was the first eight-inch. It was a 0.35 micron fabs then and now. We work and wait until these 180 nanometer fabs depreciated further, then we move there. Each step we move to a new foundry, a more advanced fab, that it doesn't impact the margin immediately. Those 12-inch fabs, and they're still expensive, okay, but three, four years later, that will be cheaper. We just follow our history. We repeat the same thing. By the time we have superior technologies and good cost.
Very good. I believe last quarter, your ASPs were up sort of in the high single digits. Is there a number you could share with us for this quarter?
Not at this point. What I can tell you is that the ASP delta has a lot to do with our mix of business and many of these new opportunities that we're going into have ASPs that are two, three, and four times what some of our legacy products, particularly in consumer, used to be. I think that you're going to see an upward bias as the higher % of our business is with these newer opportunities.
Very good. Just last question on automotive. It sounds like there could be some pretty major upside there in the second half of the year. If we think about the content you have in the car so far, I think it's been primarily in lighting and also in some of the maybe USB power stuff like that. Is there some new incremental content in other areas that could come already in the second half of this year?
Actually, as far as the technology that we've introduced into automotive, it really is centered around the infotainment, the USB-C ports, and the body controls. Interesting, the lighting, we're just at the very early stages of that. Over the course of the next 12 months, I think you're going to see the ramping and the body controls and then a little bit after that in lighting.
Great. Thank you. Again, very impressive quarter.
Thank you.
Next question comes from the line of Alex Becky with William Blair. Your line is now open.
Congratulations, guys, on the good quarter. I guess just moving back to the increased expenses on the fabs. Bernie, you said that would go on for 4 to 6 quarters. You guys just gave a 2021 sort of operating margin target at your Analyst Day. I assume those targets are still intact and these increased expenses were obviously planned at that point.
Yes. What we had been looking to do, and we've been sort of trying to provide some soft guidance on both the timing and order of magnitude. Now we're starting to see those investments translate into the P&L here. The overall commitment to manage our core business, outside of, I'm not going to describe these as one-time costs necessarily, but this is project related, and those will wind down, and that will allow us to get to the targets that we set for ourselves.
Well, here, we see the opportunity to growth, and we will growth in the next 2, 3 years. We have a lot of opportunities. We made a decision, so we're going to increase it and to increase our expenditures and our investment rather in a new fab, so that we won't have capacity issues and at the same time, our technology advance forward. Just look at last year and early this year, MPS did not have capacity constraint. We grow as normal. We spend our money wisely. As long as we grow, I only care the top line and the EPS. I care the rest of it less.
As far as characterizing what we provided at the Analyst Day, those are guidelines. For example, in the revenue, we want to be able to grow at 20%. In this case, with the midpoint of the guidance that we've offered for Q3 as well as what we've done in Q1 and Q2, we're several percentage points above that this year. You really have to look at the guidelines that we've offered in the business model. Sometimes we'll be above it, sometimes we'll be below it. The thing to focus on is we only provide guidance 1 quarter ahead at a time.
Well, to be fair, if we grow less, okay, we'll spend less.
That's true, too.
Now we're accelerating our growth. We cannot grow in a thin air.
Understood. Are you guys seeing sort of the seasonality of your business change as you become more broad-based? Obviously, your Q3 is sort of in line with normal seasonal. I know you don't guide Q4, but given some of the upside opportunities you guys have been describing, how should we sort of think about seasonality as we look out into the out year as well?
I'd say that by and large, we are looking to maintain seasonality the way we've been historically. Having said that, Q1 came in higher. There was a lower step down from Q4 to Q1 than we'd had experienced. As a result of that, the increase from Q2 from Q1 was also lower than we've historically done by about three percentage points. In the guide that we've given here for Q3, that's almost right down the middle of how we've performed in the past.
Our seasonality changed. Last year, our business changed. Also we are in a higher growth period. The last year we have a four consecutive, I think it is, right?
Yeah.
Four consecutive growth. It never happened.
Almost five.
It never happened since 2004, 2005. I can't tell you what's our seasonality anymore.
Yeah.
Okay. All right. Thank you.
Okay. Thanks, Alex.
Just a reminder, ladies and gentlemen, if you'd like to ask a question at this time, that's star then one. Our next question comes from the line of Matthew Ramsay with Cowen. Your line is now open.
Hi, this is Joshua Buchalter on behalf of Matt. Thanks for taking my question and congratulations on the great results again. I'd just like to dig a little bit more on the storage and compute bucket. Is there any more granularity you could provide on some of the moving parts within the quarter and maybe the guide, given your large socket wins there?
It's a story of we have too many riches, because all of the major product lines that we've gone after in the computing and storage are doing very well. In the guide for Q3, that just reflects a continuation. It's a situation where a lot of the technologies that we invested in developing are now coming into the market. If you focus on the servers, for example, that transition has rolled out almost identical to how we expected it, and right now we don't see any headwinds. In fact, it's continuation of tailwinds.
Understood. Thank you. You provided an update on eMotion and e-commerce. I was hoping maybe you could provide the same on field programmability.
This is tied together. The e-commerce, of course, is wider. We do some of the products is not programmable. Currently, I think we sell most of the product, then it's kind of fixed and because the website was late, and now we have the capability to reprogram the product, reconfigure the product. These are the same to me, okay, e-commerce and field programmable.
I think that as we look at the continuing demands in this area, is that we're going to take even larger number of our product catalog today and re-engineer it around field programmability, which offers our customers the best ease of use and time to market.
Got it. Thank you, and congratulations again.
Thanks.
Thank you.
I'm showing no further questions in queue at this time. I'd like to turn the call back to management for closing remarks.
I'd like to thank you all for joining us on this conference call, and look forward to talking to you again during our third quarter conference call, which will likely be at the end of October. Thank you and have a nice day.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.