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MONOLITHIC POWER SYSTEMS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance and are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. These include statements concerning, among others: • the above-average industry growth of product and market areas that we have targeted, • our plan to increase our revenue through the introduction of new products within our existing product families as well as in new product categories and families, • our intention to exercise our purchase option with respect to our manufacturing facility in Chengdu, China, • our belief that we will continue to incur significant legal expenses that vary with the level of activity in each of our legal proceedings, • the effect of liquidity of our investments on our capital resources, • the application of our products in the communications, storage and computing, consumer and industrial markets continuing to account for our revenue, • estimates of our future liquidity requirements, • the cyclical nature of the semiconductor industry, • protection of our proprietary technology, • near term business outlook for 2014 and beyond, • the factors that we believe will impact our ability to achieve revenue growth, • the outcome of the IRS audit of our tax returns, • the percentage of our total revenue from various market segments, • our ability to integrate Sensima successfully and achieve the anticipated benefits from the acquisition, • our ability to identify, acquire and integrate future acquisitions and achieve the anticipated benefits from such acquisitions, • our intention and ability to continue the stock repurchase program and pay future cash dividends, and • the factors that differentiate us from our competitors. In some cases, words such as "would," "could," "may," "should," "predict," "potential," "targets," "continue," "anticipate," "expect," "intend," "plan," "believe," "seek," "estimate," "project," "forecast," "will," the negative of these terms or other variations of such terms and similar expressions relating to the future identify forward-looking statements. All forward-looking statements are based on our current outlook, expectations, estimates, projections, beliefs and plans or objectives about our business and our industry. These statements are not guarantees of future performance and are subject to risks and uncertainties. Actual events or results could differ materially and adversely from those expressed in any such forward-looking statements. Risks and uncertainties that could cause actual results to differ materially include those set forth throughout this Quarterly Report on Form 10-Q and, in particular, in the section entitled "Part II. Other Information, Item 1A. Risk Factors". Except as required by law, we disclaim any duty to and undertake no obligation to update any forward-looking statements, whether as a result of new information relating to existing conditions, future events or otherwise or to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Readers are cautioned not to place undue reliance on such statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Readers should carefully review future reports and documents that we file from time to time with the Securities and Exchange Commission, such as our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. 21 -------------------------------------------------------------------------------- The following management's discussion and analysis should be read in connection with the information presented in our unaudited condensed consolidated financial statements and related notes for the three and nine months ended September 30, 2014 included in this report and our audited consolidated financial statements and related notes for the year ended December 31, 2013 included in our Annual Report on Form 10-K. Overview We are a fabless semiconductor company that designs, develops, and markets proprietary, advanced analog and mixed-signal semiconductors. Our products are used extensively in storage and computing products, network communications products, set top boxes, lighting products, a wide variety of consumer and portable electronics products, and automotive and industrial markets. We believe that we differentiate ourselves by offering solutions that are more highly integrated, smaller in size, more energy efficient, more accurate with respect to performance specifications and, consequently, more cost-effective than many competing solutions. We plan to continue to introduce new products within our existing product families, as well as in new innovative product categories. We operate in the cyclical semiconductor industry where there is seasonal demand for certain products. We are not and will not be immune from current and future industry downturns, but we have targeted product and market areas that we believe have the ability to offer above average industry performance. We work with third parties to manufacture and assemble our integrated circuits ("ICs"). This has enabled us to limit our capital expenditures and fixed costs, while focusing our engineering and design resources on our core strengths. Following the introduction of a product, our sales cycle generally takes a number of quarters after we receive an initial customer order for a new product to ramp up. Typical lead time for orders is fewer than 90 days. These factors, combined with the fact that orders in the semiconductor industry can typically be cancelled or rescheduled without significant penalty to the customer, make the forecasting of our orders and revenue difficult. We derive most of our revenue from sales through distribution arrangements and direct sales to customers in Asia, where the products we produce are incorporated into end-user products. Our revenue from direct or indirect sales to customers in Asia was 88% for both the three and nine months ended September 30, 2014. We derive a majority of our revenue from the sales of our DC to DC converter product family which services the communications, storage and computing, consumer and industrial markets. We believe our ability to achieve revenue growth will depend, in part, on our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and successfully secure manufacturing capacity. In July 2014, we completed the acquisition of Sensima Technology SA ("Sensima"), a company located in Switzerland that develops magnetic sensors for angle measurements as well as three-dimensional magnetic field sensing. The acquisition is expected to create new opportunities with customers by offering enhanced solutions in power management for key industries such as automotive, industrial and cloud computing. The purchase consideration consisted of an upfront cash payment of $11.7 million and additional consideration that is contingent upon Sensima achieving a new product introduction and certain revenue and direct margin goals in 2016, with a fair value of $2.5 million at the date of acquisition. In addition, key employees received $1.7 million of time-based restricted stock units and up to $8.0 million of performance-based restricted stock units in connection with the transaction. These equity awards are considered arrangements for post-acquisition services and the related compensation expense is being recognized over the requisite service period. The results of operations of Sensima have been included in our consolidated financial statements subsequent to the acquisition date. Critical Accounting Policies and Estimates Other than the adoption of the following new significant accounting policies, there have been no significant changes in our critical accounting policies and estimates used in the preparation of our financial statements during the three and nine months ended September 30, 2014, as compared to those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2013. 22 -------------------------------------------------------------------------------- Valuation of Goodwill and Acquisition-Related Intangible Assets. We evaluate intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that an impairment may exist. We perform an annual impairment assessment for goodwill and intangible assets with indefinite lives in the fourth quarter, or more frequently if indicators of potential impairment exist. Impairment of intangible assets is recognized based on the difference between the fair value of the assets and their carrying value. Impairments for goodwill occur if the fair value of a reporting unit including goodwill is less than its carrying value and are recognized based on the difference between the implied fair value of the reporting unit's goodwill and the carrying value of the goodwill. The assumptions and estimates used to determine future values of goodwill and intangible assets are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and revenue forecasts. If there is a significant adverse change in our business in the future, including macroeconomic and market conditions, we may be required to record impairment charges on our goodwill and acquisition-related intangible assets. Results of Operations The table below sets forth the data in the Condensed Consolidated Statement of Operations as a percentage of revenue: Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (in thousands, except percentages) (in thousands, except percentages)Revenue $ 78,335 100.0 % $ 65,347 100.0 % $ 206,832 100.0 % $ 174,531 100.0 % Cost of revenue 35,872 45.8 30,053 46.0 95,173 46.0 80,924 46.4 Gross profit 42,463 54.2 35,294 54.0 111,659 54.0 93,607 53.6 Operating expenses: Research and development 14,679 18.7 12,643 19.3 43,649 21.1 37,246 21.3 Selling, general and administrative 17,006 21.8 13,891 21.3 49,968 24.1 40,941 23.5 Litigation expense (benefit), net 332 0.4 104 0.2 (8,093 ) (3.9 ) (455 ) (0.3 ) Total operating expenses 32,017 40.9 26,638 40.8 85,524 41.3 77,732 44.5 Income from operations 10,446 13.3 8,656 13.2 26,135 12.7 15,875 9.1 Interest and other income (expense), net 202 0.3 (59 ) (0.1 ) 686 0.3 149 0.1 Income before income taxes 10,648 13.6 8,597 13.1 26,821 13.0 16,024 9.2 Income tax provision (benefit) (573 ) (0.7 ) 1,187 1.8 186 0.1 625 0.4 Net income $ 11,221 14.3 % $ 7,410 11.3 % $ 26,635 12.9 % $ 15,399 8.8 % Revenue The following table shows our revenue by product family: Three Months Ended September 30, Nine Months Ended September 30, Product Family 2014 % of Revenue 2013 % of Revenue Change 2014 % of Revenue 2013 % of Revenue Change (In thousands, except percentages) DC to DC products $ 70,196 89.6 % $ 57,823 88.5 % 21.4 % $ 185,304 89.6 % $ 154,801 88.7 % 19.7 % Lighting control products 8,139 10.4 % 7,524 11.5 % 8.2 % 21,528 10.4 % 19,730 11.3 % 9.1 % Total $ 78,335 100.0 % $ 65,347 100.0 % 19.9 % $ 206,832 100.0 % $ 174,531 100.0 % 18.5 % Revenue for the three months ended September 30, 2014 was $78.3 million, an increase of $13.0 million, or 19.9%, from $65.3 million for the three months ended September 30, 2013. This increase was due to higher sales of both DC to DC and lighting control products, as unit shipments increased 41% due to increased market demand, which were offset in part by a 15% decrease in average sales prices. Revenue from our DC to DC products was $70.2 million for the three months ended September 30, 2014, an increase of $12.4 million, or 21.4%, from the same period in 2013. This increase was primarily due to higher sales of our DC to DC converters, offset in part by lower sales of our battery charger and Mini-Monsters products. Revenue from our lighting control products was $8.1 million for the three months ended September 30, 2014, an increase of $0.6 million, or 8.2%, compared with the same period in 2013. Revenue for the nine months ended September 30, 2014 was $206.8 million, an increase of $32.3 million, or 18.5%, from $174.5 million for the nine months ended September 30, 2013. This increase was due to higher sales of both DC to DC and lighting control products, as unit shipments increased 39% due to increased market demand, which were offset in part by a 15% decrease in average sales prices. Revenue from our DC to DC products was $185.3 million for the nine months ended September 30, 2014, an increase of $30.5 million, or 19.7%, from the same period in 2013. This increase was primarily due to higher sales of our DC to DC converters and battery charger products, offset in part by lower sales of our Mini-Monsters products. Revenue from our lighting control products was $21.5 million for the nine months ended September 30, 2014, an increase of $1.8 million, or 9.1%, compared with the same period in 2013. 23 --------------------------------------------------------------------------------Cost of Revenue and Gross Margin Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as warranty costs, inventory-related expenses and other overhead costs and stock-based compensation expenses. In addition, cost of revenue includes amortization of intangible assets from the Sensima acquisition. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change (in thousands, except percentages) Cost of revenue $ 35,872 $ 30,053 19.4 % $ 95,173 $ 80,924 17.6 % Cost of revenue as a percentage of revenue 45.8 % 46.0 % 46.0 % 46.4 % Gross profit $ 42,463 $ 35,294 20.3 % $ 111,659 $ 93,607 19.3 % Gross margin 54.2 % 54.0 % 54.0 % 53.6 % Cost of revenue was $35.9 million, or 45.8% of revenue, for the three months ended September 30, 2014 and $30.1 million, or 46.0% of revenue, for the three months ended September 30, 2013. The increase in cost of revenue was primarily due to a 41% increase in unit shipments, which was partially offset by a 15% decrease in the average direct cost of units shipped. In addition, the increase in cost of revenue was driven by an increase of $0.4 million in the provision for inventory reserve, and an increase of $0.3 million in amortization of intangible assets from the Sensima acquisition in July 2014. Gross profit as a percentage of revenue, or gross margin, was 54.2% for the three months ended September 30, 2014, compared to 54.0% for the three months ended September 30, 2013. The increase in gross margin was primarily due to higher absorption of in-house test manufacturing overhead, compared to the same period in 2013. This increase was partially offset by an increase in the provision for inventory reserve and an increase in the amortization of intangible assets from the Sensima acquisition in July 2014. Cost of revenue was $95.2 million, or 46.0% of revenue, for the nine months ended September 30, 2014 and $80.9 million, or 46.4% of revenue, for the nine months ended September 30, 2013. The increase in cost of revenue was primarily due to a 39% increase in unit shipments, which was partially offset by a 16% decrease in the average direct cost of units shipped. In addition, the increase in cost of revenue was driven by an increase of $0.7 million in the provision for inventory reserve. Gross margin was 54.0% for the nine months ended September 30, 2014, compared to 53.6% for the nine months ended September 30, 2013. The increase in gross margin was primarily due to higher absorption of in-house test manufacturing overhead and increased sales of higher margin products, compared to the same period in 2013. This increase was partially offset by a higher provision for inventory reserve. Research and Development Research and development expenses primarily consist of salary and benefit expenses, bonuses and stock-based compensation expenses for design and product engineers, expenses related to new product development and supplies, and facility costs. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change (in thousands, except percentages) Research and development ("R&D") $ 14,679 $ 12,643 16.1 % $ 43,649 $ 37,246 17.2 % R&D as a percentage of revenue 18.7 % 19.3 % 21.1 % 21.3 % R&D expenses were $14.7 million, or 18.7% of revenue, for the three months ended September 30, 2014 and $12.6 million, or 19.3% of revenue, for the three months ended September 30, 2013. The increase in R&D expenses was primarily due to an increase of $0.9 million in stock-based compensation expenses primarily associated with the performance-based and market-based equity awards, an increase of $0.6 million in new product development expenses, and an increase of $0.2 million in cash compensation expenses, which include salary, benefits and bonuses. Our R&D headcount was 457 employees as of September 30, 2014, compared with 441 employees as of September 30, 2013. 24 -------------------------------------------------------------------------------- R&D expenses were $43.6 million, or 21.1% of revenue, for the nine months ended September 30, 2014 and $37.2 million, or 21.3% of revenue, for the nine months ended September 30, 2013. The increase in R&D expenses was primarily due to an increase of $2.1 million in stock-based compensation expenses primarily associated with the performance-based and market-based equity awards, an increase of $2.0 million in cash compensation expenses, which include salary, benefits and bonuses, an increase of $1.0 million in new product development expenses, and an increase of $0.5 million in manufacturing and lab supplies. Selling, General and Administrative Selling, general and administrative expenses primarily include salary and benefit expenses, bonuses and stock-based compensation expenses for sales, marketing and administrative personnel, sales commissions, travel expenses, facilities costs, and professional service fees. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 Change 2014 2013 Change (in thousands, except percentages) Selling, general and administrative ("SG&A") $ 17,006 $ 13,891 22.4 % $ 49,968 $ 40,941 22.0 % SG&A as a percentage of revenue 21.8 % 21.3 % 24.1 % 23.5 % SG&A expenses were $17.0 million, or 21.8% of revenue, for the three months ended September 30, 2014 and $13.9 million, or 21.3% of revenue, for the three months ended September 30, 2013. The increase in SG&A expenses was primarily due to an increase of $2.6 million in stock-based compensation expenses primarily associated with the performance-based and market-based equity awards, an increase of $0.2 million in commission expenses due to higher revenue, and an increase of $0.2 million in professional service fees primarily due to the acquisition of Sensima. Our SG&A headcount was 270 employees as of September 30, 2014, compared with 251 employees as of September 30, 2013. SG&A expenses were $50.0 million, or 24.1% of revenue, for the nine months ended September 30, 2014 and $40.9 million, or 23.5% of revenue, for the nine months ended September 30, 2013. The increase in SG&A expenses was primarily due to an increase of $7.5 million in stock-based compensation expenses primarily associated with the performance-based and market-based equity awards, an increase of $0.5 million in commission expenses due to higher revenue, an increase of $0.5 million in cash compensation expenses, which include salary, benefits and bonuses, and an increase of $0.4 million in professional service fees primarily due to the acquisition of Sensima. Litigation Expense (Benefit), Net Litigation expense was $0.3 million for the three months ended September 30, 2014, compared to litigation expense of $0.1 million for the three months ended September 30, 2013. The increase in litigation expense was due to higher expenses we incurred in litigation matters for the three months ended September 30, 2014 compared to the same period in 2013. Net litigation benefit was $(8.1) million for the nine months ended September 30, 2014, compared to net litigation benefit of $(0.5) million for the nine months ended September 30, 2013. Net litigation benefit for the nine months ended September 30, 2014 included the recognition of the $9.5 million award from the O2 Micro litigation, partially offset by $0.5 million of additional legal fees incurred in connection with the final resolution of the litigation. Net litigation benefit for the nine months ended September 30, 2013 included $0.8 million of proceeds received in connection with the legal settlement with Silergy Corporation. The increase in net litigation benefit for the nine months ended September 30, 2014 was partially offset by higher expenses we incurred in other litigation matters, compared to the same period in 2013. Interest and Other Income (Expense), Net For the three months ended September 30, 2014, interest and other income, net, was $0.2 million, compared with a net expense of $(59,000) for the three months ended September 30, 2013. The increase in interest and other income, net, was primarily due to higher foreign exchange gains and interest income. For the nine months ended September 30, 2014, interest and other income, net, was $0.7 million, compared with $0.1 million for the nine months ended September 30, 2013. The increase in interest and other income, net, was primarily due to higher foreign exchange gains and interest income. 25 -------------------------------------------------------------------------------- Income Tax Provision (Benefit) The income tax provision (benefit) for the three and nine months ended September 30, 2014 was $(0.6) million, or (5.4)% of pre-tax income, and $0.2 million, or 0.7% of the pre-tax income, respectively. This differs from the federal statutory rate primarily because our foreign income was taxed at lower rates, and because of the benefit that we realized from the release of a reserve where the statute of limitations expired and the benefit realized as a result of stock option exercises and releases of restricted stock. The income tax expense for the three and nine months ended September 30, 2013 was $1.2 million, or 13.8% of the pre-tax income, and $0.6 million, or 3.9% of the pre-tax income, respectively. This differs from the federal statutory rate primarily because our foreign income was taxed at lower rates, and because of the benefit that we realized from the release of a reserve where the statute of limitations expired. Liquidity and Capital Resources September 30, December 31, 2014 2013 (In thousands) Cash and cash equivalents $ 101,812 $ 101,213 Short-term investments 126,849 125,126Total cash, cash equivalents and short-term investments $ 228,661 $ 226,339 Percentage of total assets 58.2 % 61.4 % Total current assets $ 297,310 $ 292,086 Total current liabilities (36,928 ) (38,489 ) Working capital $ 260,382 $ 253,597 As of September 30, 2014, we had cash and cash equivalents of $101.8 million and short-term investments of $126.8 million, compared with cash and cash equivalents of $101.2 million and short-term investments of $125.1 million as of December 31, 2013. As of September 30, 2014, $67.1 million of cash and cash equivalents and $17.0 million of short-term investments were held by our international subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to indefinitely reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, inventories, prepaid expenses and other current assets, reduced by accounts payable, accrued compensation and related benefits, and other current liabilities. As of September 30, 2014, we had working capital of $260.4 million, compared with working capital of $253.6 million as of December 31, 2013. The $6.8 million increase in working capital was due to a $5.2 million increase in current assets and a $1.6 million decrease in current liabilities. The increase in current assets was primarily due to an increase in cash and short-term investments and an increase in inventory. The decrease in current liabilities was primarily due to a decrease in accrued compensation and related benefits, partially offset by an increase in accounts payable. |