Business context and reporting period
Monolithic Power Systems, Inc. (MPS) is a fabless semiconductor company designing and selling analog and mixed-signal products. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2014; comparisons are with the same 2013 periods. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $78.3 | $65.3 | $206.8 | $174.5 |
| Gross margin | 54.2% | 54.0% | 54.0% | 53.6% |
| Operating income | $10.4 | $8.7 | $26.1 | $15.9 |
| Net income | $11.2 | $7.4 | $26.6 | $15.4 |
| Diluted EPS | $0.28 | $0.19 | $0.67 | $0.40 |
| Operating cash flow | Not separately presented for quarter | $53.6 | $30.2 |
- Q3 revenue rose 19.9% year over year; nine-month revenue rose 18.5%. Net income increased 51% and 73%, respectively.
- DC-to-DC products generated 89.6% of revenue in both 2014 periods. Management attributed growth mainly to higher demand and unit shipments (up 41% in Q3 and 39% year to date), partly offset by a 15% decline in average selling prices.
- At September 30, cash and cash equivalents were $101.8 million and short-term investments were $126.8 million; working capital was $260.4 million. Total assets were $392.7 million and total liabilities $51.0 million. The balance sheet lists no borrowings.
- Cash from operations was $53.6 million; investing used $26.1 million and financing used $26.6 million in the first nine months. Cash and cash equivalents increased by $0.6 million.
Material changes and unusual items
- Gross margin improved modestly year over year. For nine months, operating income improved despite higher R&D and SG&A, partly because litigation expense included a significant prior-year comparison effect.
- Nine-month 2014 litigation benefit was $8.1 million, including release of a $9.5 million O2 Micro award liability after the U.S. Supreme Court declined review, less $0.5 million in final legal fees. This is a notable non-recurring contributor to results; Q3 itself recorded $0.3 million litigation expense.
- Stock-based compensation was $24.9 million for nine months, up from $15.1 million in the cash-flow reconciliation for 2013. SG&A rose 22% and R&D 17% year over year for the nine-month period.
- MPS acquired Sensima Technology SA in July for $11.7 million cash plus $2.5 million estimated contingent consideration. The contingent payment could reach $8.9 million, depending on 2016 product milestones. The preliminary allocation includes $6.6 million goodwill and $7.2 million acquisition-related intangible assets.
- The company began quarterly dividends in 2014 and paid $5.8 million during the nine months. It repurchased 858,000 shares for $33.0 million in that period; $46.4 million remained under the $100 million authorization at September 30, 2014.
Outlook, risks and contingencies
- No specific numerical revenue or earnings guidance is provided in this filing. Management expects existing cash, investments and operating cash generation to cover liquidity needs for the next 12 months and plans to fund dividends and repurchases from domestic cash and U.S. operating cash flows.
- Management cites product development, new market entry, customer diversification, litigation management and securing manufacturing capacity as factors affecting growth. It cautions that semiconductor cyclicality, short order lead times, order cancellations, and difficult forecasting can cause results to fluctuate.
- Revenue is geographically concentrated: 88% came from Asia in the 2014 quarter and nine-month period. The two largest distributors represented 26% and 10% of Q3 revenue. MPS notes potential disruption or revenue impact if a major distributor or customer is lost.
- Supplier capacity, manufacturing yields, inventory management and falling selling prices pose risks to shipments and margins. Inventory was $41.6 million at quarter-end, and outstanding wafer and assembly purchase commitments were $24.4 million.
- An IRS audit of 2005–2007 tax years includes a proposed potential federal tax adjustment of up to $10.5 million, plus possible interest and penalties. Appeals meetings had not resolved the matter; management believed resolution would not materially affect the company, but the outcome remains uncertain.
- Approximately $9.8 million of auction-rate securities remained illiquid and were classified as long-term investments. The filing also describes ordinary-course intellectual-property and other litigation risks.
- Management reported disclosure controls effective at reasonable assurance as of September 30, 2014. The company was still evaluating Sensima’s internal controls following the acquisition.
Important facts for investors to verify
- How much reported earnings growth reflects operating performance versus the one-time $9.5 million O2 Micro litigation benefit and unusually low tax expense.
- Whether shipment growth can continue to offset declining average selling prices, and whether gross margin remains near 54%.
- Progress integrating Sensima, commercial traction for its technology, and exposure to contingent consideration and purchase-accounting adjustments.
- Customer and distributor concentration, Asia exposure, supplier capacity, inventory levels and the $24.4 million purchase commitments.
- Developments in the IRS audit, other litigation, the liquidity and valuation of auction-rate securities, and the company’s ability to sustain dividends and repurchases.