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Monolithic Power Systems (NASDAQ:MPWR)

Q3 2010 Earnings Call

November 3, 2010 5:00 p.m. ET

Executives

Rick Neely – CFO

Michael Hsing – CEO and Founder of MPS

Steve Pratt – Marketing Director

Analysts

Steve Smigie – Raymond James

Ross Seymore – Deutsche Bank

Gus Richard – Piper Jaffray

Vernon Essi – Needham & Company

Evan Wang – Stifel Nicolaus & Company

Patrick Wang – Wedbush Securities

Doug Freedman – Gleacher & Company

Brian Piccioni – BMO Capital Markets

Nicholas Burley [ph] Janney Capital Markets

Operator

Good day ladies and gentlemen, and welcome to the third quarter 2010 Monolithic Power Systems earnings conference call. My name is Jennifer, and I’ll be your operator for today. (Operator Instructions)

I would now like to turn the call conference over to your host for today, Rick Neely, Chief Financial Officer. Please proceed.

Rick Neely

Good afternoon, and welcome to the third quarter fiscal year 2010 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. These statements will cover a number of areas concerning our business outlook, including our business and financial outlook for the fourth quarter of 2010, projected fourth quarter 2010 revenues and gross margins, our expectations for fourth quarter litigations, stock based compensation, GAAP, and non-GAAP operating expenses, our target operating ranges for gross margins, net margins, and inventory, our expected average non-GAAP tax rate for 2010, our expected production capacity in future quarters, our belief that MPS is well positioned for future growth, the expected seasonality of our business, and our expectations for future cost reductions, and new product introductions, potential customer acceptance, and the opportunity these present, and the prospects of expanding our market share.

Forward-looking statements are not historical facts, or guarantees of future performance or events, and are based on current expectations, estimates, beliefs, assumptions, goals, and objectives, and involve known and unknown risks, uncertainties, and other factors that may cause actual results to be materially different from the results expressed or implied by these statements.

Risks, uncertainties, and other factors that could cause actual results to differ are identified in our SEC filings, including but not limited to our form 10-Q filed on July 28th, 2010, which is accessible through our website www.monolithicpower.com. MPS assumes no obligations to update the information provided on today’s call.

We will be discussing operating expense, 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 this release as well as 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 earning release filed with SEC earlier today.

I would like to start this call by reviewing our third quarter fiscal year 2010 business highlights. Following this update, I will discuss our operating results. We will conclude by discussing our expectations for the fourth fiscal quarter of 2010. We will then open up the call to your questions.

Let’s start with the business highlights. In the third quarter, MPS experienced outstanding results growing revenues 37% from the third quarter of the prior year to achieve its third straight quarterly record figure with net sales up $65.8 million. This was a sequential increase of 18% from the prior quarter when MPS set its previous record quarterly revenue total. This notable revenue performance leads to our most profitable quarter in history with non-GAAP net income of $16.4 million, or 25% of sales.

MPS saw very strong demand in the first three quarters of 2010 in all of its major brand markets. The third quarter saw substantial growth in our DC to DC and lighting control markets.

Our MiniMonster product family continues to progress crossing the $10 million quarterly run rate for the first time, which compares well to the $4 million we did in the third quarter of 2009.

The new LDL family grew to $4 million in the quarter, a significant increase from a year ago when we sold less than $1 million in this family. The LDL products are being used in applications such as set-top boxes, flat-panel televisions, enterprise disc storage, and gaming machines.

In the lighting control segment, MPS had its best quarter ever for white LED-based devices shipping over $7 million in the third quarter compared with less than $3 million in the year ago quarter.

We continue to expand our footprint in computing applications with the introduction of the industry’s smallest monolithic 12-volt, 25-amp DC to DC step down converter for single staged power conversion applications in end markets, such as Enterprise Server, Storage, and Telethon Base stations.

In our ongoing initiative to increase our total available market, we are excited to announce our entry into the AC to DC offline market. We recently announced a family of solutions for the one-watt to 300-watt AC to DC power conversion that will target all applications that plug into an AC outlet from TVs and white goods, to PCs and set-top boxes.

The success of our new products enabled MPS to reach 25% non-GAAP net profit as a percentage of sales for the quarter right at the midpoint of our new target range of 22% to 27% of sales.

In the manufacturing area, gross margin was 54.7%, which is sequentially down from the second quarter of 2010, but within our expected guidance range of 54% to 56% of sales.

Our internal days of inventory improved slightly to 59 days as production started to catch up to the strong demand we have seen the first nine months of this year. Inventory dollars at our distributors ended the quarter above our target range of 30 to 45 days as we were unable to adjust our inventory levels at our distributors quickly enough in response to an anticipated decline in demand for our products in the future quarter. These near-turn demand fluctuations that caused our fourth quarter outlook to diminish.

Bottom line, non-GAAP net income was $16.4 million, or $0.43 per fully diluted share. This resulted in non-GAAP net income of 25% of revenue. Our non-GAAP net income for the third quarter was – our GAAP net income for the third quarter was $13.2 million, or $0.35 per fully diluted share.

Now, let’s look at the financials in more detail. Starting with the P&L on the revenue line, our third quarter 2010 net revenues of $55.8 million increased 18% sequentially from the second quarter of 2010, and were up 37% from the $48 million recorded in the third quarter of 2009.

Looking at our revenue by product type, third quarter DC to DC product sales were $55.2 million up 21%, or $9.7 million from the second quarter of 2010, and up 50% from the $36.7 million recorded in the same quarter a year ago.

This dollar growth was led by our general purpose DC to DC products, but about ½ of the year-over-year growth was contributed by our MiniMonster and LDL product families that I descried earlier in this conference call.

The largest end markets for MPS in the DC to DC product family continued to be flat-panel TVs, general consumer electronics products, set-top boxes, routers, and wireless LAN cards.

Lighting control revenues for the second quarter were $9.4 million, which was up 25% from the $7.5 million we did in the second quarter of 2010, and an increase of 10% from the same quarter a year ago.

Our newer white LED driver products are taking charge of this segment, as we did over $7 million in white LED revenue compared with $4 million in the prior quarter, and less than $3 million in the same quarter a year ago. We are finding new design success in flat panel monitors, notebook computers, and general consumer products for our white LED chips.

Our traditional CCFL invertors and CCFL controllers make up the remainder of the revenue in this segment. This decline in traditional CCFLs is likely to continue as it reflects the continuing shift of notebook and other back lighting solutions from CCFL to white LED solutions.

Audio revenues came in at $1.2 million, down from the $2.6 million MPS did in the prior quarter, and down from the $2.7 million recorded in the third quarter of 2009.

Let’s move down to the gross margin line. Our third quarter gross margin was 54.7%, down from the 58.2% we did in the prior quarter of 2010, and down from the 60.7% in the third quarter of 2009.

This result was in line with our expectations and guidance for the quarter. We recently adjusted our target financial model to focus on top line and bottom line growth as we expect to participate in several new fast-growing market segments with different margin profiles than in the past, which has an impact of 1% to 2% points.

We are also still shipping the higher priced wafers we bought earlier in the year, which impacted our reported gross margins by about 2% points.

Let’s look at our reported expenses and operating margins. On a GAAP basis, our operating expenses were $22.6 million in the third quarter. This includes $21.6 million in R&D and SGA expense, which includes $4.1 million for stock compensation expense, and litigation expense of $964,000. Compared with the second quarter of 2010, GAAP operating expenses were down by $3.1 million. The expense mixed changed as follows. R&D decreased by $494,000. SGA decreased by $1.3 million. Litigation decreased by $1.3 million. As a result, our GAAP operating profit of 20.4% was individually up in the third quarter of 2010 compared to our GAAP operating profit of 12.2% in the second quarter of 2010. Compared to the third quarter of 2009, our GAAP operating expenses were up by $222,000 excluding the litigation provision reversal of $6.4 million. R&D expense was up $1.2 million. SG&A increased by $858,000, and litigation expense was down by $1.8 million compared to the third quarter of 2009.

Let’s review our non-GAAP operating expenses. Excluding stock compensation, our non-GAAP operating expenses for the third quarter of 2010 were $18.5 million, down $1.7 million from the $20.2 million we spent in the second quarter of 2010, and down $773,000 from the $19.2 million we spent in the third quarter of 2009, excluding the litigation provision reversal of $6.4 million. The sequential decrease in non-GAAP third quarter spending was primarily driven by lower litigation expense as we have completed the ITC case that covered our older CCFL parts. Our combined R&D and SG expenses were down $482,000 for the second quarter of 2010.

Compared to the third quarter of 2009, non-GAAP R&D costs were up by $973,000 as we continued to grow our new product offerings and R&D teams. Non-GAAP SG&A spending was only slightly up $101,000 from Q3 of the prior year as efficiencies in the G&A area have offset increased sales and rep commissions.

Finally, litigation expense in the third quarter was $964,000, which was down $1.8 million with compared to the third quarter of 2009.

Our non-GAAP operating margin was 27% in the third quarter of 2010 compared with 22% in the prior quarter of 2010, and 21% in the third quarter of 2009, a very good performance.

Switching to the bottom line, on a GAAP basis, our Q3 2010 net income was $13.2 million, or $0.35 per fully diluted share. On a non-GAAP basis, our Q3 2010 net income was $16.4 million, or $0.43 per fully diluted share. This result is computed with a non-GAAP tax rate of 7.5%.

Let’s look at some of the major changes to the balance sheet. Cash, cash equivalents, and investments were $204.4 million at the end of the third quarter of 2010, down from the $209.3 million at the end of the second quarter of 2010, but up substantially from the $169.2 million we had on the books in the same quarter one year ago.

In Q3, MPS had operating cash flow of about $17 million. We purchased capital equipment and outfitted our new R&D building in Chengdu, China for a total of about $7.2 million in the third quarter, which was offset by cash proceeds of $2.3 million from option exercises and employee stock sales.

MPS announced a $50 million stock buyback effective from August 2010 until December of 2011 in our last conference call. Under this program, we’ve bought back approximately 983,000 shares for a total of $17 million in the third quarter.

Accounts receivable ended the third quarter at $32.3 million compared with $30.3 million at the end of the second quarter of 2010, and $19.5 million at the end of the third quarter of 2009. The increase in receivables from the prior quarter was a result of our third quarter in a row of record revenues, and higher shipments than normal for the third month of a quarter.

Days sales outstanding decreased to 45 days in Q3, 2010 as a result of the elements I just described. In Q2 of 2010, our DSOs were 50 days, and in Q3 of 2009, they were 37 days.

Our internal inventories at the end of the third quarter remain low at $19.5 million, or at about 59 days of inventory on a historical basis as a result of the continuation of our record quarterly shipments in the third quarter. This compares with $14.5 million, or 57 days of inventory at the end of the second quarter of 2010.

Inventory in our distribution channels grew in dollars as a result of the Q3 revenue increase. And total days of distributor inventory exceeded the upper end of our target range of 30 to 45 days by about $4 to $5 million. The increased level of distributor inventory was a result of two key factors, both of which are non-recurring. First, we’ve had very extended lead times due to product shortages for several quarters causing distributors to put orders on our books earlier than normal. And to keep those orders in place for fear of not getting supplies their end customers need.

Secondly, when the fourth quarter demand deteriorated in September, we were unable to adjust their inventory levels quickly enough by reducing our shipments. In response, we have modified our inventory review procedures. We expect to be better equipped to track and respond to changes in demand and inventory levels at our distributors. We expect to burn off most of this excess distributor inventory in the fourth quarter.

I would like to turn to a discussion of general business conditions. MPS has had a robust nine month period hitting all time quarterly revenue records three quarters in a row. Geographically, in the third quarter of 2010, MPS shipped 52% of revenues to Taiwan and China, and 38% to other regions with Europe and Japan performing particularly well in Q3.

By segment, MPS had excellent growth in the communications and computing segments primarily driven by new router and set top box business, and new notebook power, and white LED back lighting wins. Last quarter, we introduced a new white LED driver for the high growth incandescent bulb and CFL to replacement lighting markets. This product interfaces to a universal off-line input from 65 volts AC to 255 volts AC.

We’ve significantly increased the number of power supply rails we support with the introduction of the industry’s highest current density 6-amp to 25-amp, 12-volt to 21-volt DC to DC step down converters. Our 6-amp to 10-amp point of load solutions operated an input voltage as high as 28 volts ideal for notebook PC and industrial applications. And are housed in a tiny 3 by 4 millimeter QFN package.

Similarly, our monolithic 25-amp buck includes a 10-milione high side set, and a 3-milione low side set, and comes in a tiny 6 by 6 millimeter QFN package.

We also expanded our set top box and TV footprints with the introduction of our ASST power supply for the low noise block, commonly referred as CLND.

I would now like to turn to our outlook for the fourth quarter of 2010. Which Q3 2010 was another revenue quarter for MPS, we have seen a drop in bookings activities for the fourth quarter for several reasons.

First, our lead times remained well above average until late in the third quarter as we were constrained by product supply. This situation made it difficult to follow the true end product demand because our distributors were reluctant to cancel their backlog. It now appears that end demand for products such as flat panel TVs, monitors, and other general consumer products will decline in the fourth quarter more than seasonally. And this will impact our fourth quarter revenues by about $6 to $7 million.

Secondly, our lack of product availability earlier this year and the high volume TV and monitor markets forced several major customers in Korea to seek alternative suppliers. This will impact our near-term revenue outlook by another $6 to $7 million per quarter.

Finally, as we mentioned above, we will burn off our excess distributor inventory in the fourth quarter, which will have a revenue impact of approximately $4 to $5 million.

In total, we project fourth quarter 2010 revenues in the range of $45 to $50 million. We expect gross margin in the 50% to 52% range primarily due to underutilized capacity in our test areas, which will have an impact of approximately 3% points in comparison to Q3, 2010.

Our overall gross margin continues to be impacted by higher than normal wafer prices that were purchased earlier this year, which accounts for approximately another 2% points of gross margin compared to the second quarter of this year.

We expect stock based compensation expense in the range of $4.2 to $4.6 million. We expect non-GAAP research and development, and selling, general, and administrative expense to decline to the range of $17.5 to $18.5 million. This estimate excludes the stock compensation estimate mentioned above.

We expect litigation expense approximately flat to the third quarter at $1 million.

Finally, we expect our non-GAAP tax rate to remain in the range of 5% to 10% based on our sales and profit patterns global.

In conclusion, while we were pleased to report three consecutive record revenue quarters, our revenue outlook in the near term is below our performance in the most recent quarters. We will be working hard to improve our planning, forecasting, and demand management process. We believe that the breath of new products with good technology advantages in new market segments will get MPS back to the expected levels of revenue growth that have always characterized our company.

Now, we would like to open the microphone and take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steve Smigie from Raymond James. Please proceed.

Steve Smigie – Raymond James

Great. Thanks, guys. I was hoping we could talk a little bit about on the revenue guidance, you mentioned there I think about six to seven inventory work downs or something of that matter. And then another six to seven that will affect you for the quarters going before.

If we were to not have the inventory work down, you’d still be probably six to seven below the peak going forward assuming things stayed as they were. I’m just trying to understand, you know, the nature of that, the revenue change there going forward.

Rick Neely

Yeah, Steve, I’ll start out and then Steve Pratt, our Marketing Director is also with us on the call and he may chip in later.

Yes, you’re correct. There’s three elements to the revenue drop. One is we lost some business at several premium TV makers that was a 6 to $7 million reduction in the quarterly revenue outlook. There’s another 6 to $7 million that we would call seasonality or low-demand combination. And then the 4 to $5 million of just your inventory that we ended up at the end of Q3, more inventory in our distribution channel than we normally have. That 4 to $5 million that we burned off in Q4, so that’s 4 to 5 million distributor inventory, 6 to 7 million seasonality and demand and 6 to 7 million of the loss of business in the Korean TV market.

Steve Smigie – Raymond James

Okay. So as I think about seasonality for Q1, you’re normally down quite a bit, but it sounds like you’re burning through a lot of that stuff already in Q4. How should we think about Q1 seasonality given how much stuff has come down here I guess in this quarter?

Rick Neely

Well, I think that’s going to depend on demand. We usually don’t like to go out and give any outlook for Q1. We’re probably going to stick with that process. So I would just assume normal seasonality for Q1 at this point.

Michael Hsing

Yes. That’s what we’ve planned to have, and the market is not very stable, although in the last few weeks we see the demand has stabilized and now we’re planning for a normal seasonality – a seasonal change in the Q1 quarters.

Steve Smigie – Raymond James

Great. If I could just sneak one more in. I think there was about 200 basis points you mentioned of gross margin that you used because you’re using the high-cost wafer that you had to use. When have you burned through those wafers that you get that bump back up that you’re using floor-cost wafers again?

Michael Hsing

At this time, clearly we’re still buying higher wafer – higher-priced wafers. And as a fab capacity normally the price will reduce. It hasn’t happened now.

Steve Smigie – Raymond James

Okay, great. Thanks.

Operator

Your next question comes from the line of Ross Seymore from Deutsche Bank. Please proceed.

Ross Seymore – Deutsche Bank

Yeah, this is Bob in for Ross. I had a question about your utilization charge. Is that kind of a one-quarter phenomena and you can bring back utilization as a back-end facilities, or do you expect kind of that to persist a little bit longer?

Rick Neely

That’s a good question, Bob. Yes, the outlet that we talked about, there’s about a 3 percentage point hit to our gross margin in the Q4 guidance because of that. And as you know, we had a huge demand this year. We put in the capacity in terms of testers, people, building – increased the size of the building, moved people out into an RD building and so forth to be able to handle $70 million plus.

So in the near term, when the revenue drops significantly from say 65.7 to the 45 to $50 million range, we can’t adjust that capacity. So as capacity – as revenues improve next year, we should be able to absorb that. We can’t predict when that’s going to be, but when we get closer to $60 million in revenue we should be able to absorb most of that manufacturing capacity. That really relieved our test area.

Ross Seymore – Deutsche Bank

Fair enough. And then, so it looks like you’re kind of – given the current demand outlook and also the fact that you had a pretty straight CapEx number this quarter, what are you kind of thinking about CapEx for next quarter and then maybe – I don’t know, if you want to talk more on a sustainable level as a percentage of revenue or what you think that number should be?

Rick Neely

We expect to do 20 to 25 million in CapEx this year, and that’s relative to finishing off the building in Chengdu and so forth. Our typical CapEx is around 10 to $12 million a year. So we’re about double this year because of the new building and additional testers.

Ross Seymore – Deutsche Bank

Thanks, guys.

Operator

Your next question comes from the line of Gus Richard from Piper Jaffray. Please proceed.

Gus Richard – Piper Jaffray

Yeah, thanks for taking my question. I terms of the Korean customers, you know, where you lost share, is that permanent? Is that just because you haven’t been able to deliver on time? Can you sort of talk about the loss and then sort of the plans going forward?

Steve Pratt

Yeah. Hey, Gus, this is Steve. So you know, I have to go back a little bit in time to answer this question in full.

In 2008 we saw the transition from CCFL business to white LED. So we went into 2009 really attacking all the sockets, all the opportunities we could, especially in the TV and monitor business, and we did a great job. That was reflected in our growth in 2010 revenue. You compound that success in our market penetration with the TV market exploding in 2010, which was unforecasted caught us by surprise. We spent two quarters not being able to deliver to the customers real demand and that pain felt at the customer level in some cases, they eventually had to seek other alternatives. In certain specific applications, specifically TVs and monitors, and impacted us most in the Korean market.

Is it permanent? No. In some cases it’s shorter term and other cases it’s building back up that relationship and catching the next design cycle.

Gus Richard – Piper Jaffray

Got it. And then could you speak a little bit – there’s been, I believe, some turnover in the sales force. Can you talk a little bit about that and sort of the plans going forward?

Michael Hsing

Okay. Well, this is Michael. As we said it before, you know, in your conference, we completely change – upgraded our sales force and we have all new management in place now.

Gus Richard – Piper Jaffray

Okay. So pretty much – you’re through this process at this point? Is that correct?

Michael Hsing

Yes. And so we finished the changing now.

Gus Richard – Piper Jaffray

Okay. All right. Thanks so much.

Operator

Your next question comes from the line of Vernon Essi from Needham and Company. Please proceed.

Vernon Essi – Needham & Company

Thanks for taking my question. I just wanted to ask going into 2011 on the OpEx front, what should we be thinking about with your R&D levels? I mean, they’ve grown nicely in 2010 [inaudible] products going out. Should we be seeing sort of the similar growth rate in our R&D, or how should that play out?

Rich Neely

Yeah. I think that the commitment of the company, the technology and product in the company, that’s the one area we’ll probably continue to hire people and expand new product expenses. The only comment – I’ll turn it over to Michael for more comments, but the only other comment is, as you know with our – I believe we have our OpEx put together, Vern, we have a variable compensation component and if profits decline, some of our profit sharing decline and our expenses decline. We’re seeing that already in the Q4 guidance.

So there’s no recent declines in OpEx based on those kind of variable expenses that we’ve talked about, but in terms of actually cutting back on new products, I don’t think so.

Michael Hsing

In the R&D side, all expenses, we have to stay reasonable – to a reasonable level, and you were expected the same of – in the same level of the 2010.

Vernon Essi – Needham & Company

Okay. So expect, are you just saying, expect it to be sort of flattish in terms of dollars?

Michael Hsing

And slightly higher, slightly higher in the 2011.

Vernon Essi – Needham & Company

Okay. And then, Rick, just sort of my follow-up question that to revisit – I guess your analysis of the distribution channel in sort of fixing what you perceive to be the problem, how far back has this been going on? I guess one concern people may have is does this happen all the way back from the earlier this year onward, and will we be at sort of a depressed revenue level as a result going into 2011? Or do you feel this is really sort of a one-quarter phenomena?

Rick Neely

No, I think it’s a one-quarter phenomena of an overshoot. I think you’ve heard a few other companies talk about excess distributed inventory as well in their calls. And all the – remember, in the first two quarters of the year we had no inventory. The distributors had about 30 days and they weren’t even at the – in Q2 they were at the lower end of the range and some of them were underneath the range.

So up until probably September, they never had enough parts. A lot of our parts ran allocations until recently and the lead time has only recently come down. So the distributors were left with the dilemma of – I’ve had 16–week lead times, where if you didn’t put a four-month border in, and remember, MPS normally hs 6 and 8-week lead times, and we generally turn half our business every quarter.

So our distributor normally doesn’t have to put any new business in front of you for maybe 8 to 10 weeks out. Now we’re telling them to put an order out in 16 weeks head. So he’s got to do that, or he can’t get the parts. So the tradeoff is, do I keep the order, do I push it out, do I disappoint my customers? So they kept holding onto their backlogs until September-October when clearly there’s a lower demand. You can see the TV business is getting down, the monitor business is down, other consumer products are down.

So for Q4, it’s not an issue of the being able to sell, they’ll simply sell it through in Q4, but they won’t be ordering as much from us, and I think that’s pretty much a near-term correction.

The only other comment I can say to that is, you know, we don’t really know what the Q1-Q2 demands are going to be, but I don’t think it would be related to – we should get most that inventory flushed out in Q4.

Vernon Essi – Needham & Company

Right. Okay. That’s helpful. Thanks a lot.

Operator

Your next question comes from the line of Tore Svanberg from Stifel Nicolaus. Please proceed.

Evan Wang – Stifel Nicolaus & Company

Yes, hi. This is Evan Wang calling in for Tore Svanberg. I would like to ask you about your new products that you mentioned in your prepared remarks. AC Power and white LED lighting. Could you give some more specifics on these new products; specifically, when do you think these might see some revenue growth – contribute to your revenue growth?

Steve Pratt

This is Steve. So I’ll take one product group at a time; both of the brand new for us in 2010. On the white LED front, we entered into the white LED space with backlighting as an extension of our CCFL business. So – and white LED lighting now getting into bulb replacement. These products that we’re introducing for the last six – well, we started back in 2009 with some streetlight applications and now we’re getting into the more mainstream bulb replacement this year.

We’ll see in 2011, single-digit type revenues. It takes time to get the design in and there’s a number of customers, a very fragmented market and we just have the – we’re doing the promotional campaign into the build replacement now as we speak. So we’re just getting into that space.

And then in AC Power, this too is a very MPS and we’re going to selectively go after the AC-offline universal input global type of AC applications. Especially if they’re related to a system solutions cell. If we have the white LED driver, we can also include the AC off light component of that. And that’s something that’s very unique compared to our peers.

And the revenue contribution, again, since especially since we’re going to be selective in our AC offline penetration, it will gradually grow through to 2011, but be relatively insignificant in 2011.

Evan Wang – Stifel Nicolaus & Company

Just to clarify about your answer, so are you sort of implying that the AC Power would not be sold independently of the white LED drivers?

Michael Hsing

No. We see – this is Michael. We see the AC to DC power, it’s a big market and we’re selectively chose some very high-energy efficiency related product. We address only those to those market. That’s included in, as Steve said earlier in the LED lighting applications.

Steve Pratt

Okay. So what Michael and I are saying is that if we – we’re going to be selective and it could be standalone offline solutions but it’s really where we add value, not just customers looking for a lower cost alternative.

Evan Wang – Stifel Nicolaus & Company

Okay. Thank you for that clarification. My follow-up question is about your gross margin operating margin target model. You had said on the last earnings call that you were revising the model to 55% gross margin, 27% operating margin. Looking at your Q4 guidance and your run rate going forward, especially your OpEx plan, how should we think about you reaching your operating margin target ? What kind of timeframe are you looking at, and how might you [inaudible]?

Rich Neely

Okay, Evan. I’ll start out the answer and then turn it over to Michael. On the gross margin model, we still feel that that’s the right model, the 50 to 55. If we, you know, if we can – if the wafer costs go back to normal and we can absorb our capacity back, we would be about 55 points. So 55 to 56 points. So we’re about – we feel we’re – except of those extraordinary issues, we don’t feel there’s any problem with the 50 to 55% range.

Although admittedly in the near term, it will take us a few quarters to get those two factors that he raised. So on the rest of it, Mike can comment.

Michael Hsing

Yes. As Rick said, earlier it’s kind of a disappointment in – but overall the company is in a good foundation and we haven’t changed any – have any strategy shift. In the first nine months we demonstrate we can go to topline and we can increase the bottom lines by huge amount. And we’ll continue that path.

However, in the next couple of quarters, we do have a big hole to fill because the absence of Korean TV market. But in the few quarter after that, we believe we can grow out of that.

Evan Wang – Stifel Nicolaus & Company

Thank you for answering my question.

Operator

Your next question comes from the line of Patrick Wang from Wedbush Securities. Please proceed.

Patrick Wang – Wedbush Securities

Great, thanks. The first question I wanted to just follow up on the gross margin comments. You know, I want to kind of back out some of your one-time, your underutilization charges and your wafer – high-wafer cost. I guess it’s something kind of like 55 to 56%. I’m just curious, you know, when you think a little bit longer term when the market starts to stabilize a bit here, what do you think your steady margins would be I guess in the second half of next year, say all things equal.

And then just on that same line of thought here, your underutilization charges from your backend facility, when that does come back up sometime first quarter, I’m just curious, you know, how long does the other utilization charges hang around for?

Michael Hsing

Well, okay, all things equal, other than after the wafer cost reduced to a normal level, to a previous level, because we anticipated a huge growth in this year, we didn’t bought a lot of expensive wafers. And if we – if the price goes back to – down to the normal levels and if everything else keep it the same, and if we keep – we have a runway up to 50 to $60 million revenue per quarter, our gross margin will be somewhere in about 54 to 56% level.

Patrick Wang – Wedbush Securities

Okay. And the, other utilization charges, how long does that hang around for?

Rick Neely

I think it’s reflective of you’ve got to get the – you’ve got to get your volume revenues up to absorb it. Again, it’s mostly fixed costs, so when we get to those revenue levels that Michael talked about, that’s when it would be fully absorbed.

It will be partially absorbed along the way, but –

Michael Hsing

It will be partially from where we are –

Rick Neely

From where we are now to 60, but that’s what we see.

Patrick Wang – Wedbush Securities

Okay. I mean, I guess my question is more directed towards the cycle time here. You know, it just takes, you know, I don’t know, three months to kind of get through that, or is this just one month? How quickly those charges disappear?

Rick Neely

Well, on the fab side, or on the test side it’s, you know, or cycle time is pretty short. In getting back, your other question, I can understand it better. We are still using the wafers we bought earlier in the year. There’s a three-month cycle time and then we’ve actually, since our demand has dropped, we are currently slowing down our labor purchases, but we still have in our fab whip line all the higher-priced wafers and that will continue through Q4 at least and probably into Q1. We had said that before that when we said in the last conference call we expect a 54 to 56% all year because of those higher-priced wafers; we weren’t going to be able to get them out of our web through this year and now it looks like that’s true for sure and will probably go somewhat into Q1.

Patrick Wang – Wedbush Securities

Got you. Okay. And my other question had to do with revenues. I can you guys just talk a little bit about, you know, the – about some of the share loss that Korea, you know, how that impacted some of your other business as those customers, you know, if you guys have – are kind of on a black list for a period of time?

And then also, based on your conservative guidance, how much visibility in backlog coverage do you have here? Thanks.

Rick Neely

Steve, you want to start?

Steve Pratt

Yeah, sure. So some of – I answered some of this in the previous question, but just to follow up, you know, it’s ongoing with the TV market and Korea. In some customers it’s getting back the relationship, and we have not – really the biggest hit for MPS has been one application segment and that’s the TVs and monitors. So in other – in the large customers where they’re broad based and they’re into other applications such as networkings and [inaudible]. There is an overall MPS short-term issue at the accounts. They haven’t removed us, they haven’t found an alternative across the board in every application. Really, it was a select number of products focused in one application segment and we have to grow our way back in there. We have to get our reputation back in order and that will take some time.

And another significant TV monitor customer in Korea, we basically worked with them on making some tough choices in a particular design cycle and so our opportunity is as soon as the next design cycle in 2011.

Michael Hsing

We still have a lot of the clients in Korea. These are the storage – SST and –

Steve Pratt

There’s SST, there’s Top Box, there’s General networking, there’s cards, networking cards. There’s also the –

Michael Hsing

And LED. We still have a lot of revenue and we expect it to get in the 2011. The only setback is in the TV side, which – DC DC in for TV application, which we exposed in the – we have a very large exposure in the first nine months.

Patrick Wang – Wedbush Securities

Okay. That’s helpful. And then can you help out with the backlog coverage?

Rick Neely

With backlog, we don’t give out backlog numbers because as they said, they’re not a reliable indicator in the quarter. But we do try and put our guidance together such that we’re comfortable with the revenue guidance range I would say we’re comfortable with the revenue guidance range that we put out.

Patrick Wang – Wedbush Securities

Okay, great. Thanks so much, guys.

Operator

Your next question comes from the line of Doug Freedman from Gleacher and Company. Please proceed.

Doug Freedman – Gleacher & Company

Thanks for taking my question, guys. You know, if I could focus a little bit on the booking side of the equation, Rick you were able to give us what your sales outlook looked like, sort of linearly, can you tell us sort of how the bookings have progressed, not only during the quarter, but now that we’re about a month into the fourth quarter, how bookings have looked? Maybe give us a little bit of insight into what the book-to-bill will look like, maybe what you think book-to-bill is going to look like?

Rick Neely

Well, we actually don’t do the book-to-bill for the same reason as we’re a high-turns business and usually do 50/50. This is also been a very unusual nine months for the company. We’ve had more backlog than we’ve ever had because we’ve had parts in allocation. We’ve often had backlog much higher than these. Back in Q3 we had backlog higher than the quarter number because a lot of people were ordering parts we couldn’t deliver. We couldn’t even schedule them.

So looking at those numbers hasn’t really been able to help us out on the booking side. What we really see this quarter is when people took – the distributors took the orders and they rescheduled them into different periods, we didn’t release any cancelations, we just did what we call push out to reschedule. The distributor still wants the parts, they just don’t want as many in the current period.

So mostly in Q4, the bookings number wouldn’t tell you the activity, it’s really the backlog is in good shape, it’s mostly been rescheduled from the Q3 time, Q4 time.

Michael Hsing

Yeah, in the quarters we see push out and then we see pulling all within a couple of weeks times.

Doug Freedman – Gleacher & Company

Are you still seeing push outs presently? I mean, are we – can you give us a sense of what you’ve seen in the last couple of weeks?

Rick Neely

Michael said it’s stabilized.

Michael Hsing

Yeah –

Rick Neely

It seems to be stabilized at this moment.

Michael Hsing

Yeah, stabilized in the beginning of the quarter we see a – well, not in the beginning, but in the middle of a quarter, so we see a lot of push out and then we see pull in now to sort of stabilize it.

Doug Freedman – Gleacher & Company

Okay. Can you talk a little bit about what you’re seeing as far as ASP trends? It’s quite common when lead times do come in that we, you know, pricing has not been a real hot button for anybody lately, but now that lead times are returning to normal in the industry, are you starting to see early signs that customers are more price sensitive? You guys are going to be more price sensitive trying to buy wafers better, are your customers not going to be asking for lower prices as well?

Michael Hsing

Actually, our ASP is a very stable throughout the years. So customer now – customer is always out for lower – lower price and I think it’s a bigger issue for us is still dealing with the shipment allocation we just gone through that and that’s our biggest relationship issues with our customers.

Doug Freedman – Gleacher & Company

Okay. Thank you.

Operator

Your next question comes from the line of Brian Piccioni from BMO Capital Markets. Please proceed.

Brian Piccioni – BMO Capital Markets

Yes. So you can imagine most of my questions have been asked and answered. I was wondering if we could maybe get back to the new product comments, just in particular the AC to DC products. If you could maybe go into a little bit more detail. I mean, it’s a space that you’re relatively new to and one that has a lot of existing players. How do you expect to distinguish yourself in that space, and you know, if you could be specific as to the type of applications that you think you’re products will be particularly suited to. Thanks.

Michael Hsing

Okay. I’ll start first and then Steven can. It is a very large well-established market. At the same time there’s a lot of new requirements, EnergyStar and the European Code of Conduct, and also in China and Japan have a similar kind of requirements. That opened the door for MPS because we have these high-voltage technology, a process technology. We can – we have the capability as we go over a 1,000 volts on one – on the integrated power – version. So we don’t use a discrete device. There are very unique technologies and because of these new requirements, new regulations, they’ve really opened the door for a company like MPS.

Steve Pratt

And just to add a little bit more color on this, the market is huge. So like we’ve said earlier, we – our strategy is to really focus on the solution sell. So our first targets are where we’re already into existing accounts where the system is transitioning to meet EnergyStar requirements and have to switch their systems to have better light-load efficiency. For example, a set-top box, we’re already well entrenched into that space.

It’s relatively easy for us to migrate in to the AC offline section there. Another good example is white LED lighting, the illumination segment of that. That’s an easier solution for MPS where we can add some value there completing the solution from AC all the way to DC driving the LEDs. Another example is where they meet the highest efficiency performance, like an adaptor. Some of the set-top boxes use adapters. That would be a target, adaptors for notebooks that are trying to get smaller, higher efficiency, less power dissipation, no load deficiency.

Michael Hsing

We are not talking about either general adopters for notebooks. Some are small, very ultra-mobile if you will and also these are mobile units and these require a very small, ultra-small adapters. Those are the areas we can provide value.

Brian Piccioni – BMO Capital Markets

Okay. Thanks for the background. I appreciate it. Thank you.

Operator

Your next question comes from the line of Nicholas Burley [ph] from Janney Capital Markets. Please proceed.

Nicholas Burley [ph] Janney Capital Markets

Hey, guys. Thanks for taking my questions. Not to bring up Korea again, but just looking at the 6 to $7 million decline that you guys are assuming for Q4, are there more designs coming in the first half that would continue to show some bleed on that front, or is that 6 to $7 million kind of worse-case scenario for what you guys are expecting?

Rick Neely

I’m just trying to clarify the question. You said, we expect – and this is a design loss, so they would carry forward into the next quarter if that’s your question.

Nicholas Burley [ph] Janney Capital Markets

Are there more designs that are coming behind us that are going to be lost, or is this just one design cycle that all the sudden is just turning off and going –

Rick Neely

Okay. So there’s a combination. There’s some accounts where the design will carry over into 2011 and then there are other opportunities where we have to catch the next design cycle which happens also in 2011. So some are shorter term than others.

Michael Hsing

The question you asked, are there any other major second design, other like a 6 to $7 million magnitude lost in the Q1 and the answer is no. Only the major impact is the Korean customers. The other ones we haven’t – we don’t lose any major customers.

Nicholas Burley [ph] Janney Capital Markets

Got you, yeah. I’m basically just trying to – I mean, backing into it, maybe 10 to $15 million worth of design wins that are going to be – that I need to take out of the model for 2011. I just was wondering if that’s the correct number roughly?

Michael Hsing

Oh no. All our new product we have introduced in the last couple of years and while in progress, still we can make a comment on it. All these LDLs as Rick said earlier, we start to have revenue ramping.

Rick Neely

There’s definitely other opportunities that are going to.

Operator

There are no further questions at this time. I will now turn the call back over to Rick Neely for closing remarks.

Rick Neely

Thank you everybody for – this was a long call and we look forward to talking with you next quarter. Thanks.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation You may now disconnect. Have a great day.

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