Microchip Technology Incorporated

And welcome to this Microchips fourth quarter fiscal 2019 financial results conference call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Eric Bjornholt, Chief Financial Officer. Please go ahead, sir.

Good morning, everybody. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press releases of last evening as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. In attendance with me today are Steve Sange, Microchip's chairman and CEO, and Ganesh Murthy, Microchip's president and COO. I will comment on our fourth quarter and full fiscal year 2019 financial performance, and Steve and Ganesh will then give their comments on the results, discuss the current business environment, as well as our guidance, and provide an update on our integration activities associated with the MicroSemi acquisition. We will then be available to respond to specific investor and analyst questions. We are including information in our press release and this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the investor relations page of our website at www.microchip.com, which we believe you will find useful in comparing GAAP and non-GAAP results. I want to remind investors that during the quarter ending June 30th, 2018, we adopted the new GAAP revenue recognition standard, which requires revenue to be recognized at the time products are sold to distributors versus our historical revenue recognition policy where revenue on such transactions were deferred until the product was sold by our distributors to an end customer. We continue to track and measure our performance internally based on direct revenue plus distribution sell-through activity, and we'll provide a metric for this called end market demand in our earnings release each quarter. Therefore, along with our gap and non-gap results based on distribution sell-in, we will also provide investors with our end market demand based on distribution sell-out, but will not provide a P&L on end market demand. End market demand in the March 2019 quarter was $1.34 billion, which was $10.4 million above our gap revenue. I will now go through some of the operating results, including net sales, gross margin, and operating expenses. I will be referring to these results on a non-GAAP basis, which is based on expenses prior to the effects of our acquisition activities, share-based compensation, and certain other adjustments. Our fiscal 2019 non-GAAP results are calculated as the sum of the non-GAAP sell-through based information we disclosed previously for each of the first three quarters of fiscal 2019 plus the non-GAAP sell-in based information disclosed today for the fourth quarter of fiscal 2019. Net sales in the March quarter were $1.33 billion, which was above the midpoint of our guidance and down 3.3% sequentially. We have posted a summary of our GAAP net sales and the end market demand by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were 62.2% and well above the midpoint of our guidance, which was 61.5%. Operating expenses were at the low end of our guidance range at 25.8% of sales. And operating income was $484.1 million and 36.4% of sales. Non-GAAP net income was $370.4 million. Non-GAAP earnings per diluted share was $1.48 which was over $0.08 above the midpoint of our guidance of $1.39 and a half. For fiscal 2019, on a non-GAAP basis, net sales were a record $5.476 billion and up 37.6% year-over-year. Gross margins were a record 62.1%, operating expenses were 24.3% of sales, and operating income was 37.7% of sales. Net income was a record $1.636 billion, and non-GAAP EPS was a record $6.55 per diluted share. Please note that for fiscal year 2019, our non-GAAP results are based on our publicly reported non-GAAP results, which Q1 through Q3, as mentioned before, were based on sell-through revenue recognition in the distribution channels, and Q4 was based on sell-in revenue recognition in the distribution channels. Fiscal year 2020 non-GAAP results will be based on sell-in revenue recognition, in line with our GAAP revenue reporting, and the revenue recognition standard adopted during the first quarter of fiscal 2019. On a GAAP basis, gross margins were 61.7% and include the impact of $4 million of share-based compensation and $1.8 million of acquired inventory valuation costs. Total operating expenses were $535.9 million and include acquisition and tangible amortization of $176.9 million, special income of $23.3 million, $4.4 million of acquisition-related and other costs, and share-based compensation of $35.1 million. The gap net income was $174.7 million, or $0.70 per diluted share, and includes an income tax benefit of $23.5 million. The GAAP tax benefit in the quarter related to a variety of matters, including tax reserve releases due to statute of limitations expiring, tax reform refinements, and tax benefits associated with restructuring the microsemi operations into the microchip global structure. On a GAAP basis for fiscal 2019, net sales were a record $5.35 billion and up 34.4% year-over-year, Gross margins were 54.8%, operating expenses were 41.4% of sales, and operating income was 13.4% of sales. Net income was $355.9 million, and EPS was $1.42 per diluted share. The non-GAAP cash tax rate was 1.4% in the March quarter and 3% for fiscal year 2019. For cash planning purposes, we were able to defer the payment of some of our fiscal 19 taxes into fiscal 20, and this is one of the reasons our FY19 tax rate was lower than originally projected. We expect our non-GAAP tax rate for fiscal 20 to be between 5% and 6%, exclusive of the transition tax. Any potential tax associated with restructuring the micro-semi-operations into the microchip global structure and any tax audit settlements related to taxes accrued in prior fiscal years. We have many tax attributes and net operating losses and tax credits, as well as U.S. interest deductions that we believe will keep our cash tax payments low. The future cash tax payments associated with the transition tax is expected to be about $246 million and will be paid over the next seven years. We have posted a schedule of our projected transition tax payments on the Industrial Relations page of our website. Moving on to the balance sheet, you will notice that Microchip's accounts receivable balance is up significantly from the prior quarter. We have made an accounting presentation change to reclassify the distributor price adjustments that reduce the amount of cash we ultimately receive from our distributors from a reduction in the AR balance to an increase in accrued liabilities. Remember that we generally sell to our distributors at a price that is higher than the ultimate sales price, and then that price is reduced by a distributor price adjustment when the ultimate sale occurs to the distributor's customers. Excluding this reclassification, our accounts receivable balance was up about $5 million in the quarter. Our inventory balance at March 31st, 2019 was $711.7 million. All the inventory markup for micro-semi required for GAAP purchase accounting has now been sold through and is no longer reflected in the ending inventory balance. We had 128 days of inventory at the end of the March quarter, up five days from the prior quarter's level. Inventory at our distributors in the March quarter were at 35 days compared to 36 days at the end of December. We believe that barring any negative developments in the U.S.-China trade front, our distributors are holding a reasonable level of inventory to support end market demand. The cash flow from operating activities was $403.4 million in the March quarter. As of March 31st, the consolidated cash and total investment position was $430.9 million. We paid down $277.5 million of total debt in the March quarter, and the net debt on the balance sheet reduced by $272.3 million. At March 31st, our debt outstanding includes $3.267 billion of borrowings under our line of credit, $1.912 billion of term loan B, $2 billion in high-grade bonds, and $4.481 billion of convertible debt. Our EBITDA in the March quarter was $544.4 million, and our trailing 12-month EBITDA was $2.212 billion. Our net debt to EBITDA, excluding our very long-dated convertible debt that matures in 2037 and is more equity-like in nature, was $4.8 at March 31, 2019. Our net leverage metrics are based on 12-month trailing EBITDA, which will continue to provide some headwinds due to the distribution inventory reductions that were made in the June and September quarter for microsemi, which caused our shipment activity to be significantly less than the end market demand during these periods. The weaker economic environment also is negatively impacting our EBITDA in the December 2018 and March 2019 quarters. We are committed to using substantially all of our excess cash generation beyond our dividend payments to reduce our debt levels and we expect our debt levels to reduce significantly over the next several years. Our dividend payment in the March quarter was 86.7 million. Capital expenditures were 40.1 million in the March 2019 quarter and 228.9 million in fiscal year 2019. We expect about 35 million in capital spending in the June quarter and overall capital expenditures for fiscal year 2020 to be between $130 and $150 million. We continue to add capital to support the growth of our production capabilities for our new products and technologies, and to bring in-house more of the assembly and test operations that are currently outsourced. These capital investments will bring some gross margin improvement to our business, particularly for the outsourced Atmel and MicroSemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the March quarter was $48.4 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the March quarter and provide an update on some of the microsemi integration activities. Ganesh?

Thank you, Eric, and good morning, everyone. Before I get started, I'd like to clarify that the product line comparisons I will be sharing with you today are based on end market demand, which is how Microchip measures its performance internally. Let's start by taking a closer look at microcontrollers. Our microcontroller business was sequentially down 4.6% compared to the December quarter, reflecting the broad macro weakness in the markets we serve. Microcontrollers, however, were up 8.6% from the year-ago quarter. On a fiscal year basis, fiscal year 19 microcontroller revenue was a record at over $3 billion and grew 15% over fiscal year 18. microcontrollers represented 53.3% of our end market demand in the March quarter. During the quarter, we continue to introduce a steady stream of innovative new microcontrollers, ranging from the industry's first arm-based microcontroller with space-qualified versions that have scalable levels of radiation performance, new dual- and single-core DSPIC33 digital signal controllers with built-in functional safety, the industry's smallest IEEE 802.15.4 compliant module that combines an ultra-low-power microcontroller with a sub-gigahertz radio. And last but not least, we unveiled our unified 32-bit microcontroller software framework called Harmony, extending support for Atmel-originated SAM microcontrollers in Microchip's development tool environment. We now support our MIPS-based microcontrollers as well as our ARM-based microcontrollers on a single development environment of MPLAB and Harmony. Last month, Gartner released their microcontroller market share report for calendar year 2018. We are pleased to report that Microchip retained the number one position for 8-bit microcontrollers. Once again, we gained market share as we grew faster than the 8-bit microcontroller market overall. And in fact, we are now 73% larger than the number two player. In the 16-bit microcontroller market, we remained in the number five position and continued to gain significant market share as we grew faster than all our top competitors and at about 5x the growth rate of the 16-bit microcontroller market. In the 32-bit microcontroller market, we remained in the number six position and gained significant market share as we grew almost at 2x the growth rate of the 32-bit microcontroller market. We were also the fastest growing franchise among the top six players who make up over 80% of the 32-bit microcontroller market. These results are despite Gartner rolling up our 32-bit microcontroller revenue to be 30% lower than the over $1 billion revenue that we informed you of in our last conference call. Had Gartner used our actual calendar year 2018 32-bit microcontroller revenue, we would have moved up to the number four rankings. Additionally, our 32-bit microcontroller revenue in fiscal year 19 was over $1.1 billion, demonstrating continued momentum. For microcontrollers overall, we remained in the number three position and grew faster than the two players ahead of us. The Gartner reported revenue is considerably lower than our publicly reported revenue for calendar year 2018. Using our publicly reported revenue, we would be approximately 13% and approximately 18% away from the top two players ahead of us as we continue our relentless march towards the number one spot. Our microcontroller portfolio and roadmap has never been stronger. We believe we have the new product momentum and the customer engagement to continue to gain even more share in 2019 as we further build the best performing microcontroller franchise in the industry. Now moving to analog, our analog business was sequentially down 5.8% compared to the December quarter, reflecting the same broad macro weakness of microcontroller business experience. Analog, however, was up 60.2% from the year-ago quarter. On a fiscal year basis, fiscal year 19 analog revenue was a record at well over $1.5 billion and grew 64.6% over fiscal year 18. Analog represented 29% of our end market demand in the March quarter. During the quarter, we continue to introduce a steady stream of innovative analog products, including a new analog-to-digital converter family that enables high-speed, high-resolution analog-to-digital conversions in harsh environments. Our FPGA business was sequentially down 5% as compared to the December quarter, reflecting the same broad macro weakness. However, design wins in our new, low-power, mid-range polar fire family continue to grow strongly, and we are optimistic about this product family adding another leg of growth for the future. During the quarter, we introduced the PolarFire FPGA imaging and video solution that supports resolution as high as 4K in the small, low-power form factors necessary for a wide range of imaging and video applications. We also released our Libero SoC design tool, which delivers a unified design suite, FPGA represented 7% of our end market demand in the March quarter. Moving next to our licensing business, this business was sequentially down 42.3% as compared to the December quarter. The production activity of our licensing customers has been cut significantly in response to industry conditions. Also, as we mentioned in our February conference call, we did not expect nor have any meaningful patent licensing revenue in the March quarter. while we did in the December quarter. Our patent licensing strategy is to monetize portions of the substantial patent portfolio we inherited through our acquisitions by licensing select patents to players in noncompetitive fields of use, while retaining the rights to these patents in our products as well. Investors should expect that the revenue contribution from patent licensing in the future will be lumpy from quarter to quarter. Our memory business was sequentially up 3.8% in the March quarter, as compared to the December quarter. And finally, our multi-market and other business was up 3.5% sequentially as compared to the December quarter. A quick update about our microsemi integration as we come up on the one-year anniversary after the close. Business units, sales, operations, and support groups are all making good progress. Our thanks go to the combined company employees who are working hand-in-hand to achieve accelerated synergy results. Overall, we're ahead of our synergy targets and expect continued synergy gains for many quarters to come. Business systems and operations integration is taking the longest time to complete as we are conducting this complex transition in phases. The first and second phases were completed on November 1st and February 1st, respectively, for a combined total of four business units. The third phase went live on May 1st and involved four more business units. With that, we are about one-third of the way through the business systems and operations integration, and more phase releases are planned every quarter. We expect the overall business and operational integration will take about another 12 to 15 more months to complete. Finally, prior to our acquisition, MicroSemi had announced the closing of a small 4-inch fab in Bend, Oregon. The last wafers came out of this fab at the end of the March quarter, and we ceased production on schedule. Additionally, we were able to find a buyer for the fab and close the sale last week. The sale price was not material to Microchip. Let me now pass it to Steve for some comments about our business and our guidance going forward. Steve?