Microchip Technology Incorporated

Good day, everyone, and welcome to this Microchips second quarter fiscal 2020 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 Microchips Chief Financial Officer, Mr. Eric Bjornholtz. Please go ahead, sir.

Thank you, and good afternoon, everyone. 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 today 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, Microchips Chairman and CEO, and Ganesh Murthy, Microchips President and COO. I will comment on our second quarter fiscal year 2020 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 the ongoing 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 when comparing our GAAP and non-GAAP results. We've also posted a summary of our outstanding debt and our leverage metrics on our website. I want to remind investors that during the June quarter of 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 was deferred until the product was sold by our distributor to an end customer. As discussed in previous earnings conference calls, we continue to track and measure our performance internally based on direct revenue plus distribution sell-through activity and each quarter will provide a metric for this called end market demand in our earnings release. 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 based on end market demand. End market demand in the September 2019 quarter was $1.346 billion. And market demand was about $8.6 million more than our GAAP revenue in the quarter. 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 as described in our press release. Net sales in the September quarter were $1.338 billion, which was up 1.15% sequentially and modestly below the midpoint of our guidance of $1.349 billion. We have posted a summary of our GAAP net sales and end market demand by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were near all-time highs at 62.24%. Operating expenses were at 25.56% and operating income was 36.7%. Non-GAAP net income was $365.7 million. Non-GAAP earnings per diluted share was $1.43, which was in line with the midpoint of our guidance. On a GAAP basis, gross margins were 61.9% and included the impact of $5.2 million of share-based compensation, Total operating expenses were $643.9 million and include acquisition and tangible amortization of $248.2 million, special charges of $3.6 million, $10.1 million of acquisition-related and other costs, and share-based compensation of $40.1 million. The GAAP net income was $108.9 million, or 43 cents per diluted share. Our September quarter GAAP tax benefits included $12.7 million of net discrete income tax benefits related to tax reserve releases due to statute of limitations expiring, partially offset by a foreign tax assessment. The non-GAAP cash tax rate was 6.5% in the September quarter and was negatively impacted by a foreign tax assessment that Microchip will pay in fiscal year 2020, but defend its position and seek a refund of these taxes in the future. We expect our non-GAAP cash tax rate for fiscal 20 to be between 6% and 7%. Exclusive of the transition tax, any potential tax associated with restructuring the micro-semi-operations into the microchip global tax structure and any tax audit settlements related to taxes accrued in prior fiscal years. We have many tax attributes in net operating losses and tax credits, as well as U.S. interest deductions that we believe will keep our cash tax payments low and The future cash tax payments associated with the transition tax is expected to be about $236 million and will be paid over the next six years. We have posted a schedule of our projected transition tax payments on the investor relations page of our website. Our inventory balance at September 30th, 2019 was $734.2 million. We had 131 days of inventory at the end of the September quarter, down one day from the prior quarter's level. Inventory at our distributors in the September quarter were at 30 days compared to 32 days at the end of June. We have only had one quarter in the past 15 years, which was Q3 of fiscal year 2013, where our days of inventory at distribution have been lower than the current levels. The cash flow from operating activities was $396 million in the September quarter. As of September 30th, the consolidated cash and total investment position was $405.1 million. We paid down $315.5 million of total debt in the September quarter, and the net debt on the balance sheet was reduced by $283.5 million. Over the last full five quarters since we closed the microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down $1.729 billion of the debt and continue to allocate substantially all of our excess cash beyond dividends to aggressively bring down this debt. We have accomplished this despite the adverse macro and market conditions during most of this period, which is a testimony to the cash generation capabilities of our business. We expect our debt levels to reduce significantly over the next several years. Our adjusted EBITDA in the September quarter was $540.2 million. and our trailing 12-month adjusted EBITDA was 2.178 billion. Our net debt to adjusted EBITDA, excluding our very long-dated convertible debt that matures in 2037 and is more equity-like in nature, was 4.59 at September 30th, 2019. Our dividend payment in the September quarter was 87.3 million. Capital expenditures were 17.7 million in the September quarter, We expect between $20 million and $25 million in capital spending in the December quarter, and overall capital expenditures for fiscal 2020 to be between $90 million and $100 million, a $25 million reduction from the forecast we provided last quarter. We continue to add capital to support the growth of our production capabilities of our new products and technologies, and to bring in-house more of the assembly and test operations that are currently outsourced. We expect 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. The appreciation expense in the September quarter was $39.5 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the September quarter and provide an update on some of our ongoing microsemi integration activities. Ganesh?

Thank you, Eric, and good afternoon, everyone. Before I get started, I'd like to remind you 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. Also, as I go through the product line reports, they will reflect continued broad macro weakness in the markets we serve. This broad weakness was further accentuated in the month of September. Let's start by taking a closer look at microcontrollers. Our microcontroller business was sequentially down 1.3% as compared to the June quarter. We continue to introduce a steady stream of innovative new microcontrollers, including the industry's first commercially available serial memory solid-state drive controller, which won the Best of Show Award in the 2019 Flash Memory Summit, as well as two different USB Type-C power delivery controllers, which enable fast device charging and simplifies implementation of this functionality. Microcontrollers represented 53.3% of our end market demand in the September quarter. Now moving to analog, our analog business was sequentially up 0.2% as compared to the June quarter. During the quarter, we continued to introduce a steady stream of innovative analog products, including the introduction of the trust platform for crypto authentication, the industry's first pre-provision solution providing secure key storage for small and large volumes. Analog represented 28.7% of our end market demand in the September quarter. Our FPGA business was sequentially down 8.9% as compared to the June quarter. As we have mentioned in prior conference calls, the FPGA business does have some lumpiness because of our significant exposure to space, aviation, and defense markets, where procurement timing can be a function of programs and their shifting priorities, schedules, and budgets. During the quarter, we announced our Smart Embedded Vision Initiative, providing for designing intelligent machine vision systems with our low-power PolarFire FPGAs. Design wins for the PolarFire family continue to grow strongly, and we remain optimistic about the prospects for this product family. FPGA represented 6.8%, of our end market demand in the September quarter. Our licensing memory and other product line, which we refer to as LMO, was sequentially up 10.5% in the September quarter as compared to the June quarter. Strength in our licensing business, as well as our timing systems business, outpaced the broader macro weakness we experienced. LMO represented 11.2% of our end market demand in the September quarter. In September, we completed the acquisition of two small early stage private companies. The first acquisition enables low power embedded computing solutions for machine learning inference and smart embedded vision applications for our FPGA product families. This acquisition also adds domain knowledge depth in the areas of machine learning algorithms and vector processing. The second acquisition provides digital gate driver solutions for wideband GAP MOSFET and IGBT technologies. The acquisition complements our silicon carbide discrete and modular power conversion offerings and enables us to provide more comprehensive total system solutions. These two acquisitions were very small and more akin to acquiring intellectual property along with domain experts to help us accelerate our business agenda in specific laser-focused areas. The combined cash outflow was less than $6 million dollars and hence not material to the rate at which we're paying down our debt. Finally, a quick update about the ongoing microsemi integration. We continue to plow forward with the business systems and operations integrations. On the business systems front, we went live with a few more systems on November 1st. And as I have mentioned on prior conference calls, this is a tedious and time-consuming effort, and we estimate that we're about 50% of the way to completion and have about another year of work ahead of us. We are pleased with the synergies we have achieved since we closed the transaction despite the weaker macro environment, and we expect continued synergy gains for many quarters to come. Let me now pass it to Steve for his comments about our business and our guidance going forward. Steve?