Microchip Technology Incorporated

Please stand by. We're about to begin. Good day, everyone, and welcome to Microchip's second quarter fiscal 2021 financial results. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Microchip's president and chief executive officer, Mr. Steve Senge. Please go ahead, sir.

Thank you, operator. 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 or 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 Ganesh Murthy, Microchip's President and COO, and Eric Bjornhold, Microchip CFO. I will first comment on our CEO transition and board appointments. Eric will then comment on our second quarter financial performance, and Ganesh will then give his comments on the results. I will then discuss the current business environment as well as our guidance. We will then be available to respond to specific investor and analyst questions. So let me begin by commenting on the CEO transition announced today and the addition of board members. Today we announced that I will transition to an executive chair role effective March 1, 2021. Microchip's current president, Ganesh Murthy, will step into the role of president and CEO effective March 1, 2021. Ganesh will also join the board of directors effective January 4, 2021. I joined Microchip in February 1990 as senior vice president of operations and was promoted to president to lead this company in July 1990. Microchip then had sales of about $60 million and it was losing about $10 million per year. The main product line at that time was commodity EPROM, and the gross margin of the company was about 30%. The turnaround of the company was documented in my book, Driving Excellence, How the Aggregate System Turned Microchip from a Failing Company to a Market Leader. We took Microchip public in March of 1993, with annual sales of $89 million and a market capitalization of $85 million. In the last 27 years as a public company, Microchip's net sales grew to $5.2 billion and its market capitalization grew to approximately $30 billion. Today, Microchip produces industry-leading growth and operating margins. Since its IPO, Microchip's stock price has grown Approximately 20,000% excluding dividends, Microchip has also completed its 120th consecutive quarter of profitability on a non-GAAP basis. In the last 30 years, Microchip transformed from a small company focused on non-volatile memory products to an embedded solutions powerhouse with a broad and innovative range of solutions. as well as leadership positions in the industrial, data center, automotive, communications, consumer, and aerospace and defense markets. We have also been an industry consolidator, having acquired about 20 companies, including well-known industry names like Silicon Storage Technology, Standard Microsystems, Microwell, Atmel, and Microsemi. All of the acquired companies was successfully integrated into Microchip's business and created outstanding value for the stockholders of Microchip. Leading Microchip for the last 30 years has been the greatest privilege of my 42 years in the semiconductor industry. I turned 65 in July of this year. I often thought about transitioning to an executive chair role by that date, I discussed this with our board of directors as part of our succession planning process earlier this year, but no decision was made at that time. Then, given the unexpected COVID-19 pandemic, the board and I thought it was best to delay any transition so that it would not occur during a very turbulent and unpredictable time. I have now decided that the time is right to make this change. The overall decision was made easier given that Microchip has someone as qualified as Ganesh to assume the CEO role and given the strength of the rest of our management team. I have known Ganesh for 39 years since hiring him as a new college graduate at Intel in 1981. He has a demonstrated track record of success and a proven partnership over the last 19 years at Microchip makes him my logical successor. He is an energetic, articulate, and thoughtful leader who is widely respected amongst our customers, partners, suppliers, investors, and analysts, as well as the entire microchip employee base. Ganesh joined the microchip in 2001 and served as the vice president of multiple business units. In 2006, he was promoted to executive vice president with extended business unit and manufacturing responsibilities. and assumed the role of Chief Operating Officer in 2009. Ganesh has served as President and Chief Operating Officer from February 2016. Since then, Ganesh and I have jointly led Microchip. Now, starting March 1, 2021, Ganesh will become the President and CEO of Microchip. I will remain as an Executive Chairman. I will work with Ganesh to continue to drive the strategic direction of this company and maintain a strong culture and succession planning that we have developed here. We also announced today that starting January 4, 2021, Karen Rapp will join the Board of Directors of Microchip and will also join its audit committee. Karen is no stranger to the technology investment community. She's currently the CFO of National Instruments. She also serves on the Board of Plexus, which is a contract manufacturer. Karen brings with her extensive large company, large public company experience, and significant leadership accomplishments in financial management, financial governance, information technology, and cybersecurity. We are all very pleased to have Karen join our board. I will now pass this call to Eric Bionhold, and we will cover the earnings part of this conference call. Eric?

Thanks, Steve, and good afternoon, everyone. 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 have posted a summary of our outstanding debt and our leverage metrics on our website. We will now go through some of the operating results, including net sales, gross margin, and operating expenses. Other than net sales, 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 $1.31 billion, which was flat sequentially and above the high end of our narrow guidance range from September 9, 2020, when net sales were expected to be down between 2% and 6% sequentially. We have posted a summary of our gap net sales as well as end market demand by product line and geography on our website for your reference. On an on-gap basis, gross margins were very strong and near record levels at 62.2%. Operating expenses were at 23%, and operating income was an outstanding 39.2%. all better than the high end of our revised guidance from September 9th. Our factory underutilization charges decreased from $13.9 million to $12.2 million sequentially as we started to ramp our factories to respond to the stronger than expected business conditions. We expect the continued ramp of our factories to lead to lower underutilization charges in the December quarter. Non-GAAP net income was $416.4 million, Non-GAAP earnings per share was $1.56, 15 cents above the midpoint of our guidance, and 10 cents above the high end of our guidance from September 9th. On a GAAP basis in the September quarter, gross margins were 61.7% and include the impact of $6 million of share-based compensation expense. Total operating expenses were $581.7 million and include acquisition and tangible amortization of $232.9 million and special charges of $4.3 million, $0.7 million of acquisition-related and other costs, and share-based compensation of $43.7 million. The GAAP net income was $73.6 million, or 27 cents per diluted share. Our September quarter GAAP tax expense was impacted by a variety of factors, including tax reserve releases associated with the statute of limitations expiring, offset by tax reserve accruals, associated with developments of the Altera court case during the period, deferred tax impacts of enacted changes in tax law occurring during the period, deferred tax impacts of our convertible debt exchange transactions occurring during the period, and other matters. Our non-GAAP cash tax rate was 5% in the September quarter. We expect our non-GAAP cash tax rate for fiscal 21 to be about 5.5%, exclusive of the transition tax, any potential tax associated with restructuring the microsemity 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 remaining cash tax payments associated with the transition tax are expected to be about $221 million and will be paid over the next five years. We have posted a schedule of our projected transition tax payments on the Industrial Relations page of our website. Our inventory balance at September 30th, 2020 was $661.4 million. We had 120 days of inventory at the end of the September quarter, up three days from the prior quarter's level, and primarily a result of our strong gross margin performance. Inventory at our distributors in the September quarter were at 30 days, which was flat to the prior quarter. We believe distribution inventory levels for Microchip are still low compared to the historical range we have experienced over the past 10 years, which is between 27 and 47 days. Our cash flow from operating activities was $455.8 million in the September quarter. As of September 30th, our consolidated cash and total investment position was $370.3 million. We paid down $331.1 million of total debt in the September quarter. Over the last nine full quarters since we closed the microsemity acquisition and incurred over $8 billion in debt to do so, we have paid down $2.95 billion of the debt and continue to allocate substantially all of our cash, 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 we feel is a testimony to the cash generation capabilities of our businesses, as well as our ongoing operating discipline. We continue to expect our debt levels to reduce significantly over the next several quarters. In the September quarter, we also exchanged $796.1 million of our 2025 and 2027 convertible senior subordinated notes for cash and shares of common stock. While these transactions did not impact the overall level of debt on our balance sheet, We believe that these convertible exchanges will benefit stockholders by significantly reducing the share count dilution to the extent our stock price appreciates over time. Our adjusted EBITDA in the September quarter was $566.7 million, and our trailing 12-month adjusted EBITDA was $2.181 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 4.04 at September 30th, 2020, down from 4.24 at June 30th, 2020. Our dividend payment in the September quarter was 95.3 million. Capital expenditures were 6.3 million in the September 2020 quarter. We expect about $35 million in capital spending in the December quarter, and overall capital expenditures for fiscal 21 to be between 110 and $120 million. Our capital expenditure forecast for fiscal 21 has increased as we prepare for growth in our business, as well as actions we are taking to increase our internal capacity in the face of constraints our outsourcing partners are experiencing, which Ganesh will talk more about. We continue to add capital to maintain and operate our internal manufacturing operations, support the production capabilities of new products and technologies, and as well as to selectively bring in-house some of the wafer fabrication, assembly, and test operations that are currently outsourced. We expect these capital investments will bring gross margin improvement to our business and give us increased control over our destiny during periods of industry-wide constraints. Depreciation expense in the September quarter was $39 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the September quarter. Ganesh?