Microchip Technology Incorporated

Good day, everyone, and welcome to Microchip's third quarter fiscal 2021 financial results conference call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Chief Financial Officer Eric Bjornholt. Please go ahead.

Thanks, Chloe, 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 our 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, Microchip's Chairman and CEO, and Ganesh Murthy, Microchip's President and COO. I will comment on our third quarter financial performance, and Steve and Ganesh will then give their comments on the results and discuss the current business environment as well as our guidance. We will then be available to respond to specific investor and analyst questions. We had an unintentional posting of our earnings release on our website shortly before the normally scheduled timing today. Once we determined this occurred, we moved quickly to get the releases sent out over our normal distribution processes. We are including information in our press release and our 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 also posted a summary of our outstanding debt and our leverage metrics on our website. I 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 December quarter were $1.352 billion, which was up 3.3% sequentially and above the midpoint of our quarterly guidance. We have posted a summary of our gap net sales by product line and geography, as well as our total end market demand on our website for your reference. On a non-gap basis, gross margins were a record at 63%, operating expenses were at 23.2%, and operating income was a record 39.8%. Our factory underutilization charges decreased from $12.2 million to $3.7 million sequentially, as we continue to ramp our factories to respond to the strong business conditions. We expect the continued ramp of our factories to lead to no underutilization charges in the March quarter. Non-GAAP net income was $444.9 million. Non-GAAP earnings per diluted share was $1.62, five cents above the midpoint of our guidance. On a GAAP basis in the December quarter, gross margins were a record at 62.6%, and include the impact of $6.4 million of share-based compensation expense. Total operating expenses were $600.2 million and include acquisition and tangible amortization of $231.6 million, special charges of $4.3 million, $5.4 million of acquisition-related and other costs, and share-based compensation of $44.8 million. The GAAP-MED income was $36.2 million, or 13 cents per diluted share, and was adversely impacted by a $142.1 million loss on debt settlements associated with debt refinancing activities in the quarter. Our December quarter GAAP tax expense was impacted by a variety of factors, notably the tax benefit recorded on the convertible debt exchange transactions occurring during the period. Our non-GAAP cash tax rate was 4.25% in the December quarter, We expect our non-GAAP cash tax rate for fiscal 21 to be about 4.8%, exclusive of the transition tax. Any potential tax associated with restructuring the micro-semi-operations and 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 taxes low in the future. Our inventory balance at December 31, 2020, was $666.1 million. We had 120 days of inventory at the end of the December quarter, which was flat at the prior quarter's level. Inventory hour distributors in the December quarter were at 26 days, which is a record low level, and down from 30 days at the end of the prior quarter. In the current environment, it is quite challenging for microchip or its distributors to increase days of inventory. In the December quarter, we exchanged $1.086 billion of our 2025, 2027, and 2037 convertible subordinated notes for cash, shares of our common stock, and a new convertible bond that matures in 2024. 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 share count dilutions to the extent our stock price appreciates over time, which Steve will comment on further in his prepared remarks. In calendar year 2020, we reduced the amount of convertible bonds on Microchip's balance sheet by approximately $2.9 billion. In the December quarter, we also issued a $1.4 billion senior secured bond with a maturity date of February 15, 2024, and an interest rate of 0.972%. and used the proceeds from that transaction to pay off our term loan B, which we were paying an interest rate of about 2.15% on. Our cash flow from operating activities was $509.7 million in the December quarter. As of December 31st, our consolidated cash and total investment position was $372.7 million. We paid down $289.7 million of total debt in the December quarter, But please remember that this is inclusive of the cash paid for our various debt financing activities in the quarter, including putting a capped call in place for our newly issued convertible bond. Over the last 10 full quarters since we closed the microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down $3.24 billion of 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 we feel is a testimony to the cash generation capabilities of our business, as well as the ongoing operating discipline we have. We continue to expect our debt levels to reduce significantly over the next several years. Our adjusted EBITDA in the December quarter was a record 593.4 million, and our trailing 12-month adjusted EBITDA was 2.271 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 3.93 at December 31, 2020, down from 4.04 at September 30, 2020. But please note that the amount of the 2037 bonds were reduced by $407.7 million during the December quarter as part of the financing transactions, which has impacted this metric. Our dividend payment in the December quarter was $96 million. Capital expenditures were $21.4 million in the December 2020 quarter. We expect between $50 and $60 million in capital spending in the March quarter, and overall capital expenditures for fiscal 21 to be between $87 million and $97 million. In last quarter's conference call, we explained that our capital expenditure plan for fiscal 21 had increased as we more rapidly prepared for growth, and our business, as well as actions we were taking to increase our internal capacity in the face of constraints our outsourcing partners are experiencing. Our fiscal 21 capital expenditures are coming in lower than we indicated last quarter due to longer equipment lead times and deliveries pushing out due to overall industry conditions. We continue to add capital to maintain and operate our internal manufacturing operations, support the production capabilities for our new products and technologies, as well 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 December quarter was $40.3 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the December quarter. Ganesh?

Thank you, Eric, and good afternoon, everyone. Let's start by taking a closer look at microcontrollers. Our microcontroller revenue performed well, with revenues sequentially up 3.3% as compared to the September quarter. On a year-over-year basis, our microcontroller revenue was up 5.9%. We continue to introduce a steady stream of innovative new microcontroller solutions, including the first safety-certified capacitive touchscreen controllers for the home appliance market, the first trust-and-go Wi-Fi module delivering powerful 32-bit microcontroller functionality and verifiable identity, the industry's highest-density secured Ethernet switching solution for hyperscale data centers and telecom service providers, and last but not least, three new broad-market 8-bit microcontroller families to extend our leadership in this product line. Microcontrollers overall represented 53.7% of our revenues, in the December quarter. Moving to analog, our analog revenue also performed well and was sequentially up 3.1% as compared to the September quarter. On a year-over-year basis, our analog revenue was up 2.6%. During the quarter, we continued to introduce a steady stream of innovative analog products too, including the first cryptographic companion device supporting in-vehicle network security solutions, a new family of configurable 12-bit digital-to-analog converters, the first highly integrated radiation-hardened motor controller, and finally, a family of low-latency PCI Express 5.0 and Compute Express Link re-timers. Analog represented 27.6% of our revenue in the December quarter. Our FPGA revenue was down 8.5% sequentially as compared to the September quarter. On a year-over-year basis, our FPGA revenue was up 7.1%. As we cautioned on our prior conference calls, FPGA revenue does have some lumpiness associated with it because of the large exposure to the aerospace and defense markets and the associated purchasing patterns. During the quarter, we announced a radiation-hardened fourth-generation FPGA family and a low-power radiation-tolerant fifth generation PolarFire FPGA family. FPGA represented 7.3% of our revenue in the December quarter. Our licensing, memory, and other product line, which we refer to as LMO, was up 13% in revenue as compared to the September quarter, with strength in licensing revenue driving this growth. LMO represented 11.4% of our revenue in the September quarter. A quick note about our product line reporting. Given the relatively smaller size of our FPGA product line, at about 7% of our revenue as compared to our microcontroller and analog product lines, we have decided that starting in calendar year 2021, we will no longer break out the FPGA product line separately. Our FPGA products remain important to our overall total system solutions goals. We continue to make significant investments in our FPGA products and expect those investments will help drive our long-term growth and total system solutions initiatives. Going forward, we will combine our FPGA revenue with our LMO, our licensing, memory, and other revenue into a new category that we just call other. From an end market standpoint, we continue to see the automotive, industrial, and consumer markets strengthened further in the December quarter. approximating a V-shaped recovery in the second half of calendar year 2020 as compared to the first half. The end markets that benefited earlier in the year from the work-from-home related demand surge, namely computing, communications, and data center, remained at more normal demand patterns as the surge we saw in the June quarter dissipated. The Huawei ban, which was in effect for all of the December quarter and represented 1% to 2% of our overall revenue, had a more pronounced negative impact on our data center business, where it was a more meaningful percentage of that business. Finally, demand for our products that go into the office environment, which we refer to as enterprise demand, remained weak, as most businesses remain predominantly with work-from-home policies, thus deferring enterprise spending for the office environment. The supply chain constraints that started in the September quarter continue to grow through the December quarter, a robust overall business environment, accentuated by rising demand from the automotive, industrial, and consumer markets, combined with low levels of inventory in the distribution channel, resulted in constraints in practically all of our internal and external factories. Since September, we have been ramping our internal factories, as well as investing in capital additions to further expand our internal capacity. We have also worked with our supply chain partners to increase our FAB assembly, and test capacity allocation. However, based on the current strength of the business environment, we expect that the constraints we are currently seeing are likely to continue through much of calendar year 2021 and possibly into calendar year 2022. As a result, we have seen our lead time stretch out for many of our products where the constraints are most acute. We have also experienced increases in material and subcontracted manufacturing costs and have taken steps to secure capacity for 2021. Steve will discuss more in his prepared remarks about our actions to address the current environment of increasing manufacturing costs and seemingly insatiable demand. Let me now pass it to Steve for comments about our business and our guidance going forward. Steve?