Microchip Technology Incorporated

Good day, everyone, and welcome to Microchip's fourth quarter fiscal 2021 financial results call. As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Microchip's chief financial officer, Mr. Eric Bjornholm. Please go ahead, sir.

Thank you, and good afternoon, everyone. During the course of this conference call, we'll be making projections and other forward-looking statements regarding future events or the future financial performance of the company and We wish to caution you that such statements are predictions and that actual results and events may differ materially. We refer you to our press releases 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 CEO, and Steve Sange, Microchip's Executive Chairman. I will comment on our fourth quarter and full fiscal year 2021 financial performance and Ganesh will then give commentary on our results and discuss the current business environment as well as our guidance, and Steve will provide an update on our cash return strategy. We will then be available to respond to specific investor and analyst questions. We are including information in our press release and in 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 for 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 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 March quarter were $1.467 billion, which were up 8.5% 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 an on-gap basis, gross margins were a record at 64.1%, Operating expenses were at 23.4%, and operating income was a record 40.7%. Non-GAAP net income was a record $521.4 million. Non-GAAP earnings per diluted share was a record $1.85, 12 cents above the midpoint of our guidance. On a GAAP basis in the March quarter, gross margins were a record at 63.2%. Total operating expenses were $618.8 million and include acquisition and tangible amortization of $232.4 million, special income of $7.2 million, $2.9 million of acquisition-related and other costs, and share-based compensation of $47.2 million. The gap net income was $116 million, or $0.41 per diluted share, and was adversely impacted by a $85.6 million loss on debt settlements associated with our convertible debt refinancing activities. Our March quarter gap tax expense was impacted by a variety of factors, notably the tax benefit recorded on the convertible debt exchange transactions occurring during the period. For fiscal year 2021, net sales were a record $5.438 billion. On a non-GAAP basis, gross margins were a record 62.8%, operating expenses were 23.2% of sales, and operating income was a record 39.6% of sales. Non-GAAP net income was a record $1.784 billion, and EPS was a record of $6.59 per diluted share. On a GAAP basis, gross margins were a record 62.1%, operating expenses were 43.7% of sales, and operating income was 18.4% of sales. Net income was $349.4 million, and EPS was $1.29 per diluted share. Our non-GAAP cash tax rate was 1.8% in the March quarter, and 4.1% for fiscal year 2021. The non-GAAP cash tax rate in the March quarter was lower than originally forecasted due to a variety of factors including the receipt of a tax refund that had not been forecasted to be received until a later date. We expect our non-GAAP cash tax rate for fiscal 22 to be about 6%, exclusive of the transition tax, any potential tax associated with restructuring the microsemi operations into the microchip global structure, and any tax audit settlements related to taxes accrued in prior fiscal years. Our inventory balance at March 31, 2021, was $665 million. We had 112 days of inventory at the end of the March quarter, which was down eight days from the prior quarter's level. Inventory at our distributors at the end of the March quarter were at 22 days, which is a record low level, and down from 26 days at the end of the prior quarter. We are ramping capacity in our internal and external factories so we can ship as much product as possible to support customer requirements. In the March quarter, we exchanged $359.2 million of our 2025, 2027, and 2037 convertible subordinated notes for cash and shares of our 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 share count dilution to the extent our stock price appreciates over time. The principal amount of convertible debt on our balance sheet at the end of fiscal year 2021 is $1.263 billion compared to $4.481 billion at the beginning of calendar year 2020, putting our overall capital structure in a much better long-term position. Our cash flow from operating activities was $449.2 million in the March quarter. As of March 31st, our consolidated cash and total investment position was $282 million. We paid down $369.2 million of total debt in the March quarter. Over the last 11 full quarters since we closed the microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down $3.61 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 our ongoing operating discipline. We continue to expect our debt levels to reduce significantly over the next several years. Our adjusted EBITDA in the March quarter was a record $652.3 million, and our trailing 12-month adjusted EBITDA was also a record at $2.375 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 3.71 at March 31, 2021, down from 3.93 at December 31, 2020. Please note that the amount of the outstanding 2037 bonds were reduced by $156 million during the March quarter as part of our financing transaction. And without this transaction, our net debt to EBITDA would have been lower. Our dividend payment in the March quarter was $106.6 million. Capital expenditures were $55.4 million in the March 21 quarter and $92.6 million for fiscal year 2021. Our fiscal year 2021 capital expenditures came in lower than originally planned due to longer equipment lead times and deliveries pushing out due to overall industry conditions. Our capital expenditures for fiscal 2022 are expected to be between $225 million and $275 million. Our forecast for the June 2021 quarter's capital expenditures is between $70 and $90 million. We continue to add capital equipment to maintain, grow, and operate our internal manufacturing operations to support the growth of our business. We expect these capital investments will bring gross margin improvement to our business and and give us increased control over our production during periods of industry-wide constraints. Depreciation expense in the March quarter was $40.2 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the March quarter, as well as our June quarter guidance. Ganesh?

Thank you, Eric, and good afternoon, everyone. Our March quarter results were strong by every key metric, closing out a tumultuous fiscal year on a very positive note. which was otherwise dominated by the effects of the COVID-19 pandemic. March quarter revenue was an all-time record at $1.467 billion, growing by 8.5% sequentially. Non-GAAP gross margins were another record at 64.1%, up 110 basis points from the December quarter, as we benefited from improved factory utilization and product mix. Non-GAAP operating margin was also a record at 40.7%, the first time we had broken through the 40% mark. Our journey towards our long-term business model of 65% gross margin and 42% operating margin is off to a good start, but still has a lot of hard work ahead of us to achieve. Our consolidated non-GAAP EPS was above the high end of our guidance at a record $1.85. EBITDA was very strong and achieved another record at $652.3 million. continuing to demonstrate the robust profitability and cash generation capabilities of our business through the business cycles. The March quarter also marked the 122nd consecutive quarter of non-GAAP profitability. I would like to take this occasion to thank all our stakeholders who enabled us to achieve these outstanding and record results in the March quarter, and especially thank the worldwide Microchip team, whose tireless efforts not only delivered strong financial results, but also supported our customers to navigate a difficult environment and who worked constructively with our supply chain partners to find creative solutions in a hyper-constrained environment. Reflecting on our fiscal year 2021 results, we achieved a number of highlights and records in the last year. Revenue was a record at $5.438 billion. Non-GAAP gross margin was a record at 62.8%. Non-GAAP operating margin was a record at 39.6%. and non-GAAP EPS was a record at $6.59. All in all, the record March quarter results and the record March ending fiscal year 2021 results marks a seamless transition between Steve and I as we each embark on our new roles to build the next phase of Microchip's long-term success. I'm truly fortunate to be the beneficiary of Steve's years of managing Microchip for the long term. Taking a look at our business from a product line perspective, Our microcontroller revenue was sequentially up 12.2% as compared to the December quarter and set new quarterly and fiscal year records. On a year-over-year basis, our March quarter microcontroller revenue was up 12.3%. Microcontrollers represented 55.6% of our revenue in the March quarter. Our analog revenue was sequentially up 11.3% as compared to the December quarter. Analog represented 28.3% of our revenue in the March quarter. Our revenue was sequentially down 6.4% for other as compared to the December quarter and represented 16.1% of our revenue in the March quarter. Last month, Gartner released their microcontroller market share report for calendar year 2020. Gartner continues to have a large discrepancy versus our publicly reported microcontroller revenue to the tune of $428 million of revenue understatement for all of 2020, predominantly in the 32-bit microcontroller revenue category. Adjusting the Gartner number to use our actual microcontroller revenue, we are pleased to report that for microcontrollers overall, we remain the number three spot. However, in 2020, we substantially closed the gap between us and the two players ahead of us. We are now within striking distance of each of the two players who were just 3.6% ahead of us in revenue. As we continue our relentless march towards the number one spot, We gained market share in each of the 8-bit, 16-bit, and 32-bit microcontroller markets. While our 8-bit and 16-bit microcontroller businesses continue to do well, our 32-bit microcontroller business was our fastest-growing microcontroller business. Our microcontroller portfolio and roadmap has never been stronger. We believe we have the new product momentum and customer engagement to continue to gain share in 2021 as we further build the best-performing microcontroller franchise in the industry. Taking a look at our business from a geographic perspective, America's was up 0.8% sequentially. Europe was up 30.4% sequentially, stronger than what is normally the seasonally strongest quarter. Asia was up 5% sequentially in a quarter when business is normally down due to the Lunar New Year holidays. Taking a look at our business from an end market perspective, the automotive, industrial, and consumer markets remain the strongest markets. The computing end market was strong, while the data center and communications end markets were flat to up a little. The aerospace and defense markets, which tend to be lumpy, was the only end market that was weak. Business conditions remained exceptionally strong through the quarter, with record bookings and backlog for product to be shipped over multiple quarters. Demand outpaced the capacity improvements we were able to implement, resulting in lead times continuing to extend out. In my 40 years in the semiconductor industry, I cannot recall a time and the imbalance between the supply and demand has been more acute. In response, we launched our Preferred Supply Program, or PSB, to provide customers with supply priority beginning six months after their order in exchange for at least 12 months of non-cancellable orders. Customer response to the program has exceeded our expectations with direct customers and distributors alike. About 44% of our backlog is now in the PSB category, although it is almost 100% of our backlog in some of the most constrained capacity corridors. Additional PSP backlog continues to come in every week. This gives us a solid foundation to enable us to prudently acquire constrained raw materials, invest in expanding factory capacity, and hire employees to support our factory ramps. With a strong demand, we're experiencing constraints in all of our internal and external factories and their related manufacturing supply chains. We started ramping our internal factories in September, as well as investing in capital additions to expand our internal capacity. We are making incremental capacity decisions for our internal factories where possible, based on the strength of our backlog, especially our non-cancellable PFC backlog, which is reflected in our fiscal year 22 capital forecast of 225 million to 275 million. We also work closely with our supply chain partners who provide wafer foundry, assembly, test, and materials to secure additional capacity wherever possible. Through the combination of internal and external capacity actions we have taken, we expect our overall capacity will continue to grow every quarter in calendar year 2021. While our capacity will continue to grow every quarter, we also believe that wafer fab as well as assembly and test constraints will persist through 2021 and quite likely into 2022. Now let's get into the guidance for the June quarter. Our backlog for the June quarter is very strong. In addition, we have considerable backlog requested by customers in the June quarter that currently cannot be fulfilled until later quarters, despite us growing capacity from the last quarter. This is because the entire semiconductor supply chain remains constrained. Taking all the factors we have discussed on the call today into consideration, we expect our net sales for the June quarter to be up between 3.5% and 7.5% sequentially. Our guidance range assumes continued operational constraints, some of which we will work through during the quarter and others that will carry over to be worked in future quarters. For the June quarter, we expect our non-GAAP gross margin to be between 64.1% and 64.5% of sales. We expect non-GAAP operating expenses to be between 23.1% and 23.5% of sales, We expect non-GAAP operating profit percentage to be between 40.6% and 41.4% of sales. And we expect our non-GAAP earnings per share to be between $1.85 and $1.95. Please keep in mind that our non-GAAP EPS forecast for the June quarter includes a 420 basis point higher tax rate assumption than the March quarter. We also expect to pay down another approximately $325 million of our debt in the June quarter. Given all the complications of accounting for our acquisitions, including amortization and intangibles, restructuring charges, and inventory write-up on acquisitions, Microchip will continue to provide guidance and track its results on a non-GAAP basis, except the net sales, which will be on a GAAP basis. We believe that non-GAAP results provide more meaningful comparison to prior quarters, and we request that the analysts continue to report their non-GAAP estimates to first call. Finally, as we announced on our February conference call, Based on the strong cash generation characteristics of our business, in up cycles and down cycles, we have modified our capital allocation thought process to pivot to a cash return strategy, which has received very positive investor feedback. Steve will now provide more details on this strategy, as well as the long-term thinking that informs our actions in this regard.