Microchip Technology Incorporated

Good day, everyone, and welcome to Microchip's second quarter fiscal 2022 financial results. 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 Bjarne Holt. Please go ahead.

All right. 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 and that actual events or results may differ materially. We refer you to our press release 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 Morthy, Microchip's President and CEO, Steve Sange, Microchip's Executive Chair, and Sajid Dowdy, Microchip's Head of Investor Relations, who just joined us over the course of the last month. I will comment on our second quarter fiscal year 2022 financial performance. Ganesh will then provide commentary on our results, 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 of our website at www.microchip.com and included reconciliation information in our press release 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 our 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 effect of our acquisition activities, share-based compensation, and certain other adjustments as described in our press release. Net sales in the September quarter were $1.65 billion, which was up 5.1% sequentially, and up 26% compared to the September quarter of 2020. 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 65.3%, and operating income was a record 42.5%. Non-gap net income was a record $605.6 million. Our non-gap cash tax rate in the quarter was 6%. non-GAAP earnings per diluted share on a split-adjusted basis exceeded the midpoint of our guidance and was a record $1.07. This reflects our recent two-for-one stock split that was effective for stockholders of record on October 4, 2021. On a GAAP basis in the September quarter, gross margins were a record at 64.8% and include the impact of $9.1 million of share-based compensation expense, Total operating expenses were $652 million and include acquisition and tangible amortization of $215.7 million, special charges of $10.2 million, $2.8 million of acquisition-related and other costs, and share-based compensation of $46.6 million. Gap net income was $242 million, or $0.43 per diluted share, and was negatively impacted by the gap loss on the convertible debt exchanges that we executed in the quarter, which were not included in our guidance. Our September quarter gap tax expense was impacted by a variety of factors, most notably the tax benefit recorded on the convertible debt exchange transactions that I just mentioned. Our inventory balance at September 30, 2021 was $713.6 million. We had 112 days of inventory at the end of the quarter, which was up one day from the prior quarter's level. Our levels of raw materials and work in progress increased in the quarter, which helps position us for the increased production we are expecting from our internal factories. We are ramping capacity in our internal and external factories so we can ship as much as possible to support customer requirements. Inventory at our distributors in the September quarter was at 19 days, which is a record low level and down from 20 days as of the end of the prior quarter. In the September quarter, we exchanged a total of $263.6 million of our 2025, 2027, and 2037 convertible subordinated notes for cash and shares of our common stock. We used cash generation during the quarter to fund the principal amount of the convertible debt exchanges, and we believe that these transactions 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 the balance sheet at September 30th was $999.2 million 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 $611.7 million in the September quarter. Our free cash flow was $533.2 million and 32.3% of net sales. As of September 30th, our consolidated cash and total investment position was $255.3 million. We paid down $415.6 million of total debt in the September quarter. And over the last 13 full quarters since we closed the microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down over $4.4 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 much 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 September quarter was a record at 762.5 million, or 46.2% of net sales. Our trailing 12-month adjusted EBITDA was also a record at $2.72 billion and 45% of net sales. 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 $2.99 at September 30, 2021, down from $3.34 at June 30, 2021. Our dividend payment in the September quarter was 121.2 million. Capital expenditures were 78.5 million in the September quarter. Our expectation for the December 2021 quarter's capital expenditures is between 70 and 90 million. Our capital expenditures for fiscal year 2022 are now expected to be between 350 million and 400 million dollars. As a reminder, our fiscal year 2021 capital expenditures came in lower than originally planned due to longer equipment lead times and deliveries pushing as a result of overall industry conditions. We continue to add capital equipment to maintain, grow, and operate our internal manufacturing operations to support the expected growth of our business. We expect these capital investments will bring gross margin improvement to our business, and give us increased control over our production during periods of industry-wide constraints. Depreciation expense in the September quarter was $43.7 million. I will now turn it over to Ganesh to give his comments on the performance in the business in the September quarter, as well as our guidance for the December quarter. Ganesh?

Thank you, Eric, and good afternoon, everyone. Our September quarter results continue to be strong, with the revenue growing 5.1% sequentially to achieve another all-time record at $1.65 billion. September quarter revenue would have been even stronger, but for constraints due to some of our capacity improvements coming in later than we wanted. On a year-over-year basis, our September quarter revenue was up 26%. Non-GAAP gross margin was another record at 65.3%, up 50 basis points from 64.8% in the June quarter, and above the high end of our guidance. As we continue to ramp our internal factories and benefit from improved fixed cost absorption, as well as product mix changes. Non-GAAP operating margin was also a record at 42.5%, up 80 basis points from 41.7% in the June quarter, and above the high end of our guidance. Our consolidated non-GAAP EPS was a split-adjusted record, $1.07 per share, and was up 37.6% from the year-ago quarter. Adjusted EBITDA at 46.2% of revenue and free cash flow at 32.3% of revenue were both very strong, continuing to demonstrate the robust profitability and cash generation capabilities of our business. This, in turn, enabled us to pay down another $415.6 million in debt and bring our net leverage ratio down to 2.99 in the September quarter. With the progress we have already made, and progress we expect to continue making in bringing down our debt and leverage ratio, we believe we are well positioned to achieve an investment-grade rating in the coming months. The September quarter marked the 124th consecutive quarter of non-GAAP profitability. I would like to thank all our stakeholders who enabled us to achieve these outstanding and record results in the September quarter, and especially thank the worldwide Microchip team whose tireless efforts not only delivered our strong financial results, but also supported our customers to navigate a difficult supply environment, and who worked constructively with our supply chain partners to find creative solutions in an extremely constrained and challenging environment. Taking a look at our revenue from a product line perspective, our microcontroller revenue was sequentially down 0.9% as compared to the June quarter, in part due to the very strong shipments in the June quarter when this business was sequentially up 10.7%, and in part due to supply constraints in the September quarter. On a year-over-year basis, our September quarter microcontroller revenue was up 27.1%, and microcontrollers represented 54.2% of our revenue in the September quarter. Our analog revenue was sequentially up a strong 13.6% as compared to the June quarter, setting another record in the process. On a year-over-year basis, our September quarter analog revenue was up 35.8%. Analog represented 29.8% of our revenue in the September quarter. During the quarter, we completed our acquisition of Iconic RF, a Belfast, Northern Ireland-based, small, early-stage private company. Iconic RF makes innovative, high-performance gallium nitride and gallium arsenide monolithic microwave integrated circuits. focus on the aerospace and defense market, and we believe will further strengthen our position in this market. Revenue contribution from Iconic RF is not material. The purchase price was in the mid-single-digit million range with possible future performance-based turnouts. This acquisition is akin to acquiring intellectual property along with domain experts to help us accelerate our business agenda in specific laser-focused areas. Taking a look at our revenue from a geographic and end market perspective, America's was up 12.5% sequentially. Europe was up 4.8% sequentially, which is better than typical seasonal performance for a September quarter. Asia was up 2.1% sequentially. All end markets were strong and supply constrained. Business conditions continue to be exceptionally strong through the quarter, with record bookings and backlog for products to be shipped over multiple quarters. Our preferred supply program, or PSP, continues to grow and be over 50% of our aggregate backlog and 100% of our backlog in the most constrained capacity product areas. Demand far outpaced the capacity improvements and increased shipments we achieved in the quarter. As a result, our unsupported backlog, which customers wanted shipped in the September quarter but which we could not deliver in the September quarter, continued to climb significantly as compared to the prior quarter's level. This is the fifth consecutive quarter that our unsupported backlog for product requested in a given quarter has grown, despite our quarterly revenue having grown 26% in the September 21 quarter as compared to the year-ago quarter. We continue to experience constraints in all of our internal and external factories and their related manufacturing supply chains. During the September quarter, We experienced and were adversely impacted by COVID-related disruptions in our packaging and testing operations in Asia, as the Delta variant adversely impacted many of these countries. We took additional steps to protect our employees in these countries and worked with our partners as they took mitigation steps. We also worked closely with our supply chain partners who provide wafer foundry assembly tests and materials to secure additional capacity wherever possible. It is a challenging environment for our factories and our partners' factories to hire, train, and retain employees to support the planned manufacturing ramps. Despite all this, through all the actions we have taken to increase capacity, we expect we will be in a position to support revenue growth for at least each of the next four quarters. This extends by one more quarter, what we stated in our August conference call as the September quarter results are now behind us. We now expect that manufacturing constraints will persist through much of 2022 and possibly beyond that. We believe our backlog position, especially the proportion of PSP backlog, is giving us a solid foundation to prudently acquire constrained raw materials, invest in expanding our factory capacity, and hire employees to support our factory ramps. Our capital spending plans are rising in response to growth opportunities in our businesses, as well as to fill gaps in the level of capacity investments being made by our outsourced manufacturing partners in technologies they may consider to be trailing edge, but which we believe will be workhorse technologies for us for many years to come. In the September quarter, we were able to secure a license from one of our wafer manufacturing partners for a key trailing edge technology that runs on 8-inch wafers, which we expect to have qualified and in production by 2023. This licensed technology is still growing for us, and we expect it will be a workhorse technology for at least 10 to 15 more years. We believe our increase in capital spending will enable us to capitalize on growth opportunities, improve our gross margins, increase our market share, and give us more control over our destiny for trailing-edge technologies. We will, of course, continue to utilize the capacity available from our outsourced partners But our goal is to be less constrained by their investment priorities in areas where they don't align with our business needs. Now let's get into the guidance for the December quarter. Our backlog for the December quarter is very strong, and we have more capacity improvements coming into effect. Taking all the factors we have discussed on the call today into consideration, we expect our net sales for the December quarter to be up between 4% and 8% sequentially. much stronger than normal seasonality, which is usually down 2% for the December quarter. Our guidance range assumes capacity additions as well as continued capacity constraints, some of which we expect to work through during the quarter and others that will carry over to be worked in future quarters. At the midpoint of our revenue guidance, our year-over-year growth for the December quarter will be a strong 29.3%, accelerating from the 26% year-over-year growth in the September quarter, 19.8% year-over-year growth in the June quarter, and 10.6% year-over-year growth in the March quarter. For the December quarter, we expect our non-GAAP gross margin to be between 65.8% and 66.2% of sales. We expect non-GAAP operating expenses to be between 22.3% and 22.7% of sales. We expect non-GAAP operating profit to be between 43.1% and 43.9% of sales. And we expect our split-adjusted, non-GAAP diluted earnings per share to be between $1.14 per share and $1.20 per share. Given all the complications of accounting for our acquisitions, including amortization of 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 for net sales, which will be on a gap basis. We believe that non-gap results provide more meaningful comparison to prior quarters, and we request that analysts continue to report their non-gap estimates to first call. Finally, as previously announced, we will be holding our Investor and Analyst Day on November 8th in New York, which will also be simultaneously webcast for those who cannot attend in person. At the event, we will be providing details about our long-term expected growth rate updated gross and operating margin targets, as well as more specifics about our strategy for capital return, revenue growth, and manufacturing. We hope you will be able to join us for this important and informative event. Let me now pass the baton to Steve to talk about our cash return to shareholders.