Microchip Technology Incorporated

Good day, everyone, and welcome to Microchip's fourth 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 Bjornholt. Please go ahead, sir.

Thanks, Sarah, 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. 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 Ganesh Morthy, Microchip's President and CEO, Steve Sange, Microchip's Executive Chair, and Sajid Dowdy, Microchip's Head of Investor Relations. I will comment on our fourth quarter and full fiscal year 2022 financial performance. Ganesh will then provide 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 this conference call on various GAAP and non-GAAP measures. We have posted a full gap to non-gap reconciliation on our 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 gap and non-gap results. We have also posted a summary of our outstanding debt and 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 $1.844 billion, which was up 4.9% sequentially and near the high end of our quarterly guidance. We have posted a summary of our GAAP net sales by product line, and geography, as well as our total end market demand on our website for your reference. Going forward, we will only be providing gap net sales by product line and geography, consistent with the standard practice by our peer companies. We will continue to provide information each quarter on changes in distribution inventory levels. On a non-gap basis, gross margins were a record 66.6%. Operating expenses were at 21.9%. and operating income was a record 44.7%. Non-GAAP net income was a record $764.6 million. Non-GAAP earnings per diluted share was a record $1.35, 10 cents above the midpoint of our guidance, 7 cents of which was driven by favorable events in the March quarter benefiting our cash tax expense. On a GAAP basis in the March quarter, gross margins were a record at 66.2%. Total operating expenses were $670.9 million and included acquisition and tangible amortization of $215.5 million, special charges of $9.1 million, $3.8 million of acquisition-related and other costs, and share-based compensation of $39 million. Gap net income was $437.9 million or $0.77 per diluted share and was adversely impacted by an $11.8 million loss on debt settlement associated with our convertible debt refinancing activities. Our March quarter gap tax expense was impacted by a variety of factors, notably the tax benefits recorded as a result of releasing the unrecognized tax benefit due to the closing of an audit in Europe. For fiscal year 2022, net sales were a record $6.82 billion and were up 25.4% from net sales in fiscal year 2021. On a non-GAAP basis, gross margins were a record 65.7%, operating expenses were 22.2% of sales, and operating income was a record 43.5% of sales. Non-GAAP net income was a record $2.611 billion, and EPS was a record at $4.61 per diluted share. On a GAAP basis, gross margins were a record 65.2%, Operating expenses were 38.1% of sales and operating income was 27.1% of sales. Net income was $1.286 billion and EPS was $2.27 per diluted share. Our non-GAAP cash tax rate was 1.3% in the March quarter and 4.9% for fiscal year 2022. 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, lower taxes in certain jurisdictions, and tax benefits from our convertible debt exchanges. We expect our non-GAAP cash tax rate for fiscal 23 to be between 7.5% and 11.5%, 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. The midpoint of our June quarter tax rate guidance is 9.5%. Our fiscal 23 cash tax rate is higher than our fiscal 22 tax cash rate for a variety of factors, including lower availability of tax attributes, such as net operating losses and tax credits, as well as the impact of current tax rules requiring the capitalization of R&D expenses for tax purposes. Our inventory balance at March 31, 2022 was $854.4 million. We had 125 days of inventory at the end of the March quarter, which was up nine days 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 and helps buffer us against unexpected shortages or changes in material lead times. The carrying cost of our inventory has been and will be increasing due to the rising input costs from our supply chain. We are continuing to ramp capacity in our internal and external factories so we can ship as much product as possible to support customer requirements. Inventory at our distributors in the March quarter were at 17 days, which is a record low level, and down from 19 days at the end of the prior quarter. Following on the heels of our upgrade to investment grade or BBB- in the December 2021 quarter, during the March 2022 quarter, we were upgraded to the equivalent of BBB by both Moody's and Fitch, reflecting the strength of our balance sheet, financial results, and our franchise. In the March quarter, we exchanged a total of $64.9 million of principal value of our 2027 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 our balance sheet at March 31st was $838.1 million. This includes $665.5 million of convertible bonds maturing in November of 2024 with a cap call option in place that offsets any potential dilution from these convertibles up to stock prices of $116.79. At the beginning of calendar year 2020, Microchip had $4.481 billion in convertible bonds outstanding, so today our overall capital structure is in a much better long-term position. Our cash flow from operating activities was $747.7 million in the March quarter. Our free cash flow was $633.1 million and 34.3% of net sales. As of March 31st, our consolidated cash and total investment position was $319.4 million. We paid down $205.9 million of total debt in the March quarter. Over the last 15 full quarters since we closed the microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down almost $5 billion of debt and continue to allocate substantially all of our excess cash beyond dividend and stock buyback to bring down this debt. We have accomplished this despite the adverse macro and market conditions during the earlier years 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 at $902.6 million and 48.9% of net sales. Our trailing 12-month adjusted EBITDA was also a record at $3.246 billion and 47.6% of net sales. Our net debt to adjusted EBITDA was $2.32 at March 31, 2022, down from $2.58 at December 31, 2021, and down from $3.76 at March 31, 2021. Our dividend payment in the March quarter was $140.8 million, and we repurchased 259.6 million of our stock during the quarter. Capital expenditures were 114.6 million in the March quarter and 370.1 million for fiscal year 2022. We had originally forecasted capital expenditures of about 140 million in the March quarter and we experienced delays in receiving some of our capital equipment from our suppliers. Our expectation for capital expenditures for fiscal year 2023 is between $450 and $550 million as we continue to take actions to support the growth of our business and ramp our manufacturing operations. We continue to prudently add capital equipment to maintain, grow and operate our internal manufacturing operations to support the expected long-term 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 March quarter was $59.3 million. I will now turn it over to Ganesh to give us comments on the performance of the business in the March quarter, as well as our guidance for the June quarter. Ganesh.

Thank you, Eric, and good afternoon, everyone. Our March quarter results were very strong across the board and set several records in the process. Revenue grew 4.9% sequentially and 25.7% on a year-over-year basis to achieve an all-time record of $1.84 billion. Despite a number of operational challenges, including the rapid spread of the COVID Omicron virus, which affected several of our factories, the shutdowns in several cities in China, and the suspension of shipments to Russia, we finished just shy of the high end of our revenue guidance. This was our fifth consecutive quarter of new revenue records. Non-GAAP gross margin was another record at 66.6%, up 50 basis points from the December quarter and at the high end of our guidance as we continue to ramp our internal factories and benefit from improved operational efficiencies as well as product mix changes. Non-GAAP operating margin was also a record of 44.7%, very close to the high end of our guidance. At 21.9% operating expenses, We are 60 basis points below the low end of our long-term model of 22.5% to 23.5%. Our long-term operating expense model will continue to guide our actions to invest for the long-term growth and profitability of our business. Our consolidated non-gap diluted EPS was a record $1.35 per share, well over the high end of our guidance, and up 45.2% from the year-ago quarter. Even after excluding the tax benefit we received, our March quarter non-GAAP diluted EPS at $1.28 was at the high end of our guidance. Adjusted EBITDA at 48.9% of revenue and free cash flow at 34.3% of revenue were both very strong in the March quarter, continuing to demonstrate the robust cash generation capabilities of our business. Net debt declined by $209.8 million, driving our net leverage ratio down to 2.32 in the March quarter, as we continue to relentlessly drive down our net leverage. During the March quarter, we returned $400.4 million to shareholders, representing 52.5% of the prior quarter's free cash flow. Reflecting on our fiscal year 22 results, it was one for the record books and one of our best years ever. We made dramatic progress on all fronts, revenue growth, gross and operating margins, earnings per share, free cash flow generation, debt and leverage reduction, and last but not least, we significantly increased the capital return to shareholders through dividend increases and the initiation of a programmatic share buyback program. At our Investor Day in November 2021, we outlined our plan to increase the capital return to shareholders every quarter as our net leverage continues to drop. We are making consistent and meaningful progress towards our net leverage growth every quarter. I would like to take this opportunity to profusely thank all our stakeholders who enabled us to achieve these outstanding results, and especially thank the worldwide Microchip team for their never-give-up attitude and concerted effort to consistently deliver results to support our customers in the face of a historic and persistent imbalance between supply and demand. Taking a look at our revenue from a product line perspective, our microcontroller revenue was sequentially up a strong 7.6% as compared to the December quarter and was another all-time record. On an annualized basis, our March quarter microcontroller revenue broke through the $4 billion mark for the first time. On a year-over-year basis, our March quarter microcontroller revenue was up 28.3%. All microcontroller product lines, 8-bit, 16-bit, and 32-bit, experienced strong growth and achieved record revenue milestones. 32-bit microcontrollers had the highest growth and is now the largest microcontroller product line for us at 46.5% of our microcontroller revenue. Microcontrollers represented 56.7% of our revenue in the March quarter. Our analog revenue sequentially increased 3% in the March quarter, setting another record in the process. On a year-over-year basis, our March quarter analog revenue was up a strong 24.2%. Analog represented 27.9% of our revenue in the March quarter. Taking a look at our revenue from a geographic and end market perspective, America's was up 21.4% over the prior year quarter. Europe was up 25% over the prior year quarter. Asia was up 27.9% over the prior year quarter. All end markets remained strong and were supply constrained. Business conditions continue to be exceptionally strong through the quarter. Our preferred supply program, our PSB backlog, continued to grow and remained well over 50% of our aggregate backlog and 100% of our backlog in the most constrained capacity product areas. Demand continued to be insatiable despite the significant capacity increases we have implemented so far. As a result, our unsupported backlog, which represents customer backlog That backlog that customers want to ship to them in the March quarter, but which we could not deliver in the March quarter, climbed substantially again as we exited the March quarter with our highest unsupported backlog ever. We continue to experience constraints in all our internal and external factories and their related manufacturing supply chains. We are ramping our internal factories as fast as reasonably possible. and we are working closely with our supply chain partners to secure additional capacity wherever possible. Our supply chain partners, as well as some of our customers, were adversely impacted by the lockdowns in China during March, which continued into April and May. Our operations team worked to redirect our manufacturing activities and sourcing wherever possible to other locations that are not locked down. Looking at the magnitude of the demand supply imbalance, the size of our non-cancellable backlog, the rate at which new backlog continues to come in, and the rate at which we're able to bring on new capacity, we expect that we will remain supply constrained throughout 2022 and into 2023. Our growth is predominantly limited by how quickly we can bring on additional capacity to support demand. To reiterate what we first shared with you in March this year, we expect our five-year compounded annual growth rate using fiscal year 2021 as a baseline to be 10% to 15%. We expect our capital spending in fiscal year 23 to be at the high end of the range we have shared with you as we respond to growth opportunities in our business, as well as fill gaps in the level of capacity investments being made by our outsourced manufacturing partners in specialized technologies they consider to be trailing edge, but which we believe will be workhorse technologies for us for many years to come. We believe our calibrated increase in capital spending will enable us to capitalize on growth opportunities, serve our customers better, increase our market share, improve our gross margins, and give us more control over our destiny, especially for specialized 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 June quarter. Our backlog for the June 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 June quarter to be up between 4% and 8% sequentially. Our guidance range assumes capacity additions as well as continued materials and capacity challenges, some of which we'll expect to work through during the quarter others that will carry over to be worked in future quarters. We have also included the anticipated effects of the lockdowns in China on our supply chain partners, as well as our customers. At the midpoint of our revenue guidance, our year-over-year growth for the June quarter would be a strong 24.6%. For the June quarter, we expect our non-GAAP gross margin to be between 66.8% and 67.2% of sales, We expect our non-GAAP operating expenses to be between 21.6% and 22% of sales. We expect our non-GAAP operating profit to be between 44.8% and 45.6% of sales. We expect our non-GAAP diluted earnings per share to be between $1.32 per share and $1.36 per share after comprehending the higher tax rate that Eric shared with you. Finally, as you can see from our March quarter results and the June quarter guidance, Every element of our Microchip 3.0 strategy is firing on all cylinders as we continue to build and improve what we believe is one of the most diversified, defensible, high-growth, high-margin, high-cash-generating businesses in the semiconductor industry. To summarize the essential elements of Microchip 3.0, they are organic growth rate of 10% to 15% in the fiscal year 22 to 26 timeframe by focusing on total system solutions and our six key market megatrends. long-term non-GAAP operating margin target of 44% to 46%, and free cash flow target of 38%. Consistently increasing capital return to shareholders as net leverage drops such that 100% of free cash flows return to shareholders by the time net leverage drops to 1.5x. A capex investment of 3% to 6% of revenue and an inventory investment of 130 to 150 days over the business cycles. And last but not least, a strong company foundation built on culture and sustainability. Let me now pass the baton to Steve to talk more about our cash return to shareholders. Steve?