Microchip Technology Incorporated

Good day everyone and welcome to Microchip's first quarter fiscal 2023 financial results. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Mr. Eric Bjornholt, our CFO. Please go ahead, sir.

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 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 CEO, Steve Sange, Microchip's executive chair, and Saja Dowdy, Microchip's head of investor relations. I will comment on our first quarter 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 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 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 June quarter were $1.964 billion, which was up 6.5% sequentially. We have posted a summary of our gap net sales by product line and geography on our website for your reference. On an on-gap basis, gross margins were a record at 67.1%, operating expenses were at 21.5%, and operating income was a record 45.6%. Non-gap net income was a record $767.2 million, Non-GAAP earnings per diluted share was a record $1.37 and a penny above the high end of our guidance range. On a GAAP basis in the June quarter, gross margins were a record at 66.7%. Total operating expenses were $608.6 million and included acquisition and tangible amortization of $167.6 million, special income of $16.9 million, $1.7 million of acquisition-related and other costs, and share-based compensation of $33.5 million. GAAP net income was a record $507.2 million, resulting in $0.90 per diluted share and was adversely impacted by a $6.2 million loss on debt settlement associated with our convertible debt refinancing activities and positively impacted by a $22 million litigation accrual adjustment. Our June quarter GAAP tax expense was impacted by a variety of factors, notably the tax benefits recorded as a result of the loss on the debt settlement. Our non-GAAP cash tax rate was 9.4% in the June quarter and was in line with our guidance. The June quarter tax rate was up approximately 450 basis points from the rate in fiscal year 2022. We expect our non-GAAP cash tax rate for fiscal 23 to be between 8.5% and 10.5%, 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. A reminder of what we communicated last quarter, our fiscal 23 cash tax rate is higher than our fiscal 22 tax 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 June 30, 2022, was $911.8 million. We had 127 days of inventory at the end of the June quarter, which was up two days from the prior quarter's level. A major part of the increase in days of inventory was driven by the 50 basis point sequential increase in gross margins. Our levels of raw materials and work in progress increase in the quarter which helps position us for the increased production we are expecting from our internal factories and helps buffer to a degree some against unexpected shortages or changes in material lead times. The carrying cost of our inventory has been and will be increasing due to rising input costs from our supply chain as well as several last time buys we are forced to make because of capacity restructuring actions being taken by our suppliers. We are continuing to ramp capacity in our internal and external factories so we can ship more product to support customer requirements. Inventory at our distributors in the June quarter was at 19 days, which was up two days from the prior quarter's level. In the June quarter, we repurchased $34.6 million of principal value of our 2027 and 2037 convertible subordinated notes for cash, and we also paid cash for the value of these bonds above the principal amount. We use cash generation during the quarter to fund the amount of convertible debt repurchases, and we believe that these transactions will benefit stockholders by reducing share count dilution to the extent our stock price appreciates over time. The principal amount of convertible debt on our balance sheet at June 30th was $803.5 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 a stock price of $116.34. At the beginning of calendar year 2020, Microchip had $4.481 billion of convertible bonds outstanding. So today, our overall capital structure is in a much better long-term position. Our cash flow from operating activities was $840.4 million in the June quarter. Our free cash flow was $718.5 million and 36.6% of net sales. As of June 30th, our consolidated cash and total investment position was $379.1 million. We paid down $233.6 million of total debt in the June quarter, and our net debt was reduced by $293.3 million. Over the last 16 full quarters since we closed the microsemi acquisition and incurred over $8 billion in debt to do so, We have paid down almost $5.2 billion of debt and continue to allocate substantially all of our excess cash beyond dividends 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 on the June quarter was a record at $986.7 million and 50.2% of net sales. Our trailing 12-month adjusted EBITDA was also a record at $3.521 billion. Our net debt to adjusted EBITDA was $2.05 at June 30, 2022, down from $2.32 at March 31, 2022, and down from $3.34 at June 30, 2021. Capital expenditures were 121.9 million in the June quarter. Our expectation for capital expenditures for fiscal year 23 is between 500 and 550 million as we continue to take actions to support the growth of our business and the ramp of 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 June quarter was $71.7 million. I will now turn it over to Ganesh to give us comments on the performance of the business in the June quarter, as well as our guidance for the September quarter. Ganesh?

Thank you, Eric, and good afternoon, everyone. Our June quarter results continue to be strong across the board. setting several records in the process. Revenue grew 6.5% sequentially and 25.1% on a year-over-year basis to achieve another all-time record at 1.96 billion. This was our seventh consecutive quarter where we achieved a record revenue mark. During the quarter, we worked through several COVID-related operational challenges, including but not limited to the shutdowns in Shanghai, which affected our customers and our supply chain partners. Non-GAAP gross margin was another record at 67.1 percent, up 50 basis points from the March quarter and up 230 basis points from the year-ago quarter, benefiting from improved operational efficiencies as well as product mix changes. Non-GAAP operating margin was also a record at 45.6 percent, up 90 basis points from the March quarter and up 390 basis points from the year-ago quarter, achieving the high end of our guidance. Due to our rapid increase in revenue, operating expenses at 21.5% were 100 basis points below the low end of our long-term model range of 22.5% to 23.5%. Our long-term operating expense model will continue to guide our investment actions to drive the long-term growth and profitability of our business. Our consolidated non-GAAP diluted EPS was a record $1.37 per share up 38.4% from the year-ago quarter and just above the high end of our guidance. Adjusted EBITDA at 50.2% of revenue and free cash flow at 36.6% of revenue were both very strong in the June quarter, continuing to demonstrate the robust cash generation capabilities of our business. Net debt declined by $293.3 million, driving our net leverage ratio down to 2.05, exiting the June quarter. as we continue to aggressively drive down our net leverage. Recalling that our net leverage was almost 5x at the end of the 2018 June quarter, right after the microsemi acquisition, it is satisfying to see how far we have come in the four years since to bring down our net leverage so significantly. During the June quarter, we returned $348.2 million to shareholders in dividends and share repurchases, representing 55% of the prior quarter's free cash flow. I would like to take this opportunity to profusely thank all of our stakeholders who enabled us to achieve these outstanding results and especially thank the worldwide Microchip team for their concerted effort and never-give-up attitude to deliver results for our customers despite 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 1.6% as compared to the March quarter and set another all-time record On a year-over-year basis, our June quarter microcontroller revenue is up 17.8%. Microcontrollers represented 54.1% of our revenue in the June quarter. Our analog revenue sequentially increased 12.5% in the June quarter, setting another record in the process. On a year-over-year basis, our June quarter analog revenue was up a strong 34.2%, and analog represented 29.5% of our revenue in the June quarter. The difference in growth rate in the June quarter between microcontrollers and analog is in part based on quarter-to-quarter differences, as we have seen in the past, and in part because we are comparatively less constrained on analog products, which are predominantly produced through internal factories. Although we no longer break them out, it was notable that in the June quarter our FPGA revenue, as well as our technology licensing royalty revenue, were both up strongly and achieved new records. Taking a look at our revenue from a geographic and end market perspective, Americas was up 33% over the prior year quarter. Europe was up 28.4% over the prior year quarter. Asia was up 20.7% over the prior year quarter. Our major end markets remained strong and were supply constrained. Business conditions continue to be strong as viewed through our internal indicators. We expect to remain supply constrained through the rest of 2022 and into 2023. demand continued to be insatiable, despite the capacity increases we have implemented so far. As a result, our unsupported backlog, which represents backlog customers wanted shipped to them in the June quarter, but which we could not deliver in the June quarter, climbed again. We exited the June quarter with our highest unsupported backlog ever, with unsupported backlog coming in well above the actual revenue we achieved. We are cognizant of the weakening macro conditions resulting from rising inflation and the actions being taken by central banks in response. We're also aware that there is some inventory bill that our customers, as can be seen in their balance sheets, some of which we believe is due to strategic buffer inventory bills and some of which is due to incomplete kits or the infamous golden screw effect. While we have seen sporadic requests to push out backlog, these requests are a small fraction of the very large unsupported backlog we have over multiple quarters. and hence have not had a material impact on our business. At the same time, the level of expedites and customer escalations we're experiencing has not abated, indicating that demand and supply remain imbalanced for many customer situations. In order to best utilize the available supply and reduce customer inventory bills, we continue to thoughtfully reallocate future supply from customers who self-identify inventory positions to customers in distress with imminent lines down situations. Given the cross currents of strong internal business indicators and some uncertainty in the macro environment, we have modeled a range of potential scenarios and are monitoring our leading indicators which should enable us to take deliberate actions swiftly and early when appropriate. Our goal is to deliver a soft landing for our business if or when the softer macro environment catches up with it. And so here's how we're thinking about it. We continue to have strong PSP backlog, which is non-cancellable for at least 12 months, which comprises well over 50% of our total backlog. In addition, over the last six months, we have entered into multi-year, long-term supply agreements with a number of large customers, in effect, giving them reserved capacity in exchange for guaranteed purchases, typically over five years. We have a significant demand cushion with unsupported backlog that is much greater than 100% of supported backlog and which can readily absorb any push-outs and cancellations. Distribution inventory at 19 days is low when compared to what the channel has historically required to serve customers effectively. Any business weakness will give us the opportunity to replenish depleted channel inventory and position our channel partners to respond to business growth as well as better serve customers. Our internal die bank and finished goods inventory has been substantially depleted as demand outstripped supply for the last seven quarters. Any business weakness will enable us to replenish this inventory to better position us to support our customers. We expect continued above average secular growth trends resulting from our focus on total system solutions and megatrends. In addition, our end market exposure is concentrated in the industrial, aerospace and defense, automotive, data center, and communications infrastructure markets, all of which have demonstrated much higher durability in prior cycles. With any business weakness, we expect our capital intensity will shift to the lower end or even below the low end of our CapEx guidance of 3 to 6 percent of revenue, thus liberating free cash flow. And finally, as you've seen in prior cycles, we expect our variable compensation programs to buffer our operating expenses and protect our operating model. If you study Microsoft's peak-to-trough performance through the business cycles over the last 15 years, you will observe our robust and consistent cash generation, gross margin, and operating margin results. The investor presentation posted on our IR website today provides details about our performance through the business cycles, If or when there is a macro slowdown that impacts our business, we expect our cash generation, gross margin, and operating margin to once again demonstrate consistency and resiliency. This will help us to continue to execute our long-term Microchip 3.0 growth strategy and insulate it from whatever short-term market challenges there may be. We continue to expect constraints in our internal and external factories and their related manufacturing supply chains. We are ramping our internal factories and working closely with our supply chain partners to secure additional capacity wherever possible. We expect our capital spending in fiscal year 23 to be modestly above the 3 to 6 percent of revenue range we have shared with you as we respond to growth opportunities in our business. 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 margin, and give us more control over our destiny, especially for specialized trailing edge technologies. We're also pleased to see the Chips and Science Act approved by Congress with bipartisan support and expect the President will sign it into law imminently. This bill is good for the semiconductor industry and for America as it enables critical investments which will even the global playing field for U.S. companies while being strategically important for our economic and national security. We expect to be eligible to benefit from the grants under this legislation, as well as the investment tax credit provisions of the bill, as we do our part to invest in ensuring U.S. economic and national security. Now let's get into the guidance for the September quarter. Our backlog for the September quarter is 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 September quarter to be up between 3% and 7% sequentially. And we expect sequential revenue growth again in the December quarter. At the midpoint of our revenue guidance, our year-over-year growth for the September quarter would be a strong 25%. For the September quarter, we expect our non-GAAP gross margin to be between 67.3 and 67.7% of sales. We expect our non-GAAP operating expenses to be between 21.3 and 21.7 percent of sales. We expect non-GAAP operating profit to be between 45.6 percent and 46.4 percent of sales. And we expect our non-GAAP diluted earnings per share to be between $1.42 per share and $1.46 per share. At the midpoint of our EPS guidance, our year-over-year growth for the September quarter would be a strong 34.6 percent. Finally, as you can see from our June quarter results and September 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, organic revenue growth rate of 10 to 15 percent 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 after net leverage drops to 1.5x. CapEx investment of 3% to 6% of revenue, and inventory investment of 130 to 150 days over business cycles. and a strong company foundation that is built on culture and sustainability. Now let me pass the baton to Steve to talk more about our cash return to shareholders. Steve?