Microchip Technology Incorporated

Good day, everyone. Welcome to Microchip's third quarter fiscal 2023 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 Mr. Eric Bornhold, 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 and 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 third 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 on 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 effects of acquisition activities, share based compensation, and certain other adjustments as described in our press release and in the reconciliations on our website. Net sales in the December quarter were $2.169 billion, which was up 4.6% sequentially. We have posted a summary of our gap net sales by product line and geography on our website for your reference. On a non-gap basis, gross margins were a record at 68.1%, operating expenses were 20.6%, and operating income was a record 47.5%. Non-GAAP net income was a record $863.7 million. Non-GAAP earnings per diluted share was a record $1.56 and at the high end of our guidance range. On a GAAP basis in the December quarter, gross margins were a record at 67.8%. Total operating expenses were $659.2 million and included acquisition and tangible amortization of $167.4 million, special charges of $6.5 million, and .3 million of acquisition-related and other costs, and share-based compensation of 37.1 million. GAAP net income was a record 580.3 million, resulting in a record $4 in earnings per diluted share. As compared to a year-ago quarter, our December quarter GAAP tax expense was impacted by a variety of factors, notably the tax expense recorded as a result of the capitalization of R&D expenses for tax purposes. Our non-GAAP cash tax rate was 11.9% in the December quarter. We now expect our non-GAAP cash tax rate for fiscal 23 to be about 11% exclusive of the transition tax and any tax audit settlements related to taxes accrued in prior fiscal years. A reminder of what we communicated over the past couple quarters, 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. We are still hopeful that the tax rules requiring companies to capitalize R&D expenses will be pushed out or repealed. If this were to happen, we would anticipate about a 300 basis point favorable adjustment to Microchip's non-GAAP tax rate in future periods. Our inventory balance at December 31, 2022, was $1.165 billion. We had 152 days of inventory at the end of the December quarter, which was up 13 days from the prior quarter's level. We have increased our raw materials inventory to help protect our internal manufacturing supply lines. We are carrying higher work in progress to help maximize the utilization of constrained equipment, as well as to position ourselves to take advantage of new equipment installations which should relieve bottlenecks. We are investing in building inventory for long lived, high margin products whose manufacturing capacity is being end of life by our supply chain partners. We need to take actions to help ensure that our supply lines can feed growth beyond what we expect in the March 2023 and June 2023 quarters. And our reported days of inventory is a backward looking indicator. As gross margins rise, the effective days of inventory for the same physical inventory rises. and with every 100 basis points of gross margin growth, it creates approximately three incremental days of inventory. Inventory at our distributors in the December quarter was at 22 days, which was up three days from the prior quarter's level. Our cash flow from operating activities was a record $1.278 billion in the December quarter. Included in our cash flow from operating activities was $385 million of long-term supply assurance receipts. We are going to adjust these items out of our free cash flow to determine the adjusted free cash flow that we will return to shareholders as these payments will be refundable over time as purchase commitments are fulfilled. Our adjusted free cash flow was $751.6 million and 34.6% of net sales in the December quarter. As of December 31st, our consolidated cash and total investment position was $288.9 million We paid down $719.1 million of total debt in the December quarter, and our net debt was reduced by $701.2 million. Over the last 18 full quarters since we closed the microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down almost $6.2 billion of the debt and continue to allocate substantially all of our excess cash beyond dividends and stock buyback to bring down this debt. Our adjusted EBITDA in the December quarter was a record at 1.106 billion and 51% of net sales. Our trailing 12-month adjusted EBITDA was also a record at 4.051 billion. Our net debt to adjusted EBITDA was 1.56 at December 31st, 2022, down from 1.84 at September 30th, 2022, and down from 2.58 at December 31st, 2021. Capital expenditures were $141.3 million in the December quarter. Our expectation for capital expenditures for fiscal year 2023 is between $525 and $545 million as we continue to take actions to support the growth of our business and ramp our manufacturing operations accordingly. 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 improvements to our business and give us increased control over our production during periods of industry-wide constraints. Depreciation expense in the December quarter was $55.3 million. I will now turn it over to Ganesh to give us comments on the performance of the business in the December quarter, as well as our guidance for the March quarter. Ganesh?

Thank you, Eric, and good afternoon, everyone. Our December quarter results were well above the midpoint of our revenue guidance. marked by our disciplined execution as well as our resilient end markets. Net sales grew 4.6 percent sequentially and 23.4 percent on a year-over-year basis to achieve another all-time record of $2.17 billion. The December quarter also marked our ninth consecutive quarter of growth. Non-GAAP gross margins came in above the high end of our guidance at a record 68.1 percent, up 38 basis points from the September quarter, and up 202 basis points from the year-ago quarter. Non-GAAP operating margin also came in above the high end of our guidance at a record 47.5%, up 62 basis points from the September quarter, and up 283 basis points from the year-ago quarter. Due to a rapid increase in net sales over the last two years, operating expenses at 20.65% were 185 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, profitability, and durability of our business. Our consolidated non-GAAP diluted earnings per share was at the high end of our guidance at a record $1.56 per share, up 30% from the year-ago quarter. Adjusted EBITDA at 51% of net sales and adjusted free cash flow at 34.6% of net sales, but both very strong in the December quarter, continuing to demonstrate the robust cash generation capabilities of our business. As Eric mentioned, we have excluded $385 million of long-term supply assurance payments made by customers from our adjusted free cash flow calculation, since these payments are refundable when customers fulfill their purchase commitments. Net debt declined by $701.2 million driving our net leverage ratio down to 1.56x, exiting the December quarter. During the December quarter, we returned $409.8 million to shareholders in dividends and share repurchases, representing 60% of the prior quarter's free cash flow. We expect to get below 1.5x net leverage by the end of the March quarter. And as Steve will share with you later, the Microchip Board has decided to increase the rate at which capital will be returned to shareholders starting in the June quarter. My heartfelt gratitude to all our stakeholders who enabled us to achieve these outstanding results, and especially to the worldwide Microsoft team, whose tireless efforts and strong sense of ownership are what enable us to navigate effectively in the midst of turbulent times. Taking a look at our net sales from a product line perspective, our microcontroller net sales were sequentially up 3.5% in the December quarter, and set another all-time record. On a year-over-year basis, our December quarter microcontroller net sales were up 25.6%. Microcontrollers represented 56.3% of our net sales in the December quarter. Our analog net sales were sequentially up 5.9% in the December quarter and also set an all-time record. On a year-over-year basis, our December quarter analog net sales were up 21.2%. Analog represented 28% of our net sales in the December quarter. In the December quarter, our FPGA net sales also achieved a new record. While our overall business remained strong in the December quarter, the consumer appliance end market was weak, as was our overall business in China. Our China business was initially impacted by COVID lockdowns and then subsequently impacted by the rapid transmission of COVID when lockdowns were lifted. Both actions adversely impacted our customers' operations during the December quarter, resulting in inventory at many customers and distributors being higher than normal. In response to the weaker business environment in China and a small but increasing number of other customers who have inventory and requested push-outs, we took action in the December quarter to delay or redirect some shipments and plan to do more of the same in the March quarter. This is designed to reduce customer and channel inventory over bills, but will also increase the inventory on our balance sheet in the near term. In the medium term, we expect this will give us a better chance to achieve a soft landing and position us well to respond to a stronger demand growth as the macro environment improves. As a result of the uncertain macro environment and the multiple quarters worth of backlog on our books, most of which is non-cancellable, our bookings have slowed down as we expected. Given the circumstances, we view the booking slowdown as a positive, which will serve to preserve the quality of new backlog that gets placed. Our unsupported backlog, which represents backlog customers wanted shipped to them in the December quarter, but which we could not deliver in the December quarter, remained well in excess of the actual net sales we achieved. Unsupported backlog did decline slightly for the first time in nine quarters, and we are continuing to work hard to further reduce our unsupported backlog, as well as our lead times to more manageable levels. While we have seen an increase in requests to push out or cancel backlog, these requests remain a small fraction of the very large backlog we have over multiple quarters, and hence they have not had a material effect on our business. Despite supply gradually improving, we expect to have supply constraints through much of 2023. However, In order to achieve a more healthy and sustainable business environment, we are driving to bring average lead times down to 26 weeks or less by the time we get to the second half of 2023. And we will be publishing a customer letter to this effect shortly. We believe there are three reasons why Microsoft's business is demonstrating more resilience in the midst of the weakness seen by some other semiconductor companies. First, on the demand side, The industrial, automotive, aerospace and defense data center and communications infrastructure end markets, which make up approximately 86% of our net sales, remain solid. The consumer end market, which is about 14% of our net sales, is experiencing some weakness, but is dominated by home appliances, which are comparatively more resilient. There are some signs that the data center end market could see some headwinds in 2023. although our business remains strong based on the market share gains we have had. Hence, our overall demand remains quite durable because of the end market mix we have consciously gravitated towards over the years. Second, on the supply side, a vast majority of our products are built on specialized technologies requiring trailing edge capacity. This is the capacity that has been most constrained over the last two years, which still remains constrained and where there was less opportunity to oversharp the consumption. And last but not least, our laser focus on organic growth through total system solutions and higher growth megatrends for multiple years is giving us increased design wind momentum, farther share gains, and a resultant revenue tailwind. If you review Microsoft's peak-to-trough performance through the business cycles over the last 15-plus years, you will observe our robust and consistent cash generation, gross margin, and operating margin results. The investor presentation posted on our IR website has details of our performance through the business cycles. We remain cautiously optimistic about navigating to a soft landing for our business and expect our cash generation, gross margin, and operating margin to once again demonstrate consistency and resiliency through the cycles. Last quarter, we mentioned that Microchip was in the early stages of considering building a 300-millimeter U.S.-based fab for specialized trailing edge technologies. After a detailed analysis, we have concluded not to move forward with this project and that our business objectives would likely be better achieved through our relationships with our foundry suppliers with lower execution risk and a better return on invested capital. The CHIPS Act is already making a positive impact on our business through the investment tax credit, which started on January 1st, and with impending capacity expansion grants that we will be seeking for several of our U.S. semiconductor factories. We believe the CHIPS Act is good for the semiconductor industry and for America as it enables critical investments, which will help even the global playing field, while being strategically important for American economic and national security. Now let's get into the guidance for the March quarter. Our backlog for the March quarter is strong, and we have more capacity improvements coming into effect. However, we are also taking active steps to help customers with inventory positions to selectively push out some of their backlog. Taking all the factors we have discussed on the call today into consideration, we expect our net sales for the March quarter to be up between 1% and 4% sequentially. Further, we expect sequential net sales growth again in the June quarter. At the midpoint of our net sales guidance, our year-over-year growth for the March quarter would be a strong 20.6%. We expect our non-GAAP gross margin to be between 68.1% and 68.3% of sales. We expect non-GAAP operating expenses to be between 20.6% and 20.8% of sales, We expect non-GAAP operating profit to be between 47.3% and 47.7% of sales. And we expect our non-GAAP diluted earnings per share to be between $1.61 per share and $1.63 per share. At the midpoint of our earnings per share guidance, our year-over-year growth for the March quarter would be a strong 20%, despite a much higher tax rate than the year-over-year quarter. Finally, as you can see from my December quarter results and our March quarter guidance, our Microchip 3.0 strategy, which we launched 15 months ago, 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. Our board of directors and leadership team operate just as long-term owners of the business would, thoughtfully making the key investments in people, technology, capacity, culture, and sustainability required to thrive in the long term, while being prudent, pragmatic, and nimble about whatever short-term adjustments may be required. We are confident we will effectively navigate through whatever macro business challenges may unfold in 2023. Let me now pass the baton to Steve to talk more about our cash return to shareholders. Steve?