Microchip Technology Incorporated

Greetings and welcome to the Microchip Technologies Q3 and FY23 Financial Results Conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and then zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Eric Bjornholt, the Senior Vice President and CFO. Thank you and you may proceed, sir.

Okay, 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 for the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events and 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 operation. 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 fourth quarter and full fiscal year 2023 financial performance, Dinesh 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 earnings press release, which we believe you will find useful when comparing our GAAP and non-GAAP results. We have also identified and posted a summary of our outstanding debts 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 earnings press release and in the reconciliation on our website. Net sales in the March quarter were $2.233 billion, which was up 2.9% sequentially. We have posted a summary of our net sales by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were a record at 68.3%, operating expenses were at 20.7%, and operating income was a record 47.65%. Non-GAAP net income was a record $907.8 million, non-GAAP earnings per diluted share was a record $1.64, and a penny above the high end of our guidance range. On a GAAP basis in the March quarter, gross margins were a record at 68%, Total operating expenses were $671.3 million and included acquisition and tangible amortization of $167.4 million, special charges of $2.1 million, $2.3 million of acquisition-related and other costs, and share-based compensation of $37.8 million. GAAP net income was a record $604 million, resulting in a record $1.09 in earnings per diluted share. As compared to a year ago quarter, our March quarter GAAP tax expense was adversely impacted by a variety of factors, notably the tax expense recorded as a result of the capitalization of R&D expenses for tax purposes. For fiscal year 2023, net sales were a record $8.439 billion and were up 23.7% from net sales in fiscal year 2022. On a non-GAAP basis, gross margins were a record 67.8%, Operating expenses were 20.9% of sales, and operating income was a record 46.9% of sales. Non-GAAP net income was a record 3.353 billion, and EPS was a record at $6.02 per diluted share. On a GAAP basis, gross margins were also a record at 67.5%. Operating expenses were 30.6% of sales, and operating income was 36.9% of sales. Net income was $2.238 billion, and EPS was $4.02 per diluted share. Our non-GAAP cash tax rate was 10.8% in the March quarter and 10.9% for fiscal year 2023. Our non-GAAP tax rate for fiscal year 2024 is expected to be about 14%, which is exclusive of the transition tax and any tax audit settlements related to taxes occurred in prior fiscal years. Our fiscal 24 cash tax rate is expected to be higher than our fiscal 23 tax rate for a variety of factors, including lower availability of tax attributes such as net operating losses and tax credit, lower tax depreciation with our expectation for lower capital expenditures in the US in fiscal 2024, 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 200 basis point favorable adjustment to Microchip's non-GAAP tax rate in future periods. Our inventory balance of March 31st, 2023 was $1.325 billion. We had 169 days of inventory at the end of the March quarter, which was up 17 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. In certain circumstances, we have allowed customers to push out delivery schedules for products that were very far through the manufacturing process. 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, and these last time buys represented about seven days of inventory at the end of March. We feel that we need to take actions to help ensure that our supply lines can feed our growth beyond what we expect in the June 2023 quarter. We are targeting actions to reduce our inventory down between five and ten days in the June quarter. Inventory at our distributors in the March quarter was at 24 days, which was up two days from the prior quarter's level. Our cash flow from operating activities was $709.5 million in the March quarter. Included in our cash flow from operating activities was a net $79.5 million of long-term supply assurance receipts from customers and suppliers. 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 through dividends and share repurchases as these payments will be refundable over time as purchase commitments are fulfilled. Our adjusted free cash flow was $517.3 million in the March quarter and was adversely impacted by our working capital investments this quarter, including $158.4 million increase in inventory and $130.3 million increase in accounts receivable, which we do not expect to repeat in the June quarter. As of March 31st, our consolidated cash and total investment position was $234 million. We paid down $153 million of total debt in the March quarter and our net debt was reduced by $98.1 million. Over the last 19 full quarters since we closed the microsemi acquisition and incurred over $8 billion of debt to do so, we have now paid down $6.35 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 on the March quarter was a record at $1.139 billion, and 51% of net sales. Our trailing 12-month adjusted EBITDA was also a record at 4.288 billion. Our net debt to adjusted EBITDA was 1.45 at March 31st, 2023, down from 1.56 at December 31st, 2022, and down from 2.32 at March 31st, 2022. Getting our net leverage below 1.5 is a significant milestone for Microchip on its capital returns earnings which Steve will talk about shortly. Capital expenditures were $112.7 million in the March quarter and $486.2 million for fiscal year 2023. Our expectation for capital expenditures for fiscal year 2024 is between $300 and $400 million, as we still have a lot of equipment that was ordered with long lead times that will be received over the next year. We expect that our capital investments will continue to provide us with increased control over our production during periods of industry-wide constraints. Depreciation expense in the March quarter was $54.1 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 strong in the context of a slowing macroenvironment. marked by our continued disciplined execution as well as our resilient end market. Net sales grew 2.9% sequentially and 21.1% on a year-over-year basis to achieve another all-time record of $2.23 billion. The March quarter represented our 10th consecutive quarter of sequential growth. Non-GAAP gross margin came in at the high end of our guidance at a record 68.3%, up 171 basis points from the year-ago quarter. Non-GAAP operating margin also came in close to the high end of our guidance at a record 47.65%, up 292 basis points from the year-ago quarter. We continue to make investments that we expect to drive the long-term revenue growth, profitability, and durability of our business. Our consolidated non-GAAP diluted earnings per share was above the high end of our guidance at a record $1.64 per share, up 21.5% from the year-ago quarter. Adjusted EBITDA was 51% of net sales, and adjusted free cash flow was 23.2% of net sales in the March quarter, continuing to demonstrate the robust cash generation characteristics of our business. We returned $469.9 million to shareholders in dividends and share repurchases in the March quarter, representing 62.5% of our December quarter adjusted free cash flow. Our net leverage exiting March dropped to 1.45x, And as we mentioned a quarter ago, our capital returns this quarter will increase to 67.5% of our March quarter adjusted free cash flow. As we continue on our plan to return 100% of adjusted free cash flow by the March quarter of calendar year 2025. Reflecting on our fiscal year 2020 results, it was another one for the record books. Revenue grew 23.7% to finish at a record $8.4 billion. Non-GAAP gross margin, non-GAAP operating margin, non-GAAP EPS, EBITDA, and adjusted free cash flow all set new records. We significantly increased the capital return to shareholders in fiscal year 23 to $1.64 billion, representing a 76.6% growth as compared to fiscal year 22, through a combination of increasing dividends and our formulaic share buyback program. My heartfelt gratitude to all of us stakeholders who enabled us to achieve these outstanding results, and especially to the worldwide microchip team whose tireless efforts are what enable us to navigate effectively through the business cycle. Taking a look at our March quarter net sales from a product line perspective, our mixed signal microcontroller net sales set another all-time record, coming in sequentially up 5.8% in the March quarter and up 23.5% on a year-over-year basis. Our 32-bit mixed signal microcontrollers grew at the fastest rate among our mixed signal microcontroller product lines and represented over 48% of our fiscal year 23 mixed signal microcontroller revenue. As you may have noticed, we are clarifying the nomenclature for our microcontrollers going forward to be mixed signal microcontrollers as they have substantial analog and mixed signal content integrated on chip and as a result exhibit business characteristics that are more like analog and mixed signal products. Staying with mixed signal microcontrollers for a moment, Gartner just published their rankings for calendar year 22. Using our publicly reported mixed signal microcontroller revenue for calendar year 22, which Gartner inexplicably underreported for microchip, we ranked number three and are just 1.4% away from number one. To put this in perspective, just three years ago in calendar year 2019, By our estimate combined with the Gartner data, we were 16.5% away from number one. We are fast closing on the number one spot. Moving next to our analog business, our analog net sales also set another all-time record, coming in sequentially up 1.9% in the March quarter and up 19.9% on a year-over-year basis. Fiscal year 23 analog sales were $2.4 billion and broke through the $2 billion mark for the first time ever. We are gaining share in our analog business with our total system solutions approach continuing to provide a tailwind for this product line. While we don't normally break out our FPGA product line results, it is noteworthy to report that our March quarter and fiscal year 23 revenue for FPGA were both records. In fact, our fiscal year 23 FPGA revenue exceeded 550 million, grew more than 31% as compared to fiscal year 22. and delivered operating margins of a north of corporate average. Our design wind momentum is strong, and we offer market-leading mid-range FPGA solutions with best-in-class low power, reliability, and security. At our investor day in November 2021, we emphasized the importance of six market megatrends for our long-term growth and shared that we expected our revenue growth from customers and applications within the megatrends to be approximately 2x of Microchip's growth rate We just completed our revenue by megatrend analysis for fiscal year 23. As compared to fiscal year 21, which is the last time we conducted the same analysis, Microchip overall revenue grew 55.2%, while revenue from our megatrends grew 108.5%, right in line with our expectation of roughly 2x growth from the megatrends. Revenue from the six megatrends represented approximately 45% of our fiscal year 23 revenue, as compared to approximately 34% of our fiscal year 21 revenue. We also just completed our revenue by end market analysis for fiscal 23. As compared to fiscal 22, our industrial business grew from 40% to 41% of our revenue. Our data center and computing business grew from 18% to 19% of our revenue. And our consumer appliance business declined from 14% to 12% of our revenue. Automotive and communications infrastructure remained unchanged at 17% and 11% of our revenue, respectively. As you can see from the data, slowly but surely, we continue to curate an increasing proportion of our business towards less volatile and more resilient end markets. Now for some color on the March quarter. While our overall business remains strong in the March quarter, many of our customers felt the effect of slowing economic activity and increased business uncertainties. request to push out or cancel backlog increase, and we were able to push out significant amounts of backlog to later quarters to help customers with inventory positions. This resulted in our days of inventory growing. We are comfortable with this inventory growth, given the very long life cycles and durable end markets for our products. By taking action to reduce customer inventory overbill and carrying that inventory on our balance sheet, we expect to increase our odds of achieving a soft landing and also expect to be better positioned to respond to demand growth when the macro environment strengthens. Consistent with the flowing macro environment and the growth in our inventory, we have paused most of our internal factory expansion plans, reduced our capital investments with plans for fiscal year 24, and taken steps to lower our inventory in the coming quarters. As a result of the uncertain macro environment and multiple quarters worth of backlog on our books, Our bookings have slowed down as expected over the last two quarters. In order to provide customers with more flexibility in an uncertain demand environment, as well as to achieve a more healthy and sustainable long-term supply-demand balance, we are striving to bring average lead times down to under 26 weeks over the course of the second half of 2023. We believe there are three reasons why Microchip's business continues to demonstrate more resilience in the midst of the weakness seen by some of our semiconductor companies. some other semiconductor companies. First, on the demand side, the end markets that we have the most exposure to, industrial, which includes aerospace and defense, automotive, and data center, and the applications within these end markets where we are strong, are less volatile and comparatively more resilient. 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-plus years, and where there was less opportunity to overship the consumption. And third, a laser focus on organic growth for multiple years by concentrating on total system solutions and higher growth megatrends, which we just discussed a few minutes ago, has translated into increased design limits, further share gains, and a resultant revenue tailwind. A quick update regarding the CHIPS Act. We have been getting the benefit of the investment tax credit since the beginning of this year, and we are in the process of submitting our applications for grants to support expansion in several of our domestic factories. The timeline for when grants may be approved is not yet determinable. Now let's get to the guidance for the June quarter. Although our backlog for the June quarter is strong, we expect to continue to take active steps to help customers with inventory positions to push out their backlog, Taking all the factors we have discussed in the call today into consideration, we expect our net sales for the June quarter to be up between 1% and 4% sequentially. At the midpoint of our net sales guidance, our year-over-year growth in the June quarter would be a strong 16.5%. We expect our non-GAAP gross margin to be between 68.3% and 68.5% of sales. We expect non-GAAP operating expenses to be between 20.1% and 20.5% of sales and we expect non-GAAP operating profit to be between 47.8% and 48.4% of sales. We expect our non-GAAP diluted earnings per share to be between $1.63 and $1.65. At the midpoint of our non-GAAP EPS guidance, our year-over-year growth for the June quarter would be a strong 19.7%, despite a much higher tax rate than the year-ago quarter. Finally, as you can see from our March quarter results and our June quarter guidance, Our Microchip 3.0 strategy, which we launched 18 months ago, is firing in 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. However, we also recognize that we operate in a cyclical industry and that we are not immune to business cycles. But if you review Microchip'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. Although we don't foresee any significant decline in our business, if we were to experience a semiconductor inventory correction like the industry has seen in the past, we are highly confident that our non-GAAP operating margins would remain well above 40%. We remain cautiously optimistic about navigating to a soft landing for our business in this cycle and expect our cash generation, gross margin, and operating margin to once again demonstrate consistency and resiliency through the cycles. With that, let me pass the baton to Steve to talk about our cash return to shareholders. By the way, Steve just published a new book called Up and to the Right, which chronicles building Microchip into a technology juggernaut. Investors and analysts can get additional insights from the book about the foundational elements behind Microchip's long-term business success. Steve?