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spk40: Greetings and welcome to the Microchips third quarter fiscal year 2024 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 zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, CFO, Mr. Eric Bjornholt, Thank you. You may begin.
spk34: Thank you, operator. 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 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 Sajid Dowdy, Microchip's Head of Investor Relations. I will comment on our third quarter fiscal year 2024 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 earnings press release which we believe you will find useful when comparing 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 earnings press release and in the reconciliations on our website. Net sales in the December quarter were $1.766 billion, which was down 21.7% 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 63.8%. Operating expenses were at 22.5%. and operating income was 41.2%. Non-GAAP net income was $592.7 million, and non-GAAP earnings per diluted share was $1.08. On a GAAP basis in the December quarter, gross margins were 63.4%. Total operating expenses were $590.6 million and included acquisition and tangible amortization of $151.3 million, special charges of $1.1 million, Share-based compensation of $38.8 million and $1.5 million of other expenses. Gap net income was $419.2 million, resulting in $0.77 in earnings per diluted share. The gap tax rate was favorably impacted from an IRS notice that clarified the treatment of costs incurred by a research provider under contract that we had been accruing for, and that accrual was released in the quarter. Our non-GAAP cash tax rate was 13.2% in the December quarter. Our non-GAAP cash tax rate for fiscal year 2024 is expected to be just under 14%, which is exclusive of the transition tax and any tax audit settlements related to taxes accrued in prior fiscal years. Our fiscal 24 cash tax rate is higher than our fiscal 23 tax rate was for a variety of factors including lower availability of tax attributes such as net operating losses and tax credits, lower tax depreciation with our expectation for lower capital expenditures in the U.S. in fiscal 24, 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. The House actually passed a tax bill last night that would achieve this, and we will see how this progresses through the Senate. 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 at December 31st, 2023 was 1.31 billion. We had 185 days of inventory at the end of the December quarter, which was up 18 days from the prior quarter's level. Although we reduced inventory dollars in the quarter, we were not able to make as much progress as we would have liked as we continued to accommodate requests by customers to push out delivery schedules for products that were very far through the manufacturing process. At the midpoint of our March 2024 quarter guidance, we would expect inventory dollars to be up modestly and days of inventory to be in the range of 225 to 230 days due to the significant reduction in revenue and cost of goods sold. We also continue to invest 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 10 days of inventory at the end of December. Inventory at our distributors in the December quarter were at 37 days which was up two days from the prior quarter's level. Our cash flow from operating activities was $853.3 million in the December quarter included in our cash flow from operating activities was $30.4 million of long-term supply assurance receipts from customers. We have adjusted 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 supply assurance payments will be refundable over time as purchase commitments are fulfilled. Our adjusted free cash flow was $763.4 million in the December quarter, As of December 31st, our consolidated cash and total investment position was $281 million. Our total debt decreased by $392 million in the December quarter, and our net debt decreased by $416.4 million in the quarter. Over the last 22 full quarters since we closed the MicroCenter acquisition and incurred over $8 billion in debt to do so, we have paid down $7.1 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 $796.2 million and 45.1% of net sales. Our trailing 12-month adjusted EBITDA was $4.26 billion. Our net debt to adjusted EBITDA was 1.27 times at December 31, 2023, down from 1.56 times at December 31st, 2022. Capital expenditures were 59 and a half million in the December quarter. Our expectation for capital expenditures for fiscal year 2024 is between 300 and 310 million, which is down from the 300 to 325 million we shared with investors last quarter as we are delaying certain capital given the more challenging economic backdrop. We expect that our capital investments will continue to provide us increased control over our production during periods of industry-wide constraints. Depreciation expense in the December quarter was $47.1 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?
spk26: Thank you, Eric, and good afternoon, everyone. Our December quarter results were disappointing and below our expectations. with net sales down 21.7 percent sequentially and down 18.6 percent from the year-ago quarter. Non-GAAP gross and operating margins came in at 63.8 percent and 41.2 percent, respectively, down from our recent strong performance but somewhat resilient despite the significant sequential decline in revenue. Our consolidated non-GAAP diluted EPS came in at $1.08 per share, down 30.8 percent from the year-ago quarter. Adjusted EBITDA was 45.1% of net sales in the December quarter, continuing to demonstrate some resiliency. As a result, we had good debt reduction in the December quarter, and despite the lower adjusted EBITDA we generated, our net leverage ticked down to 1.27x. However, we expect our net leverage ratio to rise for a few quarters, as trailing 12-month adjusted EBITDA drops when replacing stronger prior-year quarters with weaker ones. Our capital return to shareholders in the March quarter will increase to 82.5% of our December quarter adjusted free cash flow as we continue on our path to return 100% of our adjusted free cash flow to shareholders by the March quarter of calendar year 2025. My thanks to our worldwide team for their support, hard work, and diligence as we navigated a difficult environment and focused on what we could control so that we are well-positioned to thrive in the long term. Taking a look at our December quarter net sales from a product line perspective, our mixed signal microcontroller net sales were down 22.3% sequentially and down 18.5% on a year over year basis. And our analog net sales were down 30.9% sequentially and down 29% on a year over year basis. Now for some color on the December quarter and the general business environment. All regions of the world and most of our end markets were weak. Our business was weaker than we expected as our customers continued to respond to the effects of increasing business uncertainty, slowing economic activity, and a resultant increase in their inventory. In addition, many customers implemented extended shutdowns or closures at the end of the December quarter as they managed their operational activities. We continued to receive requests to push out or cancel backlogs as customers sought to rebalance their inventory in light of the weaker business conditions and the increased uncertainty they were experiencing. And we were able to push out our canceled backlog to help many customers with these inventory positions. With no major supply constraints, coupled with very short lead times and a weak macro environment, we believe there is inventory destocking underway at multiple levels. At our direct customers and distributors who buy from us, our indirect customers who buy through our distributors, and in some cases, our customers' customers. The very strong upcycle of the last two to three years drove many of our customers to build inventory in order to be able to capitalize on strong business conditions in an uncertain supply environment. The term just in case instead of just in time was used by customers to express their approach to these conditions. But as the macro environment slowed, many of our customers found their business expectations to be too optimistic and ended up with high levels of inventory. And as a result, they sought to cancel or reschedule backlog. An update on our PSP program. During the early stages of the upcycle, we launched our PSP program requiring non-cancellable backlog in exchange for supply priority in a hyper-constrained supply environment. The program was aimed to discourage speculative demand and achieve mutual commitments between our customers and us for future demand. The program worked extremely well for many customers who participated during all of 2021 and 2022, as well as the early part of 2023, supporting strong growth in their businesses. However, the business challenges which led to the creation of the PSP program are no longer relevant, and we have therefore decided to discontinue the program effective today. If business conditions warrant it, we may at some point in the future initiate a similar program, which will of course have to be adapted to whatever that situation requires. Reflecting the slowing macro environment, our distribution inventory grew to 37 days at the end of the December quarter, as compared to 35 days at the end of the September quarter. We are working with our distribution partners to find the right balance of inventory required to serve their customers, manage their cash flow requirements, and be positioned for the eventual strengthening of business conditions. Our internal capacity expansion actions remain paused. Given the severity of the down cycle, our factories around the world will be running at lower utilization rates and also taking up to two shutdown weeks in each of the March and June quarters in order to help control the growth of inventory. We expect our capital investments in fiscal year 24 and fiscal year 25 will be low even as we prepare for the long-term growth of our business. To that end, we reached a preliminary memorandum of terms with the Department of Commerce for $162 million in grants targeted at existing projects for two of our U.S. fads. These grants are subject to diligence by the CHIPS office, as well as capacity investments by Microchip over multiple years. We have been driving our lead times down and have reduced average lead times from roughly 52 weeks at the start of 2023 to roughly eight weeks by the end of 2023 on average. During a period of macro weakness and business uncertainty, we believe short lead times are the best way to help customers navigate the environment successfully and improve the quality of backlog placed with us as it enables our customers and Microchip to engage an uncertain environment with more agility and effectiveness. However, A significant reduction in lead times is also resulting in lower bookings and reduced near-term visibility for our business. We're also taking steps to reduce our expenses. In addition to the variable compensation programs, which provide automatic reductions during a down cycle and normal containment of discretionary expenses, we will be implementing broad-based paid reductions. Our team members who are not a part of the factory shutdowns will take a 10% pay cut And consistent with our normal practice, the executive team will take the largest reduction with a 20% pay cut. The shutdowns for manufacturing team members and pay cuts for non-manufacturing team members are consistent with our longstanding culture of shared sacrifices and down cycles and shared rewards and up cycles. That's avoiding layoffs and in the process protecting manufacturing capability as well as high priority projects which are important for our customers and us to thrive in the long term. We took similar actions in prior periods of business uncertainty, such as the COVID pandemic in 2020 and the global financial crisis in 2008 and 2009, and we believe such actions were quite effective to navigate our business. Now let's get into our guidance for the March quarter. As our customers take further actions to adjust to a weakening macro environment and uncertain business conditions, we are continuing to support customers and channel partners with inventory position to push out or cancel their backlog. We recognize that our short lead times and increased flexibility with backlog will result in customers reducing inventory aggressively and that this could result in some degree of overcorrection. However, in response to these conditions, we are continuing to work with our customers to absorb as much of the inventory correction as we can at this time. Taking all the factors we have discussed on the call today into consideration, We expect our net sales for the March quarter to be between $1.225 billion and $1.425 billion. The guidance range is larger than normal to reflect the macro uncertainty and the resultant low business visibility. We expect our non-GAAP gross margin to be between 59% and 61.6% of sales. We expect non-GAAP operating expenses to be between 26.9% and 30.7% of sales. We expect non-GAAP operating profit to be between 28.3% and 34.7% of sales, and we expect our non-GAAP diluted earnings per share to be between 46 cents and 68 cents. To keep things in perspective, while our business results have degraded significantly over the last two quarters as a larger than normal inventory correction has played out, our full fiscal year 24 revenue decline at the midpoint of the March quarter guidance is expected to be roughly 9.5%, comparing favorably with weakness that other industry players have experienced. Our non-GAAP operating margin for full fiscal year 24 at the midpoint of our March quarter guidance is expected to be 43.6%, continuing to be among the best results across other companies in our industry. While we don't know how and when the inevitable upcycle will play out, we believe the fundamental characteristics of our business remain intact, Finally, notwithstanding any near-term macro weakness, we are confident that our solutions remain the engine of innovation for the applications and end markets we serve. Our focus on total system solutions and key market megatrends continue to fuel strong design momentum, which we expect will drive above-market long-term growth. With that, let me pass the baton to Steve to talk more about our cash return to shareholders. Steve?
spk17: Thank you, Ganesh, and good afternoon, everyone. I would like to provide you with a further update on our cash return strategy. The Board of Directors announced an increase in the dividend of 25.7 percent from the year-ago quarter to 45 cents per share. During the last quarter, we purchased $114.6 million of our stock in the open market. We also paid out $237.4 million in dividends Thus, the total cash return was $352 million. This amount was 77.5 percent of our actual adjusted free cash flow of $454.3 million during the September 2023 quarter. Our net leverage at the end of December 2023 quarter was 1.27 times. Ever since we achieved an investment grade rating, for our debt in November 2021 and pivoted to increasing our capital return to shareholders, we have returned $3.6 billion to shareholders through December 31, 2023 by a combination of dividends and share buybacks. During this time, we have bought back approximately 26 million shares of our common stock from the open market representing approximately 4.5 percent of our shares outstanding. In the current March quarter, we will use the adjusted free cash flow from the December quarter to target the amount of cash returned to shareholders. The adjusted free cash flow excludes a net $30.4 million that we collected from our customers for long-term supply assurance payments. These payments are refundable when purchase commitments are fulfilled. The adjusted free cash flow for the December quarter was $763.4 million. We plan to return 82.5% or $629.8 million of that amount to our shareholders with the dividend expected to be approximately $243 million. and the stock buyback expected to be approximately $386.8 million, which will be a new quarterly record for stock buyback since we initiated our enhanced capital return strategy. Going forward, we plan to continue to increase adjusted free cash flow return to shareholders by 500 basis points every quarter, until we reach 100% of adjusted free cash flow returned to shareholders. That will take four more quarters, and we expect that dividends over time will represent approximately 50% of our cash returned. With that, operator, will you please pull for questions?
spk40: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. And you may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Thank you. And our first question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
spk43: Hi, thanks a lot. I wanted to ask about how much of a headwind the inventory inside of distribution still is. Shipments into distribution were down about 30%, well, actually more than that. And yet, some of your largest disties are still saying that they're having a hard time working down inventory. So can you provide any guidance? Does the March guidance assume that shipments into distribution will be down a lot more than what the corporate guidance is, again, just like it was in December?
spk26: We are expecting that we will drain inventory in distribution in the March quarter.
spk43: Okay. Great. And then, Eric, can you talk about utilization rates and the potential for some write-downs? We sort of haven't been at a level yet where you would write things down, but can you talk about that? Thanks.
spk34: Sure. So, you know, we have been kind of working on an employee attrition basis in our three large fabs. And through the December quarter, that did not put us in a situation where we were taking underutilization charges from those three fabs. That will change this quarter as we have continued to attrit. And as Ganesh kind of walked through, we've got two-week shutdowns scheduled in all three of those large factories. So we aren't going to break out a utilization percentage, but underutilization is absolutely impacting our business, our gross margins in the current quarter. And on top of that, with the change that we've seen in demand and inventory still being high, we have been taking relatively large charges for inventory reserves based on our accounting policies that we have in place and all those things are really factored into the margins guidance that we've given to the street.
spk16: Thanks a lot.
spk41: Thank you.
spk40: Our next question comes from the line of Toshi Yahari with Goldman Sachs. Please proceed with your question.
spk04: Hi, thank you. My first question is on cancellation rates and what you're seeing from a customer push-out perspective. Are you seeing any signs of stabilization, Ganesh, in terms of cancellation rates or pretty much the same so far in the quarter relative to December and September of last year?
spk26: We don't have a numerical tracking process. We still have customers that have asked for help. We have done a lot of that and built it into what we have into our guidance. I don't know if you have a better view, Eric.
spk34: I would say, as we kind of talked about, that customers and distributors are feeling like they have excess inventory, and with that, if they have backlog in place for those products, they are either not placing backlog, but if they have backlog in place, they are looking to see if there's an ability for them to at least push that out. So we're having those ongoing discussions, and I'd say that they're still at a relatively high rate.
spk04: Got it. Thank you. And as my follow-up was hoping to get your comments on pricing, the headed ones you're seeing today, is it mostly volume-driven or Are you starting to see price erode as well between your microcontroller business and analog business? It seems like at the industry level, you've got more supply coming online over the next couple of quarters, several quarters. So curious what you're seeing today and how you're thinking about pricing as we progress through calendar 24. Thank you.
spk26: Yeah, all the revenue declines are really volume declines. They're not pricing related. Pricing is stable. It is not contributing to the revenue change that is in our guidance. You know, our business is one which is based on design-ins that are done, you know, one, two, three years before and production that takes place for many, many years. It's not an easy, you know, substitution that takes place on short-term price adjustments, et cetera. You know, clearly at the point of where new designs are taking place, you know, we will be price competitive to what the new design requires, but Today's revenue adjustments downward are not happening because of price. Price is stable.
spk05: Thank you.
spk26: Thank you.
spk40: Thank you. And our next question comes from the line of Chris Casso with Wolf Research. Please proceed with your question.
spk32: Yes, thank you. Good evening. My question is, and it's a difficult question about sort of where you think aggregate inventory levels are and how much progress with some of these lower revenue shipping rates that we'll make in getting those inventories down over time. I know that's difficult to answer for your end customers, your indirect customers, but perhaps you could address it from the distribution channel where you have a little more visibility and where the target inventory levels are and where you expect to get over time.
spk26: As you said, inventory in some cases is obscure to us. We have to estimate based on where customers are placing orders, what kind of feedback they're giving us. We know we're going to be substantially undershipping to where consumption is going to be, but it's very hard to put a number on what that is and how much of the inventory has been taken out. And as I said, in some cases, it is multiple layers of inventory and especially as people are getting to that point where they are less willing to carry inventory, perhaps even take it to the low end of what they might historically do because supply is plentiful. Not all of this is just inventory reduction as you would normally expect, but it is going to be at multiple levels to our customers, to their customers, and in some cases if they have an OEM that goes to the OEM there as well. We don't have a good way to put a number on what you're asking for.
spk32: Okay, fair enough. One of the things you've also said in prior downturns is, you know, typically you've seen, you know, three down quarters before you achieve a bottom. You know, you're kind of at that now, although September quarter was obviously a much smaller magnitude than now. Given where we are right now, do you think that still holds, and perhaps you could characterize this downturn against some of the prior ones that you've been through?
spk26: Well, there's nothing typical about this downturn, and I don't think there is a good comparison to history. You could say in magnitude it is on the order of what we've seen in the global financial crisis. I think we were down 36% or so at that point in time. You know, we have very limited visibility in today's market conditions. And so it's difficult to say where exactly this is. And as I mentioned, we believe we are significantly under shipping to end demand. But we're unable to provide any kind of, you know, forecast or guidance beyond this quarter.
spk16: Fair enough. Thank you.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Christopher Roland with SIG. Please proceed with your question.
spk08: Hey, guys. Thanks for the question. So around cycle times and lead times, you know, we have found that some of your products, particularly through distribution, they have lead times that are even below your cycle times. I'm assuming your cycle times are something like four weeks or six weeks, something like that. I guess my question is, how long would you expect this dynamic to last? I think this is, you know, if you do have big inventory corrections like we're going through, you see that phenomenon occasionally. But how long might this last? And when are you expecting lead times to maybe expand again? Obviously, we have some inventory dynamic we're going through here. But maybe talk about that lead times versus cycle times. and when you think that those might actually rise again.
spk26: Chris, let me just define two terms, and then we'll walk through it. So cycle time is the time it takes from when you begin with raw material and get to finished goods. That cycle time for semiconductors, depending on which product and what process, can be anywhere from three to five months, sometimes longer, depending on the specialty. So that's the typical production cycle time. We have always been able to manage lead times, which we define as from when a customer places an order on us, when can we ship the product to them? To be a lot shorter than that, and historically, pre-pandemic, that was four to eight weeks was not an unusual number for 80%, 90% of our line items. Where we have come back to is where those lead times, on average, where a customer places an order, they can get in less than eight weeks. And in some cases, if we have it in finished goods, they can get it much sooner than that as well. So I don't have a good view of when do lead times go back out, and I'm not sure that's a good thing. I think we have to obviously work to manage the supply and demand consistent with where demand is going. But for years we ran in that four to eight week as a reasonably stable lead time outside of any major increases or decreases in demand in the marketplace. and right now we think we're going to be at low lead times for quite some time. We have inventory that is high and will be growing into the March quarter, and we're going to position that inventory to be able to take advantage of orders that come in with short cycles because visibility is low, and we need to be able to position and take that as quickly as it comes in. So all of our systems are geared towards having shorter lead times and being able to take orders off the that are placed with short lead times as quickly as we can.
spk34: Maybe just one thing. I think, Chris, maybe what you were getting at is when we have product that is staged in die bank, so it's through the wafer fab, that in many cases we can turn that through assembly and test in the four to six weeks that you're talking about. And so if that's the case, if it's in die bank, that would be the case. But we've got finished goods today. We're staging the products that are high runners in die bank, so our lead times are quite short across the board.
spk08: Yeah, thank you very much, guys. There was some good stuff there. Eric, while I have you, gross margin, just for kind of simplicity's sake, my model's roughly like 300 basis points below for next quarter where I was previously. I don't know if you can kind of walk us through that. You know, what's mixed versus you know, underutilization versus inventory write-down. Sounds like pricing is not an issue here, like for like, but would love to know how those kind of various things contribute.
spk34: Yeah, so, you know, I would say the biggest change quarter to quarter is going to be in the factory utilization, and that's a combination of, you know, this continued attrition and lower production rates on a steady-state weekly basis, and then we're having these two-week shutdowns top of that and what we're having you know time off and some of our back-end factories too which is larger than the previous quarter so all those things impacted I'd say the inventory reserve piece is a part of it but you know we had relatively significant charges last quarter on that and I wouldn't expect those to be significantly more this quarter they'll probably be larger but the biggest piece is going to be what we're doing on utilization excellent thanks guys
spk40: Thank you. Our next question comes from the line of Gary Mobley with Wells Fargo. Please proceed with your question.
spk33: Hey guys, good afternoon. Thanks for taking my question. Looking at the March quarter guidance, that's basically a peak to trough in revenue terms of more than 40% all within the same fiscal year. So clearly the rate of the decay has been extreme. And I'm calling on your experience here, given that you've all been through a lot of cycles in the past and you hinted to in your prepared remarks maybe some overcorrection on your customer's part in terms of inventory depletion. So calling on your experience, how would you say the slope of the recovery may look given your lead times? Is it a gradual one or are we going to see just a sharper rebound as we saw in terms of this correction?
spk34: So I'll start, and Ganesh or Steve can add to this. I think it is unknown at this point in time, right? We have limited backlog visibility as we look out in time, which you're asking about beyond this quarter. Lead times are really short, and customers are sitting on a certain level of inventory beyond what they think is necessary for their business today. So until we start getting... short-term orders kind of at our lead times and we see that backlog start to build, it's hard for us to really imagine what it's going to do. As Ganesh said before, clearly in this quarter with our revenue guidance, we are shipping below what the end consumption for our products are, and we think that's relatively material. But giving you any guidance in terms of what the slope of the recovery is, I think it's hard for us to do at this point.
spk26: I think the recovery has many components to it, right? One is just If you assume business is flat and as the inventory drains, people will at some point just have to order enough to get back to flat consumption. Then there is also what does the macro do and what happens in actual consumption over time? And that depends on many things. Where is GDP at? What are interest rates doing, et cetera? And I think those are all variables which you can't, at least we're not able to plug in and say this is how the next three, four quarters, the shape of the recovery will look. And we don't have the visibility and backlog to give us any insight into that today.
spk33: I know, I was asking for a lot there, but I appreciate the color. So it sounds like your OpEx management is more so variable versus structural, and you've obviously done this in the past. In this recent round where you've asked employees to take a 10% pay reduction, what was communicated to them in terms of when that might be recouped based on some sort of revenue or performance metrics?
spk26: I have not been able to speak to the entire Microchip community until – and I do that on Monday morning. I did write them all a message today after the market closed and before this call – to let them know what we were doing. So those are details that I would prefer to first speak to our employees and give them all of that. But this is not new to us. We have done this multiple times. Our culture allows people to understand how shared sacrifice and shared rewards go hand in hand and how that creates excellent outcomes for the company and for the individuals in the process of doing that. And so I'm confident that our team especially the team that has been through many cycles with us, will see it, will help us with it, and pull everybody else along as well.
spk42: Thank you, Ganesh.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Vivek Arya with Bank of America. Please proceed with your question.
spk39: Thanks for taking my question. Ganesh, I appreciate you're not going beyond a quarter, but I still wanted to, you know, get some help in getting some directional sense of whether June could be, you know, flat, up or down. Because, you know, you do have some shutdowns in June, right? You're already planning for that. So that's not a great data point. But then June tends to also be seasonally up for you historically, right? So just give us some more color. What is true demand right now? And if you were sitting in our shoes, would you think about June being kind of up, down, flat, even if you don't have an absolute sense of where June might shake out?
spk26: I think the shutdowns that we communicated based on the days of inventory that we closed December and what we have indicated are going to be at the end of March are required steps we need to take. Those are not necessarily trying to provide an indication of where the June business is going to be at. In fact, the real answer is, I don't know. And I think, you know, the world is not falling apart. So we know that consumption is taking place. We know that inventory needs to drain. We're trying to gauge between, you know, the environment in the market, the inventory at multiple levels, and how all that will drain. We know this business will come back. It has, you know, in every previous cycle done that. But I think what you're asking for is a level of precision which we don't have any empirical data to be able to say, yep, this is what's going to happen and when.
spk39: And then my bigger question, Ganesh, is that, you know, how would you contrast your strategy of maintaining kind of a hybrid manufacturing model, right, where lead times can suddenly get extended, but your capex is low, your profitability is high? To say your other U.S. competitor who has high CapEx, you know, they can usually keep lead times very low, and they have managed to avoid, right, these kind of very, very large swings. How would you kind of contrast the two strategies? And do you think, you know, what you're going through, you know, could make you change your strategy about maybe, you know, having higher CapEx in the future and always trying to maintain lower lead times?
spk26: Again, there are many people that fit into what you described. I'll describe our strategy, which is we run inside of Microchip the products that we know how to run cost-effectively and consistently within our manufacturing footprint. That includes both our front-end as well as our back-end. We have grown that front-end footprint over time, but also our foundry products have grown over time. And that balance has been roughly 40% plus or minus internal, 60% external. We don't try to guide where that percentage needs to go. The market demand drives, is it higher or lower from there? But we know what products and technologies make sense within our footprint and what makes sense to drive with our partners. And that's the way we think about it. And in the aggregate, barring any near-term changes like we've had last quarter and this quarter, it's been a very successful strategy in terms of how gross margins over time have accreted and how over many cycles We've got higher highs and higher lows. So we're very happy with the strategy we have. And, you know, I leave others with their strategy to speak for themselves.
spk36: Thank you.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Tori Spanberg with Stifel. Please proceed with your question.
spk31: Yes, thank you. So my first question is on the PSP program. It was obviously put in place to try and avoid volatility, and it doesn't look like that happened. Maybe it was just the nature of the pandemic cycle. I don't know. But why do you think the PSP program did not sort of buffer the volatility that we're actually seeing?
spk26: It's a great question. Although the PSP program was aimed at discouraging speculative demand by making orders at NCNR and then giving us confidence to make investments on it. I think there was a combination of very strong OEM market demand, our customers and their customers and what they were seeing. There were persistent shortages over a long period of time and very long lead times. And I think when you put all that together, OEM customers ended up placing more backlog because they believed their business was a lot stronger than they thought. And they were trying to place orders for a lot longer than they normally would in that. So that's the way it, in our perspective, played out. How it did phenomenally for them in the 2021-2022 timeframe where those that were in the program were able to keep their business going, take market share away, and drive things. But at the end of the day, you know, the longer lead times get, the farther out someone is trying to predict where their business is going to be. And I think that's the, you know, the issue at some point in time is, you know, you don't know what your demand is with any kind of high confidence, you know, one year or 18 months out. Yet people were placing those orders as non-cancellable, thinking that their demand was strong and assuming that the risk was a good risk for them to take.
spk31: Well, that's very fair. And then as my follow-up, I recognize that, you know, oil and markets are going to be weak in the March quarter, but Any sort of relative comment on the end markets? Anything holding up a little bit relatively better than others?
spk26: Yeah, I would say if you look at our aerospace and defense market, there are strengths in those. The commercial aviation remains strong. The defense remains strong. Space has always been very lumpy in where it's at. Our portion of the data center, which is around AI platforms, those are doing extremely well. It's not big enough to move the microchip needle overall, but it's certainly a pocket of strength that we see as well.
spk30: Great. Thank you very much.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Chris Stanley with Citi. Please proceed with your question.
spk29: Thanks, guys. I guess just a little clarification on the decline here. Any comments on just your sense of end demand? Maybe talk about the end markets that have been the worst. And then also, given your revenue decline is notably more than some of your peers, why do you think it's hitting you more than some of the competition?
spk24: Sorry, what was the last part of your question? Why do you think what?
spk29: Why is your revenue declining much more than some of your competitors?
spk26: Okay. So on your second question, As I said, if you look at it over a year's period of time, you're going to find that the fiscal 24 at the midpoint of our guidance is about 9.5% down from fiscal 23. I don't think that's outside of where the normal is at. Within a two-quarter period of time, absolutely, we are correcting and correcting at a faster rate than where we were at. But I think we have to look at area under the curve for revenue rather than just peak to trough alone in terms of what you're going to look at.
spk25: In terms of end markets, you know, we – sorry, was there a question?
spk03: No, I said thanks.
spk26: Okay. In terms of end markets, as I mentioned, it's weak across the board. We don't track at the quarterly level kind of how they're all moving, but we have enough anecdotal data. I think we were among the earliest people as early as two or three quarters ago saying automotive is starting to weaken and roll over and, you know, industrial did and data center had been. So we have seen this for some time. And at this point in time, I would say that all week, you know, there might be individual customers who are stronger or weaker than what on average that we see. But nothing to write home about other than the two exceptions I spoke about, which is aerospace and defense is still holding up, and our portion of the AI servers that we provide solutions to.
spk29: Thanks, Ganesh. And then just a quick clarification on the utilization rates. Do you guys anticipate utilization rates declining again in the June quarter from March, or will they stay flattish from March to June?
spk23: We don't know yet. We will have to see, you know, how kind of the business evolves over the coming months.
spk38: Okay. Thanks, Eric.
spk40: Thank you. Our next question comes from the line of Vijay Rakesh with Mizuho. Please proceed with your question.
spk11: Yeah, hi, I had a quick question. I was wondering between the CAPEX and the funding that Microchip was getting, how much capacity you would be adding on the front end or the back end, as you look at calendar 24, I guess?
spk34: So our capital expenditures for fiscal 24 we laid out for you, and that's $300 to $310 million. We have not given a number for next fiscal year. I expect it to be lower than that. We've actually taken in quite a bit of equipment this year that we have not essentially released and placed in service for production purposes. So we've got capital that's paid for and at our facilities that we can deploy as the market returns to a more normalized level, and we need that capacity. But I expect CapEx to be quite low in our fiscal year 2025.
spk26: Richard, here's how I would think about it from a How are we positioned for growth from our capacity? Our initial response as this thing changes is going to be utilizing the inventory that we have built and being able to ship using the inventory we have. Our next response will be around getting our factories to more full utilization. We are under utilizing them at this point in time. Our third response would be taking equipment that we have already ordered and received, which we will begin to place into production. and then finally into adding more equipment or bottleneck equipment, as the case might be. So we believe we have plenty of firepower for being able to respond to an upcycle through a combination of those four things.
spk11: Got it. And if you were to combine all of that, you mentioned your channel density inventory was at 37 days versus the optimal high 20s, I guess, that you mentioned before. And your in-house inventory DUI probably goes up a little bit as you go into March. Any thoughts on when you actually see that starting to realign or start to stabilize or start to come down? Is that more of a second half? When do you actually see that happening, I guess?
spk26: You know, if I had a better picture on the demand environment, I could give you a better answer. So what we're doing is we're taking action on the things we can control, which is our internal capacity, and those are the shutdown days, the lowering of the demand, utilization factors and all that other stuff that we're doing. And that is all in anticipation that at some point the market will return, and it will reverse cycle at that point in time, first by us producing less, which we're taking steps for, and second by the market consuming more, which is what is unknown.
spk11: Got it. And last question, on the margin trajectory for March quarter, did you say that all of it was because of utilization and Should we expect that underutilization to continue into June, or how do you see that, or do you expect utilization to pick back up again?
spk34: We didn't say it was all of it. There's a large portion of the change that is utilization-driven. There's always product mix and inventory reserves and other things that impact that. I think it will be probably difficult for capacity utilization to increase. in the June quarter just because, you know, we are running on an attrition basis and that is continuing each week as some people leave. And then it just takes a while to ramp that back up even if the market dynamics are better. And so, you know, that's something that we'll watch very closely and make sure that we're making the appropriate investments in people. But it tends to be like moving a battleship out in the ocean. It turns relatively slow.
spk10: Got it. Thank you very much.
spk40: Thank you. Our next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.
spk19: Great. Thank you. I guess I wonder if you could address a couple of the bear cases that I hear. One, you sort of talked about PSP and what it accomplished and what it didn't. Do you think that having more flexibility about customer cancellations when this started to slow down, would that have you know, sort of made the issue less bad now? Is the PSP, you know, part of the reason why the hole is a little bit deeper maybe?
spk26: You know, perhaps. And I think, again, in retrospect, you know, as a Monday morning quarterback, I know exactly what I would have done. But, you know, we were under for many, many, many quarters, and even as recently as last March and June quarters, right, there were CEO-level calls that were pushing and driving for getting more product than we had. If you remember, we would provide the statistic about how much of unsupported, which is what customers wanted and we couldn't ship, was there. So in the throes of all of that, were there parts of it where perhaps we should have taken our foot off the accelerator, perhaps, but it isn't something that was knowable as we went through it. And if we ever were to do a PSP program again, those are some lessons learned we'll take and we'll look at how would we adjust the program so that the intended outcomes are available and as many of the unintended outcomes are avoided.
spk19: Great, thank you. And then, you know, the other kind of negative question that I get, you know, China obviously building significant amount of trailing edge capacity, you know, Can you talk about what types of, you know, I don't think you see a lot of direct competition from sovereign China today, but can you talk about, you know, how much of your business might see competition from that direction, you know, over the next few years? I think you've talked about that being single digits, but maybe if you could just update us on your thinking there.
spk26: Sure. So mainland China today is about 20-ish percent of our revenue. About a half of it, we estimate, is designed elsewhere than and just happens to be manufactured in mainland China, and some of that is, frankly, moving out of China as people diversify the thing. So the point of design is outside of China, and we're comfortable with that. So the other 10% of our business that's in China, that is designed in China, has another half of that, which is very complex designs, and these are not the ones that are easy to dislodge and would have significant amount of, knowledge about systems, the software that goes with it, the hardware and software interaction and all that. So that means about 5% of our business, about one-fourth of the business in mainland China, that is our more broad-based microcontrollers and analog and those type of products. And there, fragmentation is our friend. It is a very, very fragmented market. Any one opportunity is a small percentage of revenue and You know, it is not easy to go to place, but theoretically you could say if somebody had an identical offering. And by the way, a lot of that business is not just about having silicon. It's about having silicon, having tools, having design guides, having software that we make available. There's a lot of help and self-help that we provide for our customers as well that is there. So, yes, you know, there is more going on in China with trailing edge both technologies and capacity. And we will pay attention and we will, through our product line and innovation, cost reduction, be continuing to work to go head-to-head against that. But it's the portion of the business that you might think about is more broad-based where they would come after that business is less than 5% and is very, very fragmented and difficult to get at. Does that help?
spk18: Thank you. Yes, so much. Thank you.
spk26: Thank you.
spk40: Thank you. Our next question comes from the line of Joshua Buchalter with TD Cowen. Please proceed with your question.
spk28: Hey, guys. Thanks for taking my question. I wanted to ask about utilization rates and sort of the strategic decisions you're making to shut down the fabs for two weeks in March and June and also keep utilization rates, you know, lower over those two quarters. I guess why... start and stop the fabs, but also why not just take the utilization rates much lower in the March quarter and then see where things play out, given you're trying to get an inventory down, but expectations are that it'll still go up in March. Thank you.
spk26: You know, it's a balanced decision that we had to think through and make, but as inventories climb, there is a point at which the pain gets high enough. And as we looked at that, we felt on balance and, you know, we don't know what other supply demand, you know, dynamics may take place. That on balance, this is a way in which we could navigate to different scenarios that might play themselves out. And in the meanwhile, the inventory is high enough that we're comfortable that if the recovery would accelerate, we're in a good place and, you know, we are if the recovery were something different, that we're ahead of us and we have options on what we can do in the June quarter. But right now we need to prepare for where March and June, to the best of our ability to call it, is going to be. And that includes the running at a lower utilization and taking a two-week shutdown in our FABs in each of the two quarters.
spk28: Thanks, Ganesh. And then as my follow-up, And I know you have a formulaic approach to your capital return program, but you've also in the past talked about opportunistically potentially going above the rates that you've outlined. As we go through this period where you're going through the digestion and pre-cash flows depressed versus where it was the last few quarters, any thought to either using the balance sheet or returning more than you would have returned under the formula that you've outlined? Thank you.
spk34: So maybe I'll start. So you mean we actually have a very healthy cash return this quarter, right? We increased from 77.5% to 82.5%. The adjusted free cash flow in the December quarter was quite high. And even though the dividend is going up again, we are going to have kind of record share buyback in the quarter based on that formula that you spoke to. So we think it's appropriate. We're glad that we're going to be buying back a bunch of shares this quarter. Steve and Ganesh can give commentary if the Board would think of doing anything different, but I think that program is kind of in place as it is. If the market changed and the stock price declined significantly, it would be a discussion with the Board.
spk17: I think it just came out naturally that our cash flow was extremely healthy last quarter. and with the returning 82.5 percent back to shareholders with dividend increasing, it still creates a record stock buyback in a quarter, record that we have ever done before, $386.8 million. So it's a very, very healthy buyback. If that was not to be the case, where the cash flow wasn't as healthy as last quarter, then the question would be valid, should we do an extraordinary stock buyback? you know, this quarter if the stock were to become weak. But I think we just formulate, by formula, there's a very, very healthy amount of cash reserve for stock product this quarter.
spk26: And, you know, for the last many quarters, we've been steady as she goes. I think having a program that doesn't try to have, you know, quarter to quarter major variations, you know, has been a way in which to establish the consistency of the capital return program. And I think Steve and myself and the rest of the board see that as a way that we should continue with this thing.
spk38: Thank you.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Quinn Bolton with Needham. Please proceed with your question.
spk37: Thanks for taking my question. I guess first one for Eric, you know, you talked about the lower utilization, you're shutting down the factories for two weeks in both March and June. I'm just kind of wondering if you'd walk us through the accounting, how much of that hits you in the current period? How much of those lower utilization charges flow through inventory? And given how much inventory you have, could be, you know, something that hits gross margin for a longer period of time as that flows through inventory and then the income statement. Then I've got a quick follow-up.
spk34: Yeah. So our three large wafer fabs will, even without the shutdowns, with the attrition that we've had, be running below what we would call normal utilization. And so these two-week shutdowns will be period costs in the quarter and not capitalized to inventory. Okay. Now, we are running at lower utilization rates than we were at the peak, so the costs that are being capitalized to inventory on a per-unit basis are higher than what they were when we were running at full board. But, yeah, I think that answers your question. Essentially, the two-week shutdowns will be an impact to the current period and not capitalized into inventory.
spk37: That's very clear. Thank you. And then I guess just for Ganesh, you mentioned you're ending the PSP program, and so I'm curious, Does that just mean you're not signing anyone to new PSP? Does that mean that existing PSPs have now been canceled and folks have greater rights to cancel existing backlog? Just what happens with the current PSP participants?
spk26: The backlog has been shrinking for some time, and really what we're telling customers is that no more orders get accepted that are PSP orders. And customers have seen that lead times are short, capacity is available. As I said, the premise of why we kicked it off no longer exists, and therefore, you know, it will come to a natural end here fairly quickly, and we just stopped taking more orders that anyone may, if they didn't already understand, be placing as PSP.
spk36: Got it. Thank you. You're welcome.
spk40: Thank you. Our next question comes from the line of William Stein with Tourist. Please proceed with your question.
spk35: Great. Thanks for squeezing me in. I was also going to ask about PSP and the mechanics of how it rolls out of backlog. But I think you just answered that. But I do have a sort of financial question around it. I believe for many of these orders, you are getting prepaid by customers and you might have been likewise prepaying customers. or capacity at Foundry. Can you walk through how those roll off the financial activity of the company and when you expect them to be sort of in the rearview mirror? Is that done, you think, by the end of the March quarter?
spk34: Okay. So with PSP, those were not typically, you know, customer paying cash in advance for any of that. We have certain long-term supply agreements, and those have a cash prepayment element to them. Those are still in place. There's nothing that's happening with those programs related to the cancellation of PSP. So those programs are still in place, and those tend to be three- to five-year agreements, most of them five-year agreements, and those will just kind of run out over time. In some cases where customers' demand is, not as strong as originally anticipated. We work with them to find a mutually workable answer on that. Maybe it's to extend the program longer. They can add something else into the program for their volume commitments. But we're not looking to penalize customers with that program. And then on the supplier side, we have had certain prepayments that are made and contractual obligations that we have. And it's the same thing there. It's a negotiation with our suppliers and they're working with us. And I don't see that there's any significant financial disadvantage to us coming from those, but in some cases we have taken on more inventory, maybe raw materials, than what we would have otherwise.
spk05: Great. Thank you. You're welcome.
spk40: Thank you. And our next question will come from the line of Janet Ramkisson with Quadra Capital. Please proceed with your question.
spk07: Yes, thanks for taking my question. Can you guys give us a sense of what's going on with design activity? I know you've seen this real cutback, and you're saying that there is really not much of a shortfall in terms of actual demand. Do you have any visibility, less visibility, the same as before? Could you give us some sense of what's going on to give us a better sense of the long-term outlook beyond the June quarter?
spk26: Yeah, no, thank you. So design activity, as I said in my prepared remarks, is at very high levels, and I think it is because for a number of reasons. Customers were in triage for some time as they were dealing with shortages, and as all that went behind, they went back to focusing on innovation. Our products and technologies are enabling innovation in many new fields, And so by many measures, both what we measure internally in terms of design wins and design funnel and all that, and what some of our partners who are more design-in focused, particularly the catalog distributors are a good example where much of the seeding activity that takes place are also seeing very high levels of that. So I think the innovation machine is strong, and the inventory correction will pass and go, and ultimately the long-term growth of the business, as you noted, will come from how this innovation plays out and how the overall role and content that semiconductors will play in that innovation being delivered on end products.
spk07: Thanks. That's very helpful. And just one last one if I could sneak it in. Is there any particular geography or particular segment that you saw sort of a faster rate of decline? I noticed that industrial as a percent or total was down just from the supplemental slides. Is there any color that you could give us in terms of geography or end markets where you saw most of the weakness?
spk26: You know, I think they're all weak. I don't have a numerical way to give you. I can tell you that China, for example, has been weak for an extended period of time. So, you know, going back all the way to 2022 when, you know, they had the shutdowns and it really hasn't recovered from there. But I think we've seen weakness in all geographies and pretty much all end markets with the exception of the aerospace and defense and a bit of the data center that was all AI focused.
spk34: And I believe the end market data that was posted on our website still references last full fiscal year, and that hasn't been updated. That's a process that we do once a year. So we'll take a look at the slide to make sure it's not confusing, but that's what I believe to be the case.
spk06: Okay. Thanks, guys. Appreciate it.
spk15: Thank you.
spk40: Thank you. There are no further questions at this time, and I would like to turn the floor back over to Ganesh Murthy for closing comments.
spk26: Okay, I want to thank everyone for taking the time to be on this call and all of your questions. We look forward to having further discussions during some of the conferences coming up this year. And on that note, we are closing this call.
spk40: This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
spk15: © transcript Emily Beynon © transcript Emily Beynon © transcript Emily Beynon Thank you. Thank you.
spk40: Greetings and welcome to the Microchips third quarter fiscal year 2024 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 zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, CFO, Mr. Eric Bjornholt, Thank you. You may begin.
spk34: Thank you, operator. 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 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 fiscal year 2024 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 earnings press release which we believe you will find useful when comparing 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 earnings press release and in the reconciliations on our website. Net sales in the December quarter were $1.766 billion, which was down 21.7% 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 63.8%. Operating expenses were at 22.5%. and operating income was 41.2%. Non-GAAP net income was $592.7 million, and non-GAAP earnings per diluted share was $1.08. On a GAAP basis in the December quarter, gross margins were 63.4%. Total operating expenses were $590.6 million and included acquisition and tangible amortization of $151.3 million, special charges of $1.1 million, Share-based compensation of $38.8 million and $1.5 million of other expenses. Gap net income was $419.2 million, resulting in $0.77 in earnings per diluted share. The gap tax rate was favorably impacted from an IRS notice that clarified the treatment of costs incurred by a research provider under contract that we had been accruing for, and that accrual was released in the quarter. Our non-GAAP cash tax rate was 13.2% in the December quarter. Our non-GAAP cash tax rate for fiscal year 2024 is expected to be just under 14%, which is exclusive of the transition tax and any tax audit settlements related to taxes accrued in prior fiscal years. Our fiscal 24 cash tax rate is higher than our fiscal 23 tax rate was for a variety of factors including lower availability of tax attributes such as net operating losses and tax credits, lower tax depreciation with our expectation for lower capital expenditures in the U.S. in fiscal 24, 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. The House actually passed a tax bill last night that would achieve this, and we will see how this progresses through the Senate. 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 at December 31st, 2023 was 1.31 billion. We had 185 days of inventory at the end of the December quarter, which was up 18 days from the prior quarter's level. Although we reduced inventory dollars in the quarter, we were not able to make as much progress as we would have liked as we continued to accommodate requests by customers to push out delivery schedules for products that were very far through the manufacturing process. At the midpoint of our March 2024 quarter guidance, we would expect inventory dollars to be up modestly and days of inventory to be in the range of 225 to 230 days due to the significant reduction in revenue and cost of goods sold. We also continue to invest 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 10 days of inventory at the end of December. Inventory at our distributors in the December quarter were at 37 days which was up two days from the prior quarter's level. Our cash flow from operating activities was $853.3 million in the December quarter included in our cash flow from operating activities was $30.4 million of long-term supply assurance receipts from customers. We have adjusted 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 supply assurance payments will be refundable over time as purchase commitments are fulfilled. Our adjusted free cash flow was $763.4 million in the December quarter, As of December 31st, our consolidated cash and total investment position was $281 million. Our total debt decreased by $392 million in the December quarter, and our net debt decreased by $416.4 million in the quarter. Over the last 22 full quarters since we closed the MicroCenter acquisition and incurred over $8 billion in debt to do so, we have paid down $7.1 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 $796.2 million and 45.1% of net sales. Our trailing 12-month adjusted EBITDA was $4.26 billion. Our net debt to adjusted EBITDA was 1.27 times at December 31, 2023, down from 1.56 times at December 31st, 2022. Capital expenditures were 59 and a half million in the December quarter. Our expectation for capital expenditures for fiscal year 2024 is between 300 and 310 million, which is down from the 300 to 325 million we shared with investors last quarter as we are delaying certain capital given the more challenging economic backdrop. We expect that our capital investments will continue to provide us increased control over our production during periods of industry-wide constraints. Depreciation expense in the December quarter was $47.1 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?
spk26: Thank you, Eric, and good afternoon, everyone. Our December quarter results were disappointing and below our expectations. with net sales down 21.7% sequentially and down 18.6% from the year-ago quarter. Non-GAAP gross and operating margins came in at 63.8% and 41.2% respectively, down from our recent strong performance but somewhat resilient despite the significant sequential decline in revenue. Our consolidated non-GAAP diluted EPS came in at $1.08 per share, down 30.8% from the year-ago quarter. Adjusted EBITDA was 45.1% of net sales in the December quarter, continuing to demonstrate some resiliency. As a result, we had good debt reduction in the December quarter, and despite the lower adjusted EBITDA we generated, our net leverage ticked down to 1.27x. However, we expect our net leverage ratio to rise for a few quarters, as trailing 12-month adjusted EBITDA drops when replacing stronger prior-year quarters with weaker ones. Our capital return to shareholders in the March quarter will increase to 82.5% of our December quarter adjusted free cash flow as we continue on our path to return 100% of our adjusted free cash flow to shareholders by the March quarter of calendar year 2025. My thanks to our worldwide team for their support, hard work, and diligence as we navigated a difficult environment and focused on what we could control so that we are well-positioned to thrive in the long term. Taking a look at our December quarter net sales from a product line perspective, our mixed signal microcontroller net sales were down 22.3% sequentially and down 18.5% on a year over year basis. And our analog net sales were down 30.9% sequentially and down 29% on a year over year basis. Now for some color on the December quarter and the general business environment. All regions of the world and most of our end markets were weak. Our business was weaker than we expected as our customers continued to respond to the effects of increasing business uncertainty, slowing economic activity, and a resultant increase in their inventory. In addition, many customers implemented extended shutdowns or closures at the end of the December quarter as they managed their operational activities. We continued to receive requests to push out or cancel backlogs as customers sought to rebalance their inventory in light of the weaker business conditions and the increased uncertainty they were experiencing. And we were able to push out our canceled backlog to help many customers with these inventory positions. With no major supply constraints, coupled with very short lead times and a weak macro environment, we believe there is inventory destocking underway at multiple levels. At our direct customers and distributors who buy from us, our indirect customers who buy through our distributors, and in some cases, our customers' customers. The very strong upcycle of the last two to three years drove many of our customers to build inventory in order to be able to capitalize on strong business conditions in an uncertain supply environment. The term just in case instead of just in time was used by customers to express their approach to these conditions. But as the macro environment slowed, many of our customers found their business expectations to be too optimistic and ended up with high levels of inventory. And as a result, they sought to cancel or reschedule backlog. An update on our PSD program. During the early stages of the upcycle, we launched our PSD program requiring non-cancellable backlog in exchange for supply priority in a hyper-constrained supply environment. The program was aimed to discourage speculative demand and achieve mutual commitments between our customers and us for future demand. The program worked extremely well for many customers who participated during all of 2021 and 2022, as well as the early part of 2023, supporting strong growth in their businesses. However, the business challenges which led to the creation of the PSP program are no longer relevant, and we have therefore decided to discontinue the program effective today. If business conditions warrant it, we may at some point in the future initiate a similar program, which will of course have to be adapted to whatever that situation requires. Reflecting the slowing macro environment, our distribution inventory grew to 37 days at the end of the December quarter, as compared to 35 days at the end of the September quarter. We are working with our distribution partners to find the right balance of inventory required to serve their customers, manage their cash flow requirements, and be positioned for the eventual strengthening of business conditions. Our internal capacity expansion actions remain paused. Given the severity of the down cycle, our factories around the world will be running at lower utilization rates and also taking up to two shutdown weeks in each of the March and June quarters in order to help control the growth of inventory. We expect our capital investments in fiscal year 24 and fiscal year 25 will be low even as we prepare for the long-term growth of our business. To that end, we reached a preliminary memorandum of terms with the Department of Commerce for $162 million in grants targeted at existing projects for two of our U.S. fads. These grants are subject to diligence by the CHIPS office, as well as capacity investments by Microchip over multiple years. We have been driving our lead times down and have reduced average lead times from roughly 52 weeks at the start of 2023 to roughly eight weeks by the end of 2023 on average. During a period of macro weakness and business uncertainty, we believe short lead times are the best way to help customers navigate the environment successfully and improve the quality of backlog placed with us as it enables our customers and Microchip to engage an uncertain environment with more agility and effectiveness. However, A significant reduction in lead times is also resulting in lower bookings and reduced near-term visibility for our business. We're also taking steps to reduce our expenses. In addition to the variable compensation programs, which provide automatic reductions during a down cycle and normal containment of discretionary expenses, we will be implementing broad-based paid reductions. Our team members who are not a part of the factory shutdowns will take a 10% pay cut And consistent with our normal practice, the executive team will take the largest reduction with a 20% pay cut. The shutdowns for manufacturing team members and pay cuts for non-manufacturing team members are consistent with our longstanding culture of shared sacrifices and down cycles and shared rewards and up cycles. That's avoiding layoffs and in the process protecting manufacturing capability as well as high priority projects, which are important for our customers and us to thrive in the long term. We took similar actions in prior periods of business uncertainty, such as the COVID pandemic in 2020 and the global financial crisis in 2008 and 2009, and we believe such actions were quite effective to navigate our business. Now let's get into our guidance for the March quarter. As our customers take further actions to adjust to a weakening macro environment and uncertain business conditions, we are continuing to support customers and channel partners with inventory position to push out or cancel their backlog. We recognize that our short lead times and increased flexibility with backlog will result in customers reducing inventory aggressively and that this could result in some degree of overcorrection. However, in response to these conditions, we are continuing to work with our customers to absorb as much of the inventory correction as we can at this time. Taking all the factors we have discussed on the call today into consideration, We expect our net sales for the March quarter to be between $1.225 billion and $1.425 billion. The guidance range is larger than normal to reflect the macro uncertainty and the resultant low business visibility. We expect our non-GAAP gross margin to be between 59% and 61.6% of sales. We expect non-GAAP operating expenses to be between 26.9% and 30.7% of sales. We expect non-GAAP operating profit to be between 28.3% and 34.7% of sales, and we expect our non-GAAP diluted earnings per share to be between 46 cents and 68 cents. To keep things in perspective, while our business results have degraded significantly over the last two quarters as a larger than normal inventory correction has played out, our full fiscal year 24 revenue decline at the midpoint of the March quarter guidance is expected to be roughly 9.5%, comparing favorably with weakness that other industry players have experienced. Our non-GAAP operating margin for full fiscal year 24 at the midpoint of our March quarter guidance is expected to be 43.6%, continuing to be among the best results across other companies in our industry. While we don't know how and when the inevitable upcycle will play out, we believe the fundamental characteristics of our business remain intact, Finally, notwithstanding any near-term macro weakness, we are confident that our solutions remain the engine of innovation for the applications and end markets we serve. Our focus on total system solutions and key market megatrends continue to fuel strong design momentum, which we expect will drive above-market long-term growth. With that, let me pass the baton to Steve to talk more about our cash return to shareholders. Steve?
spk17: Thank you, Ganesh, and good afternoon, everyone. I would like to provide you with a further update on our cash return strategy. The Board of Directors announced an increase in the dividend of 25.7 percent from the year-ago quarter to 45 cents per share. During the last quarter, we purchased $114.6 million of our stock in the open market. We also paid out $237.4 million in dividends Thus, the total cash return was $352 million. This amount was 77.5 percent of our actual adjusted free cash flow of $454.3 million during the September 2023 quarter. Our net leverage at the end of December 2023 quarter was 1.27 times. Ever since we achieved an investment grade rating, for our debt in November 2021 and pivoted to increasing our capital return to shareholders, we have returned $3.6 billion to shareholders through December 31, 2023 by a combination of dividends and share buybacks. During this time, we have bought back approximately 26 million shares of our common stock from the open market representing approximately 4.5 percent of our shares outstanding. In the current March quarter, we will use the adjusted free cash flow from the December quarter to target the amount of cash returned to shareholders. The adjusted free cash flow excludes a net $30.4 million that we collected from our customers for long-term supply assurance payments. These payments are refundable when purchase commitments are fulfilled. The adjusted free cash flow for the December quarter was $763.4 million. We plan to return 82.5% or $629.8 million of that amount to our shareholders with the dividend expected to be approximately $243 million. and the stock buyback expected to be approximately $386.8 million, which will be a new quarterly record for stock buyback since we initiated our enhanced capital return strategy. Going forward, we plan to continue to increase adjusted free cash flow return to shareholders by 500 basis points every quarter, until we reach 100% of adjusted free cash flow returned to shareholders. That will take four more quarters, and we expect that dividends over time will represent approximately 50% of our cash returned. With that, operator, will you please pull for questions?
spk40: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. And you may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we pull for questions. Thank you. And our first question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
spk43: Hi, thanks a lot. I wanted to ask about how much of a headwind the inventory inside of distribution still is. Shipments into distribution were down about 30%, well, actually more than that. And yet some of your largest disties are still saying that they're having a hard time working down inventory. So can you provide any guidance? Does the March guidance assume that shipments into distribution will be down a lot more than what the corporate guidance is, again, just like it was in December?
spk26: We are expecting that we will drain inventory in distribution in the March quarter.
spk43: Okay, great. And then, Eric, can you talk about utilization rates and the potential for some write downs? We sort of haven't been at a level yet where you would write things down, but can you talk about that?
spk34: Sure. So, you know, we have been kind of working on an employee attrition basis in our three large fabs. And through the December quarter, that did not put us in a situation where we were taking underutilization charges from those three fabs. That will change this quarter as we have continued to attrit. And as Ganesh kind of walked through, we've got two-week shutdowns scheduled in all three of those large factories. So we aren't going to break out a utilization percentage, but underutilization is absolutely impacting our business, our gross margins in the current quarter. And on top of that, with the change that we've seen in demand and inventory still being high, we have been taking relatively large charges for inventory reserves based on our accounting policies that we have in place and all those things are really factored into the margins guidance that we've given to the street.
spk16: Thanks a lot.
spk41: Thank you.
spk40: Our next question comes from the line of Toshi Yahari with Goldman Sachs. Please proceed with your question.
spk04: Hi, thank you. My first question is on cancellation rates and what you're seeing from a customer push-out perspective. Are you seeing any signs of stabilization, Ganesh, in terms of cancellation rates or pretty much the same so far in the quarter relative to December and September of last year?
spk26: We don't have a numerical tracking process. We still have customers that have asked for help. We have done a lot of that and built it into what we have into our guidance. I don't know if you have a better view, Eric.
spk34: I would say, as we kind of talked about, that customers and distributors are feeling like they have excess inventory, and with that, if they have backlog in place for those products, they are either not placing backlog, but if they have backlog in place, they are looking to see if there's an ability for them to at least push that out. So we're having those ongoing discussions, and I'd say that they're still at a relatively high rate.
spk04: Got it. Thank you. And as my follow-up was hoping to get your comments on pricing, the headed ones you're seeing today, is it mostly volume-driven or Are you starting to see price erode as well between your microcontroller business and analog business? It seems like at the industry level, you've got more supply coming online over the next couple of quarters, several quarters. So curious what you're seeing today and how you're thinking about pricing as we progress through calendar 24. Thank you.
spk26: Yeah, all the revenue declines are really volume declines. They're not pricing related. Pricing is stable. It is not contributing to the revenue change that is in our guidance. Our business is one which is based on design-ins that are done one, two, three years before and production that takes place for many, many years. It's not an easy substitution that takes place on short-term price adjustments, etc. Clearly, at the point where new designs are taking place, we will be price competitive to what the new design requires, but Today's revenue adjustments downward are not happening because of price. Price is stable.
spk05: Thank you.
spk26: Thank you.
spk40: Thank you. And our next question comes from the line of Chris Casso with Wolf Research. Please proceed with your question.
spk32: Yes, thank you. Good evening. My question is, and it's a difficult question about, you know, sort of where you think aggregate inventory levels are and how much progress with some of these lower revenue shipping rates that we'll make in getting those inventories down over time. I know that's difficult to answer for your end customers, your indirect customers, but perhaps you could address it from the distribution channel where you have a little more visibility and where the target inventory levels are and where you expect to get over time.
spk26: As you said, inventory in some cases is obscure to us. We have to estimate based on where customers are placing orders, what kind of feedback they're giving us. We know we're going to be substantially undershipping to where consumption is going to be, but it's very hard to put a number on what that is and how much of the inventory has been taken out. And as I said, in some cases, it is multiple layers of inventory and especially as people are getting to that point where they are less willing to carry inventory, perhaps even take it to the low end of what they might historically do because supply is plentiful. Not all of this is just inventory reduction as you would normally expect, but it is going to be at multiple levels to our customers, to their customers, and in some cases if they have an OEM that goes to the OEM there as well. We don't have a good way to put a number on what you're asking for.
spk32: Okay, fair enough. One of the things you've also said in prior downturns is, you know, typically you've seen, you know, three down quarters before you achieve a bottom. You know, you're kind of at that now, although September quarter was obviously a much smaller magnitude than now. Given where we are right now, do you think that still holds, and perhaps you could characterize this downturn against some of the prior ones that you've been through?
spk26: Well, there's nothing typical about this downturn, and I don't think there is a good comparison to history. You could say in magnitude it is on the order of what we've seen in the global financial crisis. I think we were down 36% or so at that point in time. You know, we have very limited visibility in today's market conditions. And so it's difficult to say where exactly this is. And as I mentioned, we believe we are significantly under shipping to end demand. But we're unable to provide any kind of, you know, forecast or guidance beyond this quarter.
spk16: Fair enough. Thank you.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Christopher Roland with SIG. Please proceed with your question.
spk08: Hey, guys. Thanks for the question. So around cycle times and lead times, you know, we have found that some of your products, particularly through distribution, they have lead times that are even below your cycle times. I'm assuming your cycle times are something like four weeks or six weeks, something like that. I guess my question is, how long would you expect this dynamic to last? I think this is, you know, if you do have big inventory corrections like we're going through, you see that phenomenon occasionally. But how long might this last? And when are you expecting lead times to maybe expand again? Obviously, we have some inventory dynamic we're going through here. But maybe talk about that lead times versus cycle times. and when you think that those might actually rise again.
spk26: Chris, let me just define two terms, and then we'll walk through it. So cycle time is the time it takes from when you begin with raw material and get to finished goods. That cycle time for semiconductors, depending on which product and what process, can be anywhere from three to five months, sometimes longer, depending on the specialty. So that's the typical production cycle time. We have always been able to manage lead times, which we define as when a customer places an order on us, when can we ship the product to them? To be a lot shorter than that, and historically, pre-pandemic, that was four to eight weeks was not an unusual number for 80%, 90% of our line items. Where we have come back to is where those lead times, on average, where a customer places an order, they can get in less than eight weeks. And in some cases, if we have it in finished goods, they can get it much sooner than that as well. So I don't have a good view of when do lead times go back out, and I'm not sure that's a good thing. I think we have to obviously work to manage the supply and demand consistent with where demand is going. But for years we ran in that four to eight week as a reasonably stable lead time outside of any major increases or decreases in demand in the marketplace. and right now we think we're going to be at low lead times for quite some time. We have inventory that is high and will be growing into the March quarter, and we're going to position that inventory to be able to take advantage of orders that come in with short cycles because visibility is low, and we need to be able to position and take that as quickly as it comes in. So all of our systems are geared towards having shorter lead times and being able to take orders off the that are placed with short lead times as quickly as we can.
spk34: Maybe just one thing. I think, Chris, maybe what you were getting at is when we have product that is staged in die bank, so it's through the wafer fab, that in many cases we can turn that through assembly and test in the four to six weeks that you're talking about. And so if that's the case, if it's in die bank, that would be the case. But we've got finished goods today. We're staging the products that are high runners in die bank, so our lead times are quite short across the board.
spk08: Yeah, thank you very much, guys. There was some good stuff there. Eric, while I have you, gross margin, just for kind of simplicity's sake, my model's roughly like 300 basis points below for next quarter where I was previously. I don't know if you can kind of walk us through that. You know, what's mixed versus you know, underutilization versus inventory write-down. Sounds like pricing is not an issue here, like for like, but would love to know how those kind of various things contribute.
spk34: Yeah, so, you know, I would say the biggest change quarter to quarter is going to be in the factory utilization, and that's a combination of, you know, this continued attrition and lower production rates on a steady state weekly basis, and then we're having these two-week shutdowns on top of that, and we're having time off in some of our back end factories too, which is larger than the previous quarter. So all those things impacted, I'd say the inventory reserve piece is a part of it, but we had relatively significant charges last quarter on that, and I wouldn't expect those to be significantly more this quarter. They'll probably be larger, but the biggest piece is going to be what we're doing on utilization.
spk12: Excellent. Thanks, guys.
spk40: Thank you. Our next question comes from the line of Gary Mobley with Wells Fargo. Please proceed with your question.
spk33: Hey guys, good afternoon. Thanks for taking my question. Looking at the March quarter guidance, that's basically a peak to trough in revenue terms of more than 40% all within the same fiscal year. So clearly the rate of the decay has been extreme. And I'm calling on your experience here, given that you've all been through a lot of cycles in the past and you hinted to in your prepared remarks maybe some overcorrection on your customer's part in terms of inventory depletion. So calling on your experience, how would you say the slope of the recovery may look given your lead times? Is it a gradual one or are we going to see just a sharper rebound as we saw in terms of this correction?
spk34: So I'll start, and Ganesh or Steve can add to this. I think it is unknown at this point in time, right? We have limited backlog visibility as we look out in time, which you're asking about beyond this quarter. Lead times are really short, and customers are sitting on a certain level of inventory beyond what they think is necessary for their business today. So until we start getting... short-term orders kind of at our lead times, and we see that backlog start to build, it's hard for us to really imagine what it's going to do. As Ganesh said before, clearly in this quarter with our revenue guidance, we are shipping below what the end consumption for our products are, and we think that's relatively material. But giving you any guidance in terms of what the slope of the recovery is, I think it's hard for us to do at this point.
spk26: I think the recovery has many components to it, right? One is just If you assume business is flat and as the inventory drains, people will at some point just have to order enough to get back to flat consumption. Then there is also what does the macro do and what happens in actual consumption over time? And that depends on many things. Where is GDP at? What are interest rates doing, et cetera? And I think those are all variables which you can't, at least we're not able to plug in and say this is how the next three, four quarters, the shape of the recovery will look. And we don't have the visibility and backlog to give us any insight into that today.
spk33: I know, I was asking for a lot there, but I appreciate the color. So it sounds like your OpEx management is more so variable versus structural, and you've obviously done this in the past. In this recent round where you've asked employees to take a 10% pay reduction, what was communicated to them in terms of when that might be recouped based on some sort of revenue or performance metrics?
spk26: I have not been able to speak to the entire Microchip community until – and I do that on Monday morning. I did write them all a message today after the market closed and before this call – to let them know what we were doing. So those are details that I would prefer to first speak to our employees and give them all of that. But this is not new to us. We have done this multiple times. Our culture allows people to understand how shared sacrifice and shared rewards go hand in hand and how that creates excellent outcomes for the company and for the individuals in the process of doing that. And so I'm confident that our team especially the team that has been through many cycles with us, will see it, will help us with it, and pull everybody else along as well.
spk42: Thank you, Ganesh.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Vivek Arya with Bank of America. Please proceed with your question.
spk39: Thanks for taking my question. Ganesh, I appreciate you're not going beyond a quarter, but I still wanted to, you know, get some help in getting some directional sense of whether June could be, you know, flat, up or down. Because, you know, you do have some shutdowns in June, right? You're already planning for that. So that's not a great data point. But then June tends to also be seasonally up for you historically. Um, so just, you know, give us some more color, you know, what, what is true demand right now? And if you were sitting in our shoes, would you think about June being kind of up down flat, even, even if you don't have an absolute sense of where June might check out?
spk26: You know, I think, um, the shutdowns that we communicated based on the days of inventory that we closed December and what we have indicated are going to be at the end of March are required steps we need to take. Those are not necessarily trying to provide an indication of where the June business is going to be at. In fact, the real answer is, I don't know. And I think, you know, the world is not falling apart. So we know that consumption is taking place. We know that inventory needs to drain. We're trying to gauge between, you know, the environment in the market, the inventory at multiple levels, and how all that will drain. We know this business will come back. It has, you know, in every previous cycle done that. But I think what you're asking for is a level of precision which we don't have any empirical data to be able to say, yep, this is what's going to happen and when.
spk39: And then my bigger question, Ganesh, is that, you know, how would you contrast your strategy of maintaining kind of a hybrid manufacturing model, right, where lead times can suddenly get extended, but your capex is low, your profitability is high? To say your other U.S. competitor who has high CapEx, you know, they can usually keep lead times very low, and they have managed to avoid, right, these kind of very, very large swings. How would you kind of contrast the two strategies? And do you think, you know, what you're going through, you know, could make you change your strategy about maybe, you know, having higher CapEx in the future and always trying to maintain lower lead times?
spk26: Again, there are many people that fit into what you described. I'll describe our strategy, which is we run inside of Microchip the products that we know how to run cost-effectively and consistently within our manufacturing footprint. That includes both our front-end as well as our back-end. We have grown that front-end footprint over time, but also our foundry products have grown over time, and that balance has been roughly 40% plus or minus internal 60% external. We don't try to guide where that percentage needs to go. The market demand drives, is it higher or lower from there? But we know what products and technologies make sense within our footprint and what makes sense to drive with our partners. And that's the way we think about it. And in the aggregate, barring any near-term changes like we've had last quarter and this quarter, it's been a very successful strategy in terms of how gross margins over time have accreted and how over many cycles We've got higher highs and higher lows. So we're very happy with the strategy we have, and I leave others with their strategy to speak for themselves.
spk36: Thank you.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Tori Spanberg with Stifel. Please proceed with your question.
spk31: Yes, thank you. So my first question is on the PSP program. It was obviously put in place to try and avoid volatility, and it doesn't look like that happened. Maybe it was just the nature of the pandemic cycle. I don't know. But why do you think the PSP program did not sort of buffer the volatility that we're actually seeing?
spk26: It's a great question. Although the PSP program was aimed at discouraging speculative demand by making orders at NCNR and then giving us confidence to make investments on it. I think there was a combination of very strong OEM market demand, our customers and their customers and what they were seeing. There were persistent shortages over a long period of time and very long lead times. And I think when you put all that together, OEM customers ended up placing more backlog because they believed their business was a lot stronger than they thought. And they were trying to place orders for a lot longer than they normally would in that. So that's the way it, in our perspective, played out. How it did phenomenally for them in the 2021-2022 timeframe where those that were in the program were able to keep their business going, take market share away, and drive things. But at the end of the day, you know, the longer lead times get, the farther out someone is trying to predict where their business is going to be. And I think that's the, you know, the issue at some point in time is, you know, you don't know what your demand is with any kind of high confidence, you know, one year or 18 months out. Yet people were placing those orders as non-cancellable, thinking that their demand was strong and assuming that the risk was a good risk for them to take.
spk31: Well, that's very fair. And then as my follow-up, I recognize that, you know, oil and markets are going to be weak in the March quarter, but Any sort of relative comment on the end markets? Anything holding up a little bit relatively better than others?
spk26: Yeah, I would say, you know, if you look at our aerospace and defense market, you know, there are strengths in those. The commercial aviation remains strong. The defense remains strong. Space has always been very lumpy in where it's at. Our portion of the data center, which is around AI platforms, those are doing extremely well. It's not big enough to move the microchip needle overall, but it's certainly a pocket of strength that we see as well.
spk30: Great. Thank you very much.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Chris Stanley with Citi. Please proceed with your question.
spk29: Hey, thanks, guys. I guess just a little clarification on the decline here. Any comments on just your sense of end demand? Maybe talk about the end markets that have been the worst. And then also, given your revenue decline is notably more than some of your peers, why do you think it's hitting you more than some of the competition?
spk24: Sorry, what was the last part of your question? Why do you think what?
spk29: Why is your revenue declining much more than some of your competitors?
spk26: Okay. So on your second question, As I said, if you look at it over a year's period of time, you're going to find that the fiscal 24 at the midpoint of our guidance is about 9.5% down from fiscal 23. I don't think that's outside of where the normal is at. Within a two-quarter period of time, absolutely, we are correcting and correcting at a faster rate than where we were at. But I think we have to look at area under the curve for revenue rather than just peak to trough alone in terms of what you're going to look at.
spk25: In terms of end markets, you know, we – sorry, was there a question?
spk03: No, I said thanks.
spk26: Okay. In terms of end markets, as I mentioned, it's weak across the board. We don't track at the quarterly level kind of how they're all moving, but we have enough anecdotal data. I think we were among the earliest people as early as two or three quarters ago saying automotive is starting to weaken and roll over and, you know, industrial did and data center had been. So we have seen this for some time. And at this point in time, I would say that all week, you know, there might be individual customers who are stronger or weaker than what on average that we see. But nothing to write home about other than the two exceptions I spoke about, which is aerospace and defense is still holding up, and our portion of the AI servers that we provide solutions to.
spk29: Thanks, Ganesh. And then just a quick clarification on the utilization rates. Do you guys anticipate utilization rates declining again in the June quarter from March, or will they stay flattish from March to June?
spk23: We don't know yet. We will have to see, you know, how kind of the business evolves over the coming months.
spk38: Okay. Thanks, Eric.
spk40: Thank you. Our next question comes from the line of Vijay Rakesh with Mizuho. Please proceed with your question.
spk11: Yeah, I had a quick question. I was wondering between the CAPEX and the funding that Microchip was getting, how much capacity you would be adding on the front end or the back end?
spk09: I should look at calendar 24, I guess.
spk34: So our capital expenditures for fiscal 24, we laid out for you, and that's $300 to $310 million. We have not given a number for next fiscal year. I expect it to be lower than that. We've actually taken in quite a bit of equipment this year that we have not essentially released and placed in service for production purposes. So we've got capital that's paid for and at our facilities that we can deploy as the market returns to a more normalized level, and we need that capacity. But I expect CapEx to be quite low in our fiscal year 2025.
spk26: Richard, here's how I would think about it from a How are we positioned for growth from our capacity? Our initial response as this thing changes is going to be utilizing the inventory that we have built and being able to ship using the inventory we have. Our next response will be around getting our factories to more full utilization. We are under utilizing them at this point in time. Our third response would be taking equipment that we have already ordered and received, which we will begin to place into production. and then finally into adding more equipment or bottleneck equipment, as the case might be. So we believe we have plenty of firepower for being able to respond to an upcycle through a combination of those four things.
spk11: Got it. And if you were to combine all of that, you mentioned your channel density inventory was at 37 days versus the optimal high 20s, I guess, that you mentioned before. And your in-house inventory DUI probably goes up a little bit as you go into March. Any thoughts on when you actually see that starting to realign or start to stabilize or start to come down? Is that more of a second half? When do you actually see that happening, I guess?
spk26: You know, if I had a better picture on the demand environment, I could give you a better answer. So what we're doing is we're taking action on the things we can control, which is our internal capacity, and those are the shutdown days, the lowering of the demand, utilization factors and all that other stuff that we're doing. And that is all in anticipation that at some point the market will return, and it will reverse cycle at that point in time, first by us producing less, which we're taking steps for, and second by the market consuming more, which is what is unknown.
spk11: Got it. And last question, on the margin trajectory for March quarter, did you say that all of it was because of utilization and Should we expect that underutilization to continue into June, or how do you see that? Or do you expect utilization to pick back up again?
spk34: So we didn't say it was all of it. There's a large portion of the change that is utilization-driven. There's always product mix and inventory reserves and other things that impact that. I think it will be probably difficult for capacity utilization to increase in the June quarter just because, you know, we are running on an attrition basis and that is continuing each week as some people leave. And then it just takes a while to ramp that back up even if the market dynamics are better. And so, you know, that's something that we'll watch very closely and make sure that we're making the appropriate investments in people. But it tends to be like moving a battleship out in the ocean. It turns relatively slow.
spk10: Got it. Thank you very much.
spk40: Thank you. Our next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.
spk19: Great. Thank you. I guess I wonder if you could address a couple of the bear cases that I hear. One, you sort of talked about PSP and what it accomplished and what it didn't. Do you think that having more flexibility about customer cancellations when this started to slow down, would that have made the issue less bad now? Is the PSP part of the reason why the hole is a little bit deeper, maybe?
spk26: Perhaps. I think, again, in retrospect, as a Monday morning quarterback, I know exactly what I would have done. We were under for many, many, many quarters, and even as recently as last March and June quarters, there were CEO-level calls that were pushing and driving for getting more product than we had. If you remember, we would provide the statistic about how much of unsupported, which is what customers wanted and we couldn't ship, was there. So in the throes of all of that, were there parts of it where perhaps we should have taken our foot off the accelerator, perhaps, but it isn't something that was knowable as we went through it. And if we ever were to do a PSP program again, those are some lessons learned we'll take and we'll look at how would we adjust the program so that the intended outcomes are available and as many of the unintended outcomes are avoided.
spk19: Great, thank you. And then, you know, the other kind of negative question that I get, you know, China obviously building significant amount of trailing edge capacity, you know, Can you talk about what types of, you know, I don't think you see a lot of direct competition from sovereign China today, but can you talk about, you know, how much of your business might see competition from that direction, you know, over the next few years? I think you've talked about that being single digits, but maybe if you could just update us on your thinking there.
spk26: Sure. So mainland China today is about 20-ish percent of our revenue. About a half of it, we estimate, is designed elsewhere than and just happens to be manufactured in mainland China, and some of that is, frankly, moving out of China as people diversify the thing. So the point of design is outside of China, and we're comfortable with that. So the other 10% of our business that's in China, that is designed in China, has another half of that, which is very complex designs, and these are not the ones that are easy to dislodge and would have significant amount of, knowledge about systems, the software that goes with it, the hardware and software interaction and all that. So that means about 5% of our business, about one-fourth of the business in mainland China, that is our more broad-based microcontrollers and analog and those type of products. And there, fragmentation is our friend. It is a very, very fragmented market. Any one opportunity is a small percentage of revenue and It is not easy to go to place, but theoretically you could say if somebody had an identical offering. And by the way, a lot of that business is not just about having silicon. It's about having silicon, having tools, having design guides, having software that we make available. There's a lot of help and self-help that we provide for our customers as well that is there. So yes, there is more going on in China with trailing edge both technologies and capacity. And we will pay attention and we will, through our product line and innovation, cost reduction, be continuing to work to go head-to-head against that. But it's the portion of the business that you might think about is more broad-based where they would come after that business is less than 5% and is very, very fragmented and difficult to get at. Does that help?
spk18: Thank you. Yes, so much. Thank you.
spk26: Thank you.
spk40: Thank you. Our next question comes from the line of Joshua Buchalter with TD Cowan. Please proceed with your question.
spk28: Hey, guys. Thanks for taking my question. I wanted to ask about utilization rates and sort of the strategic decisions you're making to shut down the fabs for two weeks in March and June and also keep utilization rates lower over those two quarters. I guess why specifically? start and stop the fabs, but also why not just take the utilization rates much lower in the March quarter and then see where things play out, given you're trying to get an inventory down, but expectations are that it'll still go up in March. Thank you.
spk26: You know, it's a balanced decision that we had to think through and make, but as inventories climb, there is a point at which the pain gets high enough. And as we looked at that, we felt on balance and, you know, we don't know what other supply demand, you know, dynamics may take place. That on balance, this is a way in which we could navigate to different scenarios that might play themselves out. And in the meanwhile, the inventory is high enough that we're comfortable that if the recovery would accelerate, we're in a good place and, you know, we are if the recovery were something different, that we're ahead of us and we have options on what we can do in the June quarter. But right now we need to prepare for where March and June, to the best of our ability to call it, is going to be. And that includes the running at a lower utilization and taking a two-week shutdown in our FABs in each of the two quarters.
spk28: Thanks, Ganesh. And then as my follow-up, And I know you have a formulaic approach to your capital return program, but you've also in the past talked about opportunistically potentially going above the rates that you've outlined. As we go through this period where you're going through the digestion and pre-cash flows depressed versus where it was the last few quarters, any thought to either using the balance sheet or returning more than you would have returned under the formula that you've outlined? Thank you.
spk34: Maybe I'll start. We actually have a very healthy cash return this quarter. We increased from 77.5% to 82.5%. The adjusted free cash flow in the December quarter was quite high. Even though the dividend is going up again, we are going to have record share buyback in the quarter based on that formula that you spoke to. We think it's appropriate. We're glad that we're going to be buying back a bunch of shares this quarter. Stephen can ask and give commentary if the board would think of doing anything different, but I think that program is kind of in place as it is. If the market changed and the stock price declined significantly, it would be a discussion with the board.
spk17: I think it just came out naturally that our cash flow was extremely healthy last quarter. and with returning 82.5 percent back to shareholders with dividend increasing, it still creates a record stock buyback in a quarter, record that we have ever done before, $386.8 million. So it's a very, very healthy buyback. If that was not to be the case, where the cash flow wasn't as healthy as last quarter, then the question would be valid, should we do an extraordinary stock buyback? you know, this quarter if the stock were to become weak. But I think we just formulate – by formula, there's a very, very healthy amount of cash reserve for stock product this quarter.
spk26: And, you know, for the last many quarters, we've been steady as she goes. I think having a program that doesn't try to have, you know, quarter-to-quarter major variations – has been a way in which to establish the consistency of the capital return program. And I think Steve and myself and the rest of the board see that as a way that we should continue with this thing.
spk38: Thank you.
spk26: You're welcome.
spk40: Thank you. Our next question comes from the line of Quinn Bolton with Needham. Please proceed with your question.
spk37: Thanks for taking my question. I guess first one for Eric, you know, you talked about the lower utilization, you're shutting down the factories for two weeks in both March and June. I'm just kind of wondering if you'd walk us through the accounting, how much of that hits you in the current period? How much of those lower utilization charges flow through inventory? And given how much inventory you have, could be, you know, something that hits gross margin for a longer period of time as that flows through inventory and then the income statement. Then I've got a quick follow-up.
spk34: Yeah. So our three large wafer fabs will, even without the shutdowns, with the attrition that we've had, be running below what we would call normal utilization. And so these two-week shutdowns will be period costs in the quarter and not capitalized to inventory. Okay. Now, we are running at lower utilization rates than we were at the peak, so the costs that are being capitalized to inventory on a per-unit basis are higher than what they were when we were running at full board. But, yeah, I think that answers your question. Essentially, the two-week shutdowns will be an impact to the current period and not capitalized into inventory.
spk37: That's very clear. Thank you. And then I guess just for Ganesh, you mentioned you're ending the PSP program, and so I'm curious – Does that just mean you're not signing anyone to new PSP? Does that mean that existing PSPs have now been canceled and folks have greater rights to cancel existing backlogs? Just what happens with the current PSP participants?
spk26: The backlog has been shrinking for some time, and really what we're telling customers is that no more orders get accepted that are PSP orders. And customers have seen that lead times are short, capacity is available. As I said, the premise of why we kicked it off no longer exists, and therefore, you know, it will come to a natural end here fairly quickly, and we just stopped taking more orders that anyone may, if they didn't already understand, be placing as PSP.
spk36: Got it. Thank you. You're welcome.
spk40: Thank you. Our next question comes from the line of William Stein with Truist. Please proceed with your question.
spk35: Great. Thanks for squeezing me in. I was also going to ask about PSP and the mechanics of how it rolls out of backlog. But I think you just answered that. But I do have a sort of financial question around it. I believe for many of these orders, you are getting prepaid by customers and you might have been likewise prepaying or capacity at Foundry. Can you walk through how those roll off the financial activity of the company and when you expect them to be sort of in the rearview mirror? Is that done, you think, by the end of the March quarter?
spk34: Okay. So with PSP, those were not typically, you know, customer paying cash in advance for any of that. We have certain long-term supply agreements, and those have a cash prepayment element to them. Those are still in place. There's nothing that's happening with those programs related to the cancellation of PSP. So those programs are still in place, and those tend to be three- to five-year agreements, most of them five-year agreements, and those will just kind of run out over time. In some cases where customers' demand is not as strong as originally anticipated. We work with them to find a mutually workable answer on that. Maybe it's to extend the program longer. They can add something else into the program for their volume commitments. But we're not looking to penalize customers with that program. And then on the supplier side, we have had certain prepayments that are made and contractual obligations that we have. And it's the same thing there. It's a negotiation with our suppliers and they're working with us. And I don't see that there's any significant financial disadvantage to us coming from those, but in some cases we have taken on more inventory, maybe raw materials, than what we would have otherwise.
spk05: Great, thank you. You're welcome.
spk40: Thank you. And our next question will come from the line of Janet Ramkisson with Quadra Capital. Please proceed with your question.
spk07: Yes, thanks for taking my question. Can you guys give us a sense of what's going on with design activity? I know you've seen this real cutback, and you're saying that there's really not much of a shortfall in terms of actual demand. Do you have any visibility, less visibility, the same as before? Could you give us some sense of what's going on to give us a better sense of the long-term outlook beyond the June quarter?
spk26: Yeah, no, thank you. So design activity, as I said in my prepared remarks, is at very high levels, and I think it is because for a number of reasons. Customers were in triage for some time as they were dealing with shortages, and as all that went behind, they went back to focusing on innovation. Our products and technologies are enabling innovation in many new fields, And so by many measures, both what we measure internally in terms of design lens and design funnel and all that, and what some of our partners who are more design-in focused, particularly the catalog distributors are a good example where much of the seeding activity that takes place are also seeing very high levels of that. So I think the innovation machine is strong, and the inventory correction will pass and go, and ultimately the long-term growth of the business, as you noted, will come from how this innovation plays out and how the overall role and content that semiconductors will play in that innovation being delivered on end products.
spk07: Thanks. That's very helpful. And just one last one, if I could sneak it in. Is there any particular geography or particular segment that you saw sort of a faster rate of decline? I noticed that industrial as a percent or total was down just from the supplemental slides. Is there any color that you could give us in terms of geography or end markets where you saw most of the weakness?
spk26: I think they're all weak. I don't have a numerical way to give you. I can tell you that China, for example, has been weak for an extended period of time. So, you know, going back all the way to 2022 when, you know, they had the shutdowns and it really hasn't recovered from there. But I think we've seen weakness in all geographies and pretty much all end markets with the exception of the aerospace and defense and a bit of the data center that was all AI focused.
spk34: And I believe the end market data that was posted on our website still references last full fiscal year, and that hasn't been updated. That's a process that we do once a year. So we'll take a look at the slide to make sure it's not confusing, but that's what I believe to be the case.
spk06: Okay. Thanks, guys. Appreciate it.
spk15: Thank you.
spk40: Thank you. There are no further questions at this time, and I would like to turn the floor back over to Ganesh Murthy for closing comments.
spk26: Okay, I want to thank everyone for taking the time to be on this call and all of your questions. We look forward to having further discussions during some of the conferences coming up this year. And on that note, we are closing this call.
spk40: This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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