Microchip Technology [MCHP] Conference call transcript for 2022 q3
2022-11-03 22:38:05
Fiscal: 2023 q2
James Eric Bjornholt: [Technical Difficulty] Is a record $814.4 million. Non-GAAP earnings per diluted share was a record $1.46, and at the high-end of our guidance range. On a GAAP basis in the September quarter, gross margins were a record at 67.4%. Total operating expenses were $642.8 million and included acquisition intangible amortization of $167.5 million, special charges of $4.3 million, $3.2 million of acquisition-related and other costs and share-based compensation of $34.8 million. GAAP net income was a record $546.2 million resulting in a record $0.98 in earnings per diluted share and was adversely impacted by a $2.1 million loss on debt settlement associated with our convertible debt refinancing activities. Our September quarter GAAP tax expense was impacted by a variety of factors, notably the tax expense recorded as a result of the capitalization of R&D expenses for tax purposes. Our non-GAAP cash tax rate was 11.2% in the September quarter. We now expect our non-GAAP cash tax rate for fiscal '23 to be between 9.8% and 10.8%, exclusive of the transition tax, any potential tax associated with restructuring the Microsemi operations into the Microchip global structure and any tax audit settlements related to taxes accrued in prior fiscal years. This is modestly higher than our previous forecast as we have refined our tax calculations for the year. A reminder of what we communicated last quarter, our fiscal '23 cash tax rate is higher than our fiscal '22 tax rate for a variety of factors, including lower availability of tax attributes such as net operating losses and tax credits as well as the impact of current tax rules requiring the capitalization of R&D expenses for tax purposes. There appears to be some momentum for the tax rules requiring companies to capitalize R&D expenses to be pushed out or repealed. If this were to happen, we would anticipate about a 300 basis point favorable adjustment to Microchip's tax rate in fiscal year 2023. Our inventory balance at September 30, 2022, was $1.03 billion. We had 139 days of inventory at the end of the September quarter which was up 12 days from the prior quarter's level. We have increased our raw materials inventory to protect our internal manufacturing supply lines. We are carrying higher work in progress to maximize the utilization of constrained equipment as well as to position ourselves to take advantage of new equipment installations which will relieve bottlenecks. We are investing and building inventory for long-life, high-margin products whose manufacturing capacity is being end of life by our supply chain partners. We need to ensure that our supply lines can feed growth beyond what we expect in the December 2022 and March 2023 quarters and our reported days of inventory is a backward-looking indicator. As gross margins rise, the effective days of inventory for the same physical inventory rises and with every 100 basis points of gross margin growth, it creates approximately 3 incremental days of inventory. Inventory days at our distributors in the September quarter was at 19 days which was flat to the prior quarter's level. With distribution inventory still being low, we will be carrying higher inventory at Microchip to ensure our customers can be served. In the September quarter, we repurchased $36.9 million of principal value of our 2025 and 2027 convertible subordinated notes for cash and we also paid cash for the value of these bonds above the principal amount which was an additional $60 million. We used cash generation during the quarter to fund the amount of the convertible debt repurchases and we believe that these transactions will benefit stockholders by reducing share count dilution to the extent our stock price appreciates over time. The principal amount of convertible debt on our balance sheet at September 30 was $766.6 million. This includes $665.5 million of convertible bonds maturing in November of 2024 with the cap call option in place that offsets any potential dilution from these convertibles up to stock prices of $116.15. At the beginning of calendar year 2020, Microchip had $4.481 billion of convertible bonds outstanding. So today, our overall capital structure is in a much better long-term position. Our cash flow from operating activities was $793.2 million in the September quarter. Our free cash flow was $682.9 million and 32.9% of net sales. As of September 30, our consolidated cash and total investment position was $306.8 million. We paid down $264.9 million of total debt in the September quarter and our net debt was reduced by $192.6 million. Over the last 17 full quarters since we closed the Microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down almost $5.5 billion of debt and continue to allocate substantially all our excess cash beyond dividends and stock buyback to bring down this debt. Our adjusted EBITDA in the September quarter was a record at $1.056 billion and 50.9% of net sales. Our trailing 12-month adjusted EBITDA was also a record at $3.814 billion. Our net debt to adjusted EBITDA was $1.84 at September 30, 2022, down from 2.05 at June 30, 2022 and down from 3.0 at September 30, 2021. Capital expenditures were $110.3 million in the September quarter. Our expectation for capital expenditures for fiscal year 2023 is between $500 million and $550 million as we continue to take actions to support the growth of our business and the ramp of our manufacturing operations. We continue to prudently add capital equipment to maintain, grow and operate our internal manufacturing operations to support the expected long-term growth of our business. We expect these capital investments will bring gross margin improvement to our business and give us increased control over our production during periods of industry-wide constraints. Depreciation expense in the September quarter was $63.6 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the September quarter as well as our guidance for the December quarter. Ganesh?
Ganesh Moorthy: Thank you, Eric and good afternoon, everyone. Our September quarter results continued to be strong, driven by our disciplined execution and our resilient end markets. Net sales grew 5.6% sequentially and 25.7% on a year-over-year basis to achieve another all-time record at $2.07 billion. While we don't normally provide information on a distribution sell-through basis which we refer to as end market demand, we are providing information this quarter to give investors some insight into consumption. September quarter end market demand grew sequentially at about the same rate as our GAAP net sales which is based on sell-in recognition. The September quarter was our eighth consecutive quarter where we achieved a net sales record and the first time we have ever crossed the $8 billion annualized net sales mark. Non-GAAP gross margin came in at the high end of our guidance at a record 67.7%, up 64 basis points from the June quarter and up 244 basis points from the year ago quarter. Non-GAAP operating margin came in well above the high end of our guidance at a record 46.9%, up 127 basis points from the June quarter and up 438 basis points from the year ago quarter. Due to a rapid increase in net sales over the last 2 years, operating expenses at 20.9% were about 160 basis points below the low end of our long-term model range of 22.5% to 23.5%. Our long-term operating expense model will continue to guide our investment actions to drive the long-term growth, profitability and durability of our business. Our consolidated non-GAAP diluted EPS was a record $1.46 per share, up 36.4% from the year ago quarter and at the high end of our guidance. Adjusted EBITDA at 50.9% of net sales and free cash flow at 32.9% of net sales were both very strong in the September quarter, continuing to demonstrate the robust cash generation capabilities of our business. Net debt declined by $192.6 million, driving our net leverage ratio down to 1.84x, exiting the September quarter. During the September quarter, we returned $413.3 million to shareholders in dividends and share repurchases, representing 57.5% of the prior quarter's free cash flow. I would like to take this opportunity to thank all our stakeholders who enabled us to achieve these outstanding results and especially thank the worldwide Microchip team for their continued efforts during challenging times to deliver results for our customers despite a large and persistent imbalance between supply and demand. Taking a look at our net sales from a product line perspective, our Microcontroller net sales were sequentially up 11% as compared to the June quarter and set another all-time record. On a year-over-year basis, our September quarter microcontroller net sales were up 31.9% and microcontrollers represented 56.9% of our net sales in the September quarter. Our analog net sales sequentially decreased 1.3% in the September quarter. On a year-over-year basis, our September quarter analog net sales were up 16.6% and analog represented 27.6% of our net sales in the September quarter. As we mentioned last quarter, there are quarter-to-quarter differences in supply constraints which can cause differences in net sales growth by product line. If you compare the trailing 4-quarter net sales growth performance versus the prior 4 quarters for our analog and microcontroller product lines, the growth rates are almost exactly the same. In the September quarter, our technology licensing net sales achieved a new record. Business conditions continue to be strong as viewed through our internal indicators. Demand continued to be strong despite the capacity increases we have been implementing for some time now. As a result, our unsupported backlog which represents backlog customers wanted ship to them in the September quarter but which we could not deliver in the September quarter, climbed again. And we exited the September quarter with our highest unsupported backlog ever, with unsupported backlog well above the actual net sales we achieved. We are working hard to reduce our unsupported backlog to more manageable levels and expect to do so in the coming quarters but also expect to remain supply constrained through the rest of 2022 and well into 2023. We are, of course, cognizant of the weakening macro conditions resulting from rising inflation and interest rates and are monitoring such conditions closely. We're also aware that there is some inventory build at our customers as can be seen in their balance sheets. Some of this, we believe, is due to strategic buffer inventory builds arising from the learnings of the last 2 years and some of this is due to the incomplete kits of the infamous golden screw effect. While we have seen an increase in requests to push out or cancel backlog, these requests remain a very small fraction of the very large backlog we have over multiple quarters and hence, they have not had a material impact on our business. We believe there are 3 reasons why Microchip's business is demonstrating more resilience in the midst of the weakness seen by some of the other semiconductor companies. First, on the demand side, the industrial, automotive, aerospace and defense, data center and communications infrastructure end markets which make up 86% of our net sales, remain strong. The consumer end market which is about 14% of our net sales is experiencing some weakness but is dominated by home appliances. And home appliances are more resilient than other consumer markets as a high percentage of demand comes from replacements for appliances which have broken down and must be replaced. Hence, our demand is quite durable because of the end market mix we have consciously gravitated towards over the years. Second, on the supply side, a vast majority of our products are built on specialized technologies requiring trailing edge capacity. This is the capacity that has been most constrained over the last 2 years which still remains constrained and where there was the least opportunity to overship consumption. And last but not least, our laser focus on organic growth through total system solutions and higher-growth megatrends for multiple years is giving us increased design win momentum and a resultant revenue tailwind. Given the crosscurrents of strong internal business indicators and some uncertainty in the macro environment, we have modeled a range of potential scenarios and are closely monitoring various indicators which should enable us to take deliberate action when we feel it's appropriate. Our goal is to deliver a soft landing for our business, if or when there is a softer macro environment catches up with it. The playbook we shared with you last quarter for how we will deal with the macro slowdown remains unchanged. If you study Microchip's peak-to-trough performance through the business cycles over the last 15 years, you will observe our robust and consistent cash generation, gross margin and operating margin results. The investor presentation posted on our IR website provides details about our performance through the business cycles. If or when there is a macro slowdown and that impacts our business, we expect our cash generation gross margin and operating margin to once again demonstrate consistency and resiliency. This will help us continue to execute our long-term Microchip 3.0 strategy and help insulate it from whatever short-term market challenges there may be. While we are seeing some loosening of constraints in our supply chain, we continue to have several internal and external capacity corridors that remain very constrained. We are continuing with our carefully calibrated capacity increases seeking to serve what we believe is a long-term consumption growth. We believe our calibrated increase in capital spending will enable us to capitalize on growth opportunities, serve our customers that are increase our market share, improve our gross margins and give us more control over our destiny, especially for specialized trailing edge technologies. As you may have seen, Microchip has expressed its view that the recently approved CHIPS Act is good for the semiconductor industry and for America that enables critical investments which will even the global playing field for U.S. companies while being strategically important for our economic and national security. For a very long time, an important component of our business strategy has been to own and operate a substantial portion of our manufacturing resources, including wafer fabrication facilities in the U.S. This strategy enables us to maintain a high level of manufacturing control, resulting in us being one of the lowest-cost producers in the embedded control industry. In light of this strategy and potential grant funding from the CHIPS Act, the investment tax credit provision as well as state and local grants and subsidies. Microchip is in the early stages of considering a 300-millimeter U.S.-based fab for specialized trailing edge technologies. This fab project, if we decide to pursue it, would be intended to provide competitive growth capacity as well as geographic and geopolitical diversification. The availability of grants, subsidies and other incentives will all be important considerations in our analysis and will also help determine the location and timing for the fab. Now let's get into the guidance for the December quarter. Our backlog for the December quarter is strong and we have more capacity improvements coming into effect. Taking all the factors we have discussed on the call today into consideration, we expect our net sales for the December quarter to be up between 3% and 5% sequentially. We also expect our net sales based on end market demand to grow at about the same growth as our GAAP net sales. And further, we expect sequential net sales growth again in the March quarter. At the midpoint of our net sales guidance, our year-over-year growth for the December quarter would be a strong 22.7%. We expect our non-GAAP gross margin to be between 67.8% and 68% of sales. We expect non-GAAP operating expenses to be between 20.7% and 20.9% of sales. We expect non-GAAP operating profit to be between 46.9% and 47.3% of sales. And we expect our non-GAAP diluted earnings per share to be between $1.54 per share and $1.56 per share. At the midpoint of our EPS guidance, our year-over-year growth for the December quarter would be a strong 29.2%. Finally, as you can see from our September quarter results and our December quarter guidance, our Microchip 3.0 strategy which we launched a year ago, is firing on all cylinders, as we continue to build and improve what we believe is one of the most diversified, defensible, high-growth, high-margin, high cash-generating businesses in the semiconductor industry. Let me now pass the baton to Steve to talk more about our cash return to shareholders. Steve?
Stephen Sanghi: Thank you, Ganesh and good afternoon, everyone. I would like to reflect on our financial results announced today and provide you further updates on our cash return strategy. Reflecting on our financial results, I continue to be very proud of all employees of Microchip that have delivered another exceptional quarter while making new records in many respects, namely record net sales, record non-GAAP gross margin percentage, record non-GAAP operating margin percentage, record non-GAAP EPS and record adjusted EBITDA and all of that in a very challenging supply environment. The Board of Directors announced an increase in the dividend of 9% from last quarter to $0.328 per share. This is an increase of 41.4% from the year ago quarter. During the last quarter, we purchased $247.2 million of our stock in the open market. We also paid out $166.1 million in dividends Thus, the total cash return was $413.3 million. This amount was 57.5% of our actual free cash flow of $718.5 million during the June 2022 quarter. Our paydown of debt as well as record adjusted EBITDA drove down our net leverage at the end of September 2022 quarter to 1.84 from 2.05 at the end of June. Ever since we achieved investment-grade rating for our debt in November of 2021 and pivoted to increasing our capital return to shareholders, we have returned $1.457 billion to shareholders through September 30, 2022, by a combination of dividends and share buybacks. In the December quarter, we will use the September quarter's actual free cash flow of $682.9 million and plan to return 60% or $409.7 million of that amount to our shareholders. Of this $409.7 million, the dividend is expected to be approximately $181 million. And the stock buyback is expected to be approximately $22.7 million. With that, operator, will you please poll for questions?
Operator: [Operator Instructions] Ambrish Srivastava of BMO has our first question.
Operator: Next, we'll hear from Vivek Arya of Bank of America Securities.
Operator: Please remain on the line while we reconnect our presenters. You may proceed.
Operator: Christopher Rolland, Susquehanna.
Operator: Next, we'll hear from Timothy Arcuri of UBS.
Operator: Our next question comes from William Stein of Truist Securities.
Operator: Next, we'll hear from Chris Danely of Citigroup.
Operator: And then next, we'll hear from Toshiya Hari of Goldman Sachs.
Operator: Our next question comes from Harlan Sur of JPMorgan.
Operator: Next, we'll hear from Matt Ramsay of Cowen.
Operator: Our next question comes from Joe Moore of Morgan Stanley.
Operator: Tore Svanberg of Stifel.
Operator: Next one from Raji Gill of Needham & Company.
Operator: Next, we here from Vijay Rakesh of Mizuho.
Operator: And it appears to have further questions at this time. I'll turn the call back over to our presenters for any additional or closing comments.
Ganesh Moorthy: Great. I want to thank everybody for hanging in there and despite some of the technical challenges. We appreciate the questions and we look forward to seeing many of you and talking to many of you in the phone calls and conferences we have coming up. So thank you.
Operator: That does conclude today's call. Thank you all for your participation. You may now disconnect.
