Microchip Technology Incorporated (NASDAQ:MCHP) Q4 2024 Earnings Call Transcript May 6, 2024

Microchip Technology Incorporated misses on earnings expectations. Reported EPS is $0.57 EPS, expectations were $0.574. Microchip Technology Incorporated isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings and welcome to the Microchip Q4 of 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. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Eric Bjornholt, Senior Vice President and CFO. Thank you, Eric. You may begin.

Eric Bjornholt: Thank you and good afternoon everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events and results may differ materially. We refer you to our press release as 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 Moorthy, Microchip’s President and CEO; Steve Sanghi, Microchip’s Executive Chair; Rich Simoncic, Microchip’s COO, and Sajid Daudi, Microchip’s Head of Investor Relations.

I will comment on our fourth quarter and full 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 in this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the investor relations page of our website at www.microchip.com and included reconciliation information in our earnings press release, which we believe you will find useful when comparing our GAAP and non-GAAP results. We have also 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 March quarter were $1.326 billion, which was down 24.9% sequentially. We have posted a summary of our net sales by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were 60.3%, including capacity under utilization charges of $32 million. Operating expenses were at 27.4%, and operating income was 32.9%.

Although our operating income was better than the midpoint of our guidance, our cash taxes came in higher than forecasted. Non-GAAP net income was $310.3 million and non-GAAP earnings per diluted share was $0.57 and at the midpoint of our guidance. On a GAAP basis in the March quarter, gross margins were 59.6%. Total operating expenses were $536.4 million and included acquisition and tangible amortization of $151.2 million, special income of $16.9 million, which was primarily driven by the settlement of an unclaimed property audit at a value that was less than what we had accrued for. Share-based compensation of $37.4 million and $1.1 million of other expenses. GAAP net income was $154.7 million resulting in $0.28 in diluted earnings per share.

For fiscal year 2024, net sales were $7.634 billion and were down 9.5% from net sales in fiscal year 2023. On a non-GAAP basis, gross margins were 65.8%, operating expenses were 22% of sales, and operating income was 43.9% of sales. Non-GAAP net income was $2.698 billion, and EPS was $4.92 per diluted share. On a GAAP basis, gross margins were 65.4%, operating expenses were 31.8% of sales, and operating income was 33.7% of sales. Net income was $1.907 billion and EPS was $3.48 per diluted share. Our non-GAAP cash tax rate was 18.8% in the March quarter and 14.5% for fiscal year 2024. Our non-GAAP tax rate for fiscal year 2025 is expected to be about 13%, which is exclusive of the transition tax and any tax audit settlements related to taxes accrued in prior fiscal years.

We are still hopeful that the tax rules requiring companies to capitalize R&D expenses will be pushed out or repealed. If this were to happen, we would anticipate about a 200 basis point favorable adjustment to Microchip’s non-GAAP tax rate in future periods. Our inventory balance at March 31st, 2024 was $1.316 billion. We had 224 days of inventory at the end of the March quarter, which was up 39 days from the prior quarter's level and in-line with our expectation, giving the difficult revenue quarter we experienced. At the midpoint of our June 2024 quarter guidance, we would expect inventory dollars to be up modestly and days of inventory to increase based on the lower cost of goods sold, driven by the depressed revenue levels at which we believe is the low point of the current cycle for Microchip.

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 14 days of inventory at the end of March. Inventory at our distributors -- in the March quarter were at 41 days, which was up 4 days from the prior quarter's level. Distribution took down their inventory in the March quarter as distribution sell-through was about $125 million higher than distribution sell-in. The inventory days increased as this is reflective of the much lower cost of sales for Microchip in the March quarter that is used in this calculation. Our cash flow from operating activities was $430 million in the March quarter. Our adjusted pre-cash flow was $389.9 million in the March quarter.

As of March 31, our consolidated cash and total investment position was $319.7 million. Our total debt increased by $312 million in the March quarter, and our net debt increased by $273.3 million. Our adjusted EBITDA in the March quarter was $503 million and 37.9% of sales. Our trailing 12-month adjusted EBITDA was $3.623 billion, and our net debt adjusted EBITDA was 1.57 at March 31, 2024, up from 1.45 at March 31, 2023. Capital expenditures were $40.1 million in the March quarter and $285.1 million for fiscal year 2024. Our expectation for capital expenditures for fiscal year 2025 is about $175 million. Depreciation expense in the March quarter was $45.8 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the March quarter, as well as our guidance for the June quarter.

Ganesh?

Ganesh Moorthy : Thank you, Eric, and good afternoon, everyone. Our March quarter results were consistent with our guidance with net sales down 24.9% sequentially and down 40.6% from the year ago quarter. As we endured through a major inventory correction. Non-GAAP gross margin came in as expected at 60.3% and non-GAAP operating margin was better than expected at 32.9% due to the strong expense control programs we had in place. However, as Eric mentioned, our tax rate was higher than expected and as a result our consolidated non-GAAP diluted EPS only met expectations at $0.57 per share. Our revenue decline resulted in March quarter EBITDA dropping and as a result our net leverage ratio rose to 1.57x. We expect our net leverage to rise modestly for a few quarters, as trailing 12-month adjusted EBITDA drops when replacing stronger prior year quarters, with weaker current year quarters.

However, our cash generation capability remains strong and we are committed to our capital return plan. Our capital return to shareholders in the June quarter will increase to 87.5% of our March 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. Reflecting on our fiscal year 2024 results, it was a roller coaster year with a positive start that was followed by a major inventory correction. As compared to fiscal year 2023, revenue declined 9.5% to $7.6 billion. Non-GAAP operating margin was resilient at 43.9% as we took the actions required to respond to the major inventory correction. Capital return to shareholders through a combination of dividends and share buybacks in fiscal 2024 was $1.89 billion, representing a 15.4% growth as compared to fiscal year 2023.

My thanks to our worldwide team for their support, hard work, and diligence as we navigate a difficult environment and focus on actions that we believe position us well to thrive in the long-term. Taking a look at our fiscal year 2024 net sales from a product line perspective, our mixed-signal microcontroller net sales were down 10.2% and represented 56% of Microchip's overall revenue. Our analog net sales were down 15.2% and represented 26.4% of Microchip's overall revenue. While we don't normally break out our FPGA product line results, it is noteworthy that our fiscal year 2024 FPGA revenue exceeded $679 million and set another record. FPGA revenue grew over 22% as compared to fiscal 2023 and delivered operating margins of a north of corporate average.

We deliver market-leading mid-range FPGA solutions with best-in-class low power, reliability, and security, and are especially well-suited for the fast emerging opportunities around artificial intelligence at the edge. Our overall FPGA design win momentum is strong across multiple end markets. A few other product line notes of significance. Early in April, we closed our acquisition of Seoul Korea-based VSI, an ADAS and Digital Cockpit Connectivity Pioneer, to extend our Automotive Networking Market leadership. This acquisition adds Automotive SerDes Alliance Motion Link technology, otherwise known as ASA-ML, to Microchip's broad Ethernet and PCIe automotive networking portfolio to enable next generation software defined vehicles. With the anticipated increase in the adoption of advanced camera-based driver assistance systems, in-cabin monitoring, safety and convenience features, and multi-screen digital cockpits for next-generation software-defined vehicles, there is a growing requirement for more highly asymmetric raw data and video links and higher bandwidths, which the ASA Motion Link Open Standard supports.

Also last month, we closed our acquisition of Neuronix AI Labs, whose innovative software technology enhances AI-enabled intelligent edge solutions and increases neural networking capabilities. This technology expands our capabilities for power-efficient AI-enabled edge solutions deployed on FPGAs. Neuronix AI Labs provides neural network sparsity optimization technology that enables the reduction in power, size, and calculation for tasks such as image classification, object detection, and semantic segmentation while maintaining high accuracy. Finally, in July, we expect to announce our entry into the 64-bit embedded microprocessor market with a suite of products, development tools, and other support requirements to address high-performance embedded processing applications, including AI-enabled edge solutions.

This will extend our strong 32-bit embedded microprocessor portfolio to higher performance and increased capabilities, while preserving Microchip's historically strong ecosystem of leading development tools to make adoption easy for embedded system design engineers. Microchip is the only company to offer the widest embedded control and processing platform from 8-bit to 64-bit, as well as FPGAs, with a common development tool ecosystem that's empowering customers to innovate and reuse their work across a wide spectrum of markets and applications. Now for some color on the March quarter and the general business environment. All regions of the world and most of our end-markets, with the exception of aerospace and defense and the artificial intelligence subset of data centers were weak.

We believe that our product shipments were significantly lower than the end-market consumption of our products as our distribution channels drained inventory during the quarter. Our broad base of customers continued to lower their inventory and adjust their business plans in the midst of a weak macro environment and an uncertain outlook. With no major supply constraints, coupled with very short lead times and a weak macro environment, we believe that as inventory destocking, as well as reduction in target inventory levels that is underway at multiple levels, that our direct customers and distributors buy from us, our indirect customers who buy through our distributors, and in some cases our customers' customers. We are however, also seeing early signs of green shoots in our business.

First, the level of requests to cancellations and push-outs has started to subside. Second, our bookings have started to pick up, albeit from low levels. February bookings were the highest in eight months. March bookings were the highest in all of fiscal 2024, and April bookings were higher than March. Third, the new bookings are aging over a shorter period of time. And fourth, the number of expedites and shipment pull-in requests are growing. Collectively, these green shoots, we believe, are pointing to the formation of a bottom. Our average lead times continue to be eight weeks or less. During a period of 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.

However, the significant reduction in lead time is also resulting in reduced near-term visibility for our business. Given the severity of the inventory correction, our factories around the world are running at lower utilization rates. And our pre-major fabs will take another two-week shutdown in the June quarter in order to help control the growth of inventory. Our internal capacity expansion actions remain paused. We expect our capital investments in fiscal year 2025 will be low, even as we prepare for the long-term growth of our business. On the CHIPS Act front, we have nothing new to report. The CHIPS office has completed their diligence for the grants we are seeking, and we are working towards an agreement. At this stage of a major inventory correction, we believe that the days of inventory metric, whether for Microchip or for our distributors, can be deceptive, as this is a backward-looking indicator measuring off of the baseline that is well below where we believe end-market consumption is at.

For inventory planning, we are, therefore focused on where we believe consumption is running and will likely run in the coming quarters. We continue to work with our distribution partners to attempt to find the right balance of inventory required to serve their customers, manage through their cash flow requirements and be positioned for the eventual strengthening of business conditions. The operating expense reduction efforts we implemented last quarter, including broad-based salary sacrifices are continuous this quarter. The shutdown for manufacturing team members and pay cuts for non-manufacturing team members are consistent with our long-standing culture of shared sacrifices and down cycles and shared rewards and up cycles. Our culture of shared sacrifice protects our valuable employees from layoffs, helps enable us to support customers and maintain our design win momentum, helps ensure that manufacturing capacity can be turned on quickly as business conditions strengthen and helps enable our product development teams to maintain their pace of new solution introductions.

Now let's get into the guidance for the June quarter. While we see a number of green shoots in our business indicators, we still need turns orders within the quarter to meet our guidance. Operating in a high turns environment has historically been normal for Microchip. It is just not a position we have found ourselves in over the last few years due to supply-constrained high backlog environment, we and the industry experience. Taking all the factors we have discussed on the call today into consideration, we expect our net sales for the June quarter to be between $1.22 billion and $1.26 billion. We believe that the June 2024 quarter marks the bottom of the cycle for Microchip and that our business will return to sequential revenue growth in the September 2024 quarter.

We expect our non-GAAP gross margin to be between 59% and 61% of sales. We expect non-GAAP operating expenses to be between 28.25% and 28.75% of sales. We expect non-GAAP operating profit to be between 30.25% and 32.75% of sales, and we expect our non-GAAP diluted earnings per share to be between $0.48 and $0.56. We believe that the fundamental characteristics of growth, profitability and cash generation of our business remain intact. 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 win momentum, which we expect will drive above-market long-term growth. We remain committed to executing our Microchip 3.0 strategic imperatives, which we believe will deliver sustained results and substantial shareholder value.

Last but not least a month ago, we appointed Rich Simoncic as Chief Operating Officer. Rich is a Microchip Lifer who has been with us for 35 years in many different capacities, which has been expanding his role over the last few years, and he and I will jointly lead the Microchip global enterprise so that we can apply our combined leadership capacity to engage the opportunities and challenges that are ahead of us. With that, let me pass it back on to Steve to talk more about our cash return to shareholders. Steve?

Steve Sanghi: 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 approved an increase in the dividend of 18% from the year ago quarter to a record [$0.452] (ph) per share. During the last quarter, we purchased a record $387.4 million of our stock in the open-market. We also paid out a record $242.5 million in dividends. Thus, the total cash return was a record $629.9 million. This amount was 82.5% of our actual adjusted free cash flow of $763.4 million during the December 2023 quarter. Our net leverage at the end of March 2024 was 1.57 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 a total of $4.23 billion to shareholders through March 31, 2024, by a combination of dividends and share buybacks.

During this period, our share buyback in the open market was approximately 30.4 million shares, representing approximately 5.7% of our shares outstanding. In the current June quarter, we will use the adjusted free cash flow level from the March quarter to target the amount of cash returned to shareholders. The adjusted free cash flow excludes amounts we collected from our customers for long-term supply assurance payments, these payments are refundable when purchase commitments are fulfilled. Our adjusted free cash flow for the March quarter was $389.9 million, so our target return to shareholders would be 87.5% or $341.2 million of that amount. However, as Ganesh mentioned, we did complete two small acquisitions in this June quarter. So we are reducing our share buyback amount to reflect the cash outlay for those deals.

Thus, in the June quarter, our cash return to shareholders is expected to be $315.3 million, out of which dividends are expected to be approximately $243 million and our expected stock buyback will be approximately $72.3 million. Going forward, we plan to continue to increase our adjusted free cash flow to return to shareholders by 500 basis points every quarter until we reach 100% of adjusted free cash flow returned to shareholders through dividends and share buybacks. They will take three more quarters, and we expect that dividends over time will represent approximately 50% of our cash returns. With that, operator will you please poll for questions.

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