The operator welcomes participants to the Microchip Technology Q2 Fiscal Year 2024 Financial Results Conference Call and introduces the speakers. The Chief Financial Officer cautions that forward-looking statements may differ from actual results and references important risk factors. The President and CEO will discuss the company's results and the current business environment. The Executive Chair will provide an update on the company's cash return strategy. The company has posted a reconciliation of GAAP and non-GAAP measures on their website. The CFO will now go through operating results including net sales, gross margin, and operating expenses.

In the September quarter, net sales were down 1.5% sequentially, but on a non-GAAP basis, gross margins, operating expenses, and operating income were at record levels. Non-GAAP net income and earnings per diluted share were also strong. On a GAAP basis, gross margins, operating expenses, and net income were also at record levels, but included certain adjustments such as acquisition intangible amortization and special charges. The non-GAAP cash tax rate was 14.2% in the September quarter and is expected to remain the same for fiscal year 2024. However, the fiscal '24 cash tax rate is expected to be higher due to various factors. The company hopes that tax rules requiring the capitalization of R&D expenses will be pushed out or repealed.

Microchip expects a favorable adjustment to their non-GAAP tax rate in future periods if certain conditions are met. They had a high inventory balance at the end of September 2023, but were unable to reduce it significantly due to customer requests and investments in high-margin products. Inventory at distributors also increased. Cash flow from operating activities was $616.2 million, with $87.5 million coming from long-term supply assurance receipts. Adjusted free cash flow, which excludes these supply assurance payments, was $454.3 million. Consolidated cash and total investment was $256.6 million, with an increase in total debt and net debt.

In the last 21 quarters, the company has paid down a significant amount of debt incurred from an acquisition. They have also issued a term loan and retired bonds, as well as issued commercial paper to take advantage of lower interest rates. The company has also retired convertible bonds and paid above the principal amount to reduce share count dilution. Their adjusted EBITDA and net debt have improved, and they have lowered their expected capital expenditures for the year due to economic challenges.

The company's capital investments have allowed them to maintain control over production during industry-wide constraints. Depreciation expense in the September quarter was $47 million. The company's net sales for the quarter were within their guidance range and non-GAAP gross and operating margins remained strong. Adjusted EBITDA was 51.1% of net sales and adjusted free cash flow was 20.2% of net sales. The company returned a record amount of capital to shareholders in dividends and share repurchases, with plans to continue increasing this amount in the future.

In this paragraph, the writer expresses gratitude to all stakeholders for helping the company achieve positive results despite a challenging macro environment. They also provide a breakdown of net sales by product line and geographic region for the September 1st quarter. The business experienced a slowdown as expected due to increasing uncertainty and slowing economic activity. Customers are adjusting their demand expectations and rebalancing their inventory, leading to requests to push out or cancel backlog. The writer notes that customers tend to overcorrect their inventory at this stage of the cycle, similar to what was seen during the strong demand period in 2021 and 2022.

The company's channel inventory has increased due to the slow macro environment, but they are working with partners to find the right balance. Internal capacity expansion remains paused, leading to lower capital investments in the next few years. The company has reduced lead times to support customers in uncertain times, but this has resulted in lower bookings and reduced visibility. For the December quarter, the company expects a decline in net sales of 15-20% and a non-GAAP gross margin of 64-65%.

Microchip expects non-GAAP operating expenses to be between 22.7% and 23.3% of sales, non-GAAP operating profit to be between 40.7% and 42.3% of sales, and non-GAAP diluted earnings per share to be between $1.09 and $1.17 per share. They anticipate a decline in revenue for the March quarter due to current macro weakness and lower bookings. However, they remain confident in the long-term growth potential of the semiconductor market. Microchip has a consistent track record of cash generation and plans to maintain non-GAAP operating margins above 40% through business cycles. The company also announced an increase in dividends and purchased $339.8 million of their own stock in the last quarter, resulting in a record cash return of $562.6 million.

The company's net leverage at the end of September 2023 quarter was 1.28x and they have returned $3.248 billion to shareholders since achieving an investment-grade rating for their debt. They plan to continue increasing free cash flow return to shareholders by 500 basis points every quarter until reaching 100% of adjusted free cash flow returned. The operator is now taking questions from analysts, the first one being about the December quarter outlook. The company clarifies that there is no pricing driving the changes, it is all volume.

The weakness in the company's performance is widespread across different regions and markets, with the exception of aerospace and defense. The factories are running at reduced levels, but there are no plans for underutilization charges. The assembly and test process is more in line with consumption and finished goods were reduced last quarter. There have been some cancellations in orders, but no specific percentage was given.

The speaker discusses the decline in year-over-year orders and the expected length of this decline. They mention that orders can be canceled within 90 days and that longer-term orders are being rescheduled due to changing market conditions. The speaker notes that the current cycle may differ from previous ones, but typically there is a 2-3 quarter period for the inventory to be digested.

The consumption ahead of shipments is catching up, leading to a rebirth of the cycle. In the upcoming quarter, there is expected to be a decrease in revenue and potentially lower gross margins. However, the company is confident that their operating margins will still remain at the 40% threshold. Microchip has a history of being nimble and adjusting their business to the environment, such as reducing expenses or adjusting utilization. Distribution inventory has also increased sequentially.

The speaker is asked about the timing of inventory depletion and responds by saying it depends on distributor inventory and market demand. They mention that some distributors need inventory while others have excess and it will take some time to adjust. The next question is about customers pushing out orders and the speaker explains that they have been proactive about addressing this and have been doing so for several quarters. They mention that conditions can change and this is not a new issue.

The company will have discussions with customers to see how they can help each other in terms of future business. They have done push-outs to help customers. There is low visibility into the March quarter and the decline in sales is uncertain. The business and designs are still there, but it depends on macro factors and customer inventory levels.

In the December quarter, Microchip saw a significant decline of 17.5%, which is larger than previous declines during the global financial crisis. There is uncertainty about the downside risk for gross margins and whether they will return to previous levels of 68%. The company will adjust operations based on the current environment and has confidence in their long-term business. The offset between reducing utilization and building inventory reserves may balance out.

The company expects their gross margins to remain strong, although there may be a slight drop this quarter. They will evaluate the situation and adjust accordingly. If revenue levels return to normal, gross margins are expected to also return to normal. It is difficult to determine the true consumption of their business due to shifting customer demand. The company has flexibility in their operating expenses, but it depends on the extent of revenue declines.

The company is not ready to predict the size of the market, but they have measures in place to adjust their business if needed. They are closely monitoring their utilization and inventory levels and will make adjustments as necessary. They believe their long product life cycles and fixed costs make it more beneficial to maintain high utilization and inventory levels for when the market improves.

Ganesh Moorthy discusses the challenges of ramping up a fab after a drastic slowdown and the importance of careful changes in response to market shifts. He also mentions the benefits of having long life cycle products and good inventory management. When asked about pricing concerns, Moorthy reassures investors that pricing has remained stable in the past and is not expected to change in the current cycle.

During a conference call, a question was asked about the company's projected sales for the upcoming quarter. The operator introduced William Stein from Truist Securities as the person asking the question. Stein inquired about the potential decline in sales for the quarter and asked if there would be a similar decline in the following quarter. The company's representative, Ganesh Moorthy, stated that there was not enough information to give an accurate answer at this time. Stein then asked about the amount of sales that would be part of the PSP program and the company's backlog for the program. Moorthy explained that while the PSP program is still relevant, it is not as important as before due to shorter cycle times and fewer orders from customers.

The speaker discusses the market's concerns about the second half of 2024 and the use of PSP. They mention that customers have the choice to use it or not and that the program has been adjusted for more flexibility. They also mention that the cancellations and pushouts in the forecast are not specific to any particular geography. Finally, they state that a small percentage of their broad-based product line goes to China for China and it is not a significant risk for their business.

The speaker explains that competition in China is not new and the business is fragmented. There may be some designs where quality is not a concern, but this is not unusual. They are paying attention to this, but it is not causing a dramatic change in the business. The next question is about pushouts, and the speaker clarifies that new bookings are not the issue as they are more informed about market conditions. The pushouts are mainly from backlog orders placed 9-12 months ago, where the perceived need has changed due to market conditions. New bookings have been modest.

The company has experienced lower bookings, but they do not disclose their book-to-bill ratio. Customers are uncertain about their needs and this has led to pushouts and pull-ins of orders. The company has implemented a 12-month PSP, which they constantly evaluate and adjust based on lead times and changing information. They have recently changed the program to 6 months and make adjustments as needed to provide customers with solutions.

The speaker discusses the PSP program and its value in the past versus its current value. They also mention the benefits of the program in terms of backlog and customer satisfaction. The speaker then moves on to address a question about the company's cash return program and whether there is flexibility to be more opportunistic during times of downturn. The response is that the Board constantly evaluates the program.

The Board has the flexibility to take opportunistic actions for the right reasons, such as buying back stock during a severe market downturn. Microchip has the resources and headroom to do this, with over $2 billion available for buybacks and a line of credit. The company is also monitoring inventory levels and utilization in light of the current market downturn, and may adjust if necessary depending on the duration of the downturn.

Eric Bjornholt discusses the importance of evaluating inventory levels in relation to the current and future state of the business. The company's target inventory level is 130 to 150 days, but they are currently above that due to various factors. They will continue to monitor and manage inventory levels based on market conditions and may make adjustments to factory operations if necessary. In steady state, the company aims to maintain inventory levels at 130 to 150 days.

The speaker discusses the current inventory levels and compares them to the previous cycle. They mention that there is some inventory buildup, but it is not outside of the expected range. The speaker also talks about the market conditions and how they are affecting pricing, stating that customers may ask for lower prices but there is not much price elasticity in these products.

The company's prices have increased by 18, 24, or 36, but this has not affected their business in the short term. The rising channel inventories in the September quarter were due to weak distribution sell-through, particularly in China. However, the aerospace and defense sector has shown relative strength, and the data center and compute franchise, which makes up around 20% of the company's business, is also benefiting from the demand for artificial intelligence. However, this is not enough to offset weaknesses in other areas of the data center market.

Ganesh Moorthy, the speaker, is responding to a question about the potential impact of the current market upturn on future quarters. He explains that different customers have different levels of strategic thinking and that some are more focused on the short term while others are planning for the next few years. He also mentions that short lead times are giving customers more flexibility in their orders. However, as they serve 100,000 customers, the situation is different for each one. The next question comes from Ambrish Srivastava from BMO.

Eric Bjornholt and Ganesh Moorthy were asked about the target days of inventory for distributors. They responded that there is no specific target and it can vary greatly, with a range of 17 to 47 days historically. The decision on inventory is ultimately up to the distributor, who needs to have enough to effectively serve their customers. The distributor business has also changed over time, with some carrying pipeline inventory for large OEMs. Ganesh added that the company's business has also changed, with the addition of airspace.

The operator announces that there are no more questions and returns the call to management for closing remarks. Ganesh Moorthy thanks everyone for participating and mentions upcoming events where they can continue the conversation. The operator then ends the call.

This summary was generated with AI and may contain some inaccuracies.