Q1 2022 Microchip Technology Inc Earnings Call
Please standby.
Good day, everyone and welcome to Microchip first quarter fiscal 'twenty 'twenty 2 financial results.
Reminder, today's call's being recorded at this time I would like to the conference over to Microchip CFO, Mr. Eric B on Holt. Please go ahead Sir.
Thank you and good afternoon, everyone.
During the course of this conference call, we'll be making projections and other forward looking statements regarding future events or the future financial performance of the company.
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 business and results of operations.
In attendance with me today are Ganesh Moorthy, microchips, President and CEO and Steve Sammy Microchip Executive Chair.
I won't comment on our first quarter fiscal year 2022 financial performance and will then provide commentary on our results from financial 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 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 Dot Microchip Dot com.
That included reconciliation information on our press release, which we believe you will find useful when comparing GAAP and non-GAAP results.
We are also also posted a summary of our outstanding debt and leverage metrics on our website.
We will now go through some of the operating results, including net sales gross margins on operating expenses other than net sales are 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 on our press release.
Net sales on the June quarter for $1.5, 6.9 billion, which was up 7% sequentially and about 150 basis points above the midpoint of our quarterly guidance given on may 6th.
We have posted a summary of our GAAP net sales by product line and geography as well as our total end market demand on our website for your reference.
On a non-GAAP basis gross margins were a record at 64, 8% and operating income was a record 41, 7%.
Non-GAAP net income was a record $558.8 million.
Non-GAAP earnings per diluted share was a record of $1.98, 8 cents above the mid point of our guidance.
On a GAAP basis in the June quarter gross margins were a record at 64, 2% and include the impact of $8.8 million of share based compensation expense.
Total operating expenses were $638.8 million and include acquisition intangible amortization of $215.6 million special charges of $10.5 million $3.6 million of acquisition related and other costs and share based compensation of $47.8 million.
GAAP net income was $252.8 million or <unk> 89 per diluted share.
Our June quarter, GAAP tax expense was impacted by a variety of factors.
Notably tax reserve releases associated with the statute of limitations expiring.
Our non-GAAP cash tax rate was 6% on the June quarter, we expect our non-GAAP cash tax rate for fiscal 'twenty to be about 6% exclusive of the transition tax any potential tax associated with restructuring on the microsemi operations into the microchip global structure and any tax audit settlements related to taxes accrued.
On prior fiscal years.
Our inventory balance at June 32021 was $683.8 million.
We had 111 days of inventory at the end of the quarter, which was down 1 day from the prior quarter's level.
Inventory on our distributors in the June quarter were at 20 days, which is a record low level and down from 22 days at the end of the prior quarter.
We are ramping capacity and our internal and external factories. So we can ship as much product as possible to support customer requirements.
In the June quarter, we issued a $1 billion senior secured note maturing on September 1.2024 and bearing interest at 983%.
We used the proceeds from this bond offering to repay a $1 billion senior secured notes that matured on June <unk> 2021 that had an interest rate of 392, 2%.
We believe this was another excellent transaction for us as we continue to enhance our capital structure on our path to becoming an investment grade rated company.
Our cash flow from operating activities was a record at $629.9 million in the June quarter.
As of June 30th our consolidated cash and total investment position was $279.7 million.
We paid down $388 million of total debt in the June quarter.
Over the last 12 full quarters since we closed on Microsemi acquisition and incurred over $8 billion on debt to do so we have paid down almost $4 billion of the debt and continue to allocate substantially all our excess cash beyond dividends to aggressively bring down this debt.
We have accomplished this despite the adverse macro and market conditions. During most of this time period, which we feel is a testimony to the cash generation capabilities of our business as well as our ongoing operating discipline.
We continue to expect our debt levels to reduce significantly over the next several years on.
Our adjusted EBITDA in the June quarter was a record $711.7 million and our trailing 12 month. Adjusted EBITDA was also a record at 252.4 billion.
Our net debt to adjusted EBITDA, excluding our very long dated convertible debt that matures in 2037 and is more equity like in nature was 3.3 for at June 32021.
Down from $3.71 at March 31.
Our dividend payment on the June quarter was $113.1 million.
Capital expenditures were $86.3 million on the June quarter, our forecast for the September 2021 quarters capital expenditures is between 75 and $95 million.
Our capital expenditures for all of fiscal year 'twenty, 2 are expected to be between $300 million and $350 million.
As a reminder, our fiscal year 2021 capital expenditures came in lower than originally planned due to longer equipment lead times and deliveries pushing out due to overall industry conditions.
We continue to add capital equipment to maintain grow and operate our internal manufacturing operations to support the expected growth of our business we.
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 on the June quarter was $41.2 million.
I will now I'll turn it over to Ganesh to give his comments on the performance of the business on the June quarter as well as our guidance for the September quarter Ganesh.
Thank you Eric and good afternoon, everyone.
Our June quarter results continued to be strong.
Leading off our fiscal year 'twenty 2 on a positive note.
June quarter revenue was an all time record of $1.5.7 billion growing 7% sequentially and was 150 basis points higher than the midpoint of our guidance provided on may 5th.
On a year over year basis, our June quarter revenue was up 19, 8%.
Non-GAAP gross margins were another record 64, 8% up 70 basis points from the March quarter, as we continued to ramp our internal factories and benefit from improved fixed cost absorption.
Non-GAAP operating margin was also a record at 41, 7% up 100 basis points from the March quarter.
Our consolidated non-GAAP EPS was above the high end of our guidance at a record $1.98 per share.
Adjusted EBITDA for the June quarter was again very strong and achieved another record at $701.7 million.
Continuing to demonstrate the robust profitability and cash generation capabilities of our business through the business cycles.
The June quarter, Mark of 123rd consecutive quarter on non-GAAP profitability.
I would like to take this occasion to thank all of our stakeholders, who enabled us to achieve these outstanding on record results from the June quarter.
And especially thank the worldwide microchip team, whose tireless efforts not only delivered strong financial results, but also supported our customers to navigate a difficult environment.
Who worked constructively with our supply chain partners to find creative solutions, and an extremely constrained and challenging environment.
Taking a look at our business from a product line perspective.
Our microcontroller revenue was sequentially up 10, 7% as compared to the March quarter and set a new quarterly record.
On a year over year basis, our June quarter microcontroller revenue was up 26%.
Each of the 8 bit 16 bit and 32 bit microcontroller product lines established new all time revenue records.
As we have told you many times on the past rumors of the death of 8 bit and 16 bit microcontrollers have been greatly exaggerated.
For customers and applications served by Microcontrollers are highly fragmented.
And require a wide range of solutions that span the breadth of our microcontroller product lines.
Microcontrollers represented 57, 5% of our revenue in the June quarter.
Our analog revenue was sequentially up for 1% as compared to the March quarter also setting a record in the process.
On a year over year basis, our June quarter analog revenue was up 16, 7%.
Analog represented 27, 5% of our revenue in the June quarter.
Other revenue was sequentially up 5.1% in the June quarter bouncing back from a 6.4% sequential decline in the March quarter.
Other revenue represented 15% of our revenue in the June quarter.
Taking a look at our business from a geographic perspective.
<unk> was up 6.1% sequentially.
Europe was down 2.3% sequentially, which is better than typical seasonal performance and came off of a very strong 34% sequential growth in the March quarter.
Asia was up a strong 11, 1% sequentially, reflecting better than typical seasonal growth.
From an end market perspective, all end markets were strong in the June quarter.
Business conditions continue to be exceptionally strong through the quarter with record bookings and backlog for product to be shipped over multiple quarters.
Accentuated by a preferred supply program or PSP, which continues to be over 50% for the aggregate backlog.
And 100% of our backlog in the most constrained capacity product areas.
Demand outpaced the capacity improvements we were able to make.
We were able to implement in the quarter.
As a result, our unsupported backlog, which customers wanted to shift in the June quarter continued to climb significantly.
Resulting in lead time for many line items continuing to stretch out.
We experienced constraints and all of our internal and external factories and their related manufacturing supply chains.
We continue to work closely with our supply chain partners, who will provide wafer foundry.
Assembly test and materials to secure additional capacity wherever possible.
Through the combination of internal and external actions that we've taken we expect we will be in a position to support revenue growth for at least each of the next 4 quarters.
Despite that we also expect that wafer fab as well as the assembly and test constraints will persist through at least the middle of 2022.
We believe our backlog position, especially the proportion of PSP backlog.
He is giving us a solid foundation to prudently acquired constrained raw materials.
Invest in expanding factory capacity in.
And hire employees to support our factory reps.
Our capital spending plans are rising in response to growth opportunities in our business as well as to fill gaps in the level of capacity investments by our outsourced Fab Assembly and test partners in technology is that they may consider to be technology to be trailing edge, but which we believe will be workhorse technology.
For us for many years to come.
The increase in capital spending will enable us to capitalize on growth opportunities improve.
Improve our gross margins increase on market share and give us more control over our destiny for trailing edge technologies.
We will of course continue to utilize the capacity available from our outsource partners, but our goal is to be less constrained by the other investment priorities, which may not align with ours.
We also expect that while our capital intensity, maybe slightly higher in any given year and the 3% to 4% of revenue guidance. We have provided in the past.
When looked at on the context of a rolling 3 year view, we believe we will very much be in the range of our capital spending guidance.
Now, let me get into the guidance for the September quarter.
Our backlog for the September quarter is very strong.
In addition, we have considerable backlog requested by customers in the September quarter that currently cannot be fulfilled until later quarters. Despite us growing capacity from last quarter.
This is because the entire semiconductor supply chain remains very constrained.
Taking all the factors we have discussed on the call today into consideration, we expect our net sales for the September quarter to be up between 3% and 7% sequentially.
Our guidance range assumes continued operational constraints some of which we will work through during the quarter, others up with carryover to be worked in future quarters.
At the midpoint of our revenue guidance, our year over year growth for the September quarter would be 25, 8%.
We believe achievement of this revenue level will be remarkable in and of itself.
But even more so given how resilient our business was a year ago during the pandemic because of the diversity of our end market exposure duston.
Thus, making the year over year comparisons not much tougher and meaningful.
For the September quarter, we expect non-GAAP gross margins to be between $64.8 and 65.2 percentage of sales.
We expect non-GAAP operating expenses to be between $22.8 and 23.2 percentage of sales.
We expect non bank non-GAAP operating profit to be between 41, 6% and 42, 4% of sales.
And we expect our non-GAAP earnings per share.
To be between $2.5 per share and $2.17 per share.
We also expect to pay down another approximately $350 million for debt in the September quarter.
So we recognize that our gross and operating margin percentage guidance guidance effectively gets us to the long term targets. We shared with you just 9 months ago.
We will be working to update our business model for annual growth gross margin and operating margin percentage and will share our conclusions with you later this year.
Given all the complications of accounting for our acquisitions, including amortization of intangibles restructuring charges and inventory write up on acquisitions Microchip will continue to provide guidance and track its results on a non-GAAP basis, except for net sales, which will be on a GAAP basis.
We believe that non-GAAP results provide more meaningful comparison to prior quarters, and we request that analysts continue to report the non-GAAP estimates to first call.
Now, let me pass the baton to Steve to talk about our cash return to shareholders Steve.
Thank you Ganesh and good afternoon, everyone.
Today, I would like to reflect on our financial results announced today and.
And provide you further updates on our cash return strategy.
Afflicting on our financial results.
I continue to be very proud of all employees of microchip.
<unk> delivered another exceptional quarter and.
And making new records in many respects.
Namely record net sales record non-GAAP gross margin percentage a record non-GAAP operating margin percentage record cash flow from operations and record adjusted EBITDA.
So each of our strategic product lines, 8 bit 16 bit and 32 bit microcontrollers and analog individually achieved all time records in net sales.
Reflecting on our journey since the acquisition of Microsemi 3 years ago I note the following.
Number 1 at the time of the acquisition, we provided a long term operating margin target of 45% non-GAAP operating margin, which we exceeded for the first time in the March 2021 quarter and were significantly above that in the June 2021 quarter.
At 41, 7%.
At the time of the acquisition, we also indicated.
Debt, we anticipate achieving an $8 non-GAAP EPS run rate.
By the end of the third year after the acquisition.
Between the $1.98, EPS for the June quarter, we just announced.
And $2.11 EPS, we guided to for the September quarter at the midpoint of our guidance, we have effectively delivered on this expectation.
These exceptional results were achieved despite the numerous headwinds we faced from international trade tensions and tariffs.
Well as the global pandemic, which matters would not predictable 3 years ago.
Number 2 we financed for microsemi acquisition by adding $8.1 billion of debt.
Driving up on net leverage ratio in the June 2018 corridor to for 9.5 <unk>.
We know it was a concern for many of you.
In the last 3 years, we have paid down on the accumulative $4 billion of debt and brought our net leverage ratio down to 3.3 for wheat.
We continue to allocate substantially all of our cash generation beyond what we paid to shareholders in dividend to pay down significant debt every quarter.
Number 3 within the last quarter based on the debt pay down we had achieved.
On the continued strong cash and our adjusted EBITDA generation for our business.
Both Moody's and Fitch changed the rating outlook from stable to positive outlook.
At the rate, we expect to pay down over debt and bring our net leverage further down. We believe we are on target to achieve an investment grade rating sometime by the end of fiscal year 2022.
Regarding our cash return strategy.
We are continuing to provide more cash to return to the shareholders.
Just today, we announced a dividend of $43.7 per share on.
Third largest dividend increase by increasing the dividend by 5.8% sequentially.
$18.7 5% over the year ago quarter.
And in the coming quarters, we expect to continue with more actions to increase the cash returned to shareholders.
That operator will you please poll for questions.
Absolutely. Thank you so much ladies and gentlemen, if you would like to ask a question. Please signal by pressing star 1 on your telephone keypad, if you're using a speaker phone. Please make sure. Your mute function is turned off for all your signal to reach our equipment. We do ask that you. Please limit yourself to 1 question and reenter the queue for any follow ups you may have again net of Starwood.
On to ask a question and our first question today will come from Matt to Shire Hari with Goldman Sachs.
Hi, guys. Thank you so much for taking my question and congrats on the strong results.
Just wanted to ask about gross margins in the June quarter and on the outlook going forward.
Clearly very strong results in the quarter with margins coming in above the high end of guidance.
Curious what drove the upside vis vis your expectations was it primarily utilization rates or was there something else.
Hi, and behind the beat and.
Ganesh you talked about you guys performing already in line with your long term model and you think about.
Your ability to expand gross margins going forward and as you in source I guess, both front end wafer processing as well as assembly and test how should we think about the potential upside there going forward.
And then in terms of gross margin. Thank you.
So let me have Eric respond to the first part and I'll respond to the second part okay. So gross margin on the quarter. You know we are utilizing our mat manufacturing resources you know fully at this point in time, you know we have more orders and we know what to do with on with that and we're being quite efficient in our manufacturing operations. So it's really fast.
Utilizing our capacity and we're obviously continuing to make investment in capital, bringing that online as quickly as we can increase in the percentage of assembly and tests that we do internally, but the major driver was just effective utilization of what what factories and equipment that we have.
For your second question give us some time to put some thought into how we see gross margins building over time, what the long term model should be and we will come back to you later this year with a more complete picture of what that will be and what the drivers will be many of them are what you just described which is as we do.
More in sourcing there's a richer product mix that comes into play there's pricing discipline. You know those are all going to be important parts, but we need some time to process, where we are where we can get to how we get there and then we'll come back to you with some numbers.
Understood. Thank you.
Yes.
Thank you and next we'll hear from John Pitzer with Credit Suisse.
Yes, guys. Congratulations on the strong results. Thanks for letting me ask the question can I ask for its pretty astounding debt just the inventories are now down to 20 day.
It kind of makes the <unk> model.
Kind of a little bit less valuable I'm kind of curious.
What is the risk that your end customers can't rely on this day and so there is more of an inventory build going on there then you can see 1 and 2 on the more positive given what's happening in Disney on this idea of just in time inventory management going to just in case do you see yourself getting closer to end customers.
For us over time.
Strategically on what the what might that mean for margins.
So John.
The distribution inventory is low in part because we are constrained right. So distributors continue to service customers.
But we are not able to help them grow that inventory at some point, we will be able to as we get our production up to be able to ship them more for them to help build out but.
But for the moment, neither their customers nor distribution has the ability to grow inventory in any meaningful for them.
You know when we look at where are the number of customer requests, we're getting either direct or indirect through distribution.
On shortages lines downs on all of that it's pretty well represented across the spectrum. It isn't that 1 group of customers is doing better than the other.
There are a large number of customers who are unable to get what they want and are.
In the short or medium term.
Trying to get more product.
In some cases trying to get product through more than 1 source if they can but the constraints on all over the place and so I'm not seeing channel inventory or customer inventory building.
In a way that are in and you can read something into the distribution days of inventory.
Good afternoon, My second half for the question does this change the distribution model structurally for you and is there an opportunity to get closer to customers and maybe capture some of that just the margin that youre, giving them now.
So we have 125 ish 125000, or so customers we serve.
Clearly distribution is an important part of that model to reach that long of a tail of customers.
On the customers make the final choice on where do they want to buy they have an opportunity to buy direct they have an opportunity to buy from our web channel they have an opportunity to buy from distribution.
They buy from distribution when they see that the value that distribution is bringing them in support and payment terms and pipelining of inventory in other ways. The distribution of that value is good for them, but we continue to serve customers through the channel that they find to be the most effective for them and if that is someone who wants to move direct so.
For somebody who wants to stay with channels, so be it but whenever relatively channel agnostic and what we're doing clearly in a in a time of escalation more distribution customers are reaching through directly to us to get help.
But that does not necessarily mean that they will shift off of distribution than to us directly.
First of all day.
Hum.
John I'll add debt.
Kidding inventory for customers is on the 1 part of the value the distribution provides and clearly.
They have very low inventory today.
Also to do with our inability to ship, but that's not the only value distribution for Reits, They provide kidding payment terms programming.
Provide all sorts of services for which the charge. So I think distribution will continue to be an important element of you.
Microchip 2 go to market strategy, which reaches a very very long too.
I appreciate it thank you for.
Okay.
Thank you and next we'll hear from Vivek Arya with Bank of America Securities.
Thanks for taking my question.
You gave a 327% on sequential growth rate for the September quarter, it's kind of in line with the sequential growth rates you have seen on the last few quarters is this being.
Really driven by supply and growth and if that is the case, how should we think about incremental supply that could come on line in the next several quarters because I believe you said that you expect to grow sequentially for the next 4.
Quarters, if I heard correctly, so should we be keeping that 3% to 7% sequential growth rate in mind as we try to model out for next 4 quarters.
So I want to be clear, we're not providing any kind of guidance that goes beyond the September quarter. We are clearly working on supply improvements and today all of our growth is constrained not by demand but by supply.
There are supply improvements, we're making that are in our control, which is what runs through our manufacturing internally, what we're doing there to increase capacity in each of our Fabs on assembly or test for working with our supply chain partners, who bring us materials on all of that and we are working on capacity improvements with our partners that we do outside outside outsourced.
Worked through.
No I think you know we will give you the.
Quarter by quarter growth as we get to the guidance for the December and March and June quarters on all of that but I think what we do see is enough capacity coming on in the subsequent quarters on the timing is a bit hard to call. Because we don't have a stable environment in which we know exactly what equipment will come on when we'll bring on the.
Capacity and all that but we're confident enough and how we see capacity coming on that we do expect that each of the next 4 quarters will have growth in them.
Thank you.
Thank you and next we'll hear from Ambridge, Sara Hasan <unk> with BMO.
Alright. Thank you can we get back on to the PSP program.
Thank you for 44% of other business was under.
Under that and Ganesh you said over 50% is day their natural ceiling to this and then kind of tied to that getting back to the capacity.
This must be a tougher.
Equation to get to is it's a very fragmented industry, both microcontroller and analog so how do you balance capacity increase versus what others are doing it's called like DRAM, but there's only 3 guidance and everybody kind of thinks they know what the other person is doing so so ganesh.
And Steve how do you balance the capacity increase versus.
Down the road when there could be potential oversupply.
So let me start first on your PSP question right on our PSP backlog exiting the June quarter was over 50% on accrued throughout the quarter.
And we have customers continuing to enroll in the program as well as extend the time that they are providing us the backlog.
Question on other metric is really something that was important to us to convey during the early stages of launching the PSP program and so at this point in time, rather than trying to provide a.
Month by month quarter by quarter update it as a part of our normal business that we're doing.
Certain capacity corridors as I've explained are 100% booked already and we will just manage it it gives us visibility it gives us a better ability to service those customers, who have long term backlog that they can place on or not that's noncancelable that was all objective of what we day.
And then to your second question in many ways PSP is 1 element of what we have that helps us to make sure that the other side of the cycle whenever it is can be managed well.
We're also bringing capacity on.
In measured steps, we're not trying to.
Net all of the unsupported done in a short period of time. So every quarter, we are increasing capacity and so combination of what we're doing with measured steps on capacity, what we're doing with the PSP program on all of that.
Gives us reasonable confidence to be able to manage the cycle in such a way that we don't get over committed on the capacity side.
That makes sense. Thank you.
And thank you so much our next question will come from harsh Kumar with Piper Sandler.
Yeah, Hey, guys first of all congratulations on the stellar results.
Actually a couple of I wanted to go back to the question of other costs about growth for the next 4 quarters. So let me see if I understand this correctly Ganesh.
You expect supply constrained for the next 4 quarters, but you also expect demand environment to remain pretty solid on a robust and therefore youre pretty comfortable forecasting growth for the.
Revenue growth for the next 4 quarters or you're just referring to that you will have enough supply to be able to meet demand interest.
You know we have a very strong demand backlog on us we have a substantial portion of PSP backlog on us. We continue to have a you know a large amount that we're on that as unsupported. So the demand environment. We see is very very strong now.
The balance is really what can be supply.
And how much can we bring on and our.
Supply lines as we can see continued to give us the ability to bring more supply on quarter after quarter after quarter for at least on next 4 quarters, giving us that line of sight into having the capability to take advantage of that demand and grow every quarter.
Understood. Thanks for that clarity and then for my follow up.
Maybe 1 for Steve Steve So.
Everybody in the semi industry, that's established like yourself otherwise you guys are talking about the cash strategy more on more on.
Cash from the current but at the same time there is very good growth in the industry.
We appreciate the cash return, but for the industry is still growing why not use some of that cash for things like acquisitions.
Or maybe other things like growth just could you help us balance that argument.
Okay.
The way we have described before is that we began at acquisition process.
You know on back of about 13 years ago, when we were well below a $1 billion company and we were I think we were probably rug only $700.750 million company and we were trying to scale. The business 10 ex so that we don't have a competitive disadvantage against larger competitors.
For tiara is still larger but many of the others.
And on S teas in magazines and EDI is and you know, we're really caught up to all of them in the in the last 12.13 years by scaling the business almost 10 ex <unk>.
Current quarter guidance for it I mean somewhere in the extra for fixing our $1 billion.
And and we wanted to do that.
While building a portfolio of products around our microcontroller. So that we can provide the entire total system solution to the customers.
You know, having analogs from memory from connectivity.
S B Ethernet Wifi Bluetooth.
In all day, I'd power management and everything else.
So those 2 things we accomplished.
We scaled our business almost 10 X and we acquired organically build all these products to be able to complete customers solution. So at this point in time and I think we've said couple of times that we doing fine the next acquisition to be necessary.
Given small acquisitions here and there tuck in type if the opportunity arises we word but we're not really working on looking at any large acquisition because ex strategically not needed today, we have enough product portfolio and we're working very hard to train our sales force and customer.
There has to be able to use the entire total system solution from microchip and show the organic growth.
And as we adopt that strategy.
You know on as we pay down on a substantial amount of debt already and continue to pay it further than you would have you know a larger.
Somewhere around $1.5 billion burning a hole in your pocket.
And what do you do with that you're seeing why don't we acquire and I'm seeing we do not find that strategically needed today. So what we're planning to do is.
As we achieved the investment grade rating and as the.
On the debt level. It comes down further than we start giving larger and larger amount of cash back to the shareholders. Some in the form of dividend and some starting a buyback program.
That's sort of a summary of where the current strategy is and.
On harsh if I may add to it with respect to your question I think any opex or capex that is needed to grow the business is part of what we're doing every quarter right and built into our business model. It's really then the capital allocation of what we do beyond that that Steve was describing.
And for the smaller companies, maybe acquiring I think the really sort of copying our strategy, which we concluded in the prior 13 years, when they were not buying and maybe they're buying something today.
We don't do something because somebody else is doing I think are you now.
We had it laid out strategy, we completed that phase.
And that part of this strategy is no longer important severe for agreeing to the next phase.
Got it I appreciate it guys. Thanks.
Thank you and next we will hear from Harlan sur with J P. Morgan.
Good afternoon, and congratulations on the strong results and execution you know back in early May I think the team had said that the demand trends were 40% above your ability to supply and then by late may that GAAP had widened to 50%. It sounds like the GAAP either remained extended or may have EBIT expanded so if you could just give us a sense.
Of how wide the demand supply gap today is it sitting above 50%.
And it sort of seems as if we move into the second half of the year demand is only getting stronger you have areas like data Center and enterprise for example, which for a week last year and into the first half for this year, which is starting to pick up any any other end markets where demand is strongly accelerating from a softer first half.
So heartland first on the the unsupported backlog.
Exiting June.
That unsupported backlog was higher.
What it was both what we said on our conference call as well as where it was at the end of March.
Demand increased in the June quarter outpaced the supply improvements we could make.
And hence we expect as we go in through September every indication. We have is that the percentage of unsupported exiting September will be higher than where it was at the end of June so that trend continues.
Not seeing demand and supply starting to converge or get into any kind of balance itself.
And was there a second part of the question.
Just in terms of end markets that were weak either last year on into the first half of this year for example, like data center and enterprise, which feel like they're starting to accelerate as we move into the second half is that is that a dynamic that youre seeing any other end markets, where demand is strongly accelerating from UBS.
Slightly softer for style.
So as we said all end markets were strong as we went through the June quarter.
Some have been strong in prior quarters as well, we don't track end markets on a quarter to quarter by end market basis on it but anecdotally some of what you're saying is correct and we do see strength in data centers in the second half of the year.
And I don't recall, what the year over year comparisons were on them, but right now there is no market that is.
Feeling weak.
Great. Thank you very much.
Okay.
Thank you and next we will hear from Gary Mobley with Wells Fargo Securities.
Hey, everybody. Thanks for taking my question.
Want to ask about some long term supply agreements that may support that 60% debt. Your sales that are you know.
Sourced externally on the front end side.
40% on the back inside.
I know some of your competitors are entering lts, as an and quantifying them and SEC filings.
Senior Q yet but.
Have you guys officially entered into more <unk> and maybe you can just sort of give us a sense.
Holly.
Relative to your sales or how they rank relative to the last quarter and then on net flip side of the coin.
I was curious to know what your potential penalties maybe for those customers that entered to non cancer, both non returnable backlog agreements with you guys.
So with respect to.
LTA is right we have a range of how we have those agreements I don't believe any of them have been big enough to be.
In our Qs.
So youre not going to see something there.
We have a long set of partners both on the front on the backend we worked with them quite constructively at.
At this point in time, so that's where we are on it.
In terms of our capacity for 2022.
And beyond and what we need to do to secure it.
On the N CNR.
Agreements himself.
Those are there's a legal agreement that's a purchase agreement that we enter into.
Which have obligations on our side obligations on the customer side and.
And we've had these this is not new we've done this for many many years on a smaller subset of our business and we.
We have not found problems enforcing.
The CNR portions of our.
Purchase contracts.
Thanks for Nash.
Thank you and just a reminder, ladies and gentlemen, it is star 1 to ask a question at this time. Our next question will come from William Stein with choice.
Securities.
Great. Thanks for taking my question I'll add my congrats on the great results and outlook.
First I'd like to ask for clarification around capital allocation.
What is your target leverage ratio when would you slow down or stop.
The debt repurchases and.
What would be the plan after that because naturally.
You get to a certain leverage.
Ratio, if youre continuing to grow EBITDA and not adding debt then you wind up.
You know having debt debt ratio continued to decline.
Wondering if you can clarify the plans around sort of tapering the debt.
Debt repurchase.
Okay, well I'll start and Steve and Ganesh can can add on to that so if they want. So you know we don't have a stated target for our net debt to EBITDA, but we.
We've made it very clear that we're focused on achieving an investment grade rating and believe that that's something that we can achieve in this fiscal year independent decision, obviously by the rating agencies, but we're making good progress on that and even once we get there you shouldn't assume that we stopped paying down debt, we will continue to pay.
Down debt, but will have more flexibility to increase dividends more have a stock buyback program and flex that as its appropriate for our business. So Steve what would you like to add to that I think you said it well.
The board has not defined.
At bottom number for.
You know for the debt leverage at which we will essentially start paying down debt didn't give 100 per cent of the cash back they have not really define that number.
In future they might in.
In addition, even if we had some day stopped paying debt as a business today. It is an EBITDA raise is the leverage will continue to come down without even paying the debt, which was 1 of your point also so that's where we are I think it's a work in progress we keep giving you update every quarter.
We're getting fairly close to the investment grade rating and on my comments I said by the end of fiscal year 'twenty, 2 which is March next year again, it's an independent decision by the rating agencies, but we expect that.
We achieved our financial and leverage metrics, which should get us there by then.
That point in time.
Our board will have lot more flexibility to give it to you.
No.
To start a buyback program and also increase the dividend.
That's where we are today.
Does that help you at 1 point.
Sorry, I was just just to add to that but you know we have made significant increases on our dividend in the last 3 quarters and it's up 18, 8% year over year with the 3 large sequential increases that we've made so we're definitely heading in the right direction from a capital return standpoint, but you know the next step is investment grade and then we will take.
From there.
Great 1 more if I can.
We're in this environment.
You could some people describe it as peak some people describe it is peaking or extended peak or are there a lot of ways to think about it but it's certainly very good.
Part of the cycle and maybe raises questions as to how close to rolling over we are I Wonder if you could maybe highlight for us.
How you compare this cycle for others, which prior cycles. This wouldn't reminds you of and.
What are sort of the key signs you're going to be looking for.
To provide a warning to yourselves around how they manage the business for.
Our feed or a rolling cycle. Thank you.
I don't think this 1 resembles any prior cycle and to some extent.
Many of these.
Extraordinary cycles are all unique interest themselves. It's a question on what precipitated them and what is happening so.
This is a cycle. Unlike 1 we have seen before for many reasons.
We constantly look at a set of internal indicators to look ahead and peek around the corner to see when is something possibly changing.
They run the gamut of bookings billings on sell through.
The rate at which customers are able to have confidence in what they are placing with us in backlog.
Anecdotal conversations with the executives of many of our customers of our channel partners. So it's a it's a process of.
Many many points of data that we as a team meet on a weekly basis and compare notes and see what we see.
In terms of what does the data tell us and historically, we've been able to see things early on.
We will do the same this time too at this point there is no indication of any early warnings.
Thank you.
Thank you and next we'll hear from Janet Ramkissoon with QUADRA capital.
Congratulations guys nice quarter.
On I was wondering if you might be able to give us any insights.
And what you on demand might be from China.
Yes.
In terms of what the trends are and.
What you see going forward and also if you could make some comments about what you see in the auto industry specifically thank you.
So China is part of our reporting for Asia. In fact, it's a substantial portion of our Asia revenue I think it's about 2 thirds or so of that revenue.
We reported that our net.
Geography grew 11% last quarter, a little over 11%.
Is performing as we expected is it remains strong so let her know China demand issues that are.
Visible in what we see.
With respect to automotive we are continuing to increase the shipments to automotive.
We are shipping well above where we were pre pandemic, but.
The automotive demand also is quite substantially higher.
It is a matter of if they have many many companies that supply product to build a car and so you do hear about <unk>.
Factories, shutting down and customers not able to build what they want.
And you know we are providing the products that we can provide.
At a rate that is consistent with our manufacturing.
But we're still short to what automotive would like Dubai.
For their growth and for their growth plans.
Thank you.
Thank you so much on next well hear from Chris Danley with Citi.
Hey, Thanks, guys.
Can I ask you talked about.
All of these cycles being different and we read all these headlines about.
Whereas shortages ever and apparently the politicians are going to try and make sure that there is never any cycles in sami's again.
I just appreciate you guys' perspective.
Do you think that this is.
I guess, the worst upturn ever from a cash.
Customer standpoint, or I guess, Alternatively, you could argue that it's the best up turnover from a semiconductor supplier.
Are you guys looking to do anything differently or is the industry looking to do anything differently in future cycles that on.
On that prevent these kinds of shortages or do you think that this is just the normal course of business.
There are an extraordinary set of circumstances that got us to where we are.
The pandemic was 1 part of that the trade and tariff issues the year before that was another part of that.
And then make not only create a demand side, sorry supply side issues.
But created a lot of money that debt consumers had and they wanted to spend it and they spent it on things that are required electronics for a day required things to work out of the home. So I think there are all kinds of factors that came into where we are.
And of course, many customers in uncertainty independent Mick took their demand down and then realize that they have taken it down too far.
I don't know what the future.
<unk> clearly many of our customers are thinking through.
How should they.
From an inventory standpoint be preparing themselves. So that they are able to run more stable through the cycles et cetera on where they go.
I think there is a continued strong demand where people are building and selling through what they're doing.
I don't know what the shape for the next cycle would be on more importantly, what would be the causes of the next cycle and I think to a large extent those will determine what the responses will be on it I certainly don't think government health is going to be the answer to any of these cycles.
From usually when a government begins to think of something you know the cycle is long past before they can even act with respect to that so I am very confident that the industry through many many many cycles has figured out how to make adjustments in how to build in such a way that is consistent with where the market is that and I will do the same in <unk>.
This cycle I don't know, Steve you've got longer years on this and I, just well I think.
In the last several years we have.
Read reports people, calling the end of <unk>.
Cyclicality in the semiconductor business there'll be no more cycles.
I think all debt is wrong.
Let Ganesh said.
The events that precipitated this cycle.
<unk> not had been forecasted 2 years ago. So you know when that happens and it per day.
On a major major pressure on the industry from both sides decreasing the supply line and increasing the demand in certain cases, driven by work from home in medical and other.
It created the Super cycle that we haven't seen in 40 years.
Similar to other situations were to come in 5 years from now 10 years from now it will create a cycle again, so those cycles have really not been repealed.
People will make some adjustments maybe keep larger inventory and do some other things and people are trying to get long term agreements for supply.
But it's not predictable how much supply is needed 5 years from now and many of those agreements.
You will see we will have a bad ending.
If there's a recession people and they're going to need debt product there'll be that excess inventory you don't pay for play agreements don't work out very well usually.
Got it thanks for that perspective guys.
Thanks.
Okay.
Thank you and our next question will come from Rajiv Gill with Needham <unk> company.
Yes, thanks for taking my questions and congratulations as well.
A couple of questions. If I may 1 on the pricing environment last quarter.
Ganesh you had mentioned that you were engaged in some price increases and that was reflected in the revenue Im wondering how youre describing the pricing dynamic this quarter, how is that affecting the revenue how is that affecting kind of the gross margin improvement on a sequential basis as well.
Sure so.
The price increases largely have attempted to.
Has on cost increases that we've had and we continue to get cost increases on a pretty regular basis in the current environment, depending on what the material other product that.
But we need to buy our and as they come along we don't do it all instantaneously, we will match it and figure out points at which we would do the increase in prices to go with it.
And so that's a continuous process.
As and when it is needed in terms of us collecting the data.
And at this point in time, there is nothing in our <unk>.
Pricing thought process.
That would be different from what I said 3 months ago. If there is a need for our cost increases that we cannot absorb.
Batch it at some point in time, and we pass along the price increase.
And for my follow up you had mentioned that you will have capacity to support revenue growth in each of the next 4 quarters. I was wondering if you could elaborate further in terms of the capacity.
On increases does that come.
Coming on the foundry side on the test and assembly, which areas do you think are the easier to get more capacity, which areas are harder.
I would think that the foundries have been reluctant to spend on kind of lagging edge nodes. So on the wafer side it might be a bit more challenging but any color specifically in terms of.
The capacity.
That would be helpful. Thank you.
The area, we have the most the poll and the where we have been investing for multiple quarters.
Our internal factories. So we expect that there will be more help coming.
Where we have more control, which is in our Fabs, Our assembly and test factories et cetera. It doesn't mean, we're not getting anything from our partners we are.
It's selective it really depends on the situation and where were getting.
It is correct that more help is coming from the factories we control.
And then from a foundry on Assembly test partners.
I appreciate it thank you.
Thank you. So much next we will hear from Matt Ramsey with Cowen.
Thank you very much good afternoon guys.
2 questions a little bit unrelated 1 is a follow up on pricing Ganesh from from the last question.
And given what the margins are you, obviously, you're going to be able to pass on some of the higher input costs for customers, but if the input cost situation were to change and come down a bit.
With a long term agreements that are you putting in place under the PSP program, how stable are durable or how much length is there to some other new pricing.
<unk> you are having or do you expect those to sort of moderate.
As input costs moderate if and when they do and the second question completely unrelated is.
I noticed some press releases about silicon carbide from you guys.
Within the last week it seems like on much more expansive program than you might have had in the past is that the right read in and I guess, how important of a program is that for you guys going forward. Thank you.
Yeah.
Okay. So on the pricing front right I mean, I think there is there is no insight into which way input costs are growing at this point in time every indication is that input costs are going up in 2022, and we're already starting to hear of input costs going up in 2023, if and when there is a change in the.
Curry of input costs.
We'll relocate it at that point in time.
And so so nothing to really say about input cost changing directions at this point in time.
In regards to Silicon carbide is a program that is important.
<unk> focus and we have been bringing out products on a pretty consistent basis there.
And as an important part of our growth strategy is to capitalize on the markets, which have both industrial and automotive components with industrialize realizing revenues sooner.
By bringing the benefits of silicon carbide to those markets. They go nicely hand in hand, with many of our Microcontrollers that play into these power conversion opportunities, which is where silicon carbide place. So yeah. Its we havent made a big deal of it yes.
But it is an important product line, an important initiative for growth for us.
Thank you very much.
Thank you and next we'll hear from Chris Caso with Raymond James.
Yes. Thank you good evening.
Wanted to ask a bit more about what you talked about earlier about relying a bit more on internal capacity as opposed to foundries going forward.
First what what happened within the industry that is kind of causing this shortage in foundry and recognizing that the industry really didn't foundry industry didn't really.
Expand capacity and lagging edge nodes in the past, but why are we at the point now where there's just none left and no willingness to extend that.
And then following that.
If you are going to increase your reliance on internal capacity how is.
Is it that you stay within the same 3% to 4% of revenue Capex model.
How does that work going forward.
So for.
First of all I think in the from an industry perspective.
It's just the rate of growth that foundry is seen on these lagging edge technologies is so far ahead of any normal planning that they have done.
Debt, it's overwhelming what the capacity available as.
Well the normal reaction you would say well why aren't they building more while the economics of that for the foundries and the opportunity cost versus other capital objectives that they have don't always lend themselves to saying that trail.
Trailing edge capacity is where they want to be investing its not that theyre, making no investments. They are but they are not fast enough and they're not at a rate for products that we consider to be important for us and we're not doing it across the board, we're just picking and choosing places where we think.
There is significant constraint for us our opportunity for us to make that investment and that is true not only in the fab is true in assembly and test as well.
As to why we're doing it and what we're seeing it.
It will mean that we will continue to use all of the capacity available from our foundry and Assembly test partners plus we will try to make sure that we have where we can additional capacity to be able to not be constrained by what is available only from our outside partners itself.
In terms of the Capex itself I mean, you've seen if you go back and look at our.
On a history last 510 years, you'll find that we have gone above and below that 3 to 5.3% to 4% number I think for 2 years previous to this we were at about 1% and Thats, where the cycle was that's what we needed on that so I think a 3 year look gives you a better sense and we could spend more than 3% to 4%.
In any given year.
As we look at investing at a time when that need is there and then we'll breathe.
With with that capacity and let it all build out over that time, but at this point in time, that's why we feel comfortable with.
If that changes in time, we'll keep you posted but all of this capital that we're investing all of the capacity, we're bringing on all of it we think will be accretive to our gross margins and will enabled growth that could otherwise not have had if on only choice was to take it outside.
Very helpful.
For the foundry part of the answer.
Ordinarily.
When the industry or the normal kind of growth for the whatever it was over the last 10.15 years.
Usually a movement to the faster noted by the leading edge guys.
We kept seeing us enough trailing as a capacity.
So the trailing edge guys didn't get constrained because of leading edge capacity you have today is a trailing edge capacity of 5.6 years down the line and that's how trailing edge capacity became available because it was originally built for people who wanted more leading edge.
And then many years later there was available for the trailing edge.
But when the industry grew this year the weighted has grown most companies have announced a year over year growth rates of 20% plus on September guidance as I think about 25% up versus same quarter a year ago.
That is a growth rate on the trailing edge technology is much much higher.
Then then really what would become available for ordinary process nodes moving up.
And so therefore, the leading edge capacity is constrained also today, it's not like there's all of the capacity available at 40 nanometer and 28 nanometer did all constrained also but foundries are willing to add the capacity on the more leading edge nodes than they are on the trailing edge given that.
Choice of capital allocation on day priorities.
We're working on more relieving the leading edge of capacity, leaving the trailing edge much more constrained because of the such an aggressive growth thereafter.
If the growth for the industry returns back to a much more normal where the 10 years and it's quite possible that the trailing edge of capacity will not be as constrained again.
Okay. Thank you.
Thank you and our next question will come from Christopher Rolland with Susquehanna.
Hey, guys. Thanks for the question good quarter.
Whats the plan around just the inventory do you guys plan to increase that from from 20 days.
Kind of as a P R.
Is this on hold as you kind of service you know your PSP customers are correct customers first.
Any color there on on.
On your timing around replenishment.
We don't drive distribution to what inventory they should carry.
The numbers. We report are what their decisions are both in terms of what they see as a demand but in this current in the current condition, what they see as the supply available to them PSP.
<unk> customers are coming to us as much from distribution as well so I would not take PSP and say, it's direct customers only many many customers who are distribution customers are placing PSP orders on it the issue is that when demand so far exceeds supply you cannot build inventory internally.
<unk> or in the channel at that point in time so.
Until we get to the point, where we can help provide more product than they're shipping out distribution inventory is not likely to go up.
We're shipping higher and higher demand for distribution every quarter, but it sucks out the door.
Because of the strong demand for sales.
So.
Because the suppliers, who constrained you cannot really build inventory anywhere.
Yes, understood and this is definitely a longer term question.
Is there any point or condition, 1 when you guys would ever consider a 300 millimeter fab.
For example on has the same revenue as you guys and has 1.
Or is it something that given your product sets from the volumes that you guys have.
<unk> and the runs that you guys have that you wouldnt have any interest in.
No there are scenarios in which a 12 inch fab may makes sense for us, but there is nothing really to talk about at this point in time.
Currently you mentioned is not a good example for us in our operating margin is higher than the gross margin.
Yes.
Yeah.
Yeah, a lot more away for sure. Thanks, guys.
Thank you and we'll take a follow up from Harlan sur with J.
J P Morgan.
Yes. Thank you for taking my follow up in terms of potential uncertainties. On Unfortunately, we are seeing a resurgent inc. Resurgence in COVID-19 Delta Varian.
Southeast Asia seems to be quite impact the other way do you have assembly wafer and final test in the Philippines, and Thailand. Some of your sub con during Malaysia, which is probably the hardest hit and the team managed through COVID-19, shutdowns very well last year, but for the recent surge how is the team mitigating the potential of course supply chain.
Disruptions.
So firstly, taking our own internal factories rights on many of the protocols that we implemented last year to operate safely to have backup plans if people need to be in.
Inside of the factory and all of that is normal part of our contingency planning.
In addition, we have taken steps to.
Accelerate.
All vaccines can be brought in and deploy it. So for example over the course of last week and this week.
A substantial portion of our Thailand factory is going to be fully vaccinated, we're taking steps to get preventive things. We can do we're trying to do the same thing in the Philippines and then we have some.
From challenges to overcome to get there, we're working with our factory partners and for.
Where they are operating debt or challenges. So far nothing is really a major enough issue for us to result in significant losses in production.
So as that data on rolls on SBC what the.
Our rules and regulations are we.
We will manage around it and.
As best as we can we have contingency plans.
But there's no.
You know I answer, which says we have all scenarios talked through so far no major issues and we're okay with that with where things are at but being prudent on where things might go.
Absolutely. Thank you.
Yeah.
Thank you and that concludes today's question and answer session. Mr. Moorthy at this time I will turn the conference back over to you for any additional or closing remarks.
Well I want to thank everybody for attending the call today, we have several investor events coming up over the next month month on a half a timeframe and we look forward to talking to many of you at that point in time. So thank you.
Thank you and this concludes today's conference. We thank you for your participation you may now disconnect.
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