Greetings and welcome to the Microchip's Third Quarter Fiscal Year 2024 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, CFO, Mr. Eric Bjornholt. Thank you. You may begin.

Thank you operator. Good afternoon everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press 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; and Sajid Daudi, Microchip’s Head of Investor Relations. I will comment on our third quarter fiscal year 2024 financial performance. Ganesh will then provide commentary on our results and discuss the current business environment, as well as our guidance. And Steve will provide an update on our cash return strategy. We will then be available to respond to specific investor and analyst questions. We are including information in our press release and on this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations' page of our website at www.microchip.com, and included reconciliation information in our earnings press release, which we believe you will find useful when comparing 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…

Thank you, Eric and good afternoon everyone. Our December quarter results were disappointing and below our expectations with net sales down 21.7% sequentially and down 18.6% from the year ago quarter. Non-GAAP gross and operating margins came in at 63.8% and 41.2%, respectively, down from our recent strong performance, but somewhat resilient despite the significant sequential decline in revenue. Our consolidated non-GAAP diluted EPS came in at $1.08 per share, down 30.8% from the year ago quarter. Adjusted EBITDA was 45.1% of net sales in the December quarter, continuing to demonstrate some resiliency. As a result, we had good debt reduction in the December quarter and despite the lower adjusted EBITDA we generated, our net leverage ticked down to 1.27x. However, we expect our net leverage ratio to rise for a few quarters, as trailing 12-month adjusted EBITDA drops when replacing stronger prior year quarters with weaker ones. Our capital return to shareholders in the March quarter will increase to 82.5% of our December quarter adjusted free cash flow as we continue on our path to return 100% of our adjusted free cash flow to shareholders by the March quarter of calendar year 2025. My thanks to our worldwide team for their support, hard work, and diligence as we navigated a difficult environment and focus on what we could control so that we are well-positioned to thrive in the long-term. Taking a look at our December quarter net sales from a product line perspective, our mixed-signal microcontroller net sales were down 22.3% sequentially and down 18.5% on a year-over-year basis. And our analog net sales were down 30.9% sequentially and down 29% on a year-over-year basis. Now, for some color on the December quarter. and the general business environment. All regions of the world and most of our end markets…

Thank you, Ganesh and good afternoon everyone. I would like to provide you with a further update on our cash return strategy. The Board of Directors announced an increase in the dividend of 25.7% from the year ago quarter to $0.45 per share. During the last quarter, we purchased $114.6 million of our stock in the open market. We also paid out $237.4 million in dividends. Thus, the total cash return was $352 million. This amount was 77.5% of our actual adjusted free cash flow of $454.3 million during the September 2023 quarter. Our net leverage at the end of December 2023 quarter was 1.27 times. Ever since we achieved an investment-grade rating for our debt in November 2021 and pivoted to increasing our capital return to shareholders, we have returned $3.6 billion to shareholders through December 31, 2023 by a combination of dividends and share buybacks. During this time, we have bought back approximately 26 million shares of our common stock from the open market, representing approximately 4.5% of our shares outstanding. In the current March quarter, we will use the adjusted free cash flow from the December quarter to target the amount of cash returned to shareholders. The adjusted free cash flow excludes a net $30.4 million that we collected from our customers for long-term supply assurance payments. These payments are refundable when purchase commitments are fulfilled. The adjusted free cash flow for the December quarter was $763.4 million. We plan to return 82.5% or $629.8 million of that amount to our shareholders with the dividend expected to be approximately $243 million and the stock buyback expected to be approximately $386.8 million, which will be a new quarterly record for stock buyback since we initiated our enhanced capital return strategy. Going forward, we plan to continue to increase our adjusted free cash flow returned to shareholders by 500 basis points every quarter until we reach 100% of adjusted free cash flow returned to shareholders. That will take four more quarters and we expect that dividends over time will represent approximately 50% of our cash returned. With that, operator, will you please poll for questions?

[Operator Instructions] And our first question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.

Hi, thanks a lot. I wanted to ask about how much of a headwind the inventory inside of distribution still is. Shipments into distribution were down about 30%, well, actually more than that, and yet some of your largest cities are still saying that they're having a hard time working down inventory. So can you provide any guidance like does the March guidance assume that shipments into distribution will be down a lot more than what the corporate guidance is, again, just like it was in December?

We are expecting that we will drain inventory in distribution in the March quarter.

Okay, great. And then, Eric, can you talk about utilization rates and the potential for some write-downs? We sort of haven't been at a level yet where you would write things down, but can you talk about that? Thanks.

Sure. So we have been working on an employee attrition basis in our three large fabs, and through the December quarter, that did not put us in a situation where we were taking underutilization charges from those three fabs. That will change this quarter as we have continued to attrit. And as Ganesh kind of walked through, we've got two-week shutdowns scheduled in all three of those large factories. So, we aren't going to break out a utilization percentage, but underutilization is absolutely impacting our business, our gross margins in the current quarter. And on top of that, with the change that we've seen in demand and inventory still being high. We have been taking relatively large charges for inventory reserves based on our accounting policies that we have in place. And all those things are really factored into the margin guidance that we've given to the Street.

Thanks a lot.

Thank you. Our next question comes from the line of Toshiya Hari with Goldman Sachs. Please proceed with your question.

Hi thank you. My first question is on cancellation rates and what you're seeing from a customer pushout perspective. Are you seeing any signs of stabilization, Ganesh, in terms of cancellation rates or pretty much the same so far in the quarter relative to December and September of last year?

We don't have a numerical tracking process. We still have customers that have asked for help. We have done a lot of that and built it into what we have into our guidance. I don't know if you have a better view, Eric, on cancellation rates.

Right. I would say, as we kind of talked about customers and distributors are feeling like they have excess inventory. And with that, if they have backlog in place for those products, they are either not placing backlog. But if they have backlog in place, they're looking to see if there's an ability for them to at least push that out. So, we're having those ongoing discussions and I'd say that they're still at a relatively high rating.

Got it. Thank you. And as my follow-up, I was hoping to get your comments on pricing, the headwinds you're seeing today, is it mostly volume-driven or are you starting to see price erode as well between your microcontroller business and analog business? It seems like at the industry level, you've got more supply coming online over the next couple of quarters, several quarters. So, curious how you're - what you're seeing today and how you're thinking about pricing as we progress through calendar 2024? Thank you.

Yes. All the revenue declines are really volume declines and not pricing related. Pricing is stable. It is not contributing to the revenue change that is in our guidance. Our business is one which is based on design-ins that are done one, two, three years before and production that takes place for many, many years. it's not an easy substitution that takes place on short-term price adjustments, et cetera. Clearly, at the point of where new designs are taking place, we will be price competitive to what the new design requires. But today's revenue adjustments downward are not happening because of price. Price is stable.

Thank you.

Thank you.

Thank you. And our next question comes from the line of Chris Caso with Wolfe Research. Please proceed with your question.

Yes, thank you. Good evening. My question is - and it's a difficult question about sort of where you think aggregate inventory levels are and how much progress with some of these lower revenue shipment rates that we'll make in getting those inventories down over time. I know that's difficult to answer for your end customers, your indirect customers, but perhaps you could address it from the distribution channel where you have a little more visibility and where the target inventory levels are and where you expect to get over time?

As you said, inventory in some cases is obscure to us, we have to estimate based on where customers are placing orders, what kind of feedback they're giving us. We know we're going to be substantially under shipping to where consumption is going to be. But it's very hard to put a number on what that is and how much of the inventory has been taken out. And as I said, in some cases, it is multiple layers of inventory and especially as people are getting to that point where they are less willing to carry inventory, perhaps even take it to the low end of what they might historically do, because supply is plentiful. Not all of this is just inventory reduction as you would normally expect. But it is going to be at multiple levels to our customers, to their customers and in some cases, if they have an OEM that goes to the OEM there as well. So we don't have a good way to put a number on what you're asking for.

Okay. Fair enough. One of the things you've also said in prior downturns is typically, you've seen three down quarters before you achieve a bottom, you're at that now, although September quarter was obviously a much smaller magnitude than now. Given where we are right now, do you think that still holds? And perhaps you could characterize this downturn against some of the prior ones that you've been through?

Well, there's nothing typical about this downturn. And I don't think that is a good comparison to history. You could say in magnitude, it is on the order of what we've seen in the global financial crisis. I think we were down 36% or so at that point in time. We have very limited visibility in today's market conditions. And so it's difficult to say where exactly this is and as I mentioned, we believe we are significantly under shipping to end demand, but we're unable to provide any kind of forecast or guidance beyond this quarter.

Fair enough. Thank you.

You're welcome.

Thank you. Our next question comes from the line of Christopher Rolland with SIG. Please proceed with your question.

Hi guys. Thanks for the question. So around cycle times and lead times, we have found that some of your products, particularly through distribution, they have lead times that are even below your cycle times. I'm assuming your cycle times are something like four weeks or six weeks, something like that. I guess my question is, how long would you expect this dynamic to last? I think this is – if you do have big inventory corrections like we're going through, you see that phenomenon occasionally, but how long might this last? And when are you expecting lead times to maybe again, obviously, we have some - an inventory dynamic we're going through here. But maybe talk about that lead times versus cycle times and when you think that those might actually rise again.

Chris, let me just define two terms and then we'll walk through it. So cycle time is the time it takes from when you begin with raw material and get to finished goods. That cycle time for semiconductors, depending on which product and what process can be anywhere from three to five months, sometimes longer, depending on the specialty. So that's the typical production cycle time. We have always been able to manage lead times, which we define as from a when a customer places an order on us, when can we ship the product to them to be a lot shorter than that. And historically pre-pandemic. That was four to eight weeks was not an unusual number for 80%, 90% of our line items. Where we have come back to is where those lead-times are on average where a customer places an order they can get in less than eight weeks. And in some cases, if we have it in finished goods, they can get it much sooner than that as well. So, I don't have a good view of when do lead-times go back out. And I'm not sure that's a good thing. I think we have to, obviously, work to manage the supply and demand consistent with where demand is going. But for years, we ran in that four to eight weeks as a reasonably stable lead-time outside of any major increases or decreases in demand in the marketplace. And right now, we think we're going to be at low lead-times for quite some time. We have inventory that is high, and we'll be growing into the March quarter. And we're going to position that inventory to be able to take advantage of orders that come in with short cycles because visibility is low, and we need to be able to position and take that as quickly as it comes in. So all of our systems are geared towards having shorter lead-times and being able to take orders of the - that are placed with short lead-times, as quickly as we can.

Maybe just one thing. I think, Chris, maybe what you were getting at is when we have product that is staged in die bank, so it's through the wafer fab that, in many cases, we can turn that through assembly and test in the four to six weeks that you're talking about. And so if that's the case, if it's in die bank, that would be the case. But we've got finished goods today. we're staging the products that are high runners and die bank or lead-times are quite short across the board.

Yes. Thank you very much guys. There were some good stuff there. Eric, while I have you gross margin, just for kind of simplicity sake, my model is roughly like 300 basis points below for next quarter where I was previously I don't know if you can kind of walk us through that, what's mix versus underutilization versus inventory write-down? It sounds like pricing is not an issue here like-for-like, but would love to know how those kind of various things contribute.

Yes. So, I would say the biggest change quarter-to-quarter is going to be in the factory utilization, and that's a combination of the continued attrition and lower production rates on a steady-state weekly basis, and then we're having these two weeks shutdown on top of that. And what we're having time off and some of our back-end factories too, which is larger than the previous quarter. So, all those things impacted, I'd say, the inventory reserve piece is a part of it, but we had relatively significant charges last quarter on that, and I wouldn't expect those to be significantly more this quarter. They'll probably be larger, but the biggest piece is going to be what we're doing on utilization.

Excellent. Thanks guys.

Thank you. Our next question comes from the line of Gary Mobley with Wells Fargo. Please proceed with your question.

Hi guys. Good afternoon and thanks for taking my question. Looking at the March quarter guidance, that's basically a peak to trough in revenue terms of more than 40%, all within the same fiscal year. So clearly, the rate of the decay has been extreme. And I'm calling on your experience here, given that you've all been through a lot of cycles in the past and you hinted to in your prepared remarks, maybe some overcorrection on your customer's part in terms of inventory depletion. So calling on your experience, how would you say the slope of the recovery may look given your lead times? Is it a gradual one? Or are we going to see just sharper rebound as we saw in terms of this correction?

So I'll start and Ganesh or Steve can add to this. I think it is unknown at this point in time, right? We have limited backlog visibility as we look out in time, which you're asking about beyond this quarter, lead times are really short and customers are sitting on a certain level of inventory beyond what they think is necessary for their business today. So until we start getting short-term orders at our lead times and we see that backlog start to build. It's hard for us to really imagine what it's going to do. As Ganesh said before, clearly in this quarter with our revenue guidance, we are shipping below what the end consumption for our products are, and we think that's relatively material. But giving you any guidance in terms of what the slope of the recovery is, I think, it's hard for us to do at this point.

I think the recovery has many components to it, right? One is just if you assume business is flat and as the inventory drains, people will, at some point, just have to order enough to get back to flat consumption. Then there is also what does the macro do and what happens in actual consumption over time. And that depends on many things, where is GDP at, what our interest rate is doing, et cetera. And I think those are all variables, which you can't, at least we're not able to plug in and say, this is out the next three, four quarters, the shape of the recovery will look. And we don't have the visibility and backlog to give us any insight into that today.

I know I was asking us for a lot there, but I appreciate the color. So it sounds like your OpEx management is more so variable versus structural. And you've, obviously, done this in the past. In this recent round when you've asked employees to take a 10% pay reduction, what was communicated to them in terms of when that might be recouped based on some revenue or performance metrics?

I have not been able to speak to the entire Microchip community until I do that on Monday morning. I did write them all a message today after the market closed and before this call to let them know what we were doing. So those are details that I would prefer to first speak to our employees and give them all of that. But this is not new to us. We have done this multiple times. Our culture allows people to understand how shared sacrifice and shared rewards go hand in hand and how that creates excellent outcomes for the company and for the individuals in the process of doing that. And so I'm confident that our team, especially the team that has been through many cycles with us. We'll see it, will help us with it and pull everybody else along as well.

Thank you, Ganesh.

You're welcome.

Thank you. Our next question comes from the line of Vivek Arya with Bank of America. Please proceed with your question.

Thanks for taking my question. Ganesh, I appreciate you're not going beyond the quarter, but I still wanted to get some help in getting some directional sense of whether June could be flat, up or down because you do have some shutdowns in June, right? You are already planning for that. So that's not a great data point. But then June tends to also be seasonally up for you historically. So, just give us some more color, what is true demand right now? And if you were sitting in our shoes, would you think about June being kind of up, down, flat, even if you don't have an absolute sense of where June might take out?

I think the shutdowns that we communicated based on the days of inventory that we closed December and what we have indicated are going to be at the end of March are required steps we need to take. Those are not necessarily trying to provide an indication of where the June business is going to be at. Vivek, the real answer is I don't know. And I think the world is not falling apart. So, we know that consumption is taking place. We know that inventory needs to drain. We're trying to gauge between the environment in the market, the inventory at multiple levels and how all that will drain. We know this business will come back, right? It has - and every previous cycle done that. But I think what you're asking for is a level of precision, which we don't have any empirical data to be able to say, yes, this is what's going to happen and when.

And then my bigger question, Ganesh, is that how would you contrast your strategy of maintaining kind of a hybrid manufacturing model, right, where lead-times can suddenly get extended, but your CapEx is low, your profitability is high? To say your other U.S. competitor who has high CapEx, they can usually keep lead-times very low, and they have managed to avoid, right, these kind of very, very large swings. How would you kind of contrast the two strategies? And do you think what you're going through could make you change your strategy about maybe having higher CapEx in the future and always trying to maintain lower lead-times?

Again, there are many people that fit into what you described. I'll describe our strategy, which is we run inside of Microchip the products that we know how to run cost effectively and consistently within our manufacturing footprint. That includes both our front end as well as our back end. We have grown that front-end footprint over time, but also our foundry products have grown over time. And that balance has been roughly 40% plus or minus internal, 60% external. We don't try to guide where that percentage needs to go. The market demand drives is it higher or lower from there. But we know what products and technologies make sense within our footprint and what makes sense to drive with our partners. And that's the way we think about it. And in the aggregate, barring any near-term changes like we've had last quarter and this quarter, it's been a very successful strategy in terms of how gross margins over time have accreted and how over many cycles, we've got higher highs and higher lows. So, we're very happy with the strategy we have, and I leave others with their strategy to speak for themselves.

Thank you.

You're welcome.

Thank you. Our next question comes from the line of Tore Svanberg with Stifel. Please proceed with your question.

Yes, thank you. So, my first question is on the PSP program. It was obviously put in place to try and avoid volatility and doesn't look like that happened. Maybe it was just the nature of the pandemic cycle, I don't know. But why do you think the PSP program did not sort of buffer the volatility that we're actually seeing?

It's a great question. Although the PSP program was aimed at discouraging speculative demand by making orders NCNR and then giving us confidence to make investments on it. I think there was a combination of very strong OEM market demand, our customers and their customers and what they were seeing. They were persistent shortages over a long period of time and very long lead times. And I think when you put all that together, OEM customers ended up placing more backlog because they believe their business was a lot stronger than they thought, and they were trying to place orders for a lot longer than they normally would in that. So that's the way it, in our perspective, played out. How it did phenomenally for them in the 2021, 2022 time frame where those that were in the program, we're able to keep their business going, take market share away and driving. But at the end of the day, the longer lead times get the further out someone is trying to predict where their business is going to be. And I think that's the issue at some point in time is you don't know what your demand is with any kind of high confidence one year or 18 months out, that people were placing those orders as non-cancelable, thinking that the demand was strong and assuming that the risk was a good risk for them to take.

No, that's very fair. And then as my follow-up, I recognize that all end markets are going to be weak in the March quarter. But any sort of relative comment on the end markets, anything holding up a little bit relatively better than others?

Yes. I would say if you look at our aerospace and defense market, there are strengths in those. The commercial aviation remains strong. The defense remains strong. Space has always been very lumpy in where it's at. Our portion of the data center, which is around AI platforms, those are doing extremely well. It's not big enough to move the Microchip needle overall, but it's certainly a pocket of strength that we see as well.

Great. Thank you very much.

You're welcome.

Thank you. Our next question comes from the line of Chris Danely with Citi. Please proceed with your question.

Thanks guys. I guess just a little clarification on the decline here. Any comments on just your sense of end demand, maybe talk about the end markets that have been the worst? And then also, given your revenue decline is notably more than some of your peers, why do you think it's hitting you more than some of the competition?

Sorry, what was the last part of your question? Why do you think what?

Why is your revenue declining much more than some of your competitors?

Okay. So on your second question, as I said, if you look at it over a year's period of time, you're going to find that the fiscal 2024 at the midpoint of our guidance is about 9.5% down from fiscal 2023. I don't think that's outside of where the normal is at. Within a two-quarter period of time, absolutely, we are correcting and correcting at a faster rate than where we were at. But I think we have to look at area under the curve for revenue rather than just peak to trough alone in terms of what you're going to look at. In terms of end markets, we - sorry, was there a question?

No, I said thanks.

Okay. In terms of end markets, as I mentioned, it's weak across the board. We don't track at a quarterly level kind of how they're all moving. But we have enough anecdotal data. I think we were among the earliest people as early as two or three quarters ago saying automotive is starting to weaken and roll over and industrial did and data center had been. So we have seen this for some time. And at this point in time, I would say that they're all week. There might be individual customers who are stronger or weaker than what – on average that we see but nothing to write home about, other than the two exceptions I spoke about, which is aerospace and defense is still holding up. And our portion of the AI servers that we provide solutions to.

Thanks Ganesh. And then just a quick clarification on the utilization rates. Do you guys anticipate utilization rates declining again in the June quarter from March? Or will they stay flattish from March to June?

We don't know yet. We will have to see how kind of the business evolves over the coming months.

Okay. Thanks Eric.

Thank you. Our next question comes from the line of Vijay Rakesh with Mizuho. Please proceed with your question.

Yes, hi. I had a quick question. And I was wondering between the CapEx and the funding that Microchip was getting how much capacity you would be adding on the front end of the back end as you look at calendar 2024, I guess?

So, our capital expenditures for fiscal 2024 we laid out for you, and that's $300 million to $310 million. We have not given a number for next fiscal year. I expect it to be lower than that. We've actually taken in quite a bit of equipment this year that we have not essentially released and placed in service for production purposes. So, we've got capital that's paid for and at our facilities that we can deploy as the market returns to a more normalized level, and we need that capacity, but I expect CapEx to be quite low in our fiscal year 2025.

Vijay, here's how I would think about it from a - how are we positioned for growth from our capacity. Our initial response as this thing changes is going to be utilizing the inventory that we have built and being able to ship using the inventory we have. Our next response will be around getting our factories to more full utilization. We are underutilizing them at this point in time. Our third response would be taking equipment that we have already ordered and received which we will begin to place into production. And then finally, into adding more equipment or bottleneck equipment as the case might be. So, we believe we have plenty of firepower for being able to respond to an up cycle through a combination of those four things.

Got it. And if you were to combine all of that, you mentioned your channel disti inventory was at 37 days versus an optimal high 20s, I guess that you mentioned before. And your in-house inventory I probably goes up a little bit as you go to March. Any thoughts on when you actually see that starting to realign or start to stabilize or start to come down? Is that more of a second half? When do you actually see that happening, I guess?

If I had a better picture on the demand environment, I could give you a better answer. So, what we're doing is we're taking action on the things we can control, which is our internal capacity, and those are the shutdown days, the lowering of the utilization factors and all that other stuff that we're doing. And that is all in anticipation that at some point, the market will return, and it will reverse cycle at that point in time, first, by us producing less, which we're taking steps for; and second, by the market consuming more, which is what is unknown.

Got it. And last question on the margin trajectory for March quarter. Did you say that all of it was because of utilization? And should we expect that underutilization to continue into June? Or how do you see that? Or do you expect utilization to pick back up again?

So, we didn't say it was all of it. There's a large portion of the change that is utilization driven. There's always product mix and inventory reserves and other things that impact that. I think it will be probably difficult for capacity utilization to increase in the June quarter just because we are running on an attrition basis, and that is continuing each week as some people leave, and then it just takes a while to ramp that back up even if the market dynamics are better. And so that's something that we'll watch very closely and make sure that we're making the appropriate investments in people, but it tends to be like moving a battleship on the ocean, it turns relatively slow.

Got it. Thank you very much.

Thank you. Our next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.

Great. Thank you. I guess, I wonder if you could address a couple of the bear cases that I hear. One, you've sort of talked about PSP and what it accomplished and what it didn't. Do you think that having more flexibility about customer cancellations when they started to slow down, would that have sort of made the issue less bad now? Is the PSP part of the reason why the hole is a little bit deeper, maybe?

Perhaps. And I think, again, in retrospect, as a Monday morning quarterback, I know exactly what I would have done. But we were under for many, many, many quarters and even as recently as last March and June quarters, there were CEO-level calls that we're pushing and driving for getting more product than we had. If you remember, we would provide the statistic about how much of unsupported, which is what customers wanted and we couldn't ship was there. So in the throes of all of that, where there parts of it where perhaps we should have taken our foot off the accelerator perhaps. But it isn't something that was now able as we went through it. And if we ever were to do a PSP program again, those are some lessons learned we'll take, and we'll look at how would we adjust the program so that the intended outcomes are available and as many of the unintended outcomes are avoided.

Great. Thank you. And then the other kind of negative question that I get, China obviously building significant amount of trailing edge capacity. Can you talk about what types – I don't think you see a lot of direct competition from sovereign China today, but can you talk about how much of your business might see competition from that direction over the next few years? I think you've talked about that being single digits, but maybe if you could just update us on your thinking there.

Sure. So Mainland China today is about 20-ish percent of our revenue. About half of it, we estimate is designed elsewhere and just happens to be manufactured in Mainland China. And some of that is, frankly, moving out of China as people diversify other things. So it doesn't - the point of design is outside of China, and we're comfortable with that. So the other 10% of our business that's in China that is designed in China has another half of that, which is very complex designs, and these are not the ones that are easy to dislodge and would have a significant amount of knowledge about systems, the software that goes with it, the hardware and software interaction and all that. So that means about 5% of our business, about one-fourth of the business in Mainland China that is our more broad-based microcontrollers and analog and those type of products. And there, fragmentation is our friend. It is a very, very fragmented market. Any one opportunity is a small percentage of revenue, and it is not easy to go to place. But theoretically, you could say if somebody had an identical offering. And by the way, a lot of that business is not just about having silicon. It's about having silicon, having tools, having design guides, having software that we make available. There's a lot of help and self-help that we provide for our customers as well that is there. So, yes, there is more going on in China with trailing edge, both technologies and capacity. And we will pay attention, and we will, through our product line and innovation, cost reduction be continuing to work to go head-to-head against that. But it's the portion of the business that you might think about is more broad-based where they would come after that business is less than 5% and is very, very fragmented and difficult to get at. Does that help?

Thank you. Yes, so much. Thank you.

Thank you.

Our next question comes from the line of Joshua Buchalter with TD Cowen. Please proceed with your question.

Hi guys. Thanks for taking my questions. I wanted to ask about utilization rates and sort of the strategic decisions you're making to shut down the fabs for two weeks in March and June and also keep utilization rates lower over those two quarters. I guess, why start and stop the fabs but also why not just take the utilization rates much lower in the March quarter then see where things play out and given you're trying to get inventory down, but expectations are that it will still go up in March? Thank you.

It's a balanced decision that we had to think through and make. But as inventories climbed, there is a point at which the pain gets high enough. And as we looked at that, we felt on balance and we don't know what other supply-demand dynamics may take place. But on balance, this is a way in which we could navigate to different scenarios that might play themselves out. And in the meanwhile, the inventory is high enough that we're comfortable that if the recovery would accelerate, we're in a good place. And we are - if the recovery were something different, that were ahead of us and we have options on what we can do in the June quarter. But right now, we need to prepare for where March and June to the best of our ability to call it is going to be, and that includes be running at a lower utilization and taking a two-week shutdown in the - in our fabs in each of the two quarters.

And then as my follow-up, and I know you have a formulaic approach to your capital return program, but you've also in the past talked about opportunistically potentially going above the rates that you've outlined as we go through this period where you're going through the digestion and free cash flow is depressed versus where it was the last few quarters, any thought to using the balance sheet or returning more than you would have been returned under the formula that you've outlined? Thank you.

So, maybe I'll start. So I mean, we actually have a very healthy cash return this quarter, right? We increased from 77.5% to 82.5%. The adjusted free cash flow in the December quarter was quite high. And even though the dividend is going up again, we are going to have kind of record share buyback in the quarter based on that formula that you spoke to. So, we think it's appropriate. We're glad that we're going to be buying back a bunch of shares this quarter. Steve, Ganesh can give commentary if the Board would think of doing anything different, but I think that program is kind of in place as it is. And if the market changed and the stock price decline significantly, it would be a discussion with the Board.

I think it just came out naturally that our cash flow was extremely healthy last quarter. And with returning 82.5% back to shareholders with dividend increasing, it still creates a record stock buyback in a quarter, record that we have ever done before, $386.8 million. So it's a very, very healthy buyback. If there was not to be the case, where the cash flow wasn't as healthy as last quarter, then the question would be valid, should we do an extraordinary stock buyback this quarter, if the stock were to become weak. But I think we just formulate – by formula is a very, very healthy amount of cash reserved for stock buyback this quarter.

For the last many quarters, we've been steady as she goes. I think having a program that doesn't try to have quarter-to-quarter major variations has been a way in which to establish consistency of the capital return program. And I think Steve and myself and the rest of the Board see that as a way that we should continue with this thing.

Thank you.

You're welcome.

Thank you. Our next question comes from the line of Quinn Bolton with Needham. Please proceed with your question.

Thanks for taking my question. I guess, first one is for Eric. You talked about the lower utilization, you're shutting down factories for two weeks in both March and June. I'm just kind of wondering, if you could walk us through the accounting. How much of that hits you in the current period? How much of those lower utilization charges flow-through inventory? And given how much inventory you have could be something that hits gross margin for a longer period of time as that flows through inventory and then the income statement then I've got a quick follow-up.

Yes. So our three large wafer fabs will even without the shutdowns, with the attrition that we've had, be running below what we would call normal utilization. And so these two-week shutdowns will be period costs in the quarter and not capitalized to inventory. Now we are running at lower utilization rates than we were at the peak. So the costs that are being capitalized to inventory on a per unit basis are higher than what they were when we were running at full board. But I think that answers your question. Essentially, the two-week shutdowns will be an impact to the current period and not capitalized into inventory.

That's very, very clear. Thank you. And then I guess just for Ganesh, you mentioned you're ending the PSP program. And so I'm curious, does that just mean you're not signing anyone to new PSP? Does that mean that existing PSPs have now been canceled and folks have greater rights to cancel the existing backlog? Just what happens with the current PSP participants?

The backlog has been shrinking for some time. And really, what we're telling customers is that no more orders get accepted that our PSP orders, and customers have seen that lead times are short, capacity is available. As I said, the premise of why we kicked it off no longer exists. And, therefore, it will come to a natural end here fairly quickly, and we just stopped taking more orders that anyone may – if they didn't already understand, replacing as PSP.

Got it. Thank you.

Welcome.

Thank you. Our next question comes from the line of William Stein with Truist. Please proceed with your question.

Great. Thanks for squeezing me. I was also going to ask about PSP and the mechanics of how it rolls out of backlog. But I think you just answered that but I do have a sort of financial question around it. I believe for many of these orders, you were getting prepaid by customers and you might have been likewise prepaying for capacity at foundry. Can you walk through how those roll off of the financial activity of the company and when you expect them to be sort of in the rearview mirror? Is that do you think by the end of the March quarter?

Okay. So, with PSP, those were not typically customer paying cash in advance for any of that. We have certain long-term supply agreements and those had a cash prepayment element to them. Those are still in place. Those aren't - there's nothing that's happening with those programs related to the cancellation of PSP. So, those programs are still in place, and those tend to be three to five-year agreements, most of them five-year agreements, and those will just kind of run out over time. In some cases where customers' demand is not as strong as originally anticipated. We work with them to find a mutually workable answer on that, maybe to extend the program longer, they can add something else into the program for their volume commitments. But we're not looking to penalize customers with that program. And then on the supplier side, we have had certain prepayments that are made and contractual obligations that we have. That's the same thing there. It's a negotiation with our suppliers, and they're working with us, and I don't see that there's any significant financial disadvantage to us coming from those. But in some cases, we have taken on more inventory, maybe raw materials than what we would have otherwise.

Great. Thank you.

Welcome.

Thank you. And our next question will come from the line of Janet Ramkissoon with Quadra Capital. Please proceed with your question.

Hi yes. thanks for taking my questions. Can you guys give us a sense of what's going on with design activity? I know you've seen this real cutback and you're saying that there is really not much of a shortfall in terms of actual demand. Do you have any visibility, less visibility the same as before? Could you give us some sense on what's going on to give us a better sense of the long-term outlook beyond the June quarter?

Yes. No, thank you. So, design activity, as I said in my prepared remarks, is at very high levels. And I think it is because for a number of reasons, customers were in triage for some time as they were dealing with shortages. And as all that went behind, they went back to focusing on innovation. Our products and technologies are enabling innovation in many new fields. And so by many measures, both what we measure internally in terms of design wins and design funnel and all that and what some of our partners who are more design and focused particularly, the catalog distributors are a good example where much of the seeding activity that takes place are also seeing very high levels of that. So, I think the innovation machine is strong. And the inventory correction will pass and go and ultimately, the long-term growth of the business, as you noted, will come from how this innovation plays out and how the overall role content that semiconductors will play in that innovation being delivered on end products.

That's very helpful. And just one last one, if I could sneak it in. Is there any particular geography or a particular segment that you saw a faster rate of decline. I noticed that industrial as a percent of total was down just from the supplemental slides. Is there any color that you could give us in terms of geography or end markets where you saw most of the weakness?

I think they're all weak. I don't have a numerical way to give you. I can tell you that China, for example, has been weak for an extended period of time. So going back all the way to 2022 when they had the shutdowns, and it really hasn't recovered from there. But I think we've seen weakness in all geographies and pretty much all end markets with the exception of the aerospace and defense and a bit of the data center that was all AI focused.

And I believe the end market data that was posted on our website still references last full fiscal year, and that hasn't been updated. That's a process that we do once a year. So we'll take a look at the slide to make sure it's not confusing, but that's what I believe to be the case.

Okay. Thanks, guys. Appreciate it.

Thank you.

Thank you. There are no further questions at this time. And I would like to turn the floor back over to Ganesh Moorthy for closing comments.

Okay. I want to thank everyone for taking the time to be on this call and all of your questions. We look forward to having further discussions during some of the conferences coming up this year. And on that note, we are closing this call.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.