Good day, everyone, and welcome to Microchip's Third Quarter Fiscal 2021 Financial Results Conference Call. As a reminder today's call is being recorded. At this time, I would like to turn the call over to Chief Financial Officer, Eric Bjornholt. Please go ahead.

Thanks and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events 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’s business and results of operations.

Thank you, Eric and good afternoon everyone. Let's start by taking a closer look at microcontrollers. Our microcontroller revenue performed well with revenue sequentially up 3.3%, as compared to the September quarter. On a year-over-year basis, our microcontroller revenue was up 5.9%. We continued to introduce a steady stream of innovative new microcontroller solutions, including: the first safety certified capacitive touchscreen controllers for the home appliance market; the first Trust&GO Wi-Fi module delivering powerful 32-bit microcontroller functionality and verifiable identity; the industry's highest density secured Ethernet switching solution for hyperscale data centers and telecom service providers; and last but not least, three new broad market, 8-bit microcontroller families to extend our leadership in this product line. Microcontrollers overall represented 53.7% of our revenue in the December quarter. Moving to analog, our analog revenue also performed well and was sequentially up 3.1% as compared to the September quarter. On a year-over-year basis, our analog revenue was up 2.6%. During the quarter, we continue to introduce a steady stream of innovative analog products too, including the first cryptographic companion device supporting in-vehicle network security solutions, a new family of configurable 12-bit digital-to-analog converters, the first highly integrated radiation-hardened motor controller, and finally a family of low-latency PCI Express 5.0 and Compute Express Link retimers. Analog represented 27.6% of our revenue in the December quarter. Our FPGA revenue was down 8.5% sequentially, as compared to the September quarter. On a year-over-year basis, our FPGA revenue was up 7.1%. As we cautioned on our prior conference calls, FPGA revenue does have some lumpiness associated with them because of the large exposure to the aerospace and defense market and the associated purchasing patterns. During the quarter, we announced a radiation-hardened fourth-generation FPGA family and a low-power radiation-tolerant fifth-generation PolarFire FPGA family. FPGA represented 7.3% of our revenue in the December quarter. Our licensing memory and other product line, which we refer to as LMO was up 13% in revenue, as compared to the September quarter, with strength in licensing revenue driving this growth. LMO represented 11.4% of our revenue in the September quarter. A quick note about our product line reporting. Given the relatively smaller size of our FPGA product line at about 7% of our revenue, as compared to our microcontroller and analog product lines, we have decided that starting in calendar year 2021 we will no longer break out the FPGA product line separately. Our FPGA products remain important to our overall total system solutions goals.

Thank you, Ganesh, and good afternoon, everyone. Today, I would like to first reflect on the results of the fiscal third quarter of 2021. I will then provide guidance for the fiscal fourth quarter of 2021. The December quarter represented the shift of the business cycle back to revenue growth with a 3.3% sequential growth in a quarter where ordinarily, we would see 3% sequential decline from typical seasonal factors. December quarter revenue also grew over prior year’s December quarter by 5%. We started ramping our internal factories in September, as well as investing in capital additions to expand our internal capacity. We also started working with our supply chain partners to receive more allocation from wafer foundries and assembly test subcontractors. These efforts improved product availability in the December quarter, but still constrained to some of the revenue upside. We delivered a record non-GAAP gross margin of 63%, helped by a significant reduction in factory underutilization and better overhead utilization from revenue growth. We also achieved a non-GAAP operating margin of 39.8%, an all-time record and getting very close to and an emotional 40% mark. We also hit a record EBITDA of $593.4 million, despite revenue not yet a record, yet showing the robust strength of our business model. Our consolidated non-GAAP EPS was $1.62, $0.05 above the mid-point of our guidance. This was also our 121st consecutive quarter of non-GAAP profitability. Now, I will discuss our guidance for the March quarter. Our bookings were exceptionally strong in the December quarter and were an all-time record. We received bookings both for short-term as well as into the future quarters. The backlog is also an all-time record. Please remember that bookings, as well as the backlog is what is shippable in the next 12 months. The backlog for the March quarter is the strongest starting backlog I’ve ever seen. Our bookings have remained strong in January. On the operational side, the December quarter was constrained by product availability. We will have more internal and external capacity in the March quarter since we have had multiple months to ramp. Although, I believe that wafer fab, as well as back-end constraints are here to stay with us through calendar year 2021. In response to the business environment, we have taken three actions. First, in the middle of December, we changed our cancellation and pushed out terms with our customers and distributors. The standard terms used to be that an order cannot be canceled or pushed out once it is within 45 days of shipment. We changed our standard terms so that an order cannot be canceled or pushed out within 90 days of shipment effective January 1, 2021. We gave customers a couple of weeks to adjust their backlog before it went firm for 90 days. In response to our change in terms, we did not see any unusual cancellations or push-outs which indicates to us that the backlog was firm and needed by our customers. That gave us a solid backlog for the March quarter, which cannot be canceled or pushed out. Therefore, we can batch process the orders and use our manufacturing assets most efficiently, knowing that what we build will get shipped. The second action we took was that we sent a letter to our customers on January 4, 2021, informing them of the business environment. We also informed them that we are seeing broad-based cost increases and some aggressive commercial terms from our supplier base, and we must pass these cost increases to our customers through a broad-based price increase. The third action we took just this morning, we posted a letter on our website and sent it to our customers and distributors, announcing a new program called the Microchip Preferred Supply Program, or PSP. This program offers our customers the ability to receive prioritized capacity in the second half 2021 and first half 2022. The program has the following elements. The customers participating in this program will have to place 12 months of orders, which will be non-cancelable and non-reschedulable. The capacity priority will begin for shipments in July 2021. The program will not be a guarantee of supply. However, it will provide the highest priority for those orders which are under this PSP program. And the capacity priority will be on a first-come-first-served basis until the available capacity is booked. We will, of course, reserve a portion of our capacity for new customers, small long-tail customers, and new designs. We expect that a significant portion of our capacity will be booked under this new program with a large committed non-cancelable backlog for 12 months, Microchip will be in a stronger position to make capacity and raw material commitments to our suppliers by capital equipment with confidence, hire employees and ramp up manufacturing, and manufacture products more efficiently. Taking all these factors into consideration, we expect our net sales for March quarter to be up between 5% to 10% sequentially. The March quarter guidance at the mid-point would represent record GAAP net sales with the prior record being in the September quarter of 2018. The September quarter of 2018 based on GAAP sell-in revenue recognition was $1.432 billion. Some of you may still carry a sell-through base number of $1.513 billion for September 2018 in your historical financial model spreadsheets. The March quarter will also be limited by product availability on many product lines. Our guidance assumes working through a myriad of capacity constraints, qualifying incremental equipment installed, qualifying alternative subcontractors in some cases, and still dealing with a risk of production constraints with a new wave of COVID cases plaguing the planet, and at the same time, ramping of vaccinations. For the March quarter, we expect our non-GAAP gross margin to be between 63.3% and 63.7% of sales, which would be a new all-time record. We expect non-GAAP operating expenses to be between 23.2% and 23.6% of sales, and we expect non-GAAP operating profit percentage to be between 39.7% and 40.5% of sales. We expect our non-GAAP earnings per share to be between $1.67 per share to $1.79 per share. We also expect to pay down another approximately $350 million of our debt in the March quarter. Finally, I want to cover one other area, which is our future cash return strategy. At the rate we’re paying down debt, we expect to break and net within a year and continue to decrease from there. At that time, we expect to begin distributing more of our substantial amount of free cash flow to the investors in the form of dividends and stock buybacks. Regarding buybacks, through multiple tranches of convertible debt buyback, we have essentially bought a substantial amount of stock back from the future. This is because as the stock price rises and exceeds the conversion price of the debt, convertible debt dilutes the share count back prevents future dilution as the stock price rises. Our first convert buyback was in March 2020 when Microchip stock price was about $71. Since then, we have done four other buyback transactions at various stock prices. By doing these various buyback transactions, we have purchased a total of $3.525 billion in face value of our convertible bonds. For the transactions from March 2020 to September 2020, we issued a total of about 20.4 million shares of our common stock to the investors for in the money value of their bonds. If these bonds have remained outstanding until an assumed stock price of $140 per share, the stock price about now, the dilution would have been about 26.4 million shares. Thus our repurchases had the impact of creating a savings of about 6 million shares worth $840 million savings to our investors at $140 per share. This calculation does not include our November 2020 transaction, which was very recent and executed at 133.47 per share, so it is not yet accretive. Therefore, while we have not done any open-market stock buybacks in the last year, our convert transactions have had the impact of a buyback of approximately 6 million shares. At some point in the future, we expect to start pure stock buyback from the open market. We are also initiating a path to higher dividends and not waiting until our leverage, which is a given number before the dividend starts to increase. In this regard, we announced today that the Board of Directors have approved a dividend increase of 5.8% sequentially to $0.39 per share, up from $0.3685 previously. We expect to continue to increase dividends quarterly as part of our cash return strategy. Given all of 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 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 expect that the analysts – and we request that the analysts continue to report their non-GAAP estimates to first call. With this, , will you please poll for questions?

Certainly. And we'll take the first question at this time. Caller, please go ahead.

Not able to hear you, maybe you are on mute.

Steve, can you hear me?

Yes, now.

Apologize. I didn’t hear my name get called. Just heard caller. Apologize for that. Just really quickly, we've lived through multiple times of you sending out customer letters. And we kind of have an understanding of how the market responds to that, I'd be kind of curious, the preferred supplier agreement that you talked about in your opening remarks, is this the first time that you have done that? And if it's not, what's been the historical response to programs like this?

So, the preferred supplier program is brand new. I have not ever implemented it in my 42 years of career, and I have never seen anybody else do that too. The program is largely a response to the current environment, because bookings level is just so strong and people are booking parts out in time. The industry seems to be, you know, 30% plus sure to really what the capacity requirement is. And many of our customers have been asking, you know, what can they do if they give us longer-term demand, longer-term orders, you know, will that give them parts, will that give them better support? Now, you know, customers can give us longer-term orders, but if the orders cancellable or reschedule, you know, after 90 days, which was the case prior to the program, then I could have a lot of orders for September and December and could buy capital, hire people to rent but just before I get there, people could cancel, if there was a double ordering, people were asking more than they need, and they cancel part of the orders. So there is often the problem always and you guys ask the question, is there any double ordering or whatever. And in this program, basically, eliminates all that. It asks the customers to place 12 months of backlog, which will be non-cancelable, . So, I can take that one to the bank, buy raw material, do batch processing, grow the capacity and give them preferential supply. So, this is the first time we have implemented. It’s just a need of the times.

And I know it was just this morning, but what do you expect the intended response to be from your customers?

Well, you know, small number of customers, you already have feedback through the day, including a couple of distributors, their response is positive. They will place such orders, you know, I don't expect any customer to place their entire backlog on every product on the PSP program, because customers themselves have some programs where they're solid, that the demand is good, they have a good market share on that particular design. But some others could be some new programs where the demand is yet not known. So, I think customers will really take a lot of the product and put it on and some others that they want.

Perfect. Thank you guys.

Welcome.

We’ll take the next question. It comes from Toshiya Hari. Please go ahead.

Hi, good afternoon. Thanks so much for taking the question. Steve and Ganesh, given the current supply and demand situation, what are your thoughts on pricing across your microcontroller and analog business and if you can kind of speak to gross margins on the back of that, that will be helpful. And I guess, sort of related to that, given the preferred supplier program, how should we think about the economics of that program? Thank you.

So, you know, we sent a letter to our customers on January 4, really informing them, first of the business environment and also informing them that we were seeing broad based cost increases and some very aggressive commercial terms from other suppliers who were facing similar issues from their suppliers really up and down the supply chain. And we must pass these cost increases to our customers through really a broad based price increase. So after writing that letter then we need to really develop that program and we got, you know, several hundred thousand skews and going through the price increase on, you know, on which part and how much and passing on to the customers working through their contracts and long-term prices and stuff like that. So, all that really has been implemented at this point in time. We're in breaking out, you know, what portion of the guidance is price increase, you know, that's going to be relatively difficult, but the price increases have already been made effective. As far as the economics of the PSP program, the economics of the PSP programs really are in having a committed non-cancelable, non-reschedule level backlog on the books that we can build it in batches by raw material ahead if we wanted, you know, increase the inventory if we wanted to serve that and build it whenever we have a , essentially, that's why the economics are, to be able to serve the customers better who joined the program, and Microchip not be subject to ordering more than they need and double ordering because they're not going to double order and order more than they need if they cannot reschedule or cancel. So that's where the economics are. There’s no price change with that price program is totally separate.

Thank you.

I don’t know if that answers your question.

Thanks.

We'll take the next question that comes from Vivek Arya. Please go ahead.

Yes, go ahead. Thanks for taking my question. Steve, you use this phrase, significant revenue growth in calendar 2021, and you're starting the year at about 10% year-on-year growth. Is that a significant number, is it something higher than that? And more importantly, what kind of growth can your supply chain support this year?

I know, you must have noted what I said, I thought I talked about – the question really was that, you know, Street had 7% growth, do you expect something higher than that? And my answer was yes. So, you know whatever – anybody interpreted, I don't know what significant means. And I can't really give you a number for the growth for the year although I think the revenue is more constrained by capacity than the demand, at least now and for the next several quarters, which leads to your second question, what kind of growth the supply chain support? I think one of the problems that we're dealing with is that the supply chain is not as stable. You know, we're finding that, you know, subcontractor will commit that they can do X number of parts per week. And as we get there, they would change that number, they would lower that number or push it out by a couple of weeks. Well, what happened? Well, what happened was they got a from their supplier. They didn’t get some bundles they were expecting. They couldn't hire some people, somebody tested positive for COVID. So they had to send 50 people home, who had come in contact with it. So, you know there is no slack in the system. Everything that gets built, get shipped, there's absolutely no slack in the system. So, any perturbation, there was an earthquake in Taiwan, we had a car that hit our substation in fab in Oregon that knocked out about three or four days, partial knockout, not complete. You know, none of those things are makeable, because all factories are working seven days a week, you know, full board. So, any delay in equipment, just leads to a de-commitment. So, I think those are all the myriad of problems we're dealing with, in adding equipment, adding people, qualifying additional subcontractors, getting our customers to waive qualification. You know, automotive are the hardest customers to qualify production in a different plant or to approve a change. And in the last six months, we have been so successful in getting even all the automotive customers that they would buy the product from this alternative assembly site, a test site or all that. So, we're getting help in that area. But it's still a very, very complicated, you know, process to put it all together. And therefore, we're not willing to dollarize the number or what percentage we could grow. Not yet.

Thank you.

We'll take the next question that comes from Craig Hettenbach. Please go ahead.

Yes, thank you. Just a question on inventory at 26 days, you know, when would you expect that to perhaps get back to kind of within normal ranges and any trends you could share just by geography in terms of ?

You know, distribution would love to grow the inventory in this environment to serve the customers better. But, you know, the can't grow, there isn't – it's not enough product available to grow the inventory, because product keeps getting shipped out. Another point I would like to make is that our inventory, as well as distributor inventory is calculated based on last 90 days of sales. So, it's based on the prior quarter. So, essentially, you know, if you – the real value of the inventory is to support the future. So, if you take our guidance and take the mid-point of that guidance, let's say, and calculate the days of distributor inventory, or Microchip inventory, based on that guidance, then the inventory numbers are extremely low. But they are calculated as we report which is a standard convention based on the past 90 days. In a very stable environment flat sales it doesn't matter, but in a significant growth, the real inventory is actually much lower than the numbers were reporting, and we don't think it's going to grow. I think our internal inventory will drop this quarter. We expect by several days and distribution will do the same.

Got it. And then just a follow-up for Ganesh on the total system solution, any progress there or things you can share with us in terms of developments?

Sure. So, you know, it's not a one-quarter progress. It's a multi-quarter activity that we've had. The processes that need to be put in place have been there. The process of going in, is reflected in how we see the design activity taking place, some of which we've shared anecdotally and some of the conferences we will share some more this coming quarter as well. But I think the power of the whole coming together, putting all the different parts of Microchip on a customer's board is very much strong and alive and a key part of our growth strategy.

Got it. Thank you.

We'll take the next question that comes from Gary Mobley. Please go ahead.

Hey, guys, thanks for taking my question. So, I know you started the December quarter with your distributor inventory levels slightly below average, and looks like you under shipped into the channel by about 26 million in the December quarter, is that how we should think about perhaps what, you know, how much higher your revenue could have been, if you had, you know, available, you know, production capacity and whatnot, a similar amount, as we look out into the march quarter?

Well, you know, we, we had unsupported orders, for every geography, for every product line, for direct as well as for distribution. So, just picking a number that the distribution inventory went down by – and just seeing, you know, that's the revenue we missed for the December quarter will not be accurate. We're not breaking up the number, but the total amount of revenue that we missed also was also from direct and essentially in every geography.

Okay. As my follow up, I wanted to ask about your philosophy towards M&A when you get to that magical net leverage ratio of less than 3 x, is that, should we take that to mean that you're also open to some M&A transactions at that point, as well?

I think we have spoken extensively about this in the past saying that we believe, you know, there was an era of M&A, as you know, in the last 12 years or so we did 16, 17, 18 acquisitions, a few large ones public and lots of them small private and all that was intent to, you know, scale the company, you know, 10 x or so, and now we're over $5.4 billion company, and really not have a scale disadvantage to our competitors. I think we have achieved that. And today, we have a product line with which we can complete a customer's entire solution and essentially have all the parts built out of Microchip products and other than and connectors and battery, everything else is really made from Microchip. So, today, there is not, you know, that need for M&A and no . So, we are really building a strategy going forward on organic growth built from really large amount of success in providing total system solutions to the customers. It could be a tuck-in acquisition here and there, you know, private, smaller or really buying some people, which is a, you know, technology pipeline or something like that, but there is really no plan currently for doing any kind of large acquisition even after we reach a certain leverage.

Appreciate it. Thank you.

We'll take the next question that comes from Chris Caso. Please go ahead.

Yes, thank you. The first question is about some of the capacity additions that you're undertaking now, could you talk about one the direction of CapEx over the next couple of quarters as you try to address these – some of these supply constraints? How long does it take to, you know, get the capacity in place? And then lastly, you know, to what extent are you looking to address these constraints through internal means, as opposed to, you know, getting them through outsourcing? What's going to be the quicker and more sustainable path to getting some more product to your customers?

Eric, you want to take the CapEx question?

Sure, sure. So, we've indicated that in the very short-term, for the March quarter, we're expecting to stand between $50 million and $60 million in CapEx. We've kind of given general guidance to the Street, the longer-term, we expect our CapEx as a percentage of net sales to be somewhere between 3% and 4%. You know, this quarter we’ll be going through our annual operating plan for our next fiscal year and will provide kind of a more detailed forecast in fiscal 2022. But I wouldn't be surprised if we're on the high end of that range for next fiscal year. We’ve been well below it for the last two fiscal years and so quite clear environment is driving that. And I'll start with the second piece of the question. And Steve or Ganesh can add on to it, but you know, we have been making significant investments, and assembly and test expansion. And actually, this last quarter, we did 65% of our assembly in-house that's up significantly quarter-on-quarter. And we did 57% of our final test in-house. So, you know, these metrics tend to be slow moving, but we are making progress on that, and is allowing us to take a little bit more control of our own destiny. So, with that, I'll turn it back to Steve.

So, I think one of your questions implies that, what portion of the CapEx we were spending for internal versus external, I think 100% of our CapEx is really being applied to grow the capacity internally. The external capacity growth, we're getting it just by getting larger allocation and negotiating for a larger piece of the total capacity pie at foundries and subcontractors. We're not really spending our CapEx dollars in growing their capacity, but our capacity is growing significantly, outside also. But overall, as Eric mentioned, you know, especially in the assembly and test area, a large portion of capacity growth is happening inside.

All right. As a follow up, you know, given the strongly better than seasonal March, the fact that you've got, you know, backlog that that's difficult to fill all of that, you know, how do we think about seasonality through the rest of the year, and they're always difficult questions right now, but, you know, any kind of qualitative comments that you can provide would be helpful.

I think seasonality has been difficult to define for Microchip for some time because of all the acquisitions, and especially with Microsemi, the end market mix changed so much that we said, you know, if you got a year or two years of stable environment, then one could figure out what the seasonality would be. And we haven't gotten that stable environment. First for the U.S. China trade, and last year was COVID. And this year is this runaway growth, our capacity constraint. So, in this environment, it's not the seasonal factor that's changing what you can or cannot do. It's a combination of how much capacity you can grow what the overall demand is. So, I can't really comment much on seasonality in this kind of environment.

Thank you.

We'll take the next question. It comes from Harlan Sur. Please go ahead.

Good afternoon. Thanks for taking my questions. Maybe as a follow up to the last question, I know the difficulties and complexities in quantifying full-year of revenue generation potential, but maybe more near term, you know, I assume that the team is almost fully booked for the June quarter, maybe you guys can confirm that. And that would include any unshipped delinquencies from March. And June, you know, we could argue, you know about seasonality, but typically June is up sequentially. So, your requirements are probably already fixed for June, given the lead time of some of your foundry partners, but wondering if you guys would be able to bring on, you know, and qualify additional wafers in assembly and test capacity in time to support higher levels of revenues from where you are here in March, if it plays out that way in June?

So, you can’t qualify different fabs in a matter of three months or six months. You know, depending on what the process and products are to you, it's a much longer effort. So, a lot of the capacity growth is really coming out of, you know, growing capacity where the processes are already installed. You know, we got some processes that are installed outside, as well as inside. And most of the other majority of our processes either run outside or an inside and when they run outside, they usually only either run in one foundry or the other foundry. So, there's really no process that runs in three or four different foundries. They may run in three or four different fabs of the same foundry. You know, like take TSMC, it could run in three different fabs of TSMC, but it doesn't run in TSMC, as well as global, as well as UNC or something. So, the capacity growth is largely coming from where the processes are already installed, from a fab standpoint. From an assembly test standpoint, yes, we're qualifying additional alternate assembly subcontractors which could give additional capacity. But there also, majority of the growth in assembly, as well as test is coming from buying capital and installing in three of microchips large facilities, two in Thailand, and one in Philippines. They are basically doing record amount of assembly and test every day. And capacity is rising, every week, every month, every quarter for the rest of the year.

So, I guess my question is…

A second comment there from, Harlan talking about or kind of implying that June quarter is fully booked, and you know that is not the case. June quarter isn't fully booked, the March quarter isn't fully booked, it can be fully booked on certain products. And you maybe are going to ask and expand on that a little bit.

Yeah, I mean, you know, even for this quarter, we have strong backlog. But we have some turns we have to pay. And there's turns to pay for the June quarter. As Eric mentioned, there are certain product lines, which can be much closer to being booked up. And that's typically, you know, it is starting at a much higher backlog than a normal quarter would be, but there is still work to be done and there is capacity coming online, which will help with some of the growth, both that's helping this quarter, as you can see this December and some more into June.

Okay. So you answer my – well that was going to be my third question or what was my third question in that which is, irrespective of how the demand plays out, you know, if June quarter backlog ends up suggesting a higher June quarter, you guys would have the capabilities in place foundry or internal to drive higher revenue levels sequentially in the June quarter?

Absolutely, yes.

Okay. Thank you, Steve. Thank you, Ganesh.

You’re welcome.

You’re welcome.

We'll take the next question at this time. It comes from Ambrish Srivastava. Please go ahead.

Hi. Thank you. One the near-term, and then I have a longer-term, Steve, and really just wanted to make sure I understood that part. On the near-term, the Preferred Supply Program you started just this morning. But does the guide for March, does it include the change in cancellation from 45 days to 90 days? Is that part of – has that been implemented long enough to reflect in the March guide?

So that was told to the customers in early December or maybe it was the middle of December, around maybe 8th or 10th December. And we gave them then the following three weeks or so to make any changes to the backlog they wanted to make, and on January 1, the backlog will go hard for the 90 days. So – and there were very few changes made. There were just meaningless very small changes. So, as of January 1, then whatever was on our books for the March quarter, it became firm with no changes to be made. And that backlog position for the March quarter was very strong, strongest we have ever seen in our careers. Now as Ganesh answered earlier, and Eric answered, that doesn’t mean the March quarter was fully booked because you always have products where this product available and customers and distributors can continue to come and buy those products for the lead time is still fairly short and shippable within the quarter. But a very large number of products were also completely booked and nothing available for March, and some products even nothing available for June. So, the impact of that 90 days was effective on January 1.

Got it.

And then as you go, as you finish the month of January, then the backlog is now hard for February, March, April. By the end of February, the backlog will be hard for March, April, and May. So that was the 90-day program. The PSP program is an entirely new program. The 90-day program was applicable to all customers worldwide, direct or distribution. The PSP program is a customer adoption. It’s not – we can’t force them to give us one year of backlog, so that was an option given to the customer, so they can have an ability to get preferred supply support if they would give us 12 months of non-cancelable backlog, which helps us in bringing capacity online and buy capital and hire people with confidence, and it gives them preferential capacity. So, there is something in it for both.

Got it.

Just want to make sure this is clear – I want to make sure this is clear that has zero impact on the March quarter.

Or the June quarter, for that matter.

Got it.

Yes. The preferential, just .

Yeah, I understand. I just want to make sure…

The PSP program support starts from July. Now, the order, they can replace it now for 12 months. But if they come up with a whole bunch of new orders for March, April, May, June, they can’t get the supply ripped off from other people who have placed the backlog before. So, PSP capacity support does not begin till July.

Got it. I wasn’t confused about PSP. I just wanted to make sure that the March quarter is – it sounds like you were able to pull together a lot of internal and external to guide to what you did, and it also has some back – or some solidity, I lack of a better word, because of the 90 days that you started in December. That’s what I wanted to understand because there is a concern about double booking, but sounds like the way you have framed it and the way you’re running the business at this point seems like you have quite a lot of visibility on that. My longer-term question, Steve, and thanks for addressing that. Your business model is transforming and you have been talking about M&A being less of a priority given where the valuations are and focus on organic. So, the question – and you addressed it by saying the buyback, even though not directly, you have been bringing down dilution. What was the point you made on dividend? I missed that. What’s the formula that you have in place for dividend growth?

We don’t really have a formula in place. We just – Board will meet every quarter and decide the dividend for every quarter. In the current quarter, we grew the dividend by 5.8%, and you couldn’t expect that Board will grow the dividend every quarter. And that’s really our commitment. I told in the last couple of quarters that we would build a glide path towards higher dividend, and this is a glide path towards a higher dividend. So, if you cumulate the increase in dividend for four, five, six quarters, then by the middle of 2022, you already would have a significantly higher dividend after seeing fixed increases of the kind we just did. That’s really what we’re trying to do to get to higher dividends, and by that time, leverage would have come down and such – that higher dividend will really be supportable at that point in time both – from the cash flow, and still have enough cash available to keep bringing the debt down further.

Got it. Thank you.

We’ll take the next question that comes from Chris Danely from Citi. Please go ahead.

Hey, thanks, guys. I guess just a little bit of color on the capacity constraints and shortages. So, Steve, you talked about it being in the automotive, industrial and consumer sectors or end-markets. Most of your competitors are just saying, automotive. Would you expect this to spread to those other end-markets for your competitors and other folks in semis? And then when do you remember these shortages being this bad? Do we have to go back to like 2010 or 2000?

I do not remember shortages being this bad ever. So, this is just like – this is a Six Sigma event in terms of shortages, call it a Black Swan event, although that’s more meant for negative. I don’t really know what other competitors are seeing what, but our capacity for automotive products and industrial products and consumer products is really common. It runs at the same fabs, the same processes, sometimes they have the same parts that we can ship into an automotive or ship into an industrial. So, the capacity constraints would really be shared by all markets. Now, the largest increase in demand has been in automotive, wherein the June quarter, automotive demand went to 20% of normal because all the factory shut down. And as that demand has gone back to 95% of normal or 100% of normal, that’s 5x increase in auto demand. So, they are seeing sort of there were shortages, because they didn’t place their orders, they didn’t really guide towards having this stronger V-shape recovery, so their are worse than that, but the capacity is common.

Okay. Thanks.

There is also a fact that in automotive, $1 part can prevent a $40,000 car from shipping. In industrial, $1 part could just prevent 1,999 power drill from that shipping. So the hurt factor is quite different, so therefore the noise from automotive and the escalations of the management team and the pressure and all that is really of a different level.

We’ll take the next question that comes from Harsh Kumar. Please go ahead.

Yeah. Hey, guys, first of all, congratulations on the tremendous guide, I guess, just a sign of what you’re seeing. And Steve, I had two , I wanted to go back to what Harlan was talking about earlier. As you get over year supply issues, let’s say whether it’s June or July, am I incorrect in thinking based on your kind of what you mentioned in the press release of having a very strong year? As you are able to supply, should we not expect the second half that is better or stronger? Or help me think about linearity from here. And then for Eric, the question is on gross margin. If I’m not mistaken, you’re at your target or very close to it. With no M&A, would there not be a to think about that gross margin as you get more and more efficient?

So, I think taking the question of capacity, you mentioned somehow that we catch up by June, July. We don’t expect to catch up on demand capacity balance for the balance of the calendar year 2021, and could possibly go into 2022. I mean we already know that the demand on lots and lots of products succeeds where we have no product available. If you place an order today, we were shipping here in September, October. And people are booking September, October, November, fast. And with the PSP program, we’re going to get backlog all the way through next January, February. So, I don’t think the capacity issue is getting solved in the next four, five, six months. I think we’re talking a 12-month at least to solve that – to really have the capacity get in balance. And I don’t remember the other part of your question for Eric.

The other one was gross margin.

Yeah. I’ll take the gross margin question. So, we did actually update our long-term targets for gross and operating margin back in December. We took the gross margin target to 65% and the operating margin target to 42%. So, we essentially achieved what was our prior target of 63% on the gross margin with the last quarter results, and are guiding at the midpoint to about 63.5% this quarter. So, gross margin was absolutely going to highlight over the last couple of years, and we’re continuing to do all the right things to be efficient in our operations to drive improvements. And I’m not sure if you have more follow-up on that, but we definitely have outlined five or six things that are going to help us continue to make improvement on gross margin into the future, and we can go through that separately if you’d like, Harsh.

I appreciate the clarification, Eric. I’m good. Thank you.

We’ll take the next question that comes from Janet Ramkissoon. Please go ahead.

Yeah. Nice creativity, guys with this new program. I was going to ask a question about the margins as well. It just seems to me that if you have a lot of visibility and you could procure supplies in a more timely and efficient manner, and you just plan better generally speaking, as you go – as you exit 2021, you should be in a position where you would hit those target margins – you could hit those targets margins a lot sooner. Am I correct in thinking that, Steve or is there something I’m missing?

Well, you know the PSP program doesn’t really do anything to the margin, and historically it could make us more efficient if we get a large amount of backlog, lots and lots of customers pick up on that offer, and then we can build the product more efficiently. It could help a little bit on the cost side of the equation. But PSP program wasn’t launched to drive margins. It was launched to get a firm customer backlog that we can be confident of growing our capacity and not have any double ordering or excess ordering in that backlog, which could go away when we get there. That’s why it was launched. It was not launched for margin. And I don’t think it’s going to have a lot of impact on margin. Now, as we are growing through this growth period, you have three or four things happening. Number 1, all the underutilization is going away. Most of it has gone away in March, but some could be going away in June. Number 2, as the incremental capacity is being added, the incremental capacity usually is more productive because you’re not adding the entire – every machine, you’re adding bottlenecks here and there. So, when you add debt capacity, the incremental margin through and for every dollar of revenue tends to be better, and if you go back in the prior cycles and calculate incremental margin to get some idea. The third being, we are bringing some products, both in fab and assembly and test from outside to inside, and those moves are accretive, there could be something else. The impact of price increase, I think is going to be relatively benign because we largely launched that to offset the cost increases. But you can’t always increase the price on a product. We have seen the cost increase. We got to look at the product whether there is a competitive element there or it’s a proprietary product, so the price increase and cost increase don’t completely match product-by-product. But overall, we might get some benefit and certainly in revenue, probably not in margin.

That’s very helpful. Thanks very much. Great quarter.

You are welcome.

We’ll take the next question at this time. It comes from Denis Pyatchanin. Please go ahead.

Hi. Thanks for taking my question. I’m here to ask a question on behalf of Raji Gill. Is there any chance you could provide us with some more color on the various, kind of end-market gross margins, kind of how do those move throughout the last quarter? So, you know, if you maybe you can break it out by your reporting segment?

We don’t break out gross margin either by end market or by product line. So, we reported at the company level and that’s all we have.

I see. And as a follow-up, how do you expect kind of the recent investments into the internal capacity to impact your margins over the next three quarters? Would you say that there is going to be a noticeable impact of the internal capacity coming online? And has that been factored into your guidance? Or do you expect that to maybe hit towards the – kind of the end of the calendar year?

So, I think – go ahead.

No, I was going to say, I think these come on slowly. They’re not going to make big quarter-to-quarter changes in what they’re at. Directionally, each of them is a small step in the roadmap that we have said we want to improve our gross margins through the long-term target. But I would not be looking for quarter-by-quarter. These are making big changes in the gross margin of the company overall.

I see. And that was all. Thank you.

We’ll take the next question that comes from Christopher Rolland from Susquehanna. Please go ahead.

Thanks for the question, guys. Just two quick ones from me and then I’ll get off. I guess, Steve, first of all, PSP. Ultimately, what percent of revenue do you expect to go through the PSP program versus other? And then secondly, as you bring some internal capacity home, even on the wafer side, does this bring up a conversation about a 300-millimeter fab or not? Is that – at what point does that become of interest to Microchip?

So, I think the first part of your question, what portion of the revenue we expect to go through PSP, we really have no idea. It’s never been done before. It is being launched by taking on questions from many large customers saying, what can you do to make sure I get capacity support in the second half. I’m delinquent now, you’re not giving me everything I need, so how can I ensure that I get that in the future? And so, we came up with this program and saying if you commit that your orders for that next 12 months and non-cancelable and non-reschedulable then we will go with confidence, bill that product and give you preferential support. So, we do not know what the uptake would be and we’re just purely guessing. We just launched it this morning, and have gotten three or four inputs since then, one from a major distributor and few from customers. One customer, I had talked to personally. So, I think this is the heart of the . So that’s that. The other part of your question was the 300 millimeter. There is no plan to do any 300 millimeter inside. And we continue to have two large 8-inch fabs and one large 6-inch fab and a number of small 4-inch sort of fabs that we are transitioning product away from those 4-inches to a 6-inch and 8-inch fabs. The 12-inch capacity continues to be at our foundries for any foreseeable future.

Thanks, guys.

There are no further questions at this time, and that ends our question-and-answer session for today. I’d now like to turn the conference back over to Mr. Sanghi. Please go ahead.

Yeah. I want to thank everyone for attending the call. Also want to say that this is my last call as CEO. As many of you know, Ganesh Moorthy would be the CEO starting March 1. I would still attend the call. I will stay engaged with investors, but Ganesh will take the lead role. And if some of you are expecting to find a softer version of Steve, you may not get that. Internally, he is than I am, but we’ll see externally how Ganesh acts. So, thank you all. Bye-bye.

This concludes today's call. Thank you for your participation. You may now disconnect.