Good day, everyone, and welcome to Microchip's Fourth 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 Microchip's Chief Financial Officer, Mr. Eric Bjornholt. Please go ahead, sir.

Thank you, and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual and events 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. In attendance with me today are Ganesh Moorthy, Microchip’s President and CEO; and Steve Sanghi, Microchip’s Executive Chairman. I will comment on our fourth quarter and full fiscal year 2021 financial performance. Ganesh will then give their 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.

Thank you, Eric and good afternoon, everyone. Our March quarter was also strong by every key metric, closing a tumultuous fiscal year on a very positive note, which was otherwise dominated by the effects of the COVID-19 pandemic. March quarter revenue was an all time record at $1.467 billion, growing by 8.5% sequentially. Non-GAAP gross margins were another record at 64.1%, up 110 basis points from the December quarter as we benefited from improved factory utilization and product mix. Non-GAAP operating margin is also a record at 40.7%, the first time we have broken through the 40% mark. Our journey towards our long term business model of 65% gross margin and 42% operating margin is off to a good start, but still has a lot of hard work ahead of us to achieve. Our consolidated non-GAAP EPS was above the high end of our guidance at a record $1.85. EBITDA was very strong and achieved another record at $652.3 million, continuing to demonstrate the robust profitability and cash generation capabilities of our business through the business cycles. The March quarter also marked 122nd consecutive quarter of non-GAAP profitability. I would like to take this occasion to thank all our stakeholders who enabled us to achieve these outstanding and record results in the March quarter, and especially thank the worldwide Microchip team whose tireless efforts not only deliver our fine strong financial results, but also supported our customers to navigate a difficult environment and who worked constructively with our supply chain partners to find creative solutions in a hyper constrained environment. Reflecting on our fiscal year 2021 results, we achieved a number of highlights and records in the last year. Revenue was a record at $5.438 billion, non-GAAP gross margin was a record at 62.8%, non-GAAP operating margin was a record at 39.6%, and non-GAAP EPS was a record at $6.59. All in all, the record March quarter results and the record March ending fiscal year 2021 results marks a seamless transition between Steve and I as we each embark on our new roles to build the next phase of Microchip's long term success. I'm truly fortunate to be the beneficiary of Steve's years of managing Microchip for the long term.

Thank you, Ganesh and good afternoon, everyone. Today, I would like to provide you further updates on our cash return strategy. But before I do that, I would like to say, how I continue to be very proud of all employees of Microchip that have delivered a flawless quarter and making new records in many respects: Namely, record net sales, record non-GAAP gross margin percentage, record non-GAAP operating margin percentage and record EBITDA. Now, I will turn to updating you on the cash return strategy. We completed the March quarter with a net debt leverage ratio of 3.71, excluding the long day to 2037 maturity converts that are more equity like in nature. At the rate, we are paying down debt we expect to break net debt leverage ratio of 3 within a year and continue to decrease from there. Around that time, we would also expect to achieve an investment grade rating, but the exact timing will depend on the analysis of the rating agencies. At that time, we expect to begin distributing more of our substantial amount of free cash flow to our investors in the form of dividends and stock buybacks. Regarding buybacks. Through our various convertible debt exchanges, we have essentially bought a substantial amount of stock back from the future. This is because as our stock price rises and exceeds the conversion price of the debt, convertible debt dilutes the share count. Buying converts back prevents future dilution as the stock price rises. Our first convert buyback was in March of 2020 when Microchip stock price was about $71. Since then we have done five other buyback transactions at various stock prices. By doing these various buyback transactions, we have purchased a total of $3.884 billion in face value of our convertible bonds. For the transactions from March 2020 to December, 2020, we issued a total of about 27.5 million shares of our common stock to the investors for in the money value of there bonds. If these bonds had remained outstanding until an assumed stock price of $160 per share, the dilution would have been about $36.4 million shares. Thus, our repurchases had the impact of creating a savings of about $8.9 million shares, worth $1.424 billion savings to our investors at that assumed price of $160 per share. This calculation does not include our February 2021 transaction, which was very recent and executed at $163.25 per share, so it is not yet accretive. While we have not done in open market stock buybacks in the last year, our convert transaction had the impact of a buyback of approximately 8.9 million shares or about 3% of our outstanding shares. We expect to start stock buybacks from the open market after we have achieved an investment grade rating, which we expect within a year depending on the rating agency. Meanwhile, we did not want to wait for starting higher dividends until our leverage ratio reaches a given number, so we initiated a path to higher dividends in our February 2021 dividend announcement with 5% dividend increase. We are continuing on this path as we announced today that the Board of Directors have approved a dividend increase of 5.9% sequentially to $41.3 per share, up from $0.39 previously. We expect to continue to increase dividends quarterly as part of our cash retention strategy. With that, operator, will you please poll for questions?

We'll take our first question from Mark Lipacis with Jefferies.

Steve, I had a question for you about the PSP program. On the surface, it seems like you instituted this program to help customers on a more tactical basis. But I wonder if you believe there are secular drivers that ultimately may have led you to PSP kind of program anyway. And do you think -- now that you have this program, do you think it becomes a more permanent part of your standard operating model going forward?

Well, going back to as we implemented the program and why we implemented the program, let's kind of revisit that history. The backlog was so strong and constraints were so widespread as Ganesh mentioned in his 40 year career and mine, 42 plus year careers, we have never seen this kind of shortage in constraints in the semiconductor industry. So the question really became how do we take our key customers in various segments, not only automotive but industrial and communications and data centers and PCs and all and allow them some mechanism where they can get preferred supply of parts, and it's something in it for them and something in it for us. And the design of that program became this Preferred Supply Program in which we asked that if you could give us 12 months of noncancelable nonreschedulable backlog, and there is a tremendous benefit to Microchip, we could buy supplies ahead, we could hire people, we could make capital investment, we could do all these things with the assurity of a very, very large, solid, noncancelable, nonscheduleable backlog, that's a benefit to us. And what the customer gets is after six month period, and we did that six months period because we don't want to create a lot of churn in the first six months, and there was more availability of capacity after six months. So at that point in time, we said anybody who gives a PSP backlog, they will get the preferred supply. And if there is any shortage at that time, it will be spread among the non PSP customers. So long answer, but that's really how the program came about, not knowing what the acceptance would be and the results just have been absolutely tremendous. We have billions of dollars of PSP backlog, 44% of the total backlog on some of the most constrained supply corridors the PSP backlog is almost equal to 100% of capacity. So you can see the advantage where we could go ahead, make those investments or buy additional equipment. Now leading then to your question, could this become a permanent landscape. I think it will depend largely on the experience of our customers and Microchip together in the year as we progress. When the cycle ends on the other cycle, when there is a lot of capacity available, customers may not be willing to make a year long commitment that is nonchangeable. So that's what the customers would be thinking, but the environments go come back and forth. So our intent would be to show the customers how well we serve them because they had PSP and what the benefits are if they continue with that program going forward. And I think -- let Ganesh comment on that, it's really going to be how we manage it going forward.

So my view is we're in the early innings of PSP. We've just launched it. It's a couple of months. It's going extremely well. I think we continue to make fine tuning of the program. And it's too early to tell how long term it will be. I think for many, many customers they've learned in this cycle that running low on inventory or low on backlog visibility can have extreme impact on their business. And so give it a few more months, let's see how it looks.

A lot of buzzwords, programs the industry develops some of them last for a short period of time in a cycle or so, and some of them last a very long period of time. I think you're seeing the beginning of the end of the word, GIT. The losses in the industry by our customers due to constraints are so large that they have lost more money than all the money they save for a decade on GIT. And that could be the long term benefit where industry plans better rather than just in time give me 50% more, where does it come from and lead times are very long.

We'll take our next question from Vivek Arya with Bank of America Securities.

When investors look at this extreme level of supply demand imbalance that their reaction is that this will surely create a hard landing. And I'm curious to get your perspective, Ganesh or Steve, that will the situation be resolved in an orderly way? When does the industry get back to a more balanced environment? What is your visibility into inventory at your end customers? Just when do we get back to normal and what does normal look like, or is there a hard or soft landing that you had to go through?

We do not have a line of sight for when things get to be normal. As I mentioned, the gap between demand and supply grew in the March quarter and continues to be quite large. But we have taken a number of steps to get ahead of whatever change in cycle cycle will come to soften how that landing will take place. So we just discussed the PSP in quite a bit of detail and that gives us 12 months of continuous noncancelable backlog, and that will enable us to spot and plan for whenever that change becomes apparent to us on longer term backlog. The capacity additions we're making, we're not trying to solve the entire gap all in one quarter. We're making measured steps every quarter and improvements over multiple quarters. And to the extent we see a change, we will taper off the build plans and capacity additions consistent with that. Third is if you look at where our inventory is and where you look at our channel inventories are at historic lows from the channel perspective and pretty low for us as well. And that gives us time and ability to continue to replenish that inventory. It will help to minimize any underabsorption that might have happened otherwise. And it positions us well to capitalize on whatever the subsequent upcycle will be. There is going to be an up cycle to whatever next down cycle there's going to be. And when that happens, we actually push out capital requirements because we will have replenished some of that inventory. And finally on that if and when there is that next hard landing or soft landing. For us, what we are doing is our bonus programs and other variable compensation programs, as you've seen in prior cycles, give us a fair amount of to mitigate which way our expenses go as we go through the cycles, and that flexibility in operating expenses is one more item that helps us in terms of getting to a soft landing.

We'll hear next from Gary Mobley from Wells Fargo Securities.

Congrats on the strong finish to the year, what a difference a year makes. I wanted to ask about your target margin goal of 65% and 42% on gross and operating margin, respectively. It would seem to me that you're in the most optimal of conditions to see the achievement of those goals with respect to revenue mix and manufacturing utilization. And so my question to you is, is that target a best case scenario, or is it sustainable over the long term? And what revenue level are you looking for to achieve those targets?

We're making good progress towards that. We obviously, from quarter to quarter, can make rapid progress and sometimes it will be a little slower beyond that. So I wouldn't take last quarter and apply that as how it's going to be every quarter going forward. We just introduced this new model in December. So it's not been that long. And we've made a good start here. Conditions are strong for where we're at. We're executing well in the many different areas we outlined for investors as to how will we achieve the gross margins. There are also other pressures. There are cost pressures in some of the materials and input costs as well that we're working through. And then the operating expenses, we continue to have investments we need to make so that the long term growth and profitability of the business can be realized. So let's continue to have several more quarters as we go through this. But we feel good about these long term targets, and we think we're working on the right things operationally as well as in our business units and our other operating expenses to get to the place where we have a combination of good balance between growth and profitability.

We'll hear next from Harsh Kumar with Piper Sandler.

I had a philosophical question. With this kind of a supply demand environment, is seasonality out the door in the near to midterm? And then I have a follow up.

So seasonality has been hard for us for many quarters. There hasn't been a normal environment for quite a while. We went through trade and tariff, which was an overriding issue. Then we went through COVID, which was an overriding issue. We're now in this significant demand growth environment. Clearly, there is an underlying seasonality that has contribution, but these externalities are driving a much higher multiplier on that. So for the moment, we don't have clear bearings on seasonality other than directional statements as to where they will be.

And Ganesh, one more for you. With the PSP program, you're seeing tremendous amount of success. Are you seeing that backlog in the PSP program, mostly for the sole sourced kind of items are the ones that are mostly very constrained? Is there also a risk that you may lose some of the customers that are not able to commit or is supply simply that bad that there's no place for these guys to go?

So pretty much just about everything we do is sole source proprietary products. So we don't have a commodity product line that's a big piece of this thing. Some of our memory products may come the closest. And even there, we’re often in very highly protected positions in those sockets as well. I think the short answer is exactly what you said. There is not another place people can go to, to get capacity today. In fact, there's a lot more coming to us, trying to find ways in which we can help support them as they flee some of the other suppliers who are not able to provide them capacity in today's environment.

PSP is not an absolute requirement. So a customer who does not have visibility into their own business and does not want to give us noncancelable 12 months backlog can just place normal orders over 12 months and 90 days of those orders would be from noncancelable and after that, they can change it. The only difference is they would not be preferred. And if there was a strong demand among the PSP customers then they could get allocated much more harshly. But that doesn't mean that they won't get any part and they should really go with somebody else. If they go with somebody else, other people are similarly constrained and may not have PSP program to really help them. So I think there is no reason for loss of business. We're actually gaining business in this environment, have people coming from other companies where they cannot get the support.

We'll hear next from Chris Caso with Raymond James.

I've got a two part question on some of the capacity additions that you spoke of. First, if you give us some sense of the timing of these capacity additions, we know you're growing CapEx all through the year, but there's some constraints in getting tools. So when does capacity become available to you? And then secondly, if you are adding this capacity through the year and you're expecting to remain supply constrained with, I guess, some visibility from the PSP program. Is there any reason why your revenue wouldn't just continue to grow sequentially as we go through the end of the calendar year?

So firstly, on the capacity additions, they are happening. There's not a single discrete event when it's happening. It's happening every month, every quarter. We have equipment on order. We have materials on order. We're hiring people. There's a number of activities that are all going in place to be able to do it. So it will be a more continuous process through the year. Sometimes we get delays on equipment. Sometimes we are able to get the equipment on the time we have. So that's the way we see it for the rest of the year. And therefore, we are expecting that we will have capacity to be higher than the prior quarter, which should give us the ability to have continued growth as we go into the second half of this year

We'll take our next question from Ambrish Srivastava from BMO.

Steve, I had a question a follow-up on, actually, on the comments on capital allocation. So could you -- that's a pretty substantial increase on divi over the last couple of quarters. What's the rate we're seeing until you get to the net leverage that you're targeting? And then longer term, what are your thoughts on divi versus buybacks? So any color or any thoughts you could share on that would be helpful. And then I had a quick follow-up on PSP, Ganesh. How do you hedge for, assuming that pricing is set earlier on when the customers are committing to this, how do you hedge for the cost side of it when cost goes up unplanned? So just help us understand that factor as well.

So let me take the capital allocation part of that, and then Ganesh will take the pricing on the PSP backlog. So we have internally had discussions with the Board what happens now until we get investment grade rating and what happens after as we bring the stock buyback into the mix. But we're not prepared to dollarize that for you well into the future regarding how much stock buyback, and how much dividend, and when does it start and all that. So I think it's directionally the Board is committed to continue to increase dividend every quarter. And then as we get to the investment grade rating, then add the stock buyback into the mix. And what that mix would be could also change from time to time depending on market conditions and stock price and all that. So it's really not all figured out for the next five years. There have been some discussions but I think we will continue to advise you every quarter as we make further decisions.

I wasn't thinking dollars, Steve, I was thinking more in terms of percent of free cash, but that's fine. We'll wait…

So they're not willing to disclose well into the future what percentage of our free cash flow we will give it to the investors back. We would still -- when we get an investment grade rating, we would still have a leverage on the books of about 3, and desire is to continue to decrease that leverage further. 3 is not a number where we want to stop and give 100% cash back. So the leverage will continue to go down. But the rate at which that leverage go down could change as we start to give more cash back.

Ambrish, on your PSP question. PSP is a priority for capacity. It is not a guarantee of price. And we will not be just making price changes without good reasons. So if there are input costs that are unexpected that need to be passed on, PSP backlog can receive price changes at that point in time. We're not anticipating that it needs to. But nothing in PSP backlog precludes price adjustments if there are significant cost increases.

We'll hear next from Harlan Sur with JPMorgan.

With the current backlog -- PSP backlog, it paints a pretty good picture for demand, and based on that and combine that with your current booking trends. How far above your current supply capabilities is overall demand trending, is it 20% higher, is it 30% higher? And then given the strong demand trends, it seems like you and your distribution partners are building and buying products and immediately shipping them out. So given that and despite your capacity increases, do you guys anticipate your days of inventory and disti inventories declining again in the June quarter?

So firstly, to give you a sense of what is our unsupported in a given quarter look like. I think a quarter ago, we had said, hey, we have 30% more that we could be shipping than what we are planning to ship, and that number has since grown to over 40% that we could be shipping. So that's what we meant earlier as in -- even as we add capacity, demand grows even faster. So There is a significant amount of unsupported demand into each quarter. And what happens is every quarter, we ship a little more and we squeeze some of it out into subsequent quarters. Was there a second part of the question?

Yes, he was asking about what our expectations were for distribution inventory. That's a very difficult thing to forecast. It went down four days last quarter. Distribution inventory is at record lows. What we're shipping in, they're shipping out right away to meet their customers’ demand. So I don't anticipate it going up, but it's at very, very low historic levels, so I don't anticipate a large change.

We'll take our next question from John Pitzer with Credit Suisse.

I've got a two part question that speaks to the supply demand imbalance that both Steve and Ganesh, you've talked about. I'm just kind of curious, on the supply side, we've seen a significant amount of consolidation in the semi industry over the last decade. You guys have been a big driver of that. I'm wondering, Steve or Ganesh, if you can comment on how that's impacting both yours and the industry's ability to actually grow supply? And then on the demand side, I'm just kind of curious, typically, when your demand is this strong, we're usually in an economy that's firing on all cylinders. And yet we're still -- have an economic backdrop, which is probably best described as under potential. And so if we go into the back half of the year, Steve, when we start to see a macro recovery, is there a real risk that supply shortages actually accelerate even further and why not get ahead of that with even more CapEx?

So let me start on the supply side. If you look at our eight, 10 years of acquisitions that we have done and the consolidations from our perspective, the percentage of what we build, particularly from a fab standpoint, internal versus external, has changed. We used to have a higher percentage of it in our in house fabs. We're now down to about 39% of it is in house, the balance is down to the foundries. We obviously have a higher degree of control and ability to influence in a shorter period of time, the the capacity that we built in house than we do from a foundry standpoint. And so in that sense, that is something that has changed over this period of time. It has never been an issue until this cycle where the imbalance has been so large that the instantaneous response from foundry has been difficult. And a high percentage of what Microchip does through foundry is what foundry would consider to be the trailing edge of capacity they have. And that has also been not where all their investments have gone. They're making some but the majority of the investments have been in leading edge, which is where not a lot of our capacity requirements are into. Packaging and testing, we've been able to do more in house, and we've reported on the increases. We're now into the mid 50s as a percentage of our packaging that had been as low as in the high 30s and low 40s as a percentage. So there, as and when we can, we're going as fast as we can. We are looking at our capital investments and what do we need to be doing and how -- and a bit of this is finding the right mix between stepping on the accelerator where we have high confidence. PSP backlog, for example, gives us high confidence. And being a little more thoughtful where we have risk of putting a lot of capital in place and then perhaps having under absorbed capacity and that's always a judgment call. We make that every month, every quarter with what should our capital posture be. And we could yet change and have increased capital posture as we go into the second half of this year if that demand imbalance continues and persists at the level that it is. Steve, you want to add some more?

Well, let me add to a little economic macro side of his question. So John what happened last year was that the biggest destruction of demand really was on the service side, the hospitality, hotels, the airlines, travel, restaurants, golf courses. Basically, the service side of the industry got decimated last year because of social distancing and all that. The manufacturing side didn't do that bad. I mean, there was really not a single quarter where our revenue even went down 10%. Most companies in the technology industry and manufacturing industry did reasonably well. Automotive was really bad for one quarter, but overall, not too bad. So now when you get to the recovery side of it, a fair amount of recovery is likely to take place on the service side, which got so decimated, restaurants and hotels, and airlines, and travel, and vacationers, and cruise lines and all that coming back. Now as they come back, and people have more money in their pocket with more jobs, certainly some of that money will flow to the hardware, electronics and cars and other things where our product goes, and we will benefit from it. But the big part of the upcoming surge is really going to be on the service side. Having said all that, I think demand is very strong now. And as you mentioned, when the economy picks up further steam with all these people coming back on the job, could it really even get more heated. The answer to that is it's definitely possible. But the other part of your question was, why not add more capital now. Well, we can't get it. I mean, we have so much capital on order and lead time is long. And some of the scheduled capital gets delayed by a month with a short notice because the supplier is also constrained. So it's not a question of what you can order. We're willing to order more. It's a question of what you can get. We can't get everything we want.

We'll take our next question from Toshiya Hari with Goldman Sachs.

Ganesh, you talked about higher utilization rates utilization rates gross margins in the quarter. I'm curious what you saw from a pricing perspective in March relative to December. I was a little surprised how fast you were able to grow your microcontroller business and analog business on a sequential basis. So I'm guessing pricing played a role there. But if you can kind of speak to that, that would be super helpful. And then separately, assuming you guys managed to execute on the CapEx that you have planned today for the year, where do you see your internal capacity exiting the fiscal year versus where it is today?

So first on the pricing front, we announced and we did raise prices in the March quarter. It wasn't in place for the entire quarter, but it was in place for a good amount of that quarter. And not all prices changed all at the same time. There are contractual requirements, different product lines and different things, but prices go up. With that, we also had costs go up that we were trying to offset with these price increases, and we continue to have increases coming through in our supply chain. So we think the price increases contributed some but was really not the major part of what drove our growth in the March quarter. Do you want to take the second part, Eric?

So the second part was on our, what our internal capacity can do in fiscal '22, which we're just entering. And I don't expect the fab mix to be much different. Last year, the year we just finished, we did 39% of our fab internally. I don't expect that mix to change. For fiscal '21, we did 53% of our assembly and 57% of our test in house. Those percentages should go up as we're continuing to invest and then bring some more capacity internal. But I don't have a specific number by the end of the year that's going to depend on what the demand environment is and how quickly we can respond with the CapEx.

And some of the internal capacity takes time as it comes through and it may have an ongoing impact as we go into the next fiscal year.

My question wasn't so much on the mix exiting the year. But again, assuming you guys do get all the tools that you're asking for and you manage to spend $250 million. How much higher could your internal capacity be in 12 months, is it 10%, 20%? A rough ballpark number would be super helpful.

I don't think that's a number we're willing to disclose. As Ganesh says, it takes time for that capacity to come on board at different stages. Something in fab is going to take longer than it might in assembly or test, and we're obviously not giving revenue guidance outside of the current quarter…

There are too many corridors of capacity, both internally and externally, by process, by wafer size, by technology complexity. And somewhere, the capacity is being added, the other capacity is not being added. And to roll all that into just general number, our capacity goes of X percentage when we are not really sure from foundries what we can get. We know what we can do internally in terms of the capital we're adding. So I think that number is a complex one I'm not willing to share.

We'll take our next question from Vijay Rakesh from Mizuho.

So just briefly, I know you mentioned shortages. Could you give us an idea of which segment you're seeing the highest shortages and where are things starting more kind of -- or getting to more normalize in terms of lead time?

I think if you listen to the media, you would think that automotive is the only place where there are shortages and I think clearly, they've been the most vocal. Shortages are in every single segment that are taking place to varying degrees. And we do not see any segment starting to come back to some form of equilibrium where it is. So there are shortages and growing imbalances in every market segment we're in.

And I know you mentioned very strong backlog orders as you look at the June quarter here. Wondering as you look into the back half in terms of calendar Q3 and out, do you think -- are you expecting a better than seasonal outlook given how strong demand is and the pretty strong sign up on the PSP side as well?

We talked earlier on about seasonality and all that. Right now, our revenue is not limited by the demand side of the equation. And often, seasonality speaks to where is the demand at and how does that come about. Our growth at this point is limited by how much can we manufacture and ship, and that's where all hands on deck are. So seasonality by itself is not as meaningful in the current environment.

We'll take our next question from Craig Hettenbach from Morgan Stanley.

I had a question on data center and comm, I mean, that's been an area that's been consolidating for a number of quarters. Just want to get a sense of what you're seeing in that market and if there's any visibility as to how you think it will trend as we go through the year.

So we're not trying to provide guidance on how those are going to do by market segment as we go through the year. I think clearly, in the December quarter, we indicated to you that it seems to have bottomed out. That came to be the way the March quarter ended up, a slight bit of improvement from there. So we're quite optimistic about the data center segment, in particular, as we look into fiscal year '22. And then the communication sector has its own set of infrastructure rollouts that are taking place. But that's about as much as we're able to provide. We don't really track at the level of specificity with exact numbers. We have more of a directional statement, which is kind of what we've included in our conference call notes.

We'll take our next question from Raji Gill with Needham & Company.

This is Denis here asking a question for Raji. I was wondering, could you speak about as far as these component supply constraints go up, which end markets are currently maybe kind of doing the best in terms of having some inventory available? And also, what proportion of these constraints is kind of on the front end or the back end?

So there is no -- as I said in the earlier question, there is no end market in which there is available supply that's any better or not. They're all constrained to varying degrees. And so there's nothing from an end market to think. As far as back end and front end, we have constraints in both internal and external factories, in the back end and in the front end, in the material supply chain. And depending on what exact combination, what capacity corridor you're in, there might be more constraints and maybe less constrained, but they're all constrained.

We'll take our next question from David O'Connor from BNP Paribas. David O'Connor: Maybe a follow up on the just and tying that, Steve, that you mentioned earlier. What changes do you foresee the level of inventories that the industry needs to hold? I mean, who in supply chain is going to be forced to carry more inventory, if that's the case and who is going to foot the bill for these higher inventories? If you could talk around that, how you see that, that would be great.

Let me take a shot at that, and Steve may want to add to this as well. So I think what inventory people need to carry is going to have to be determined by the ultimate end market equipment manufacturers, the OEMs. And I think it can be very different in different product lines. When you build an $80,000 car and you're constrained by $10 of semiconductor content, the decision you may arrive there could be different from when you're building $200 consumer product that you have. So each industry, depending on the value of the product they're creating, the profitability of that industry, has to decide based on their experience, what is the inventory level that they need to assure themselves of the value of the product that they're trying to ship. And those answers are going to be different. I think some got burned quite badly. I suspect they will be the ones that want to do the most here. But there is not a single answer that comes with it. And as far as who foots the bill, ultimately, the manufacturer, the original equipment manufacturer, will foot the bill and more than likely have to pass that on in terms of what they're building to their end customer to the extent that they can. But if the choice is to invest in inventory, that is two, three orders of magnitude less than the value of the product that they're creating, many of them will have to rethink that equation of what kind of, just in time, makes sense for us. Steve, do you want to add to that?

I don't really have a whole lot to add. But I would say that if you look at some of the Japanese car manufacturers did much better this time around, because they learned their lesson during the tsunami, and when a lot of the renaissance and other factories were shut down due to earthquake and radiations and all that. So they learned from that time and built a structure where they were not as much relying on JIT and reach the current time with a level of inventory on the semiconductor parts, and they did a lot better. And that's really the lesson the US and European auto manufacturers need to learn. And time would tell when the cycle goes the other way, is it all lost and it's just the same standoff, we don't really know. But they have to start thinking that building semiconductors is different than getting a bent metal for doorknob or something. Right now, we get some comments that are sometimes laughable, what's the big deal about lead frame, just bend the metal and make my parts, and it's just not that simple, building semiconductors. So I think a lot of learning needs to happen. And we don't directly ship the parts to the car manufacturers. We have the people in between like the Contis, and GenTechs, and Aptiv, and Hella and all these people. They're in between. So we have a buffer. But the car manufacturer really need to really take the bull by the horn and drive the process to get out of JIT. And I don't know whether they will, I don't know that.

You know, a positive step is many of the carmakers have been at the forefront of embracing a PSP program and PSP program and requiring the Tier 1s to be . At least for the moment, you can see how we're trying to drive towards having a level of inventory that assures them they can build their very expensive or very highly valuable end products. How that will persist a year or two years from now, we don't know.

We'll move on to our next question from Christopher Rolland from Susquehanna.

It's a little bit more open ended here, but, Ganesh, you said in 40 years, you haven't seen such an imbalance between supply and demand as acute as this one. And Steve, you may want to chime in here as well. But can you guys talk about maybe something that was similar, the number two most acute time or number three, and are there any analogies to this? And how did that eventually unwind where we had that match of supply and demand in DC, something like that taking place here?

All cycles eventually come to an end as the participants in the battlefield work on how they adjust to where the situation is. In prior cycles, the semiconductor companies put in the additional capacity in place and began to get closer in their self interest to be able to grow. And the players in the market began to adjust with what they were building and how they were building. I would say in my timeframe, probably the sharpest rebound was probably 2008, 2009. And again, we were extremely fortunate in that time, because we did not shut down our factories and we kept things running and we grew our inventory. But not all people did that. And we know it did create dislocations as a result of doing that. Steve, do you want to add to that?

Well, finishing your thought, in 2008, 2009, we didn't shut down our factory and continue to run the factories, although, we had some rotating time off. And then we entered the up cycle with a very good amount of inventory position. And through that, we grew a lot and we did very well. We didn't repeat that this time, because this time we had a very, very substantial debt leverage, which was very high. And therefore, we didn't choose to really put the money into inventory and kept the factories running and all that. At that time, I recall, investor concern was what happens if your demand goes down 35%, do you miss the covenant? So sometimes your memories can be short. But this environment presented different challenges, so we were not able to repeat the experience of 2009 and did not reach this time with a high inventory internally. And we're trying to build it now but unsuccessful because we're shipping as we build. The other point I wanted to make is people use this word double ordering. We don't really get double ordering because parts are all proprietary. You cannot buy from us and from another company for the same socket nor can two distributors ship the product into the same socket in the way we register and make it economically impossible for the nondesigning distributor to shift the part into that socket. So the only other remaining avenue is a customer orders a little more than what they need, which we never know and we cannot detect. If you want to call it double ordering, there could be some excess ordering by the customers we can't be sure of. But one thing we are sure of is there's no double fulfillment. We are in daily phone calls, escalation meetings with a number of customers, threatened line downs and actual lines down for many of the car manufacturers and others. There is no double fulfillment. People are -- everybody is getting a fraction of what they need. So therefore, there is a fair amount of runway ahead with such a large amount of demand. I think it's going to be the rest of the fiscal year, we're just trying to get our head above the water.

And unlike prior cycles, right, we have noncancelable windows that are significantly longer than we have had in other cycles. And that puts a a lot more responsibility on the customer to have orders that they need and not orders that they don't need.

We'll take a follow-up question from John Pitzer from Credit Suisse.

Let me ask another question. Just, Eric, on the target model, I'm just kind of curious on the gross margin line. What's been really impressive is the incremental margins you guys have been able to put up over the last, call it, six to eight quarters. I mean, on quarters where you've had sequential growth, I think incremental gross margins have been right around that 80% mark. And so was there something unusual about the last kind of six to eight quarters that drove such high incremental gross margins, and where should we think about that going forward?

Well, I think there's a couple of things. In the more recent quarters, we had significant underutilization charges, which have now gone away. So those costs are now being capitalized to inventory. We're running the factories more full, so that’s gone away. And then we had a large acquisition in Microsemi that we were integrating over that time frame, too, and finding ways to improve margins on the acquired business. Those are the two things that I would point to. Steve or Ganesh, anything else?

The only other thing I would add is we continue to add value into many, many of our products through a combination of hardware and software, which makes them more valuable as improved the gross margins we have on those products. And as you then get to a weighted average of all these products and what are we doing to make them more valuable, it shows up in the aggregate gross margin.

And that does conclude today's question and answer session. I'd like to turn the conference back over to Mr. Ganesh Moorthy for any additional or closing remarks.

We want to thank everyone for taking the time to join us. We do have investor meetings that are coming up that we look forward to meeting and talking to more of you. But have a good afternoon. Thank you.

Thank you. That does conclude today's conference. We do thank you all for your participation. You may now disconnect.