Good morning, everyone. I'm Chris Danely, your friendly neighborhood semiconductor analyst here at Citigroup. Apologies for being a little late. I had the CHIPS for America guys asking for more money next door. At any rate, Microchip is one of my favorite companies. It's actually the first company I covered in semis 25 years ago. And on a personal note, I'm very proud to have had more buy ratings on them than any other company through the years. Really love these guys. So, up here, we have Ganesh Moorthy, the President and CEO. We also have Nawaz Sharif, the VP of European Finance. I believe Ganesh is going to do a short presentation, and then we will jump right into Q&A. So, Ganesh, I'll let you take it away. Thanks very much for coming.
Thank you. Okay, a quick safe harbor. During the course of the presentation, we will be making projections of the 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 the actual events or results may differ materially, and we refer you to our SEC filings that can identify these important risk factors. To start with, you know, we wake up 22,000+ employees worldwide with a singular purpose, which is, how do we empower innovation that enhances human experience by delivering these smart, connected, and secure solutions? So I want to show you some examples of what does that mean, and it's in diverse markets and very durable markets. And I won't go through each and every one of these, but a picture sometimes says a thousand words.
So industry by industry, end market by end market, you can see how our technologies change what is able and what is possible to be able to deliver these game-changing solutions. I want to spend today on Microchip 3.0, which is really a summation of the strategy of the company that drives the growth, profitability, the cash generation, and the capital return that we have. So I'm going to start with the growth part of it. So the growth is focused organically. We have a five-year growth target of 10%-15% annualized growth on a base of fiscal 2021, and it comes from two major strategies that we're following, which is Total System Solutions, aggregating all that we bring into solutions, and a focus on six major market megatrends. We'll speak about those here in a minute.
So this is our history over 30 years. You see, over this whole time frame, it's 16%+ compound annual growth rate. You can see some acceleration in more of the recent years as we've had this, the wind in our back, for the industry as a whole. And the last quarter, we just finished, the June quarter, was $2.29 billion, and again, 16.6% year-over-year growth. I talked about total system solutions, and this is the entirety of what we've built, a very broad, probably the broadest portfolio in the industry, of everything that is needed in an embedded system, from the brains to the signal chain, to the power, to the clock, to the networking that's needed. We put it all together in how we take solutions to market, how we help our customers complete their solutions.
And those are just not hardware. The hardware, the software, and the services that then bind the solution together into something that is very sticky solutions that we provide. And then the other is our focus on major market megatrends, and there are six market megatrends. That is where we're putting a lot of our energy into. These are growth areas that'll grow much faster than Microchip on average. I'll show you what it has done in the last two years. There's 5G infrastructure, it's IoT, and in particular, edge computing. It's data centers, EVs, autonomous driving or advanced driver assist and sustainability. And across many of these, and in fact, all six of them, AI and ML play an increasing role with how these solutions become more effective. So I want to double-click on three areas.
This is data centers first, and you may not think of us in the data center, but we're in many, many places inside of the data center. So in the infrastructure for compute and storage, SSD solutions, and SSD becomes an increasingly important requirement for many of the high-performance AI type of servers as well. The infrastructure for memory, timing, very critical in these systems, security, the boot, and many, many other areas. So all of these take product from across Microchip and are present on the data center products that our customers are building. Second, perhaps something we haven't talked a whole lot about, but edge computing and AI, in particular, is moving to not just be on the server, but actually on the edge. And the edge means many different things, depending on what end market.
So here are some examples of what it is in the 5G and data networks, in the industrial edge, in precision diagnostics for medical, in the car, and how it does. So each of these areas offloads the processing and the intelligence that you need to the edge so that the latency is low and the performance is better than that. And in every one of these edge nodes, we have products from us, from our FPGAs, our microprocessors, our microcontrollers, analog, that all go in to enabling this edge computing itself. And we believe that is a major trend, and in fact, is going to be a very large growth area for us and for the industry.
And then the third area to double-click on is sustainability, and this has many components to it, but there's tremendous amount of money being spent on how to improve energy storage, the grid infrastructure, distribution of, how energy happens, monitoring of these resources, and optimizing these resources, how and when this, you know, usage of, energy is more efficient, et cetera. And semiconductors are at the core of how all this is being enabled, and our products are at the core of how we enable sustainability. So not only what we do as a company for our own sustainability, but what we enable the rest of the world for their sustainability as well. So just three of the major megatrends in terms of double-clicking down on them....
Now, I talked about the megatrends, and a good way to look back, as we said two years ago, we expect that this will grow roughly 2x the company, and in fact, that's exactly what it did. If you take fiscal 2023 versus fiscal 2021, in that period of time, overall company grew 55%. The contribution from the megatrends grew 110%, so almost spot on at 2x. The size of the pie that is in the megatrends grew from about 34% of the total revenue to 45% of the total revenue in that period of time. So major growth over that time, and we expect continued growth, probably not at 2x forever, but certainly much faster growth than the rest of the company to enable overall company growth.
Now, the next two parts of Microchip 3.0 are the business model. We do all this growth, but how do we drop down to the bottom line? That comes from both the end markets that we're in, and then the durability of those markets, and the performance, the financial performance, that follows this growth in those end markets. So here's the end markets, and you can see these are very, very durable markets. 41% of our revenue is industrial, and that includes aerospace and defense. Another 17% is automotive, 19% is our data center business. And so these are very, very nice long-term businesses that have, over the years, been the bedrock of how the company has grown, particularly industrial and automotive.
Now, I wanna show you a little bit of our financial performance, but also put the backdrop of the semi industry. There's always been, you know, a talk sometimes that, oh, the cycles are over, and you can see the cycles are nowhere close to over. We continue to be a cyclical industry. This is the industry overall, what it has done in the last 15, 16 years or so. Now, our performance through this all has been outstanding. This is the gross margin performance over that time frame. You can see through the highs and the lows, how resilient the gross margin and how, how much improvement we have seen. Higher highs, higher lows throughout this window of time, continuing through this cycle as well.
Now, in Q1 of the, the, this is the June quarter, again, a record gross margin, 68.4%, that we got to. Looking at operating margin, what drops down? You see the same trend. We're, you know, continuing to have improvement, and some of this operating performance includes many acquisitions that we did in the years from five years ago to, you know, ten years ago, where the performance came in, dropped the average down, and then we were able to bring it back up, on our clock as well. And we've taken a, And in the last quarter, we had record operating margin, 48.1%.
And we also put a floor down saying, "We don't see a scenario in which our operating margin, at least no reasonable scenario, in which our operating margin drops below 40%." And we think, in fact, it'll be substantially better than that as we go through this cycle. The next element is: What are we doing to achieve these results, in terms of our capital, and that we're deploying, inside of the company itself? And that's two different areas. One is in the, capital intensity. We have a 3%-6% capital intensity over the cycle. We were closer to 6%, in the last year.
We're gonna be a lot lower than that, this year, probably closer to 4%, and it will go down most likely again into fiscal 2025, depending on how business conditions are. Our inventory is a little higher than the range. Some of that is last time buys and where we're at, but still well inside of what we have. And we have very, very long-lived products, so inventory obsolescence risk is almost zero on where we're at. And you take it all and you measure it on the return on invested capital, and here we are in the top 25% of all companies in the S&P 500, in terms of the ROIC that we're able to deliver.
The next two areas is around cash generation and, what are we doing with that cash generation in terms of capital return itself. So firstly, looking at, the EBITDA margin, over 50%, of EBITDA margin, 51% last quarter, and you can see how it's been rising, through this time. So $4.5 billion over the last four quarters of, EBITDA margin generation. And through the cycles, this is going back again 15 years, you can see the blue section, is how the cash generation of the company has performed. It's growing at a 23% compounded annual growth rate over this window of time, and continues to be a tremendous part of what the business is able to do, is generate cash in up cycles and in down cycles.
Last quarter, we had $776 million, almost 34%, of adjusted free cash flow that we generated. Now, not only is it the adjusted free cash flow, but what are we doing in terms of free cash flow per share as we're buying back shares, as part of our capital return? You can see how the free cash flow per share is also rising over this time frame. And just last quarter, we had $1.41 of free cash flow per share. And now you take that same S&P 500 and look at how do we rate, and we're in the top 8% of all companies in terms of free cash flow as a % of revenue that we're generating.
Over the last five years, and I know five years ago, there were a lot of concerns about the leverage we had after the last big acquisition that we did, and we have systematically driven that leverage down, paid back the debt. We're well under the 1.3. 1.5 at one time, now we're under 1.3. At 1.45, we were guided. Last quarter, we actually did 1.29 in terms of leverage. So leverage has come down dramatically as we've taken all that cash generation and paid down a significant portion of the debt. And as that has happened, we've been able to increase the capital that we can return to our shareholders.
Starting from 2 years ago, we began to accelerate the rate at which both dividends would grow, but also started to have a programmatic share buyback. We continue to be on track to have 100% of our capital return to shareholders by the March quarter of 2025. This quarter, we will return 72.5% of last quarter's free cash flow. So every quarter, we're bumping it up by 5 percentage points, so next quarter will be 77.5, and so on and so forth. So a key part of the profitability, the cash generation, is then eventually to be able to return it to our shareholders. And again, if you measure cash return as a percent of revenue against the entire S&P 500, we're in the top 22% of all companies.
And then the last piece of it is more inward focus, which is not just what results we get, but how we get it. And for us, that is as important. It is based on a company with a very strong culture for 30+ years that we have built, and a company that is committed to sustainability and, and, and what we want to be able to achieve within the company itself. So, we believe we have a compelling valuation as the company, over the last 5 years, has changed dramatically in terms of where the focus is, what the results are, what the cash generation is, and what the capital return is. And I won't read all the slides in there, or the bullets down in there, but we think Microchip 3.0 should drive higher multiple expansion.
I show you some benchmarks there against peers, who have similar business models, against the S&P 500, against the stocks as well. That expansion is ahead of us. We think there's premium performance that is available at a significant discount today, but not for long. In summary, consistent long-term growth from durable end markets. You've seen some of those here in the pictures I just showed. Outstanding and improving gross and operating margin performance. Strong free cash flow generation through the cycles, in up cycles and down cycles. A reduction in the net leverage rapidly taking place and giving us the opportunity to return all of that free cash flow to our shareholders. Again, a compelling valuation relative to peers itself. Thank you.
Thanks, Ganesh. I guess to start, in looking at those gross and operating margin charts, pretty good track record have been going up over, I guess, 25 years, since the 1990s. There's a pretty big spike, last year in gross and operating margins. Can you discuss why that happened? And then is it, you know, achievable, in the next upturn, whenever that may happen?
Yeah. So there are two major reasons why the gross margin improved as dramatically as it did in the last two and three years. Coming into the upcycle, we had a significant underloading of our factories, and so we were actually writing off every quarter, you know, part of the underutilized capacity. What happened in the early stages, we were able to rapidly reuse all that capacity, get our factories running in full, and so that was the one big contributor to start with. The second big contributor was, in a constrained environment, we allocated our resources to where we had the best returns, and so the mix of our product line also began to shift and to have a much higher, higher gross margin profile mix.
And of course, you drop some of the low gross margin, even lower, compared to where we're at, and where we're at. So those are the two big reasons why the gross margin made as big a change as it did and as quick a thing on it. The operating margin improvements came in addition because, you know, the rate of growth of the revenue, we could not have operating expenses that could grow at that rate, so it dropped down even further, you know, the operating margin one.
Okay. Now, in terms of your business model, the semi industry is in the middle of a correction, especially on the analog and embedded side. You know, you guys are not immune to that. Historically, and I put out this chart/table in notes for literally the last, you know, 15, 20 years, Microchip has been very resilient, and has outperformed during corrections and downturns. Maybe share with us what enables you guys to get through this better than, you know, your average semiconductor company.
You know, there's many aspects of how we manage the company. So first, let's look at, on the gross margin side of things, right? We have a mix of inside and outside, so we have flexibility in terms of how the overall capacity overhang is, during a down cycle. On the inside, you know, we have these products that have such long life cycles that, we're able to continue to have the factories run, building some of that inventory, because it's high gross margin product. We'll sell it through. There's no obsolescence. We use up the factories, in the down cycle, and then we drain that inventory in the up cycles. That pushes out when we need our CapEx to be spent. And then the rest of the company has a cost structure that has significant flexibility.
So our operating expenses, as a percentage, as well as in the absolute, have a significant amount of movement that we can have in a down cycle without laying off employees, just to the way the bonuses are structured and the other ways in which our discretionary expenses can be managed. And so through it all, we've been able to manage both the gross margins, not that we're, you know, immune to it. We know that will be a something that we will continue to work hard on. Same with the OpEx, but we have levers that we have honed in over many, many years of how to manage the gross margin and the operating margin in the cycles, and in a down cycle, in particular.
Yeah. And maybe talk about specifically what you're doing in terms of your own inventory, and utilization rates in terms of managing this, you know, part of the cycle.
Yeah. So our internal factories, we paused on the expansion. So we had a lot of expansion that was planned and in the works. We paused the expansion because we were getting to a point where we're able to meet demand, and we had some uncertainty on where the demand would be and where it would go. We were growing inventory, and inventory always allows us to very quickly respond to whenever the market changes.... So at this point in time, our overall inventory has grown. It's sitting at 167 days exiting March. About 8 or 9 of those days are what I call last time buys. These are our partners who are, you know, closing down their factories, but we have high, high margin products from them. We've built ahead for 8, 10 years of time for them.
But on the rest of it, our range is 130 to 150 days. We're slightly above that. We will come down. We came down last quarter, 2 days. We'll come down a few more days this quarter as well. And we're balancing between the internal and the external. We have obligations to our external partners, but at the same time, we wanna keep running the internal factories as consistently as we can so that they absorb all the fixed costs. All that inventory is in great shape, will all sell through, will contribute to long-term gross margin and cash generation.
And so is there, I guess, an ideal inventory level you have right now during this period of softness, or is it still within that range? And when do you think you will be there?
So we're within 130-150 days is notionally what our range we wanna be in, and that's our comfort zone and where we're at.
That's whatever the cycle gives us, right?
Whatever the cycle is, yeah. Typically, you know, in a down cycle, you'll be at the higher end of that range. In an upcycle, you'll be at the lower end of the range. Now, in the last two, three years, you know, we were down as low as, I think, 108, 109 days. We've been as high as 169. So the reality is, you go, you do go beyond those, and you're taking actions when you're below the low end, you're taking actions to expand and get capacity in place. When you're above the high end, you're taking actions to pause where you're going. So we'll get back there, and in the meanwhile, you know, the inventory has no concern to us in terms of any risk of obsolescence.
Okay. And then your, your two competitors, you mentioned on that chart, they, you know, felt the correction before you guys did. We asked them, you know, what, what caused it or what triggered it, and they said it was their lead times dropping below a certain level. In retrospect, what do you think triggered it for, for you guys? Was it a, you know, sort of a lead time thing, or was it a macro demand falling off a certain geo? Now that we've had a few months to, to look back and think about it, what do you think, you know, triggered it for Microchip, and why did it hit you guys later? Do you think it's the resiliency of the business model or something else?
All right, you got multiple questions. Let me see if I can remember them all.
I wrote them all down, so if you forget.
Oh, okay, good. So you, you might need to. So I look at lead times as an output of the system, not an input into the system. So lead times coming down aren't the reason why things are... Lead times are gonna do what they are. Lead times reflect customers view of how much do they need to be able to place backlog for-
Mm-hmm.
To get secure on where they're at. We have always preferred to run low lead times. Historically, we've run 4-8 weeks lead time for 90%+ of our line items, because short lead times allow the most responsiveness from our side and the best flexibility for our customers to respond to their business.
Right.
That's where we wanna run. Now, you know, supply and demand got so far out of whack in the last two years. Lead times went to 52 weeks, sometimes longer than 52 weeks. It's difficult for everybody. It's difficult for us, it's difficult for our customers. They're trying to guess what their demand is gonna be out in time. So we've been working hard to get that, and you, you catch a breath to bring lead times down when the supply/demand imbalance begins to, you know, start narrowing and when your own capacity investments start to come into play.
Between the beginning of this year and the end of June, we cut lead times in half, from 52 weeks to 26, and I expect we will cut it at least half, if not more, before the end of this year and where we go. Heading back to what I call is normal. Normal is 4-8 weeks. It's where we'd like to be. I don't know if we'll get there, all the way this year or not, but that's what gives everybody the best chance to be market responsive to where things are at. You had more questions, so why don't you ask me the rest?
No, that's fine. I think, I think you went through it. So just to reiterate, the lead times were at 52 weeks at the beginning of the year, 26 weeks in June, and the goal is 4-8 weeks at some point the end of this year.
We're driving hard to make it this year. Whether we get to 10 weeks, 12 weeks, 8 weeks, I'm not completely sure yet.
Got it. Would we see the same dynamics on the shortages side? You know, shortages are everywhere, but they do seem to be going away. Do you think that most of these shortages will be gone by the end of the year?
Yeah. And so there are always going to be constrained corridors. They were there even pre-COVID and whatever. So that will always work. It's a one-off you have to find and knock itself down. But by and large, the constraints of the last two years, all the customer escalations and all of that, will have, you know, tamped down to something which is much more normal. Now, there will always be somebody who has an upside in business, who has something else, a factory that has a yield issue, something to work on. But those will be the nature of constraints for the most part, and there could be some very specific corridors where we're still getting the capacity to get to the point where it meets with supply and demand.
But, by and large, I think, constraints are behind us. Now, I don't think they're behind us forever. And I think, you know, this industry, and what we provide, and the solutions that Microchip has for all these megatrends, this is the engine of innovation. This is what so many customers, applications, and markets are using to drive their innovation. And just as a year ago, no one could see a slowdown here, we're sitting here. A year from now, we could be back into a very strong environment.
Mm.
as all of the other, you know, parts of the market slowness, you know, get behind us. And so, but long term, we are very, very confident in the strength of semiconductors, in the nature by which they change the playing field for our customers and what they offer and the innovation that they will build, that it's got a great long-term compounded annual growth.
Mm-hmm. And like you said, you know, by nature of your programmable products, your lead times have historically been among the lowest in the industry. And so traditionally, you guys have felt the upturn and the downturn and whatever the heck else is in between, before your competitors. This time was a little different. You know, some of your competitors felt it before you guys. Any reason why? Was it just a quirk of the cycle?
Yeah, I think this cycle has been different from any other cycle that we've had. I think not all segments of the business were hit at the same time. You know, consumer electronics and mobile phone and some of the PCs seemed to feel it the earliest. You know, a year ago, those were already down, but automotive and industrial and medical and aerospace and defense and, you know, some of the infrastructure had continued to be strong. So we're fortunate that the mix of our business has more of these stronger and more resilient end markets. And that has continued longer than some of the other markets I've saw it.
So I think this year, this cycle has been different in that different end markets are, you know, slowing down or growing at, different timelines and different rates, and whose end market exposure has advantages to what's, you know, staying on longer or disadvantages for what's been going down sooner, has reflected when they saw the reset.
Yep. Yep.
That's largely playing itself out, which is why you said earlier on, some of the analog guys are starting to see it as well. I think automotive and industrial, for anybody who has had that exposure, has been the most resilient for the longest. But as I mentioned in our conference call a month ago, I said, you know, we're beginning to see automotive and industrial starting to see some of the slowing down as well. And then regionally, I talked about seeing, you know, China being weak, which has been weak for some time. But also we said, hey, we're starting to feel that Europe has an impending slowdown coming.
All the GDP reports that you will read out of Europe, and you're welcome to ask Nawaz, if you want some more detail, because he's got a closer feel on it. Germany is in a recession, effectively. Many other parts of Europe are slow, and Europe has a very large export economy. And so when you have an export economy, and if China is a big part of your exports, you're going to feel the slowing in China as well.
Yeah. Again, Nawaz, why don't you step up to the plate here? Two of your bigger competitors we had yesterday, both of them mentioned European weakness, so I think that's out there. Maybe give us some insights as to what's going on across the pond.
Yeah. So as Ganesh mentioned, I mean, the struggle is that the macro headwinds are there and will stay a little bit longer in Europe than the U.S. It took a little bit longer, I think, maybe for the governments or the ECB to react. It was late in changing its QE. It was late in terms of, you know, raising interest rates, so there's still more medicine to be taken. Energy costs are obviously picking up across the board again, and so that's, I think, going to stifle inflation coming down, particularly for the month of August. I think it's actually going to go up. ECB has a meeting next week. I think the bet is that it's going to go up by 25, maybe 50 basis points still, and there's more to come until the end of the year.
So it's going to work itself out. But as Ganesh mentioned, being such a large exporter and one of your largest customers being China, being particularly weak, how do you fill the gap? And there is no gap to be filled until China decides or is able to manage its own issues, and generally, business picks up. But energy costs are a big piece. Wage pressure is enormous. There's obviously a lot more unions in Europe than the U.S. I know UAW here is exerting pressure, but there's a lot more of that taking place in Europe, and that wage increase is adding to that inflation problem, which then just extends that cycle.
Mm-hmm.
So I think that's what we're seeing across the board. It's just going to take them 1-2 quarters longer to resolve these issues. As a company, we're still robust. We have great locations. We have very engaged employees working on phenomenal number of designs and activity, all of which will come to fruition and, you know, continue on the mega trends and end markets that we have. It's just that it'll be, you know, 3, 6, maybe 9 months later.
Yeah. You know, Ganesh, you guys have always been one of the more honest semi companies. You call it like you see it. When things are great, you say things are great, and when things are bad, you say, "You know what? It's not working right now." So you came out and said, you know, this quarter's weak and probably next quarter's weak, and I think folks appreciate that. You know, give us some confidence that it's not going to get much worse than this, that, you know, we're sort of seeing the bottom here and, you know, maybe in whatever, six months or something like that, that things will turn around. Or maybe not.
I don't have any guidance to provide that is beyond what we provided the last conference call, but I think you can look at, historically, how have these cycles gone? What does an inventory cycle look like? And historically, inventory cycles in the semiconductor industry have been 2-3 quarters of time-
Mm-hmm.
is what it takes, and within that, the supply and demand begin to normalize and perhaps, you know, the cycle, the demand cycle begins to strengthen by that time as well. So that's the only, you know, benchmark that we have against which to try to plan for things. What we also see is, unlike last year and year before, where our customers were, you know, enmeshed in just dealing with shortages and how to redesign products so that they could get supply and all of that, we're seeing some of the strongest design momentum ever in the company over the last nine months or so, as all our customers put their effort into new products, technologies, innovation. And I think all of that ultimately creates demand, because you create products that have more value, that a customer desires, that an end market will want to buy.
I think that innovation that is being fueled today, will become the growth that you see as we go at some point into 2024 and 2025.
Mm-hmm.
More than anything, that's what gives me the confidence in the long-term growth of the business: it is how much customers have just, you know, refocused on getting new products and new solutions and innovation into their pipeline, all of which will be coming out over the next 1 to 2, 3 years.
Yep. I had a couple of people ask me in the halls yesterday. We've had a few of your competitors present, you know, especially on the microcontroller side, saying that they are not seeing any weakness out there. So any explanation for that? It's like you've got, you know, a certain group of analog and microcontroller companies saying things are, you know, weaker, and then a certain group saying that we're fine. How do we interpret that as investors here?
You know, I don't know who the companies are and where they're at. So, within micro, a very, very broad portfolio of products-
Yeah. That's what I'm asking you.
We have areas that have strengths that are going on, that there is no recession. It's going well, right? So if I look at anything that we do that is tied to AI and AI servers, doing really well, as well as some of the edge computing things. Anything that has to do with renewable energy is doing well. Anything to do with EV is doing really well. Anything to do with aerospace and defense is doing really well. So what you see when we present is a blend of the entire company, but inside of that are micro pockets that have strength and micro pockets that have weakness.
So you mentioned, and I like the slide that says, I think it's 75% exposure to the three best end markets, auto, industrial, and data center. Within those three end markets, as we're looking out over the next, you know, year or two years, which do you feel best about and which would you be, you know, relatively more concerned on?
You know, I think the natural answer that may come out is everybody is down on data center today. I think if you look at a three-year horizon, you know, there's substantial amount of investment that will take place there. Not all of it is AI, some of it will be AI. I like all three markets. I'm not good enough to call which one is going to do better or worse over a three-year window of time, which is why we stay invested in the megatrends, in the key end markets, because we're not trying to prognosticate which one will do well, but we're going to make sure that whichever one does well, we have an outsized presence in, to drive the growth of the company.
Mm-hmm. And on the geographic side, you mentioned China and Europe. Between those two, which do you think will recover first? And do you think either is a bigger concern or both the same?
I think they're both concerns for different reasons and how they go about them. Nawaz, you know, outlined the case for what's going on in Europe, and I don't know how and when the policy actions there will help to bring that back. But I think for Europe to recover, it's also going to need China to recover because it is a large export market for them. And I was just in China all of last week, so I got a kind of on-the-ground view of where things are.
I'm glad you escaped. They didn't hold you hostage.
They let me go, yes, at the end of the week. I do think even inside China, there is a vibrancy in many areas. I visited multiple EV companies as well as the tier ones that supply them, and, you know, that's doing really well in where they're at. But there is a malaise in China that is being felt, that for multiple quarters, our industry has been able to feel it. The law of averages is that, you know, the longer that goes, the more likely a recovery is coming and coming sooner.
Yeah.
Right? This is the second largest economy in the world. It isn't going to stay in a malaise forever, but when you go through it, it feels like it's just going to be like this forever. And, so I do expect that China will recover. I do expect that it's a large economy, a very capable economy, and I can't put the date on exactly when, but as every day goes by, where it looks bad, it's going to get better sooner.
Yeah. Hey, Ganesh, so you spend a lot of time with customers. Would you say that this is more of an inventory issue or a demand issue? And has anything, you know, I guess, changed in the last three months as to what your customers are asking for or concerned about or anything like that? Any insight there?
I think a demand issue and an inventory issue, in many cases, are two sides of the same coin. So when your demand slows down, and clearly, at this point, there are macro headwinds, there's business uncertainty that's out there, demand is slowing down. Customers' confidence is slowing down. As that happens, the same inventory you had or that you were planning on now looks to be high because your business is changing or your business concerns have grown. So those two, they go hand in hand, just as on the other side, when your demand strengthens, you feel, "I don't have enough inventory. I got to go order more product," and et cetera, because you're anticipating a better future. And I think today, there's more uncertainty that our customers are facing.
There's more macro headwinds that they're facing, they're reading about, and I think that's just causes them to be more cautious. And that's why short lead times actually are even more important in the current environment, because we're not asking them to bet 6 and 12 months out when they can barely see the next 3 and 6 months.
Mm-hmm.
That's how we make ourselves more responsive, make our customers more competitive.
How has the PSP program fared during this time of tumble? You know, you guys were one of the pioneers of, you know, incentivizing customers to, to sign up for this. Have you seen any PSPs get renegotiated or try to get renegotiated?
So let's be clear, we weren't trying to incentivize customers to do anything they didn't want to do. We were offering them priority in exchange for certainty. We would go make investments, we would go expand the capacity, they would get priority in exchange for doing that. They didn't have to do it. They could do part of their backlog with PSP, part of it without PSP, completely their choice. The takeaway was very high because our end market exposure has many customers with very high-end value products.
Yeah.
They wanted to make sure that semiconductor content didn't stop them. That remains high. We still have well over 50% of our backlog that is in PSP today. You know, while backlog is coming down and PSP backlog, as a result, is coming down as well, the program effectively is the customer's choice, and do they see value in it or not? I suspect there will be a point at which it doesn't have the same value as it did two years ago. We're adjusting the program. We're adjusting the window of time from 12 months, it's now 6 months. We're providing more flexibility. We're responding to the environment so that the program serves a purpose for the customer's business success.
So, have you had people say, "Hey, we need less units?" And do you say, you know, "Tough noogies, you have to take it," or are you working with them? Or how do those, maybe give us some insight into how that's going?
Oh, yeah. You know, we have plenty of customers for whom, including PSP customers, for whom, what they planned on as their business nine months ago, 12 months ago, is different from where the business is today. And they need help. They need help with pushouts, with cancellations. I've been publicly on the record that said, "Hey, I'm not in favor of just letting people off with cancellation," but we will help them on lots of pushout, and we're doing large amounts of pushouts. And you can see that part of our inventory is reflected in the fact that we have held on to product that customers had wanted and have committed to buy-
Mm-hmm.
To enable them to have some breathing room and to be able to run their business. So we have huge pushouts in what we have done over multiple quarters. But I do think that there is a certain responsibility or irresponsibility that it would encourage if we just said, "We're just kidding. We don't mean anything about non-cancellable," because people place orders when they don't need it, if there isn't a certain amount of skin in the game that they would have.
Yep.
We want less orders with higher certainty, rather than saying, "Yep, you can place all your orders as NCNR, and when push comes to shove, we'll just forgive everything.
Yep.
We are extremely flexible on the non-reschedulability, but not on the non-cancellability.
Great. I have time for one last quick question. So any issues or any lack of confidence in the ability to get back to those peak margins you achieved, you know, only a few quarters ago whenever we come out of this?
Well, we had peak margins last quarter.
Yeah.
And, I expect that, you know, we're not going to be very far from those, and in the long term, you know, those margins will come back to where they're at. And you've seen our long-term targets are 48%-68% for gross margins, it's 45% for our operating margins. We've been doing better than that. You know, let's go through the cycle and where we're at. But these are phenomenal growth in operating margins, in the top five, in the entire industry for where we're at, and we're proud of how we've been able to get it. And we have shown in the past that, once we get there, we have higher-