All right, good morning and thank you for coming to T.D. Cowen's 53rd Annual TMT Conference. Really pleased to be joined by Rich and Eric from Microchip. Guys, thank you for participating in our conference.
Thanks for having us.
I think to start, maybe we could walk through an update on what Steve's vision is having come back into the CEO role and maybe an update on where we're at and some of the key points in the nine-point plan that he's outlined.
Sure. I'll start by giving the typical disclaimer that during the course of this discussion, we may be making forward-looking statements about the future financial performance of Microchip and I refer you to our SEC filings. Our 10-K was just filed last week that identifies important risk factors about the company. Steve has been back for about six months now. He unveiled his nine-point plan to the street. We went through that in detail on March 3rd. There's a number of pretty significant steps that are being taken in there. Firstly, he was focused on inventory management. We have done some restructuring on our manufacturing footprint. With that, we closed our Fab two manufacturing facility in Arizona just a couple of weeks ago. That was well ahead of schedule. We had previously said kind of end of September.
We pulled it in, got the bridge build done. Now we're starting to get those cash savings today. Eventually, they will result in lower inventory and better margins in the future by taking out that facility. That was a big thing. He's focused on a lot of things related to, are we focused on the right markets? We did a full business unit by business unit review and there were some changes that came out of that. An example of that is we combined our 8-bit and 32-bit microcontroller divisions. We're excited about that. We had a bit of a product gap on the low end of 32-bit and that's being addressed very rapidly. That's being done. Rich has details on all the other kind of restructurings that were done within the business units, but those were all implemented at this point in time.
We were very focused on customer relationships. During the upcycle, customers did not feel that they were treated fairly in all cases. We had this Preferred Supply Program that essentially pushed inventory on them later in the cycle when they did not really need it any longer. Those were based on non-cancelable, non-reschedulable orders, which we backed off from, but we had some damaged relationships that we needed to address and we have done that. We feel after going through that process that the customer relationships are in really good position. We made some small tweaks to our distribution program on top of that. We unveiled our new long-term business model, which is a 65% Non-GAAP Gross Margin target and a 40% Non-GAAP Operating Margin target. We have got clear sight to get there.
That's kind of high-level summary, but I think we went through this reduction in force that we announced in early March. That's been implemented. I would say that morale in the company is pretty high after that, which you might be surprised at, but I think the company is in a good position. We've seen the bottom at this point in time. We're guiding for nice growth this quarter and we think that this upcycle has legs behind it for us. With that, I'll turn it back over for your questions.
No, thank you for a super comprehensive overview there. Maybe we start with the manufacturing side. You closed Fab two. Are there any more changes you think you need to make to the manufacturing network as you think about the next, they're analog Fabs, they should be in service for 30 years. How do you view any changes in what you think is the right mix of Microchip's manufacturing over the next few years? Maybe you could talk about the redundancies you have in place as you go through these Fab transitions.
Fab two was largely landlocked. It was our smallest fab. There was really no expansion room within that facility where we had huge campuses in our Colorado and our Oregon Fab. We had lots of room for expansion there, lots of room and diverse clean rooms for analog growth or specialty A&D products growth. We had lots of space there. Seventy percent of the products that were in Fab two were already cross-qualified in the two other Fabs. In terms of adjusting inventory, it made the most sense because we had the largest ability to grow fab space in those other two locations. Also within those other two locations, we've got the most diversity in terms of analog capacity.
You guys are Fab light, you're talking I think it's 60-40 internal, external mix. Is that the right ratio for Microchip going forward? In particular, you've in the past talked about, you've explored the idea of going down to 300 millimeter Fab. Is that possibility off the table and it's just not the right move for you guys?
It's not the right move for us because of the diverse product portfolio. It just doesn't make economic sense in terms of ramping it and getting the flywheel moving on that to have that payback in terms. We have instead worked different Fab arrangements with our foundry partners. To our foundry partners, Microchip is a very important partner because we also supply memory technology or flash technology that's used by almost every major foundry. We are a very strategic partner with them in our overall relationship.
Okay. Eric, you mentioned the customer relationships that you have been managing over the last six months. Where are we in that? What is the status update on how your customers are feeling now?
Go ahead, Rich.
Yeah. Yeah. We surveyed about 6,700 of our direct customers. About 24% of those customers, the relationship actually was improved over the COVID period and 12% it was negatively affected. We focused on about roughly about 800 customers. I have spent personally a lot of time on the road working with them to work through those different issues that we had with them. In fact, I was with one CEO of a company here yesterday and having dinner with them and working through relationship issues here in New York. We've spent a lot of time, almost all of those have been repaired, almost 90% of those have been repaired. We really think this was overdone in terms of a concern or a worry. This is largely behind us.
I guess zooming out, I mean, it's been a very strange five years for the analog industry. As you're going to your customers and having these conversations, if we zoom back pre-COVID, I mean, are there big changes you think you need to make from a go-to-market or how you engage with your customers looking forward? I mean, it seems like many are de-emphasizing the channel, for instance. Is that something that you see happening more so going forward?
We have made some channel changes in terms of the relationship to make sure that they are aggressively going after new customers. I think the biggest change that we are making going forward is how you have that relationship with customers. The whole idea of that PSP or almost all semiconductor companies had some level of a PSP type program where you had long-term, non-cancelable, unreturnable. That does not work for customers. We are working with a lot of our top customers to come up with alternatives to those strategies that were employed during COVID. We have got this whole program where we are working on know your customer much better.
Even in the face of tariffs, we employed a very different process where we're meeting face-to-face with all of our top customers and discussing the effect of tariffs and what that means and how do we handle it together, what do we do together. The customer relationships are much more in focus now.
Another point you mentioned in the plan, Eric, was resizing the employee base. You mentioned that the employees feel like they are feeling excited and feeling good about Microchip. From an OpEx standpoint, how should we think about that tracking going forward with revenue? Are most of the cuts done? Is there more to come? I mean, you guys took a lot out of variable comp over the last few years. I'd be curious to hear how you're thinking about that as we hopefully get into a better environment.
Yeah. The OPEX cuts are done at this point in time. Our guidance for the current quarter on kind of OPEX dollars on a non-GAAP basis is about $356 million. You should really view that as kind of the low point. That has no variable comp assumed in it. Clearly, when the results have been there, there should not be bonuses being paid. Eventually, those will need to come back into the model. We will need to make investments as the business grows. What I would expect is as we move forward and revenue is growing, that OPEX as a percentage of sales continuously comes down. It grows at a rate clearly quite a bit less than revenue as we are very focused to get to that 25% of sales OPEX number long term.
Okay. From the inventory standpoint, how much more work is there to do from that standpoint, both on books and in the channel? How far are we from shipping to end demand? I guess how much better does end demand have to be to get to the point where you're shipping more directionally in line with actual pull from your customers?
We still have a ways to go. We quantify every quarter what the difference between distribution sell-through or sell-out versus our sell-in or what our gap revenue, our revenue reporting is. Last quarter that was about $103 million. Now that is on what I consider a pretty depressed level of sell-through because our distributors, customers have been draining inventory also. We cannot quantify that. I would suspect as we move through this fiscal year that will end in March that the difference between sell-through and sell-in essentially converge on each other over the course of the fiscal year. It was a $103 million difference last quarter. I expect that to decline as we go through the year. I think customer and distribution inventory will be corrected as we go through this year for the most part. At what stage it is at is different by customer and distributor.
I think distributor is getting closer to being corrected because we can see those and having discussions with distributors. They were at 33 days of inventory ending last quarter. That's been a wide range over time ranging from 17 at kind of the peak of the last cycle when nobody could get inventory to as high as 47 days in the past. It is kind of in the middle of the range. I'd expect it will come down a little bit more from here, but it's getting closer. Customer inventory, it's hard to forecast that out, but again, everybody's been correcting and lead times are short. I think they will continue to correct until they get to that right level. I expect it to be sometime this year.
Are there any geographies or end markets that are better or worse off and where you think you're further along?
In the inventory correction.
Yeah.
I don't think so. It was very broad-based, right? Lead time stretched out across the board and customers protected themselves by buying inventory. So my perception is that it doesn't really vary by end market.
Got it. All right. Switching to a more fun topic. You did mention leaning into more attractive secular growth. What does that mean for Microchip? What do you have to do to the, is there other wholesale changes from a technology standpoint you need to make? Or is this more about just focusing your sales effort on the right sockets and where you have the opportunity to participate in content growth, but also synergistic content growth that can pull in more Microchip parts across your MCU, FPGA, and analog portfolio?
There's a big focus on connectivity. When we looked at overall new markets to grow, when you look at wired and wired Ethernet and two-wire Ethernet, Microchip is a leader within those marketplaces going back to when we acquired the technology from SMSC. We've significantly grown that business. That business in itself drags in a lot of other business from the company. Analog, it drags in microcontrollers, timing products. That has substantially been growing. The other business been growing and doing very well has been our FPGA business. That has a drag on effect from a lot of our other product lines. A&D has continued to be a large focus for us. Microchip is still the world's largest supplier of semiconductors to A&D.
Anything that leaves Earth's atmosphere or defense programs has significant content from Microchip, whether it's the India moonshot space flight that landed on the south side of the moon, significant content from Microchip, or any other things that leave Earth's orbit. That particular part of our business went from about 11% revenue, although revenue down to about 18%. That really has not seen any real reduction and continues to grow.
I think when people think about your aerospace and defense business in particular, the space part, usually think of the radiation-hardened FPGAs for Microsemi. Are there FPGAs pulling in other parts of your microcontroller and analog family into those sockets? How should we think about that growing?
Now that actually very much so is pulling in other products. So we're doing rad tolerant or rad hard testing on some of those. And then some of those products that are rad hard and rad tolerant for new defense applications or new space applications, we're derating a number of those devices for those applications as well.
I think when you add it all together, the six mega trends are about half the business today.
About half.
How should we think about that mix in three or four years out? If we get to a normalized environment, how much more are those businesses going to grow compared to the legacy end markets?
Yeah. In March, we had shown that it's been growing about 2X Microchip's overall growth rate. We've readjusted some of those marketplaces. We got rid of 5G, molded some of ADAS into connectivity and networking. Now as we look at industry 4.0 and reindustrialization of Western marketplaces, all of those are using the latest connectivity technology that we offer. That will continue to outpace the rest of Microchip's growth.
On the newer product standpoint, you guys introduced a 64-bit microcontroller, I think it was about a year ago. What's the, I guess, key applications and go-to-market there? Because that's a pretty transformational product that I think will probably take some evangelism on your guys' part because people aren't used to dealing with a 64-bit microcontroller. I'd be curious to hear how you're thinking about why you felt the need to bring that product to market and given it's been so long that the microcontroller business is very mature and nobody's really scaled a 64-bit microcontroller yet.
Fascinating development is most people aren't aware that Microchip won the next generation of space computer with NASA. NASA hasn't upgraded their space computer in probably 25 years. We won that contract and we started developing an octa-core 64-bit RISC controller or CPU or processor.
It's actually a microprocessor.
Oh, microprocessor for future space flight. We've then taken that development and what we're doing in that particular area and offered a number of other product offerings, again, derated for other marketplaces. Where we're seeing uptake in that is industrial control, medical applications, places that need accelerators or AI/ML or edge compute functions built in. Those are the areas where we see that uptake on that 64-bit product.
How big can that be within your microcontroller franchise? I mean, should we expect to hear you talking more about MPUs going forward as there seems to be more pull from many embedded applications for more high-performance embedded processing?
You'll probably hear us talking about more compute as we go forward. When it comes to FPGAs in compute type functions or edge compute functions and 64-bit and edge compute functions on the RISC side, you'll hear us talking about that more.
I think on the last earnings call, you guys mentioned that you felt like during COVID accelerated the move from 8-bit to 32-bit. I kind of jumped over and skipped to 64. How do you feel about the competitiveness of your 32-bit franchise? Because Microchip's historically had very high share in 8-bit, less so in 32.
Yeah. We still have very high share in 8-bit, but strategically what was missing, the way we had our BU structure set up at the company, we had people working on higher-end 32-bit products and then we had 8-bit and there was no overlap between those two product areas. One of the items that we recognize in the deep dive is we've consolidated those organizations to offer customers a very seamless transition from 8 to 32-bit from a product line standpoint. We've also combined, even more importantly, the software development and tools groups between 8-bit and 32-bit to offer a seamless common platform that allows customers to move from one to the other.
We spend a lot of time talking about new products and attractive secular growth trends. To oversimplify it, if we step back, what's the right growth profile for Microchip through cycle, acknowledging that it's been really hard to figure out a normalized growth rate the last several years?
I'd say the way we've framed it is industry plus, right? I mean, we're coming off a very steep downturn where we have underperformed. I mean, we outperformed on the upside. Clearly there was overshipping that was happening when customers were building inventory. And because of that, we've outperformed on the downside. I guess we'll call it underperformed on the downside. There's definitely going to be a bounce that we get from that. Stephen Roach does not like the word bounce, but essentially we should see an acceleration.
That is not allowed in the vocabulary.
I thought about.
I think we're really set up well to show outperformance here. Once we return to whatever that normalized revenue run rate is, we would expect to be able to outgrow the industry.
Okay. In the vein of returning to normal, I'm going to ask you about the very not normal times right now. There's a lot of uncertainty. You guys were pretty clear in your earnings call. You're not seeing any evidence of pull-ins. What gives you the confidence that your customers are not pulling parts now? I mean, how are your engagements with the customers? Again, it's a really challenging time to be a semiconductor company and a customer of a semiconductor company. How are those conversations? Are people seized up? Are they nervous? Or are they acting normal?
We got in front of this. At the same time we were having these conversations to just repair relationships, we have changed that whole conversation with our customers. The minute that this whole tariff thing started getting in front of us, we set up senior level C-level meetings with all of our top customers. I have been in C-level meetings since February at all of these top customers, even yesterday, trying to understand and make sure that people are not overreacting. What happened during COVID and any semiconductor cycle is when human emotions come in and people overreact. What we tried to do is have rational conversations to make sure that there was no overreaction or doing things that were unrealistic in terms of not meeting what was actually happening in the business world. Our customers are not pulling in. We service 120,000 customers.
Could there be some fringe of customers that are doing some of that? Very well could be. That's just human behavior. At larger accounts, we're not seeing that behavior.
Okay.
The benefit that we're seeing, obviously we've talked about an increase in bookings activity that we're getting. That is not just short term. We are seeing our backlog build quarters out in time. That's a helpful sign that, hey, this upturn we're seeing has legs behind it.
Yeah. I believe in the call you said each month of the year had been better than the previous one. That's still holding?
Still holding. I do not think we said that exactly. Because bookings can be a little bit up and down, but they have been materially higher every month in calendar year 2025 than anything we saw in calendar 2024. You should not take that that bookings are falling. Bookings in May are still trending very, very well.
Okay. Got it. On that topic as well, I mean, Steve had some pretty pointed comments about his views of some of the tariff situations that are, I guess, potentially happening. How do you see the industry reacting and how are you guys positioned in an environment where we sort of get into a China and U.S. versus everybody else environment? You talk about your China for China strategy and also how you're positioned to deal with tariffs from a manufacturing standpoint.
Yeah. So what we've done is we've opened up portals for all of our customers to have visibility as to where everything is manufactured. And so all of our customers know where it's manufactured.
Meaning they can see where it's fabbed, where it's assembled, where it's tested.
Utmost clarity. About 37% of our wafers are built in the U.S. Fabs where we think there may be potential issues where cross-qualifying that outside the U.S. and where we think we have issues where it's built overseas, we're cross-qualifying it in the U.S. In some cases where we can, where we have a lot of dual sourced product, we're making sure that we can cross-qualify it in two locations.
Is that proactive on your part or are you seeing customers that are already looking into that level of granularity or not yet?
Proactive on our part, depending on where it's going to fall. You might as well start planning. From a built-in China standpoint, less than 4% of our revenue is built in China. We started that transition many years ago. Not much of our product wafer Fab, only about less than 4% is assembled in China and much less than that is actually fabbed in China.
What's your view on the necessity of a China for China strategy? Would you envision partnering more aggressively with local foundries there going forward?
You know what? We still are a technology provider in some cases with Flash technology. We have built some products there. It is not a big focus for us to build lots of product within China. When we do focus on sales within China, it's mainly for external shipment out of China. We do not focus on a lot of local demand for our products from a designing perspective in China.
Okay.
We talked a bit about a China for China strategy back on our March 3rd call. I would say that we are waiting for these tariff rules to kind of be finalized before we really put our foot on the gas pedal and move forward aggressively on that. Let's see where the rules are going to fall and then we can adjust our business accordingly as it makes sense.
Got it. Makes sense. I guess from a demand standpoint, it seemed like there was, I don't know, sustained optimism that China demand was hanging in. Is that what you guys have observed the last few quarters? Again, any changes in your China customer base over the last few months, acknowledging that it's a small portion of your mix?
Not a significant change. Most of our China distributors, a lot of our business in China goes through distribution. Most of them have corrected overall. The distribution levels have corrected for the most part. What we're seeing is reordering of certain CPNs or certain part numbers that we haven't seen them order in quite some time because they had high distribution inventory.
There has been perpetual concern of local competition. Any changes there? Are you seeing, are there certain sockets that you feel like China is more advanced versus some others or you're not really seeing the impact at all?
We've always had, we have more competition today than ever before, but we have to be competitive. Like I said, we're not focused so much on local consumption. We're focused mostly on export products.
We have said pretty consistently that a large portion of our customer base values the broad portfolio, which the China competition does not have today. Take a microcontroller as an example. A customer does not want to come to market or start their design process with a company that might have 20 products in their portfolio, and then they get feedback from their customer base that they need to add features and they get stuck. That is the advantage that Microchip and our large competitors have, that we have these broad portfolios that give customers options. If you are building a high-volume consumer application, it probably does not matter because that China competitor can target that and bring them the product.
In our industrial, automotive, data center clients, they are looking at that optionality and need the surety that we've got a product platform that can carry them where they need to be.
Okay. May for Eric, you guys obviously, your gross margins now are well below where they historically have been for reasons that you've been pretty forthcoming with. Can you walk through what's the path to get back towards your target model range in the 60% plus range? What levers, I guess, near term and then longer term do you have to structurally improve the margins?
Yeah. So we've made the structural changes that we needed to make in right-sizing the Fab footprint, which we already talked about. We've got roughly about a $55 million under-utilization charge per quarter that's hitting, and that's not changing this quarter. The larger piece that's impacting our gross margin today is inventory reserve charges that we take from an accounting perspective. We broke those out for the December quarter at being like $82 million, and they haven't gone down from there. What's going to happen, we've forecasted to the street that we expect our inventory dollars to fall by about $350 million this fiscal year. The pool of inventory that is subject to reserve is coming down, and our revenue is increasing. We expect those reserve charges to fall off pretty dramatically.
Not this quarter, but as we move past this, we expect those reserves. That will be the first benefit that we start to see in our gross margin is a much lower inventory reserve charge. By the way, all this product that we've written off over the last five or six quarters, most of this product is product that is going to sell at some point in the future. When it does, it might be written off when it gets to die form, so it's not a finished good. It might not sell at 100% gross margin, but it will eventually sell at a supercharged gross margin. I do not know if that is going to start happening in six months or three years, but it is going to happen.
Okay. As we bump up on time, last question. Microchip has been historically a consolidator in the industry. Right now, you're kind of in protection mode and focusing on capital returns. I mean, should we think of the consolidation phase as done from Microchip standpoint? Or on the flip side, are there assets that you have acquired that you could look to monetize going forward?
There's always going to be small acquisitions that we're doing. We just completed a small acquisition two weeks ago. There's always going to be some M&A activity or acquisitions or technologies that we're going to acquire or bring into the fold. I wouldn't rule out M&A transactions or technology acquisitions from Microchip.
Subscale generally?
Yeah, generally subscale. We are pretty, between the different technologies, we pretty much have the major technologies that we need to complete the applications that we're targeting.
All right. We are out of time. But gentlemen, thank you so much for joining us again this year. We really appreciate it.
Okay.
Thank you.
Thank.