All right. Good morning, everyone. Welcome to the Stifel CSI 2023 Conference, and the first session of the whole conference. My name is Tore Svanberg. I'm a senior semiconductor analyst. I cover semiconductors, primarily focused on analog connectivity. It's my great pleasure to introduce Microchip this morning. With us from the company, we have one of the company's chair to my left, Steve Sanghi, and also to Steve's left is Sajid Daudi, who's Head of Investor Relations. The particular format for this session is fireside chat. Before I jump into the questions, you know, I'm not doing this as a favor to Steve to promote his book just because he came to my conference. This is Steve's second book.
It was published a couple months ago. I read the book. It's a fascinating book. I think especially for this audience, if you are interested in semiconductors, and you are interested in finance, this is the book to read. I think a lot of you know Steve, you know, he's very analytical, so he focuses a lot on the numbers, a lot on the data, but he also has that amazing historical context of the industry. Again, if you love finance, you love semiconductors, this is the book to read. Thank you, Steve, for publishing, 'cause it's a great book.
Thank you.
With that, we always start with some of these softer questions, Steve, so if you could just offer a brief introduction to the audience about Microchip, especially those that may not be that familiar with the company. I mean, it's been around for a long time, but there's always a few new investors that are not that familiar with the name, so just sort of five minutes introduction first.
Sure. Before I begin, I wish to remind you that a lot of feedback, that during this presentation, I'll be making some projections and other forward-looking statements. These involve predictions, and the actual results may vary materially, so I refer you to Microchip's filings with the SEC regarding some important risk factors about the company. A little history of Microchip. You know, Microchip began in late 80's, in 1989, when we used to make EEPROM memory products. A new management team, headed by me, changed the focus of the company to building field programmable microcontrollers. Prior to that, the microcontroller market was custom ROM-based market, where the parts were programmed in the fabrication process, taking 15, 16 weeks to deliver those parts, and they were custom in nature.
Enter the next decade, Microchip did to the microcontroller market what Xilinx and Altera did to the high-end market, where we converted it from a custom market to a field programmable market. Microchip rapidly became the leader in field programmable microcontrollers. Over the years, through successive development as well as acquisitions, we added everything that goes around the microcontroller: analog parts, mixed signal parts, sensors, networking, connectivity, power management, timing products. You know, then we became a total system solution supplier, so we have pretty much everything on the board that our customers might need on or around the microcontroller. You know, that's sort of the history of Microchip. To tell you a little bit about, you know, how the business is doing right now, business is doing very well.
The current quarter is on track to the guidance we provided in our earnings call, and we're also confident that, you know, we talked about the next quarter. The next quarter is highly unlikely that the next quarter is down. Next quarter is building very well with the backlog in orders and trends and everything we're getting. A lot of people ask questions about the cycle. You know, we recognize we're in a cyclical industry and are not immune to the business cycles. However, we see very strong business conditions for our business. Like I said, it's very highly unlikely that the next quarter is down. If we do get into an inventory correction kind of cycle, we are confident that our operating margins will be remain in excess of 40%, maybe much higher than 40%.
You know, today, our last quarter, our gross margin was about 47.5%. If you look at Microchip over the prior business cycles, 15 years or so, you will see this history of very resilient gross and operating margins, and we're confident that we should be able to soft land the business in this cycle also and continue to have very robust performance in gross margin, operating margin, and cash flow.
Great.
I'll kind of stop there for a second.
Perfect. Yeah. Thank you, Steve. Of course, I want to ask you more questions about Microchip, but given your vast experience in the semiconductor industry, I was also hoping you could talk a little bit about this cycle versus previous cycles. I know they tend to look the same, but there's always a different trigger, right? You know, clearly this last one, you know, with the pandemic, you know, was very different from anything we've seen. I was hoping you could maybe talk a little bit about what's your view of this cycle. And I'm not asking you to talk about the inventory. What does this cycle mean for the role of semiconductors throughout the supply chain? Because I do believe that semis have become much more critical.
One thing that happened is, you know, when the pandemic hit without seeing any kind of demand destruction, the customers pulled back very hard. If you look at, you know, in the month of June of 2020, going back three years, the automotive industry was, like, down 80% that month. They basically just stopped in their tracks, and many other customers in other industries, despite, you know, begging them: "Well, you know, okay, we have a pandemic. You have a short-term problem, but what happens three months from now, six months from now, one year from now? You know, give us visibility. What should we do with the factories? What should we do with the inventory?" Nobody had any visibility, and there were really no good answers.
What the industry did back then was they blew off the safety stock. People didn't add any capacity. Some people shuttered down some of the capacity. Some people laid off some of the people. Basically, you know, people cut back on the capacity. It didn't take very long. By September, October, everybody was, you know, clamoring for parts. You know, people were looking for parts, but industry had, you know, blew off the inventory. There was no safety stock left for any customer. In that pandemic environment, it was very hard to ramp because the factories were affected. You couldn't work full-time. A lot of people were sick. A lot of people didn't wanna come to work for fear of getting sick. There were all these issues due to which, you know, companies couldn't produce a full amount of product.
That led to this humongous demand that couldn't be satisfied because, you know, people couldn't ramp. Over the last two years, we have seen just the biggest business cycle in terms of demand, and a lot of new demand came up. In Microchip's case, you know, one example, in the March of 2020, if you had asked me, you know, what is the thing that people used to use in hospitals to pump oxygen into the ventilator? Do they call it ventilator? If you had asked me what a ventilator was, you know, my answer would be some sort of fan in the attic that takes the heat out.
Soon I discovered that we were designed into ventilators around the world. A hospital that had two ventilators now wanted 4,000, one for every bed. The demand for those products wet up 1,000x. That was one example. The second example was, the PC and home, work from home kind of environment. Lots and lots of our people had desktop at work, and we needed to buy them a PC so they can work from home, also upgraded their broadband, buy them a printer, a camera, and all these things. Demand on those two areas just skyrocketed. In every other area of the economy, the digitalization of the economy, which was kind of well underway but would have taken a decade-plus to do, basically happened overnight in a year.
You know, everybody got, you know, so efficient in working from home, having meetings like you're talking to the person next door, with Zooms and Teams and others. All those products were not available just a year before that. The innovation happened at a rapid speed, and it created a lots and lots of demand. Once that demand got satisfied, and there was some euphoria also, which led to then the inventory correction and, you know, the whole rest of the industry has seen, maybe we'll get to it, Microchip is the only company in the industry that has not seen the inventory correction yet. We haven't had a down quarter. Last 10 quarters were a record, and we could get into that if you wanna get into that.
Yeah, why don't we get into that? 'Cause, I think you've talked about, I mean, we all know the markets have corrected at different times. We've talked about this rolling correction, right? By you having exposure everywhere, you know, you may start to see some of these corrected markets come back before the others start to correct.
You know, I'll describe maybe two or three reasons why we haven't seen this. Number one, you know, different market exposure. Clearly, PC markets have corrected, and cell phone markets have corrected. Those two are really sort of the worst ones in the consumer space. You know, Microchip business is in industrial, automotive, aerospace, and defense. Those are some of our larger segments, and, you know, there's no problem there. There's a war going on, and, you know, we've got $650 million a year of defense and aerospace business that's very strong and growing and, you know, just huge demand for that. The industrial market has stayed good, and the automotive market has stayed good. You know, the end market mix is one of them.
The second one is really our focus on the mega trends. We have increasingly focused our business on six mega trends, which are 5G, IoT, data center, electric vehicles, sustainability of power and water, energy consumption, harvesting, measuring, all that kind of stuff in sustainability, and finally, the Advanced Driver Assist, leading someday to self-driving cars. 45% of our business is in these six mega trends, and that business is growing at 2x the rate of our core business. That's the second issue with why the wind has still been on our back. The third issue is the total system solutions, where, you know, a customer upgrades their equipment from the prior generation that may have one or two of Microchip's parts to the current generation, which could have five, 10, or 15 of Microchip parts.
Last time he did that design, let's say it was six, seven, eight years ago, when we didn't have all these analog, mixed signal, discrete, FPGA, everything else, and today we do. Our focus on total system solution is adding an increasing amount of new content, you know, which is higher than the general people talk about, you know, content is growing 4%, 5%. We're not talking those kind of numbers. We're talking significantly higher numbers of the content increasing through total system solutions. All those factors working together, I think, you know, we're the only company in the industry that has not had a negative quarter, and I'm not forecasting one next quarter either.
Yeah, thank you for that, Steven. Maybe if I can expand a little bit on the, on the last topic there, which is the total system solutions, 'cause, you know, I think a lot of investors, they still think of Microchip as a microcontroller company, but, you know, to your point, the company's changed a lot with the acquisitions you've had. Can you give us a few examples of where the total system solution approach has been really, really successful, where, you know, perhaps you have FPGAs, microcontrollers, and analog content in a meaningful way?
No, certainly, I mean, you know, I keep hearing that investors don't fully understand it, you know, the total system solution. We have been talking about it for quite a while. Actually, it disappoints me that that message doesn't seem to sink through, so let's take another shot here. When you look at a customer's board, the center of that board, the mother chip on that board, is often either a microcontroller or a microprocessor, or it could be a custom SOC, it could be an FPGA, some sort of CPU. You know, some sort of central processing unit is a mother chip. For the entire system to work, that mother chip is surrounded by analog parts, mixed signal parts, sensors, memory, networking, connectivity, timing products, and power management. You know, all that stuff is needed to make the things work.
Take a simple example of a thermostat. You know, a sensor has to sense the temperature, compare it to a reference, you know, convert it from analog to digital, you know, process inside a microcontroller, make some sort of decision, then the output of that has to drive in a motor or LED, or a switch turn is on or off or something. When you look at the input and output, you need analog and mixed signal components on the both side. If that thermostat is, you know, connected to internet, either through Wi-Fi or through Ethernet, or through USB, or through Bluetooth, you need connectivity, networking. A system to work needs all these various components. You know, 20 years ago, or even 12, 15 years ago, we provided one component in a system, which would be the, you know, microcontroller.
Today, when you look at that system, it is entirely built of parts from Microchip. We, in the last 12, 15 years, we have either built or built through acquisitions, every functionality that needs to be on that board. One example we have given in the last couple of years is an example of FPGA reference design. When we bought Microsemi in 2018, Microsemi's FPGA reference design had their own FPGA, and there were 14 chips around it. Only two happened to be from Microchip. Just by accident, they had designed two of Microchip chips. The other 12 were from our competitors, you know, Analog Devices, Linear, Maxim, TI, Intersil, and others. Fast-forward two or three years after we acquired them, we re-spinned that reference design to have all of those 14 chips from Microchip.
That kind of thing has continued in every design. That's sort of how the TSS is working. You know, let's take a bigger example at the, you know, end customer level. Take two examples. One would be, let's say, a commercial plane. I had dinner with some investors last night, and I asked this question: What do you think is the average Microchip dollar content in a commercial airplane? The answer from the investor, one of the investors, was $300. Well, that answer is over $100,000. We have over $100,000 of content in every commercial airplane built. All through the plane, in the cockpit, in the control, air control, fuel control, you know, rudders and wheels and landing gears and seats and seat positioning and displays in the seats.
Up and down the airplane, everywhere, we're loaded with microcontrollers and other chips from, you know, parts that go around the microcontroller. The second example is of an automobile. For many years, we have been showing pictures of, you know, a Cadillac class car and a Mercedes-Benz S-Class car. Both of them have about 63+ of Microchip's chips in it. Recently in the last year, we have introduced, actually, maybe just in the last few weeks, we have been talking about another car. It's a Hyundai Kia car, HKMC. Model is, IONIQ 6. which has 88 chips from Microchip in that car. This TSS is not, you know, going from, you know, $1- $2 or, you know, 5% improvement. These are just huge numbers.
As you look at the electric vehicle, and we have lots of designs in those, electric vehicle has about twice the semiconductor content than you have in a non-electric vehicle. When you look at the electrical vehicle, a lot of people, you know, look at electrical vehicle regarding what is new than the gasoline engine. You know, the power management, charging the battery, preserving the battery, when you apply the brake, you know, reharnessing the energy and all that, and we got lots of chips in that. An electric vehicle has all the other stuff that a gasoline car does: windows and doors and locks and antennas and air conditioning and, you know, garage door opener and taillights and safety and cameras, and those are not different in an electric vehicle than a gasoline car.
We have content all around the car, in the body electronics, networking, you know, entertainment, seats, windows, positions, sun roofs. We have chips everywhere. In addition to that, in the electric vehicle, you have chips related to, you know, battery and power and electric vehicle and management, storing, and reharnessing the energy. All that, you know, all those are examples of TSS that are just driving our business.
Yeah. No, thank you for that, Steve.
Steven, do you want to add something?
I was going to say, just the numerical or the impact, the financial impact of it, can be seen in incremental gross margin, 'cause a lot of this, as Steve said, is pulling in a lot of richer content. You know, our incremental gross margin is kind of low mid-70s for the past couple of years.
Right. Another way to think about it, and I'll just steal something from your book, Steve.
Sure
... which is, I mean, since the company went public 30 years ago, revenue's gone from $90 million to $9 billion this year. The stock's price has gone from split-adjusted $0.285 to roughly $75 where it is today. I don't think you can do that by only selling microcontrollers, right? Very good. The other big topic for Microchip these days, of course, is PSP. Again, there seems to be some cynicism from investors, where they think that PSP is gonna create this sort of, you know, vacuum of demand over the years. Clearly, PSP has served you really well during the pandemic.
More importantly, and I believe this was the strategy where, you know, you use the PSP program to get closer to your customers, especially at a time that you're really promoting TSS, right? help us understand a little bit, you know, how the PSP program is gonna help you, not just during the pandemic years, but over the next five to 10 years.
Certainly. You know, as the industry became very constrained and you didn't have parts for everybody, we came up with a program called PSP, which was a Preferred Supply Program, which we never thought would be so outrageously successful. We thought a handful of customers will take that offer. The offer was that if you come to us and place a 12 months of non-cancellable, non-reschedulable backlog, then we will give you preferential supply over the other customers. You know, in the very first couple of months, I think we have signed up thousands of customers. The program became so successful that, you know, our PSP backlog became well in excess of our total ability to supply.
The entire idea of PSP was, you know, you place the backlog, and we'll give you preferential supply, means you get what you wanted. When the PSP demand exceeded our overall capacity, then despite becoming PSP, you were allocated because we couldn't make everything. This is how successful it became. Then we had a backlog, you know, some of it we wouldn't satisfy for a year and a half or two years. One thing investors either don't get it or they don't wanna get it, I think it's the latter, that when a customer has to place a 12 months of non-cancellable orders, it's not the junior purchasing guy who sends you an order over the internet.
It goes through substantial review at the company, and it is done with the approval from fairly high level, where ability of the company to see through those parts, that they have multiple use, and if the demand on one project would be lower, they will reuse the parts in another project, or when they design the next project, they'll preferentially give Microchip that design, so they have, you know, use for all these parts. The quality of the backlog we received in the last two, 3three years has been the best quality we have received in 30+ years. It became a norm, and people who didn't join the PSP, you know, heard about it, you know, learned through reference. As people move around, it was also. In our customers, it was a time of great resignation.
Lots of purchasing managers and engineers moved from one company to the other. The word of PSP got through from, you know, customers who had it to the customers who didn't have it, everybody wanted it. It became a very, very successful program. Even till today, large majority of revenue that we are shipping, and we've been telling you that PSP is well over 50% of our backlog. It's well in excess of 50. Management never wanted to give that number. You know, it had continued. In the next phase of that, we introduced a, you know, a program which is an enhancement of PSP.
Basically, we call it supply assurance, where we ask our customers to sign 5-year agreements with us for an increasing amount of dollar revenue they'll buy from us every year, and give us an advance payment of an amount to be not disclosed. If then they, you know, then we will assure that they have capacity for those many dollars every year on a quarterly basis, and if they make the purchases that they're committed to, then they'll get 1/20th of that advanced dollars back every quarter, and over five years will be paid up. Any time in between, we can renegotiate by adding more years to it. You would think that in current environment, where everybody's worried about inventory, you know, customers won't be signing up for those agreements.
You know, I personally, as an executive sponsor of one of the large industrial account, signed one of the customers to a five-year long-term agreement just two weeks ago. We have signed a couple other customers just in the last couple of months. The program has teeth. People have benefited from it and are now signing up to benefit from it for the next five years. The other thing it has done is it has taken a lot of customers who traditionally will buy through distributors or buy through subcontractors, or in the case of automotive, you know, automotive OEMs don't buy the parts directly. They buy them through their tier ones, 'cause tier ones build the modules. One thing it has caused is all these people now have direct relationship with them.
We have a number of direct long-term agreements with the car OEMs, that you could never think that they would, you know, talk to a semiconductor guy and sign up a long-term agreement. They would be consigning the parts to their tier ones. Many other customers who bought through subcontractors and distributors have signed up the agreements to acquire them directly and then consign it to their subcontractor if needed. You know, all that means more visibility, more direct relations with the customer, getting closer to customer, long-term supply agreements, higher probability of put the whole TSS together, because a distributor and subcontractor, you know, divvies up the pie, right? You know, there are 14 parts, let's keep everybody happy. Give some to STMicroelectronics, give some to Analog Devices, give some to the others. When you have a direct relationship, you get the whole TSS.
It's better for TSS, it is better for gross margin, better for operating margin, and better for visibility.
Yeah, and don't go to Avnet now and ask them, you know, what about this program? That's just a joke. Steve, we just simply can't have a semiconductor fireside chat without using the word AI these days. I know Microchip is a mixing company. Obviously, you sell to 120,000-130,000 different customers, AI at the Edge is clearly something that, you know, eventually is gonna hit Microchip in a big way. Obviously, today, a lot of the AI is still at the core. There's some smarts at the edge, it just continues to innovate. What's Microchip doing to, you know, really get the AI at the Edge market going?
You know, AI at the Edge is already going, and we have huge content in it. A year ago, AI and machine learning was one of our six mega trends. You know, we ask our worldwide sales people that call on customers to take the designs and to categorize them, what category they're in, you know, whether they're 5G, whether they're IoT, whether they're data center, what category they're in. What we discovered was that, you know, every AI design was embedded into one of the other mega trends. It's a data center design that is also doing AI. It's an IoT design that's also doing AI. It's an advanced driver-assist design, but it's also doing AI. It's a 5G, but also doing AI.
We took AI out as a mega trend, replaced it by sustainability, and then bracketed the AI into every other trend. We have AI all over the place. When you look at, you know, a lot of the self-driving cars today or advanced driver-assist cars, you know, camera is capturing an image, you know, through whatever means it does, then it comes in. When it comes in, it's in our hands, that image, and it's the thing at the edge, and then bring that thing to a central processing unit, process it, and then make decisions. You know, Microchip is in all kind of AI. You know, we have launched a initiative called Embedded Machine Vision, you know, which is essentially another way to say that is AI.
A lot of this AI at the Edge, you know, require very compact products that have a very, very small thermal footprint, because, you know, you can add, you know, fans and stuff like that to a central processing unit and cool it down in front of a radiator or in a data center when it's in a server. When it's at the edge, it needs to be very small thermal footprint. Microchip products, like our mid-range FPGA, our microprocessors and microcontrollers, they're all especially designed for very, very low power, which is critical, giving robust compute performance, but using a very, very low power and generating a very small thermal footprint. Those are some of our differentiations, why we're winning a lot of AI designs.
Excellent. Very good. With that, we've run out of time. Thank you, Steve. Thank you, Sajid, for coming to our conference. Thank you, everyone, for coming through the Microchip session. Again, I really encourage you to buy this book. It's a great book. Thank you again, everyone. Enjoy the rest of your day.
Thank you.