All right. Good morning, everyone. Day two of our conference. I'm Melissa Fairbanks. I am the analog semiconductors and IT supply chain analyst here at Raymond James. We are thrilled to have the team from Microchip here with us today. we've got CFO Eric Bjornholt and Nawaz Sharif , VP of European Finance and Investor Relations. probably going to give us a little bit of a different perspective than we normally get. Eric's gonna start off by doing a short presentation, then we'll go into Q&A. Eric?
All right. Thanks, Melissa. Hi, everybody. Before I start, I'll be making for-certain forward-looking statements about the future financial performance of Microchip. I refer you to our filings with the SEC that identify certain risk factors about the company. Big, big picture, Microchip is about an $8.4 billion revenue company in our fiscal year that's going to end here in March. We are focused on the embedded control market with microcontrollers, analog products, timing, FPGAs, security, and have built this business up over the last 12 years or so through a series of organic investments and acquisitions. Our last acquisition was of Microsemi back in May of 2018. Everything that you've seen over the last four and a half years or so has been the organic growth of the company.
We have very high gross and operating margins, high capital returns, free cash flow, and the company has been performing very well over the last couple of years. Our guidance for the March quarter is to grow at about 2.5% from a revenue perspective to about $2.2 billion. We'll have record gross margins at about 68.2% at the midpoint of guidance on a non-GAAP basis. Operating margins are about 47.5% this quarter, and both of those metrics are at or above our long-term model, which is about 68% gross margins and 45% operating margins. The company is performing really well. We've grown about 20% year-over-year in fiscal 2023 that ends in March, and our earnings is up about 20%, also EPS on a year-over-year basis. We are confirming today that we are gonna grow again in the June quarter.
Our CEO talked about that on our last earnings call and quantifying that to be at about the same rate of growth that we're expecting in our guidance for the March quarter. We get a lot of questions from investors in terms of the growth that the company's seen over the last couple of years. There's concern from investors about, you know, how we are going to navigate to a soft landing if the macro effects catch up with us. First of all, about 86% of our business is in very durable end markets. Industrial is our largest exposure at about 40% of the business. That includes about 10%, which is aerospace and defense. Second largest end market is data center, which is about 18% of the business. Automotive is the third largest end market at about 17%. We've got a very strong backlog today.
We've been extremely supply constrained over the last couple of years. We've introduced a program a couple of years ago called the PSP program, called the Preferred Supply Program. That requires customers participating in this program to give us 12 months of non-cancellable, non-reschedule backlog, and today that still makes up well over 50% of our backlog. We've got a growing list of customers that have now signed up for long-term supply agreements with us. These cover typically about a 5-year period. They pay for a portion of that capacity, I'll call it, upfront, which allows Microchip to then go invest those dollars with our supply chain, invest in capital equipment, people, raw materials, et cetera, to be able to support them. That's a growing piece of the business. We've got a very significant cushion today in what we call unsupported backlog.
We ended the December quarter with unsupported backlog, meaning backlog that customers had requested to be delivered in the December quarter that we can't fulfill until a future quarter that was greater than the revenue that we actually shipped in the December quarter. We've got a lot of backlog that we need to catch up on to catch up with the demand. We build most of our products on trailing edge technologies that have been really the most constrained technologies in the industry. We still have a ways to go to be able to catch up with that. We're replenishing our internal inventory so in order to bring our lead times down. We've been focused on the fastest growing of the markets that we call the megatrends in the industry.
That has driven higher growth than the industry has seen. We've really been focused in providing what we call Total System Solutions or TSS to our customers and selling not just the microcontroller or the central chip on the embedded control board, but everything that goes around that, including the analog, timing, security, et cetera, to become more value-added suppliers, trying to get a larger share of our customers' BOM in every customer opportunity that we have. If we were faced with a softer spot in the economy, we would still continue to derive really high gross and operating margins and free cash flow because the capital required to be invested in the business would also go down. We also have a very high variable compensation program in our company, which can help buffer operating expenses if we saw a softer spot.
Today, those expenses, the bonuses will be paying at a record high, we can back off from that at any given point, allowing us to maintain high gross and operating margins and free cash flow throughout the cycle. This slide looks at, you know, kind of what the semiconductor industry has done over time in terms of year-on-year growth over the cycle. We've got some slides here that show what Microchip's financial history has been throughout those cycles. This is our non-GAAP gross margins, you can see that we've shown resiliency over this 15-year period in terms of the gross margins. During this time period, we've been acquiring companies that have had lower gross and operating margins, even with that, have showed gross margins improving.
That's been a very steep climb over the last couple of years since we have not been doing acquisitions, have completed the integrations for these companies, and margins have gone to a record level. Operating margin's a very similar story, that our long-term GAAP target is about 45%. We're above that today. The company has grown extremely well over the last couple of years. We've done it efficiently, and we can't see any scenario where operating margins could fall below 40% no matter what the cycle brings. We think our margins are gonna be very consistent, both on the gross and operating margin line, for many years to come. Our free cash flow has also grown very nicely at a 23.4% CAGR over the last 10 years.
We introduced what we called Microchip 3.0 at our Analyst and Investor Day about 16 months ago. These 9 blocks on here kind of outline, you know, what that meant to Microchip. Really looking at growing the business organically, as I mentioned before, and focusing on the megatrends in the industry and selling these Total System Solutions to our customers. We introduced at that time a 5-year expected CAGR for our business of between 10% and 15% using fiscal 2021 as a baseline. We're off to a very good start on that over the last couple of years, and we absolutely believe that we will continue to hit these targets. We've got a very diversified end market mix. That leads to really what we have: a leading semiconductor company operating model with very high gross and operating margins.
We generate a ton of cash flow from the business. Free cash flow more recently has been above these targets of 48% and 38% of revenue. EBITDA margin's above 50% is what we've recently produced, and a free cash flow margin of about 38%. Now, when we were doing all these acquisitions, we were funding that with debt and cash from operations, and so our leverage got pretty high. We are investing today in having more inventory on our balance sheet. We sell very long-lived products that, you know, sell for 10, 15, 20 years, and now that we have the balance sheet to do so, want to invest in inventory to be able to support our customers with short lead times. That we're executing on today. From an investment standpoint, our CapEx requirements are really pretty low. We do about 40% of our wafer fab in-house.
The rest we use professional foundries for. We do about 60% of our assembly and test volume in-house. With that, we feel that our CapEx can be about only 3%-5% of sales. 3%-6%, excuse me. In the current fiscal year, we expect to be just a little bit above that. Again, we've had very high growth over the last couple of years and have had to invest in our capacity to drive what our customers need. The other thing that's changed with Microchip now that we're not doing acquisitions is we've really increased our capital returns. In the current quarter, we are returning 62 and a half% of the prior quarter's free cash flow to customers through a combination of dividend and buyback. Our dividend has been growing at about a 40% annualized CAGR, and our buyback has kind of been the sub-subtract answer.
Now we've communicated to investors that we're gonna take that 62 and a half% free cash flow return to 100% over the next 8 quarters. By the March quarter of 2025, we will be returning 100% of our free cash flow to customers. Excuse me, to investors. You know, this shows that history that since we acquired Microsemi, we've generated about $9.4 billion of adjusted free cash flow, used $6.2 billion of that to pay down debt, paid $2.1 billion in dividends, and repurchased $1.1 billion of our shares from the marketplace. We've been reducing debt for the last 18 quarters. We've had 82 consecutive quarters of dividend payment, and as I mentioned, that's been growing at about a 40% CAGR per year. Our buyback program, we've got a $4 billion program in place, and we've bought about $1.1 billion of that so far, and that will continue to grow.
I'm gonna end with just saying that our business is built on a strong foundation of culture and sustainability. We think our company culture is a very unique thing about Microchip that we can talk in individual meetings with you about, but something that is a significant growth driver for us. We've got to focus on sustainability. We're growing revenue organically at 10%-15% per year. We're generating a lot of cash, and we're increasing our capital returns to 100% over the next 3 quarters, excuse me, next 8 quarters. We really think that this is allowing us to deliver differentiated results to our shareholders. With that, I'll turn it over to Melissa for questions.
All right. Great. Thanks very much, Eric. That was a great overview of what I think is a great story. I'll kind of get into, we have to talk about supply and demand, right? I don't think you can turn on the news without hearing about chip shortages. Everyone seems to be talking about it, even if you don't follow the semiconductor industry. Microchip has always been viewed as a bellwether for analog semiconductors. Your business, for all the reasons that you highlighted above, has proven to be a little bit more resilient than some of your analog peers. Do you, given your extended backlog and given your content growth story, especially with the TSS, do you believe Microchip's cycle will be different from the broader industry this time?
You know, we are subject to the industry cycles just like everybody else, but I think our end market exposure is something that differentiates us. We don't really have any cell phone exposure. We have very little exposure to consumer electronics. The end markets where we have most of our business are very durable. The technologies that we're serving this market with. Our trailing edge where there's been the largest capacity shortages. That is coming on gradually, and we're making progress in terms of, you know, getting our lead times down and being able to support customers on a faster basis. We've got a lot of backlog that we gotta catch up on. You know, this might be different than other cycles in the past. We feel that our focus on the megatrends and then selling these more complete solutions to customers.
Mm-hmm.
Is something that's going to allow us to continue to gain share and show differentiated results compared to the peers that we compete against.
Okay. I know this is a tricky question to answer. Do you have a view of when supply will begin to normalize, either through your own internal efficiencies, you know, kind of adding capacity internally, or just kind of waiting for the market to catch up?
Yeah. There isn't a date that I.
Yeah. Of course.
Can point to. I mean, we have lots of products today that still have 52-week lead times but, you know, we've said publicly that we think that we can get our average lead times down to about 26 weeks sometime in the second half of 2023. You know, that's probably not quite normal. In a normal period, we could probably get lead times lower than that, but we are so behind in terms of what customers need, it's gonna take us, you know, several quarters to catch up.
Maybe just touch on some of the demand dynamics that you're seeing. I think it's important to note that they are growing as a result of some of these megatrends. You have, though, seen some weakness in some areas, so this isn't just, you know, you're, you've got your head in the sand. Maybe discuss where some of that macro weakness is. Maybe touch on some geographic dynamics.
Okay. I'll start.
Okay.
I'll have Nawaz kind of give his input. You know, we've definitely seen some weakness in the consumer side of our business, and for us, that is really consumer appliance. That's about 14% of our business. Industrial, automotive, data center has still been pretty strong. We did make some comments in our earnings call that we're starting to see a little bit of weakness in the data center market, we've still been very supply constrained there.
Mm-hmm.
That's kind of from an end market perspective what we're seeing. Nawaz, do you wanna speak on geographic exposure?
Yeah.
And what we're seeing?
From a European perspective, you know, the PSP program was really in reaction to what customers were asking us. They wanted us to help them to try and, you know, counter the shortages which were taking place. We developed in concert with some of our large customers. I mean, automotive got a lot of, you know, were very noisy, I think, speaking about the challenges they had. As a reaction to them, we put in the PSP program. They equally have engaged in that very, very well. They've been enjoying prioritization for the last, you know, eight, nine quarters in particular.
They are one of a group of customers, but it's an extended group of customers who are signing up for long-term supplier assurance programs, so trying to solidify and have that longer term, which, you know, 5-year type of supply assurance program in place, to make sure they can meet their customer needs. Overall, I think, you know, Europe and Asia and the U.S., they all have similar issues in terms of supply shortages. Europe's probably been hit a lot more with energy challenges.
Mm-hmm.
B ecause of the macro, and that spilled over in terms of what, you know, clients can produce in terms of their factories and what else may happen. I think that's lagging in comparison to North America. Inflationary pressure's been very high. Again, it's taken longer to react because of the fragmentation of different countries and different challenges. I think, you know, all of that should normalize later on this year. Strong dollar has a bit of an impact on commodities, and I think that's likely to stay from what I understand at least. You know, all of these things can change.
You know, we're working very, very diligently with all of our customers and clients, whether they're distributors, whether they're regional distributors, global, regional, or OEMs, in making sure we can help them with today's issue, but equally a very big eye to that next design. We're an organization which is really aligned to our customer needs and making sure we can help them with, you know, what are they doing next to help redesign where they need to redesign, come to that new design for the product they want to introduce and make sure we help support them for the longer term.
That's a really interesting point. you know, as part of your Total System Solutions business, you are helping to kind of further some redesign in order to help alleviate some of the supply constraints and maybe just provide better stickiness, for lack of a better word, with some of your customers longer term. That's a really interesting point.
Yeah. It's been our goal always to make sure that we are, you know, solution-led.
Mm-hmm.
It's not about what product are we supplying, it's about what problem are we trying to help solve. We try and solve that with products, with software, with an ecosystem, with an environment where they can travel from 8, 16-32 bit up and down all day, 'cause what they start with as a design and what they finish with can sometimes be substantially different.
Okay. Just touching on the PSP, Preferred Supplier Program, this is a really unique approach and obviously it was, it was kind of fueled out of necessity, but we haven't seen anyone else, you know, kind of embark on a similar type explicit program. How do you think that this changes your view into the cycle and your longer term backlog? Do you think this is something that customers will enter in permanently, or are you starting to see customers just cycle into more traditional long-term supply agreements?
You know, PSP program was introduced 'cause it was something that customers were asking for, right? They were saying, you know, "Microchip, how can you help us with our supply challenges and give us more assurity that we're gonna get product when we need it?" It was a, I'll call it a voluntary program.
Mm-hmm.
B ut lots of customers signed up for it, and the customer had skin in the game where they gave us 12 months of non-cancellable, non-reschedule orders that, you know, every week or every month that rolled by, they added to that for, you know, month 13. You know, it's been very well-received by customers. You know, we've indicated that it's been well over 50% of our backlog for quite some time. It continues to be today. You know, with this, these long-term supply agreements that Nawaz's talked about are just really an extension of that for customers that it makes sense for. It doesn't make sense for everybody, right?
Mm-hmm.
If the end customer is our customer selling an end equipment that is really highly valued, so they're selling an $80,000 automobile or a $50,000 piece of medical equipment, they don't wanna be cut short on that and not be able to supply because they haven't bought $200 worth of semiconductors, right? I think there's a set of customers that will continue.
Okay.
On that program. As lead times come down, it'll probably be a smaller set of the customers that think that that makes sense for them. It's been a great program. Customer feedback on it has been great. You know, customers are pretty smart in terms of how they manage their backlog, right? They might give us 6 months of orders under the PSP program that is 100% of what they think they need, and then they might modify that as they get into month 7 through 12 and give us 80% or 90% or 70% of what they need to manage any risks that they see in their business. Every month or every week that goes by, they adjust the orders that they put into that program.
We've got a lot of feedback from investors like, "Oh, my gosh, this PSP is gonna lead to a crash." Honestly, we think that we have much better backlog because of PSP because it's well thought out. In order for a customer to place a PSP order, they need to go to a higher level in their organization, get approval for that, and so we think our orders under PSP are very solid.
Okay. I think that's a really important point.
Yeah.
I'm gonna open up for questions, just to be sure that I don't take up all the time. Eric?
Yeah. You had a slide where you went through, you know, the various cycles and where your margins went. You know, I mean, you've obviously just said that June will be up, so you're not, you're not looking at a downturn right now. How are you, how are you thinking about your margins if we do go into a little bit of slowness? Is there a better floor than what you've seen in the past?
There is. I mean, if you look at the gross margin side on this chart, you know, we've seen through cycles maybe a 300 basis point impact on gross margins. Over that time period, we've had periods where we've had much higher amounts of internal manufacturing as a percentage of the total. Today it's only 40% wafer fab that we do in-house. The other thing that was happening through here is we had lots of acquisitions that came to us with lower gross margins that put some pressure on these, and we don't have that today. You know, I think that our gross margins can stay very high through the cycle. We're willing to invest in inventory because our products have such long lives that we shouldn't see the extent of underutilization charges that we might have seen in some previous cycles. I screwed this up.
When you look at operating margins, you know, it's a similar story. You know, today, you know, we have a high variable compensation element in than the compensation for our people, and that's being paid at the highest levels that it has been in our company history. If we were to hit a soft spot in the economy, and our revenue came under any sort of pressure, you know, we could take those bonuses down overnight in the next quarter and still drive really high gross and operating margins. We're in a very good position to maintain this. I said that, you know, we don't see any situation, you know, even if we were faced with like a 2008, 2009 downturn, which we don't see in our business, where operating margins still don't stay, you know, well above 40%.
Got it.
Okay.
Anyone else? Yep.
Yeah. If I understand it correctly, the pricing environment has been quite different over 2 years now. Do you think that that will change, sort of supply chain risk, remediation, and people may be more confident in sort of having open orders? Adding on to that, is that notion reflected in your longer term growth guidance?
Yeah. The question is on pricing. You know, what I will say on pricing is Microchip for many, many years has been very firm on pricing. We sell proprietary products, right? They are designed in, once the customer selects that product, you know, they have to go through a significant effort that the engineering community doesn't wanna do to potentially design Microchip out. They chose Microchip because we were the right solution for them. We've been very firm with customers in terms of holding pricing flat. The last couple of years have been interesting because all of the supply chain cost increases that we've been in a position where we've had to pass those costs on to customers through higher ASPs.
We've done that thoughtfully, where we take our cost increases that we're getting in our own business or through our suppliers, passing those on to customers and marking them up at a Microchip-like margin. Customers have been accepting of that because they're seeing inflationary pressures throughout their business and through, you know, our competitors that also sell to our customers. I think these prices that we are passing on today are here to stay. We don't see that these will have to fall in the future. We think that, you know, the capital costs, the labor costs that we've incurred and our partners have incurred are not going down, and those are fixed costs that are in the structure today that the customer is willing to pay for.
I don't know if that completely answers your question, but we think that the prices that we've passed on are very sticky with the customers. They've been fair, we've been fair with them and are here to stay. Okay.
All right. That's actually it. Excuse me. When we met last last month or when we spoke last month, you made a really interesting comment about how the inflationary pricing is actually incentivizing foundries to add more trailing edge capacity. This is kind of a unique situation that we've never seen before. How is some of that, the incremental investment, either going to help ease supply constraints across the industry, but then also impacting your own capital allocation strategy?
Yeah. Just maybe to elaborate that on a little bit. You know, we were for a period of time, we did not have super high confidence that our foundry partners were going to invest in some of the trailing edge process technology nodes that we needed to drive the growth of our business for the next 10, 15, 20 years. You know, what's happened is, you know, the capital costs are higher, but the market has essentially told us and our partners that, you know, customers are willing to pay what these costs are because they need these trailing edge products to drive their business.
Those prices have become sticky and acceptable by the customer base and has given, you know, the industry, including foundry partners, confidence that if they make these investments, that there's a market for it, that customers are going to pay for. I think that's the point.
Mm-hmm.
The question you were asking, right?
Yep.
Yeah.
Yep. You did touch on your CapEx intensity, your target range. You're a little bit, you know, at the high end for this year, next year probably going to normalize. What are your expectations, or where are you adding the capacity? Are there geographic considerations, front end versus back end?
Yep.
Maybe touch on that.
Our own internal capacity, you know, the majority of the wafer fabs that we have, our three large fabs are located in the U.S. That, you know, again, 40% of our business goes through our internal fabs, and so that's where that investment is being made. On the assembly and test side, we have large sites in Thailand and the Philippines. We actually just opened a new factory in the Philippines, that gives us lots of growth capacity for quite some time. We're investing there. We expect the percentage of our business that we assemble and test internally will grow over time to higher percentages. There'll be investment there for multiple years to come, and that will be done in areas where we think that it makes sense that the cost benefits for doing it internally will help us drive gross margins even higher than they are today.
Okay. We have to ask about the CHIPS Act. How do you think initial applications just opened up in February? How do you think Microchip is going to benefit from the CHIPS Act?
You know, first of all, we absolutely are benefiting from the investment tax credit, right? 25% of the investments that we're making in U.S. semiconductor equipment and facilities qualify for that credit. We're getting benefit of that starting this quarter. In terms of grants, you know, we are the largest supplier of semiconductors to the U.S. Department of Defense, right? There is kind of a joint partnership there, where it could make sense for us to get funding in certain areas. You know, we are going to make applications. I will say that the rules are still being defined and understood. We are not going to have any grants that we could receive in any way impact our capital return program.
You know, there's been some talk about there about not being able to pay dividends or do share repurchases if you are getting funding under any of these programs. We need to evaluate all that. You know, we are not doing a major 12-inch fab expansion and so, you know, the getting funding is not built into any of the models that we've shared with the Street.
Mm-hmm.
You know, if there's ways that we can accelerate investments or defray some costs from investments, get CHIPS Act funding, we absolutely are interested in doing that. Making investments in the United States can make sense, and there's also programs outside of the U.S.
Mm-hmm.
that are available to us and our suppliers that are being evaluated.
Okay.
Okay.
It's hard to believe we only have a couple of minutes left. Is there any kind of parting words that you'd like to just kind of summarize the Microchip story?
I mean, we've gone through a very significant transformation as a company over the last 10 years, going from about a $1 billion in revenue to over $8 billion this fiscal year. Lots of acquisitions in that timeframe. You know, our acquisition strategy is behind us at this point in time, and we're really focused on growing organically, you know, improving our margin metrics, our free cash flow metrics, and returning that free cash flow to shareholders, and that's been a significant transformation.
I think if you look at our valuation compared to some of the high-class analog peers that you might compare us to, you know, there's an opportunity there for investors, because we are valued at a lower multiple than many of our high-quality peers that, you know, we have a very similar business model to and are actually growing at a faster rate. Happy to take questions from you guys in the breakout session or meet with you individually in the future. Thanks for your time today.
All right. Thanks very much.