Welcome back. Welcome back, everybody. I'm Joe Moore, Morgan Stanley Semiconductor team. happy to have the management team of Microchip, Eric Bjornholt, CFO, and Richard Simoncic , COO. thanks guys for coming. Really appreciate it.
Thanks for having us.
You know, a lot of interest in Microchip these days. You guys have probably the best rate of change off the low point and a lot of faith in Steve's ability to kind of get the business reoriented. You guided March up 6% sequentially, quite a bit stronger than seasonal. Can you help us understand that? Is how much of that is, you know, customers not depleting inventory anymore? Any indications of restocking, half the customers destocking and still. Just where are we in that dynamic?
Let me start by saying during this discussion, we'll be making some forward-looking statements about the future financial performance of Microchip, and we refer to our filings with the SEC that identify important risk factors about the company. Yes, we're guiding the current quarter up 6.2% at the midpoint. I think it's a combination of things. We've got good product momentum in various areas, which Rich can talk about as we go through some of your other questions. Bottom line is distribution inventory is kind of normalized at this point in time. If you look back a year ago, we had like a $100 million difference between what we were selling to the distributors and what they were selling through, and now that's collapsed down to only be about $12 million last quarter.
I think customer inventory is still normalizing a little bit at the end customer and at distributors' customers, there's still a little bit to go there. Distribution is completed at this point, and then we've got, as I said, some pretty good product momentum in certain areas that we'll touch on throughout this discussion.
Great. You know, you've talked a little bit about visibility building. You talked about a good January bookings month when you reported. You talked about June backlog looking better, getting that forward-looking visibility a little bit. You know, how much of that feels like it's end demand related? You know, did that persist after the Chinese New Year holidays?
You know, I think the demand environment is definitely improving. Our February bookings were also quite strong, and if you look at the first two months of the current quarter, they are the highest first two months we've seen in bookings since I think the June quarter of fiscal year 2023. But bookings.
I get through a lot of math when you say stuff like that. I gotta go back.
It's all right. Gotta make you guys think. you know, it's been a long time.
It's been pretty good, yeah.
It's been good. backlog is filling up nicely, giving us confidence obviously in the current quarter guidance and then giving us better visibility into June and beyond.
Are customers wanting you to have that visibility, or are they still believing that you can turn stuff in a pretty quick fashion?
They mostly believe that we can still turn it in a pretty quick fashion. We've got 200 days of inventory still on the balance sheet, and our lead times are generally short.
Yeah.
There are some anomalies to that or some instances where lead times have extended, if it's on very advanced process technology, could be some things with substrates and some of our back-end assembly and test manufacturing. Generally, lead times are still short.
Okay. You mentioned distribution inventory looks cleaned up, but direct is mixed. I guess that seems a little bit more cautious than what we're hearing elsewhere. Some of that due to the, maybe the excess inventory build that you guys saw at the last peak. Just, you know, what's your visibility into that starting to get cleared up?
You know, we have this program called PSP, the Preferred Supply Program, and with that, many of our small to mid-sized customers didn't get inventory when they wanted it. They had to wait because that capacity and inventory was consumed by those that came first for the product. with that, when they finally could get product, they bought more than what they needed, right? They did not wanna get caught in that situation again, in some cases, bought a year's worth or two years worth of product, and that's what's taken this long time to really drain through. I think we see significant progress on that, and we're waiting to see a nice inflection in sell-through from distribution. That's the next thing we're really looking for, 'cause now distribution inventory is corrected for the most part.
Are their customers now correcting or in the process of correcting, that will lead to higher sell-through, and the distributors will need to buy more?
Helpful. Thank you. When Steve was here last year at this time, he walked us through a 9-point strategic plan, and were kind enough to orient that around our conference, which we appreciate. You know, the numbers part of it we know, the inventory aspects and gross margin and things, but how are we progressing on the customer relationship improvements, the sort of product focus and those elements of the plan at this point?
I'll let Rich speak to customers and products.
On customer progress, you know, we really revamped, we changed our whole ethos and how we actually work with customers and talk to customers. We really sped up the rate at which we are releasing products within the company and getting answers to customers. You know, Microchip for a period of time there, had become arrogant, right? I don't know how else to say that. We had to fix that whole relationship with customers, and so that has significantly changed over time. Then at the same time we were doing that, you know, working with customers on where do we need to move to, you know. We really doubled down on wired connectivity, ASA, camera connectivity, robotics.
We launched PCIe Gen 3 and Gen 4, believe it or not, 12 and 24 lane switches for industrial applications. All of those are taking off and doing much better in the marketplace, providing much better growth than our more traditional microcontrollers and basic analog products.
You have a very rich business portfolio, all the acquisitions that you did. You know, we know all the pieces that are in there. I guess if you went through that period where you were maybe a little bit arrogant, you know, are those cultures still there? The richness of the product portfolio is still evident, and we'll get into some of the specific drivers, but, you know, how do you feel overall about the Microchip portfolio? And are you gonna give us, at some point, more. Yo u know, we sort of have the three segments, but, like.
We, you know, there was quite a bit to fix over the last two years. You know, the, you know, we reorganized the company to remove the silos of technology, and we built it into now just five pillars, right? It used to be, 8-bit and 32-bit and 16-bit and you know, everything was separate, right?
Yeah.
Now we've changed the organization, so all microcontrollers are under one person, right?
Okay.
All of compute is under one person. All of connectivity is under one person. All of analog is under one person.
We have those groups then working together based on mega trends to put together reference designs and bundled products that actually work together. We got rid of some of the personalities that were in there that were preventing us from actually working as one cohesive team.
Okay.
That's actually really moved our product development substantially.
Okay. That's helpful.
I think you had a second part of your questions there that was kind of talking about how we disclose things today.
Yeah.
Right now, we disclose microcontroller, analog, and other as our product lines, and we are working internally to find ways to better and more frequently update the street in terms of how some of these faster-growing areas are growing.
Yeah.
'Cause right now it all kind of gets lumped together. We update end markets only once a year. We're working on that and more to come on that probably in our next earnings call.
Okay. Yeah, 'cause I just asked the question because you've got a lot of really interesting businesses that I knew that. I'm old. I've been doing this a long time.
Yeah.
I know the companies you acquired.
Yeah.
MPCR is in there instead of Microsemi and other things.
Yeah, FPGA.
Yeah, FPGA.
And other , you know, all of our, you know, everyone in here has timing on their devices.
Yep.
Y ou know, Microchip keeps the world's time.
Yeah.
You know, all of the cesium clocks or every GPS, every credit card transaction, you know, that's all based on our atomic clocks that are out there, and that's also part of.
Yeah.
That's in there.
Okay. Great. I look forward to more clarity on that. Underutilization, you mentioned inventory still north of 200 days. You've been absorbing underutilization charges. What's the target there, and at what point do you view that as being less of a headwind?
That's gonna take us some, a while to work through. I think in the December quarter, last reported quarter, underutilization charges were about $51 million. You know, the majority of that is coming from our two large wafer fabs. There's some of it that is in our assembly and test factories. You know, we built up significant capacity during the last upcycle.
We have to grow back into that over time. You know, we did do a fab rationalization where we're, we shut down our Arizona fab, that's in a better position. We still have a lot of capacity that we need to grow into. It's gonna take us some time. Some of the growth areas that we'll talk about are actually not internally produced from a fab perspective. You know, anything in FPGA, most of Ethernet, our data center products are all externally produced. Those growing is not gonna help us with the fab utilization. It has to be more of our, you know, standard microcontrollers and analog, timing, memory products that grow to help us grow back into that footprint. It will happen, but it's gonna take some time.
I think it's still gonna be a couple years that those charges hang on. Now we'll be increasing production as we move through, and revenue is increasing. We're increasing capacity this quarter. You know, you shouldn't expect that $51 million charge to go down by $15 million or $20 million in a single quarter. It's gonna be more gradual.
Okay. What is the target inventory level, and is that different from the external versus internal fabs?
Our total days of inventory target is between 130 and 150 days. We ended last quarter with still 200 days of inventory. We have progress that we need to make. We are significantly underproducing from what we're shipping today from our internal fabs, so it is coming down.
Yeah.
A nd will continue to come down. We can't wait for it to get to 150 days until we start the ramp because there's some limitations on how quickly we can add people and get them trained and start more wafers in the factories. We'll be doing it gradually and making sure we don't get too low, but we still have a ways to go on inventory correction internally.
The reason you don't take it down further quickly is because it just ends up being disruptive.
Well, there's a mix issue, right?
Yeah.
During the upcycle, we were adding capacity and building inventory at the peak of the cycle. You know, when the cycle crashed and revenue went down so much, the product that we had was out of mix from where orders are coming in today.
Yeah.
Doesn't mean that product isn't gonna sell eventually, but it's gonna take time.
Yeah, many of these devices, it's a foot deep, mile wide application space, right? There's, you know, some wafer lots we produce may produce products for five years off of that.
It's gonna take a while to bleed that off.
Okay. Makes a lot of sense. You have talked about 65% being a realistic long-term gross margin target, and that seems consistent with your business mix. It's gonna take a while, as you said. Any other aspects to that improvement besides utilization?
It's utilization and it's product mix. We are guiding to a midpoint this quarter on gross margin on a non-GAAP basis at 61%, so there's 400 basis points of improvement to come. If you added back the underutilization charges from last quarter, we'd essentially be there.
Yeah.
Again, that's a longer-term process to get there. We also have very high gross margin products that are going to be ramping at a faster rate than Microchip is growing overall, whether it's PCIe 6 in data center, the Ethernet products that we talked about in our last earnings call, FPGA, and they all have higher than corporate average gross margins, so that'll be a tailwind to gross margin. Again, doesn't help fab utilization.
Yeah.
Helps with the overall profitability.
Okay. Makes a lot of sense. Maybe if we could talk about some of the growth drivers, Data center, you've been pretty vocal on PCI Express Gen 6. Can you just give us an overview of that technology? We had Astera on stage earlier today. Obviously, they've had some first-mover advantages there. Can you talk about your progress?
You know, we launched our product line in September of last year. To date, we've gotten four confirmed design wins. One of those is one design win is a $100 million-plus, like, per year usage dollars. There's about 20 others that are in design at different customers. you know, feedback that we're getting from customers is the power consumption is about 20%-30% less than everyone else's. you know, typical gigabit data center PCI switching is about 8% of the power. You know, 20% power saving is pretty significant. The security that's built in. All of the form, fit, and function is really exceeding a lot of customer expectations.
You know, and for short distances, the fidelity of the devices, the feedback from customers is so good that there is not a need for retimers in some of the applications.
Okay.
A nd we're also working on a series of retimers to match up with this PCIe Gen 6 product and we'll be releasing that over the next month or two .
I don't think Rich said this, but just a reminder that we are the only company that has a 3-nanometer Gen 6 switch. We are the most advanced product out there in this area.
Okay.
All right.
That's helpful. You have a long history in PCI.
You know, we started in PCI switches with Gen 3 and Gen 4. We were the market leader in Gen 3 and Gen 4. Unfortunately for Gen 5, we decided to roll and build our own SERDES inside rather than licensing it. That delayed our release to market by 12 to 18 months, and we lost our number one market status. We decided, in the midst of that, we decided not to come out with a 5-nanometer device, but to jump ahead to 3 nanometer and take that risk. Then we developed a bunch of IP partners to help develop and bring that vision to life. The whole reason to jump to Gen6 on 3 nanometers was to be able to quickly come out with Gen 7 within 12 months.
We are planning to have that Gen 7 device within a very short period of time.
Okay. That's helpful. In general, as you think about data center, seems like a lot of opportunities for Microchip, knowing the portfolio, again, of the historic acquisitions that you've done. Can you talk about your focuses in data center? Any other things to highlight besides PCI?
Within data center, we've also got timing products, precision timing products that we build around these products. All GPUs utilize our security compute devices for root of trust in data center. We also, for AC to DC or DC to DC power supplies, almost all of those power supplies using our microcontrollers with integrated DSP to form the basis of their digital power within data centers. That's a pretty big growth engine for us in that space too. It's not just the switches.
Yeah.
There's many other areas. What we're also seeing now is that most data centers are now implementing our cesium-based clocks into the data center for precise clocking within the racks.
When I was an engineer, I did clock chips, but 35 years ago, so. Ancient history. FPGA for you guys. I actually, speaking of me being old, I did the Actel IPO, covered it for a decade.
Oh, really?
It didn't really grow until you bought it.
Well, it's actually grown significantly because, you know, when, you know.
After you bought it grew nicely.
Yeah. Yeah. When, when, you know, it's fascinating. You know, they were so focused on the aerospace and defense market, they failed to see just if you brought that you know, low power value proposition to industrial control, medical markets, there was so much more opportunity for that. That's essentially what we did is, you know, Microchip is our largest market segment is industrial control. We've brought that into all of our customers and we've seen tremendous uplift in design wins. Now what we're doing is where we've worked, you know, one of the things that we had to educate our FPGA team on, you know, it shouldn't take a PhD to write the software code for every FPGA.
I remember going out and visiting with the development team a couple years ago and I sat down with them and I said, "You know, this is ridiculous. I don't want a PhD to write the code. I want this much simpler." Now we're bringing out a whole development suite later on this year, much like we did with our microcontrollers that use AI and VS Code and will generate a great deal of the code, so, you know, you don't have to have an advanced degree to get a product out to market.
That seems like a pretty exciting space, I mean, given the two biggest companies have been acquired and various, you know, distractions that they have to deal with, kind of you and Lattice have really sole opportunity to really pursue this.
There's really only four players out there within the FPGA space, right? You know, where we're really winning is in just that low power space. You know, a lot of customers, you know, will bring us in for those particular low power places. We're still winning a great deal within satellites that are being launched, the Artemis rocket that was up there. You know, whether it's an Airbus or Boeing, you know, our FPGAs are all over those particular products.
Yeah. All right, cool. connectivity, automotive, industrial connectivity, you have a broad portfolio of products in those markets. Can you talk about the progress there and when does that turn into more top-line growth?
You know, we announced just this past quarter that a working relationship with Hyundai Motor Group. We've designed in our Ethernet products within Hyundai Kia Motor software framework. We are working with other manufacturers. We just BMW just announced something with ASA, where they're using our connectivity for cameras in advanced vehicle architectures going forward. We've Ethernet, whether it's in data centers, industrial control, robotics, you know, a lot of humanoid or robotics that are being built up out there, all are using our Gen 3 and Gen 4 12-lane switches in those humanoids. That's also a new growth area connected with our Ethernet products. There's been a lot of activity there.
A lot of this ramp, or this conversion starts to really take hold, later part of this year, 2027, 2028.
Okay, great. The aerospace defense market that is definitely in favor with semi investors at this point. You know, you guys have a pretty big portfolio with the Microsemi assets, big increases in defense budgets. Can you talk about the growth prospects and then maybe wrap in, you know, low Earth orbit and, you know, data centers and space, any opportunities you're excited about there?
Yeah. You know, that is a huge growth area for us. You know, typical, you know, satellite may have anywhere from 25 to 200 devices from us inside of it, you know, whether it's FPGAs or power products, discretes, MIL-PRF-19500 devices are all part of those satellite systems. There really isn't a satellite system that launches without something from Microchip in it. Right. You know, it's just that the LEO launch and, you know, there's significant content, you know, from Microchip in that satellite system. Almost anything that goes through Earth's atmosphere has from any country, has something from Microchip in it.
Okay.
Good.
That's helpful.
Yeah.
Maybe moving away from the products, talk about some of the trends. Can you talk about pricing? You've talked about pricing discipline. You seeing any change in competitive dynamics there? You've actually seen a couple companies raise prices on the back of commodities prices rising, input costs. Just how do you think about the role of pricing?
Yeah. Pricing has been stable for us. You know, we have not done a wholesale price increase on our customers. You know, we are very conscientious with our customers today about preserving and enhancing relationships. You know, that was one of the nine-point plan points was to, you know, get our customer relationships back where they needed to be. If there's any area that we see a significant increase in raw material costs or whatever it might be, we would selectively share that with the customer and raise prices on them. This is not any sort of wholesale program that we have. No intention to do that.
Okay. Really more stability then.
Right.
Yeah. You know, I, you know, I just mentioned before, you know, we have become arrogant in some ways.
Yeah
Just trying to stay away from that.
Okay.
Right.
Okay. China, an important market for you guys, one where you do have some domestic competition, but you've talked about it as being relatively small impact. Can you give us a sense of is China different than the rest of the world?
Yeah. You know, China, where we're focused in China is really acting at typical with our customers, China speed, right? They're trying to get out the best products as fast as possible. You know, cost is always part of the conversation. It seems like acting with speed is more important to them right now.
That's where we're focused on. We're bringing in our Ethernet products, our ASA products, and so they're really fascinated by the new technology and how can they use it and get newer products and newer technology out to market sooner. That's, that's where we're focused. That's. You know, I think there was too much discussion on China for China and this. In the end of the day, what we found in meeting with a lot of customers, you know, just give us great technology and, you know, reasonable cost and let's move.
Yeah.
Right.
Do you see any parts of that market as being vulnerable to domestic competition that's different than other parts of the world?
You know, there's always been. You know, I remember my first acquisition that I did, you know, there was always domestic competition, you know, of telecom way back when, where they were building the products locally. You know, it's always been there. You know, there's always, you know, whether someone that has similar products to our microcontrollers or analog products with the same part numbers, that's always been a part of the marketplace there.
Yeah.
You know, I think I'd summarize it as, you know, we are gonna be cautious about it. We're gonna make sure we're protecting our intellectual property. That is, you know, really key for us that, you know, we're not turning over our manufacturing technology IP, so it can be copied. That's gonna be important for us to maintaining our margin structure long term.
Yeah. I don't think building there is as important as, you know, making sure that you have the right technology at the right time.
Okay. Okay. Is the traditional microcontroller business changing at all? I mean, there's been sort of a migration from a bunch of custom architectures to more Arm types of technologies. Doesn't seem to have changed the margin dynamics at all, which you said it wouldn't, but.
Yeah. You know what? I think Arm is still prevalent out in the marketplace, but I think, you know, customers are interested also in RISC-V now to some degree. You know, whether it's 64-bit or 32-bit. You know, they're interested in common accelerators between the devices, you know, as they adopt AI on the edge, you know, to do more autonomous decision-making. I think the core becomes less of importance. Rather, I think tools and software support are actually more top of mind for customers than.
Okay.
what the hardware actually is.
Okay. Helpful. Thank you.
All right.
I have a couple more financial questions, and then I'll open it to the audience. Leverage. You know, it's still a little bit elevated. How, how quickly are you looking to pay down debt? Is there cash return in your future, as you think about that? It'd be above and beyond the dividend, which is.
Yeah. Leverage is still high. You know, essentially we've flatlined our dividend at this point in time. The board is 100% committed to keeping the dividend where it's at, investors don't need to worry about the dividend being cut. You know, that's consumed a lot of cash flow, it was really just last quarter where we had the first quarter in quite some time where we generated enough cash to pay the dividend.
We were borrowing for a period of time, and that's not a good position to be in. We've turned the corner on that. Obviously revenue and earnings and EBITDA is growing significantly, so net leverage is coming down. We're still focused on anything above and beyond dividend is going to be used to pay down debt for, I would say, the foreseeable future.
Okay.
We haven't set a new net leverage target. We set one back on our Analyst Day in like November of 2021, which was 1.5x.
When we got below that, we were returning 100% of free cash flow between dividend and share buyback. Unfortunately, at that time, that was at levels of earnings that were not sustainable during the upcycle.
Yeah.
EBITDA crashed and we got ourselves in a situation where we issued essentially an equity instrument that's mandatory convertible preferred last March to ensure we maintained our investment-grade rating, which is important to us. We don't wanna find ourselves in that situation again. Focus is gonna be maintain the dividend and anything above and beyond that, pay down debt, and I think we're gonna be in that mode for some time.
Yeah. Okay. Just generally, how are you guys feeling about all of this? I mean, you talked about that the company had become kind of arrogant about certain things. You know, you feel like you're on a path now that people are excited. I know Steve in his book talked about, you know, shared pain and kind of we don't lay people off, and I know you had to because it got very difficult. You know, how are you guys feeling about the trajectory from here from the standpoint of morale and customer relationships, things like that?
I think employee morale has definitely improved a great deal, right? You know, that the whole PSP program created a lot of tension with customers for a period of time. We are beyond that with customer interfaces. We spend a lot of time visiting customers on the road. You know, next week, you know, I was invited to do the keynote for opening of Embedded World where I'm talking about autonomous edge and what we're doing on creating AI at the edge for our customers, right? The software environment and everything we're putting together. Have a ton of customer meetings all next week. I get a totally full. You know, customers are graciously and we're graciously working with them to.
Yeah
Right, much better than we've ever done in the past.
Okay. Well, I have to follow up on AI at the edge. The, you know, a really popular theme this time last year that people kinda have moved away from, and AI is now just a data center thing for people. Ultimately, you know, when the AI gets deployed, there's a lot of applications where we're gonna need stuff at the edge. What are you gonna talk about next week and.
Yeah.
For this week.
In one application, you know, there's a drill, you know, a ready battery-operated drill, right? You wouldn't think that you would use an ML model inside a drill. We work with the customer, we collect the data, we figured out how to get 15% more battery life from that drill by putting a simple model, you know, about 200 K bits of memory on that drill. No hardware changes, just software, 15% more battery life.
Wow.
That's-
Pretty cool.
A drill. I think as we're working with customers, you know, a lot of applications with just simple software models, or changes just. We're not talking large language models or gen AI. We're just talking ML, machine learning models, right? Well-done suite of models that customers can use for wear and tear, vision, keyword spotting. There's a number of different applications where you could benefit from this technology.
Yeah. That's very cool. All right. Thank you. Let me stop there and see if we have questions from the audience. In the front.
Hi. When do you think we'll start to see the impact of these new ML models or edge AI, physical AI? What would that impact be on your company financially?
Yeah. You know, great question. We spent a lot of time visiting and working with customers to find out what they really need, right? You know, are we just gonna throw out a microcontroller with a 100 TOPS accelerator and then, you know, go to town on it. What we found is that some microcontroller manufacturers have four versions of accelerators in four different software suites, making it relatively impossible to scale or move this around. What we did was we formed a group to just focus on the software suite, no hardware. We're a hardware company, right? We gave this group a different charter.
We said, "We wanna develop the best software suite." We've been acquiring companies and putting that together to create that software suite. Then I worked with in the team, CEVA Technologies to bring in CEVA accelerators anywhere from 50 GOPS to 1,000 TOPS, so that we can put that same accelerator across our FPGAs, our RISC-based products, our Arm-based products, our 8-bit products, our It doesn't matter, right? But what matters is that we have the same accelerated topology anywhere from 55 nm to 3 nm, but we have a software suite and model suite that can work across all of the products, right? That's the division that we set up for this group.
That vision is resonating well with customers because in many more than half of the applications that we found, you don't need an accelerator. You just use your standard hardware to help me develop a model that I can program on a device. Does it have sufficient memory for me to run that and do I have sufficient memory to store the code required? Right.
Is it a product margin?
Yes. There will be a SaaS model to that, software as a service. You know, there will be a place for people to put models, you know, in terms of working with that. There will be a SaaS portion to that as we go. SaaS as well as hardware, as well as, you know, Like at the, you know, battery-operated drill, you know, it just was not obvious to customers. They, you know, they had people coming in there selling, you know, "No, you have to buy this new $10 microcontroller with a 100 TOPS accelerator on it." No. I just keep buying the same $1.50 device and add the software.
We don't need to replicate.
Yeah.
The cloud in our power drill.
Yeah. Yeah, yeah. There's a lot of applications like that that we're finding out there. A lot of them.
Great. Well, that brings us up to the end of our time.
Great.
Eric, Rich, thanks so much. Appreciate it.
Yeah. Thanks, everybody.
Thanks.