Microchip Technology Incorporated (MCHP) Earnings Call Transcript & Summary

Good day, everyone. And welcome to the Microchip Technology Q4 FY '20 Business Update Conference Call. As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Microchip's Chief Executive Officer, Mr. Steve Sanghi. Please go ahead, sir.

Thank you, operator, and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions, and that actual events or results may differ materially. We refer you to our press release of today as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. Today, I would first describe some of the steps that Microchip has taken to cope with the COVID-19 virus. I would then discuss the effect we are seeing on our supply chain as well as our customers and provide revised net sales guidance for the current quarter. We will then be available to answer investors and analysts questions. I have Mr. Ganesh Moorthy, Microchip's President and COO; and Eric Bjornholt, our CFO, with me here today. As we continue to monitor the impact of the COVID-19 virus, our top priority remains the health, safety and well-being of our employees and their families. We have implemented a very strict policy on travel to and from the affected regions. There will be no business travel to and from the countries of China, Hong Kong, Taiwan, South Korea, Singapore, Italy and Iran, which are the most affected countries so far. As any other country shows significant increase in the affected patients, we have been adding those countries to the list. If any employee is returning from an affected country, he or she is required to follow a strict 14-day quarantine period during which such employee is required to work from home. You may have a question about Iran. While we do not do business in Iran, we do have employees from the Iranian region. With Iranian New Year approaching, there might be family travel that we are mindful of, hence, adding Iran to the list of countries. We are also restricting travel to any event in any country, including the U.S., if the event will have large number of people gathering. Therefore, we have canceled our attendance at 3 different investor conferences this quarter, and we are doing this conference call instead. At this point, none of our 18,000 employees or their family members have tested positive for the virus, knock on wood. Now the impact on our suppliers and customers. At the Goldman Sachs conference on February 12, I described that our supply chain from China is fairly small, and the factories of our partners were just then coming back to production with a utilization ranging from 30% to 100%. We expected most factories to return to full loading within a week. The supply chain is returning to normal operations at a pace slower than we anticipated. The question remains whether such factories will be able to make up the lost production within this quarter. Such impact to Microchip net sales remains small at this point based on what we know. The bigger issue is the demand from our customers. Our business in Americas and Europe has remained strong and trending towards our original guidance. However, we are seeing a very weak demand in Asia, especially in China. The customers are returning to work at a slower pace than anticipated. The returning customers are not yet able to evaluate what their demand will be for this quarter. Even though Microchip supply chain from China is small, our customer supply chain from China is large. The customers may not order our devices if they are not able to complete the entire kit of parts. Based on our current assessment, we expect our net sales for the current fiscal fourth quarter of 2020 to be about flat sequentially. There are a lot of moving parts on gross margin based on product mix. There are also a lot of moving parts on operating expenses due to travel limitations and other discretionary and variable costs. Therefore, we are not able to provide updated earnings per share guidance at the current time, and we are withdrawing our prior EPS guidance. With this, operator, will you please poll for questions?

[Operator Instructions] We'll take our first question from Vivek Arya from Bank of America.

Steve, I appreciate that the visibility is probably limited right now, but I was hoping if you could describe what's happening in your distribution channel. I believe, exiting last quarter, distribution inventory was about 28 days. Do you have kind of a real-time sense of where you are now and where you might be possibly exiting the quarter?

We do not have assessment at this time. The inventory at the distribution through the quarter is usually not constant. It's because within the quarter, you're not completely linear. So at this point in time, with the entire March month left, we do not know whether we're going to be getting normal orders from distribution with the delivery in this quarter. Or will they reschedule the orders to the next quarter and what the sales out would be as the factories are returning? So that whole thing is relatively difficult to model.

But any restocking trends that you saw so far in the quarter outside of China, perhaps?

Do we have any indication on that?

We really don't. I mean, we just provide quarterly information and haven't provided monthly information. We don't have the month of February as of yet. We're still going through that reporting process. So it's too early to tell, as Steve says.

We'll now take our next question from John Pitzer with Crédit Suisse.

I appreciate that there are a lot of moving parts, and it's very fluid, but relative to the old midpoint for the March quarter, you're taking revenue down by about $70 million. As you kind of see the world today, is the expectation that, that comes back in June quarter, i.e., is this more of a pushout of orders? Are you seeing outright cancellations? Just help us understand that dynamic.

Well, let's see if we can talk through it. Longer term or even nearer term, there should not really be any demand destruction if work were to -- the whole world were to go normal for the June quarter, then there should not be a demand destruction. So the only issue for the June quarter is, will all the factories be back to work? Will coronaviruses should be resolved? We don't really know that. At this point in time, the cases in China are starting to decline, but the cases outside of China are rising rapidly in Italy and Germany and Korea and Japan and lots of other places. So where would that net effect be? We don't really know. But coronavirus itself, if you get out a couple of quarters, if coronavirus issue goes away, it should not be destructing demand. And some of the demand we're losing right now, there should be some makeup for it because there'll be a pent-up need for product from all the customers who wanted to buy it.

We'll now take our next question from Craig Hettenbach with Morgan Stanley.

Steve, just a question on the end markets. Are there any particular end markets that you feel are seeing the biggest impact as this plays out in the quarter?

Ganesh, take it.

The way coronavirus plays itself out, there's nothing end market-specific. Separate from that, what we had told you at the earnings call a month ago was that data center remained one of our strongest end markets. And that's continued to play itself out, but nothing about this update today is specific to end market.

We'll now take our next question from Ambrish Srivastava.

Uncertain times, for sure. Steve, can you just give us some insights into how are you managing the factories with respect to utilization and inventory on your balance sheet?

So Microchip's factories are all running full production. So we did not take or have to take any action in our 2 factories in Thailand and our 2 factories in Philippines, which are the back-end factories. And all our front-end factories are all in U.S., so there is really no action in those places. We have cut the travel of the people going overseas to affected areas so they don't have to be quarantined when they come back. So Microchip-owned factories really have really no impact. There is scattered 1 or 2 issues I heard about, couldn't get some lead trends from China, but the latest input is even we have gotten enough lead trends and had a second source to really go through the quarter with no issues. So that's the Microchip factories. Now when you talk about customers' factories, there are thousands of them. We have many, many 70,000, 80,000 customers probably in the Asia Pacific region. And there, we cannot track -- keep track of all the customers' factories. And to our knowledge, they are all coming back slower than expected, some at 60%, some at 80%, some at 90%, some at 100%. And even the ones who have come back in the last 10 days or so are just now starting to assemble the information regarding what parts they're able to acquire to complete the gate and what part they are not. And that is our concerns. Even though on the supply side, we're not impacting our customers, our customers are seeing the impact or maybe seeing the impact from other components on the same board. So in those cases, we don't really know what actions our customers would take. So we're in a standby position.

We will now take in our next question from Gary Mobley with Wells Fargo Securities.

I know it's probably difficult to distinguish between supply chain issues and weak customer demand. But just try to figure out how that $70 million revenue shortfall breaks out. But can you give us a sense of how much of your sales are driven by China and demand? I'm not talking necessarily about ship to mix, but rather goods that are consumed in China.

So across a very large customer base, the accurate numbers are very hard to come by. But I think you started your question by saying it's hard to decipher the impact because of supply chain and the impact because of demand. It's actually not that difficult. I think our product comes from a handful of about 18 factories in China. And that is still a single-digit percentage of our business. And we don't really have a lot of impact. As I described earlier, we're not seeing a lot of impact from the supply chain. So the entire impact we're seeing is at the customers. And what we have said before is that for our China business, about half of it was to export roughly and half of it is consumed...

Yes. And based on ship in, we do about 21% to 22% of our ship in revenue into China.

Yes. So 22% -- 21% to 22% of the business, we ship into China, and half of it is for exports and half of it is for internal consumption.

We'll now take our next question from Shawn Harrison with Longbow Research.

My question is more of your customers in the west. I know, Steve, you said they've been strong quarter to date. Are you seeing any changes in order patterns in terms of maybe we need to stockpile a little bit more? Maybe they get a little bit more cautious here in March because of the virus spreads outside of China?

So far, we haven't seen any noticeable changes in their order patterns. As Steve mentioned, the business appears to be strong for what they are doing. And at this time, there's no changes there.

And if I may as a brief follow-up. Eric, the change in guidance anyway significantly impact how you were thinking about debt repayment during the quarter other than kind of the loss fall through in the profitability you see?

No, nothing significant. Obviously, when we're shipping less then, we are -- where our collections activity is going to be lower from our customers. So there's some impact in the current quarter and probably some follow-on impact for what's the lower amount of shipments that happened in March and what we collect next quarter. But still, same theory is that all cash beyond what we're paying to dividends is being used to pay down debt, and we'll continue to do that. So we should have a reasonably decent debt paydown in the March quarter.

There would be also a little bit to offset from the capital because as we were guiding towards the midpoint of 5.5% increase, in certain cases, we would be spending some money on the capital. So I think the capital budget, we would tighten up again because in this environment, we will spend less today than maybe we were going to spend 3 months ago.

[Operator Instructions] We'll hear now from William Stein with SunTrust.

I know the situation remains a bit cloudy and certainly fluid, but as I'm contemplating the model a little bit further out and I think about calendar Q2, you typically have a sequential uptick. And as I'm thinking about how to risk adjust that, maybe you can remind us which geos and markets might typically be responsible for the sequential growth in June and maybe any clues to help us think about whether that would be damaged this year.

So in a normal year, although it's hard to define what is normal in the last many years, but in a normal year, usually, you'll have a bounce back in Asia from March quarter that has a Chinese New Year to the June quarter that does not. And Americas is usually very strong in June quarter also. The strongest quarter for Europe usually is March quarter. So Europe slows down a little bit from March to June, but the other 2 quarters are very strong -- other 2 geographies are very strong. And that's why, historically, we have had stronger June quarter. And at this time, if all the challenges we're having are in China and Asia, if June quarter were to go normal from a coronavirus standpoint, that growth in June quarter from those regions is going to be very strong for obvious reasons.

Yes. And one clarification, actually, if I can squeeze it in. I think you characterized the shortfall as something that's more related to your customers' supply chains. Do you have a way to distinguish between a customer pushing out or canceling an order because they can't get a complementary product versus something that's more generic in nature?

So no, we cannot decide for whether a customer couldn't get another product or really had a shortfall in their own demand. But you said that that's the primary reason we described for the customer demand to be lower. That's not quite correct. The Chinese New Year was extended by a week. And then many other companies extended it by a second week. And then when they came back, they came back anywhere from 30% to 60% in terms of people and then have been slowly rising. So a lot of that product didn't get built in all that time they were off and all that time they were not at 100% utilization. So a good portion of the impact we're talking about is not because customers cannot complete the kit. A lot of the impact we're talking about is because all these days of production lost. And then we said we do not know whether customers will come back so strong that they'll be able to make up with any of that loss. In fact, there is jeopardy that they may not be able to complete the kit and have additional impact. So I want to be clear about that.

And we'll take our next question from Harsh Kumar with Piper Sandler.

Guys, thank you for hosting the call and providing at least some level of clarity. Steve, I had one for you. You talked very distinctly about the trends out of China. Is these distribution trends you are seeing more so versus direct customers?

I don't think we're seeing any different.

I mean things like factory shutdown, extended time off, people coming back at a partial rate, they don't distinguish between direct and distribution.

Okay, understood. And we had another company that had a call this morning, and they gave a little bit more color. I know you don't want to give us numbers, but I'm hopeful you can give some color. They said that they have seen improvement here recently in the last 2 weeks, up from the previous 2 weeks. And I was curious if you would be kind enough to provide some color of that nature, if you've seen any difference here recently shortly versus right after the Chinese New Year.

So yes, we have. After Chinese New Year, a few customers came back. A few customers took a week longer. And a few customers took a week even after that, and not everybody came at 100% right away. So after the Chinese New Year, week after week, things have been improving. The bookings have been improving, and the shipments from distribution, which is POS, have been improving. So yes. And that's natural. As more and more customers come back, the bookings as well as POS will increase as higher and higher percentage of the factory goes into production, the bookings will improve and POs will improve. So yes, we can verify that those things are improving.

We'll now take our next question from Chris Danely, Citigroup.

Steve, you said you're not assuming any impact in the U.S. or Europe, but this thing is like clearly spreading pretty rapidly here in the U.S. So if the U.S. goes through some sort of blend of China, Korea, Italy, Iran, what would the impact be to you guys? And if you don't want to comment or feel comfortable commenting on that, maybe just sort of list as to your production facilities here in the U.S. versus abroad and if you have any contingency plans.

So U.S. is a very vast country compared to places like Korea and other places where these things are spreading. There are a handful of cases in U.S., 2 deaths. Even though 1 death is more than anything we should anticipate or be -- and be acceptable, I think the risk to a broad-based blowout of this virus in the U.S. is really not there. We're reading all the stuff you're reading, all the guidance from CDC and administration and others. We have very strict protocols. We have employees in so many different cities in U.S., factories in so many different states, not a single employee or their families are affected. So currently, we are not anticipating that U.S. will get engulfed in a way that U.S. factories are working 100% of the utilization because we can get people to work for. So that is not in our plan, that's not in our forecast today.

We'll take our next question from Harlan Sur with JPMorgan.

Good to see that the employee base is safe and in good health. Now prior to today, the team was anticipating or ramping your back-end assembly and test utilizations in anticipation of a return to more normalized demand trends and, therefore, anticipating lower underutilization charges this quarter. But given the weaker-than-expected demand dynamics here in March, it still sounds like you guys are not dialing back utilization. So is your view on underutilization charges here in March still the same as back at the time of the earnings call?

So I think we have gone middle of the way. So if you look at our guidance before was a midpoint of 5.5%, and now we are seeing about flat. So that's a change of 5.5%. We have not taken the foot off the pedal in our back-end factories to go to 0. We have kind of gone in between, halfway. Because one concern is this thing could resolve itself and then be a stronger demand in June. If it is, June is a quarter where our 2 largest factories in Thailand have a national holiday for an entire week in the first week of April. So we'll be -- a little bit pre-build that would help in that scenario for that upside. If things were not to resolve, when we have to have another flat quarter, then we can always take attrition and cap the build rate in the following quarter. So this quarter, after a fair amount of discussion, we did not want to go to 0. We went halfway.

I think I'll add one more thing to that, is the last couple of quarters we've been draining finished goods from our back-end factories, and we didn't want to do that again this quarter. So that required an increase in the output out of the back-end.

That would require an increase in the back-end even if we had gone to 0.

The next question comes from Mark Delaney with Goldman Sachs.

I was hoping to better understand the backlog for the June quarter and if you can describe how the backlog is building and maybe how it compares to what backlog was running at, at the same point in the current quarter.

So the backlog is building nicely. Bookings have continued to come in, some of which have aged into the June quarter. I don't have an exact comparison of where it is versus at the same point in time, and usually, we are -- March is a strong month that we would see bookings and backlog coming in as people prepare for a seasonally stronger June quarter. But there's nothing that gives us concern in the June backlog at this point in time.

The next question comes from Gil Alexandre from Darphil Associates.

To what -- can you judge at all to what degree your automotive business will be affected? It's bound to be affected, but I have no idea.

So Gil, I think as Ganesh mentioned in an answer to another question about the end market, coronavirus has not differentiated or distinguished between factories that's an automotive factory or building consumer products, building communication gear. And this has largely been -- the demand has largely been the issue of factories were shut down longer than the normal 1-week Chinese New Year. Some were shut down for 2 weeks. Some even were shut down for 3 weeks. And when they came back, they didn't come back to full production. So this is not an end market kind of issue. All end markets have been affected because the factories have been affected in China.

But the automobile companies are able to get the parts they need?

So U.S. and Europe, automobile business has not gone down. I think either they had a pipeline of products or they got enough that they needed. If there is a cut related to not being able to get parts from China, to our knowledge, we have not seen that yet.

I think Chinese automotive companies obviously are affected. They have a much bigger local supply chain. They're having sporadic instances where Korean automotive guys have had some issues. But I think Steve's point was it isn't just automotive as a market that gets affected. Certainly, automotive is affected, more so in the Asian automotive market. We haven't seen that in the U.S. and Europe markets.

And how much is the Asian auto market to you normally?

I don't have a precise split. But if you look at worldwide, China has been about 22%, 23% of the world's automobile market. So about 1/4 to 1/3 of the market is out of Asia.

Gil, I just wanted to mention that our content is a lot higher in the higher-end cars built in U.S. and Europe. The Mercedes, the BMWs, the Cadillacs, the others have a much higher content of our product because they're feature-rich loaded with our products. And the lower-end cars will have less of our content so we're buffered a little bit because of that if U.S., Europe stays stronger.

We'll now take our next question from Vivek Arya with Bank of America.

Thanks for letting me ask a follow-up. Going a little bit off tangent, I'm wondering if the interest rate that we are seeing, the declines recently, does that provide you any opportunity to refinance your debt in any way?

We're watching the same numbers you are. It certainly provides that opportunity. And we constantly do that analysis as some prior interest rate cuts have happened. We refinanced our line of credit a while ago and cut the interest rate by 0.25 point. And if there is a further opportunity, those are the things that we'll be looking at.

Right. And as rates come down, we have a floating rate debt for both our line of credit and our term loan B, so we get the natural impact of that or the benefit from that when rates go down and have risk when they go up in the future.

We'll take our next question from Raji Gill with Needham & Company.

Thanks for the transparency. In terms of withdrawing the EPS guide, just wondering if you could provide some thoughts on that. Is it mostly the puts and takes around the gross margins that are difficult to quantify? I would presume that the OpEx -- there might not be big changes to OpEx, but let me know if that's not the case either.

So I think you mentioned those things. When the world is normal, we understand the gross margin. We understand the product mix, and the gross margin has small brackets around it. But when there is such a large dislocation from 1 country, China prices most time tend to be lower. So there may be -- this may be positive to the gross margin. But if we took the utilization down a little bit, they would be negative to gross margin. With all those puts and takes, where it comes, I don't know how to guess that. Maybe it's at par, maybe gross margin won't change, but we haven't been able to do that math. On the operating expense side, there are so many conferences, training sessions, investor conferences, all these things we're not going to. And there's a few million dollars' worth of expense savings from not going to those things. But some of the expense was already committed, and we don't know whether we get our money back or not. So again, that's an around-the-world analysis. A lot of these things are controlled locally in Europe and Asia and spending money on a lot of this stuff. So I think in preparing for this call, we just made this decision last week and made the announcement on Friday that we're going to give this update. We just cannot put it together. So I think the operating expenses probably should be lower. So that would be positive gross margin for all we know, could be wash, but I don't really know. I think there are puts and takes.

And just a follow-up. The other kind of large company that talked about it this morning indicated that the customer orders that they're seeing for the past 2 weeks have returned back to pre-Lunar New Year levels, implying some sort of normal steady run rate. I wanted to get your thoughts on this. You talked a little bit about it earlier. But that the main issue you're seeing is that -- is days of production that have been lost. Any kind of sense in terms of how many factories in your viewpoint that are coming back online and kind of what level, what rate? Any thoughts there would be helpful.

Comments, Eric?

Kind of when the factories are coming back?

Not the factories. The rate of the bookings, has it returned to pre-Chinese New Year level?

Pre-Lunar New Year.

Yes, it has. So as we mentioned in response to an earlier question, the bookings have been good and increasing. And the sell-through activity has also been ramping up as it normally does coming out of Chinese New Year, which just had a bit of a delayed effect to the store. But I think given the fact that the factories have not been working at full production, that ramp has been a little bit more gradual than what we would have seen out of a normal Chinese New Year. You want to comment on the factories, Ganesh?

Yes. I think when you look at factories in general, they are running at a wide range of operational completeness. So there are a few running at 100%. There are several running at 70%, 80%, 60%, all the way down to about 30%, 40%. The situations are different, depending on where they're located, where their workforce comes from, but it's improving every week. So this week is better than last week. Last week was better than the week before. And step-wise, I think everybody is getting closer and closer to 100%. Some, it may take to late in March. Others are already there right now. The average will keep growing as the March weeks go forward.

So it goes back to really the 2 things I described earlier. One is the time that has been lost. We don't know whether they can make up for that time. Whether they can assemble a workforce higher than 100 within the quarter or with a month left to really make up for the time that had been lost. And the second issue is, while the bookings and sales out has recovered, we are concerned about customers not being able to complete the kit. And if they are not, then will that have some impact where they wouldn't want that product either?

At this time, that does conclude our question-and-answer session. I'd like to turn the conference back over to Mr. Sanghi for any additional or closing remarks.

Okay. We want to thank everybody to get on this call on a short notice and get a chance to tell you how we see the impact of coronavirus. And sorry, we had to cancel out of some conferences. And we'll really talk to you on our next earnings call. Thank you.

Thank you. That does conclude today's conference. Thank you all for your participation. You may now disconnect.