Microchip Technology Incorporated (MCHP) Earnings Call Transcript & Summary

Greetings, and thank you for attending the second day of JPMorgan's auto conference. My name is Harlan Sur. I'm the semiconductor and semiconductor capital equipment analyst here for the firm. Very pleased to have the team from Microchip here today. Ganesh Moorthy, President and Chief Operating Officer; Eric Bjornholt, Chief Financial Officer. Microchip, as most of you know, is a leader in embedded system semiconductor, so that's microcontrollers, analog and a broad portfolio of application-specific semiconductors, targeting a very diversified set of end markets, including automotive. Ganesh will be taking us through a short presentation, which you should all have on your conference cockpit, and then we'll go ahead and kick off with Q&A. So with that, let me turn it over to Ganesh and Eric. Gentlemen, thank you for joining us this afternoon.

Great. Thank you, Harlan. If you move to Slide 2, I'll save you the fine print. 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 our actual results and events may differ materially. We refer you to our earnings releases of last week as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operation. Starting with a summary of our last quarter business and this quarter's guidance, we finished last quarter, the June quarter, with net sales of $1.31 billion, down 1.3% sequentially, substantially better than our original guidance and better than even our updated guidance provided in early June and only down 1% from a year ago quarter, substantially better than many of the other semiconductor companies on a year-over-year basis. Our non-GAAP gross margins in the June quarter were 61.7% and operating margin was 38.6%, and diluted earnings per share of $1.56. So all strong results there. Our guidance for the September quarter, Q2 fiscal quarter for us, is to be down flat to down 8% sequentially at midpoint of minus 4%, with non-GAAP operating margins between 37% and 39%. Our guidance for non-GAAP EPS, diluted EPS is to be between $1.30 and $1.52 per share at midpoint of $1.41. We did declare a record dividend last quarter, $0.368, paid down another significant amount of our gross debt, $394 million more and then paid down $2.6 billion of debt over the last 8 quarters. So a pretty consistent pace quarter-after-quarter of bringing down that debt. This slide hasn't got a lot of numbers, but let me break it down into some manageable chunks. So notice the yellow line in the middle, the vertical line. To the left of that yellow line represents our results from when we acquired Atmel through the quarter just before we acquired Microsemi. And if you focus on the blue box that we have for operating margin, soon after we bought Atmel, the combined operating margin was at 27.4%. Microchip was high into the mid- to high 30s, Atmel was pretty low in the single digits. And you can see the progression of how we took that acquisition and significantly improved quarter after quarter after quarter, over 1,200 basis points improvement in this window of time, that we were able to improve the combined business performance, too. Then to the right of the yellow line is the history until now with Microsemi being added in. So we did acquire Microsemi in Q1 of fiscal year '19, but it was a partial quarter. So if you look at the next column over, Q2 of fiscal year '19, that was the first full quarter of Microsemi and Microchip being together. And at that point, the Microchip operating margins were higher and the Microsemi operating margins were good, but not as high. Blended number was 38.3%. And you can see the revenue in that time went from about $1.513 billion and then we went into the whole series of trade and tariff and then subsequently COVID. And we're about $200 million less in revenue today on a quarterly basis. Yet that operating margin has continued to improve as we have improved the various parts of the business in which we had leveraged. And last quarter, the operating margin was back up to where it was as we were at the beginning of this cycle, post Microsemi. So a significant improvement in this time frame through all the challenges of what happened with revenue headwinds and all that. At the bottom left is our guidance. I won't go through that again. I just read that out on the last slide. And then towards the middle on the box is our long-term model that we're continuing to strive towards 63% in gross margin, 22.5% in operating expenses and operating margin of 40.5%. Now a summary of Microchip today is leading provider of total system solutions, with those solutions being comprised of high performance, both standard and specialized microcontrollers, digital signal controllers, microprocessors, a pretty broad range of mixed-signal analog, interface and security solutions, a growing amount of clock synchronization and timing solutions, lots and lots of connectivity, wired as well as wireless. FPGA is a new growth platform for us coming through the Microsemi acquisition and then some nonvolatile memory and Flash-IP solutions. We finished fiscal year '20, which ended at the end of March this year at $5.3 billion of revenue and with about 18,000 employees worldwide. This has been the progression of our revenue over this time. Fiscal year '20 was a very small smidge below fiscal year '19 and fiscal year '21 is just the first quarter. So with the June quarter multiplied by 4, so it's just run rating that, with no changes as we go through the rest of the year. So holding our own in terms of where the revenue is and continuing our string of consecutive quarters of non-GAAP profitability, the June quarter being 119th consecutive quarter of that. We updated our revenue by end market about 2 months ago, and this is a new complexion of where combined company, Microsemi, Microchip and all that are running today. So no change in industrial. It was 28%. It remains 28%. The data center and computing side has continued to grow, and that has moved up from about 15% to 18% of our revenue. So it's the second largest segment for us. Automotive has shifted down to about 15%, still a pretty significant amount of our revenue. And then the balance are split between communications, consumer, aerospace and defense, which are 14%, 13% and 12%, respectively. And today, we'll speak more about the blue slice, which is the automotive slice itself. And these are all based on fiscal year '20 ending. So it's a whole fiscal year '20 data that we have put together. This is not data that is easy for us to collect with as broad customer base and product line as we have, serving 120,000 customers and 50% of it through the distribution channel. So we do this only occasionally. We did take the time to put it together here in the last quarter. So before we talk about automotive itself, ownership, I want to show you kind of what are the market megatrends and how are they converging in the car of tomorrow. So on the left-hand side of this slide, I'm on Slide #9 at this point called market megatrends. The 6 end market segments I just spoke to, so exactly those 6 are represented here. But separate from those, we also have mega trends that are driving what we believe will be growth over the next 5 to 10 years that are above normal, that intersect one or more of these markets -- end markets that you see on the left-hand side. Those 6 megatrends are the advent of 5G and how that rolls out, it's just getting started as a 5- to 10-year window of time for it to roll out, particularly the infrastructure side of that is of most interest to us. The growth of the Internet of Things and specifically the Internet of Things or industrial side of business. The growth of data centers, and that has been a significant growth story over the last several years, and we believe will continue to be, on a long-term basis, a big driver of growth as data just grows exponentially year after year after year. The advent of electric vehicles continue to take a higher and higher portion of automobiles. Artificial intelligence and machine learning and how that all begins to deploy on a more broad scale basis. And then finally, the growth of advanced driver assist and autonomous driving. So automated driving in some format and how that all unrolls as well. So these are 6 durable growth trends over the next 5 to 10 years. Year-to-year, they may be stronger or weaker as the case might be, but long term, we see these as important growth trends that we have to intercept. And these megatrends go hand-in-hand with the automotive future. So we put them in 3 buckets, connected and secure. And in that, we see 5G, the data center and IoT, all intersected into a connected and secure automobile. In automated, where in addition to the megatrend of ADAS and autonomous, we see 5G, IoT, data center and artificial intelligence, all playing a role in how automotive -- the automated car unrolls. And finally, with electrification, besides the EVs itself, how data center and IoT would play a role in these as well. So these megatrends play very much into what we see as the automotive future itself. Now cars are getting more complex. And mainly due to the software effort inside of the automobile, it's a very complex software effort. The R&D costs and time to market are increasing rapidly, and the focus has been on how you gain control of that using some established standards. And Ethernet, at different speed grades, will help our OEMs attack this R&D cost and time to market. And our Ethernet story which is around low speed, mid-speed, high speed Ethernet, not only in physical layers, integrated in microcontrollers and in switches, all play quicker roles with that. We also see the car as a large Internet of Things device, it's always connected, and it has a large attack surface. And there is no way to have security on a car without -- or safety in a car without all the security requirements. And so security is a must. And with the limited R&D dollars that are available and the time to develop everything from scratch, we are providing solutions that can be retrofitted on existing design. The first of those is called a trust anchor as well as microcontrollers with hardware security modules that build into it. And so these will be critical parts of how we enable both the connected and the secure automobile. The automation in the car has also been rapidly rising primarily as a safety assist for the driver. Most of us probably have some form of a lane departure or side object detection. So these are simple devices but increasingly, you get more and more features available in a car that augment the car, the driver as a responsibility. And then as we look forward into more advanced cars today having Level 2 automation, in the future getting up to Level 4 or level 5 and acquiring [ more band ] sensing, precise positioning, instant decision-making and fail-safe operation, a lot of capabilities that we would be bringing to enable all of that. And then electrification, we see as an unstoppable force. It's a small percentage of the cars today, in single digits still, but growing rapidly with significant investment from many, many companies as well as government regulations that are driving it in that direction. And we see this is a key place where silicon content can grow very significantly, almost double in some cases of where silicon content is in cars today. And that's both on the car side of things, but also on the charging side of things. And we have a robust portfolio of silicon carbide solutions at various voltages that will play here as well as some very significant microcontrollers that would play into this space as well. So we do have a broad range of solutions to enable this connectivity and security automation for driving and electrification. I thought I'd share with you a little bit of where the market's at before we try to wrap this up. So first is, we track very closely where is production and where our sales taking place. So this is some historical data over 12, 13, 14 months, showing you the number of cars produced, automobiles produced worldwide by country, and you can see on the right-hand side, the noticeable dip that took place in the March, April, May, June time frame. And the first half 2020 production was disrupted significantly by COVID-19 pandemic-related shutdown. So these are, in some cases, the supply chain, but in many cases, the carmakers themselves shutting down their factory. And we estimate that global car production dropped by about 30% in just the second quarter alone as compared to the year ago quarter. Now the bright spot is, if you look at the fifth bar from the right-hand side, which represents the February month of 2020, you can see the blue section shrunk to almost nothing. That was China pretty much shutting down in February. And that blue segment grew in March, grew in April, grew in May, grew in June. And you can see China continuing to come back to where they were, not only where they were recently, but really pretty much all the way back to where they were a year ago and now seeing year-over-year growth during these months. And there's some preliminary data out of China for July, which continues to show the year-over-year growth continuing as well. This is the same data but on sales. So firstly, there were 1.6 million more cars sold in the first half of 2020 than were produced. And that creates some shortages in inventory and some rebuilds and prebuilds that got to be done. Again, China here, the sales reflect what the build was following as well and with sequential and year-over-year growth each of these months. And we are beginning to see that sales in the Americas, in Europe and Japan are all starting to recover into June. And by the month of June itself, approximating about 70% of what I would say is normal, normal being what it was in June, the prior year. And we expect that as we go into July and August and September, it would slowly inch its way back up through the second half of this year, as the sales continue to have momentum and production builds behind it to both catch up for any inventory that has been sold off, but also keep matching with where sales are at. So these are good signs for automotive as we look into the second half of this year. So to summarize before I hand it back to Harlan. Microchip is effectively navigating the COVID-19 challenges. We have outstanding non-GAAP operating margins in what is pretty close to the bottom of the cycle at this point, about 38.6% last quarter. We have had a relentless paydown of the debt, $2.62 billion over the last 8 quarters despite all the challenges in the macro environment. Our market segments are very well aligned with the 6 global market megatrends. And then within automotive, the 3 megatrends of connected and secure, automated and electrified, they align very nicely with our 6 global megatrends. The broad portfolio we bring is an enabler for our total system solutions approach, which is to have a maximum amount of ours content that can go into any one design, and we believe we're well positioned to participate in the long-term growth of the automotive market. And with that, Harlan, I will pass that back on to you.

Yes. Great presentation. Thank you for that overview, Ganesh. So I'll just start off with one near-term question. So in last week's earnings call and actually today, you gave us a really good profile of the trajectory of the automotive end market, customer production trends for automotive. As it relates to your business, you guys started to see partial recovery of the auto business in April and May, driven by China auto customers. And as you mentioned, you started to see a pickup in the European, North American, Japan auto sectors starting in the month of June. So is this one of the segments that actually grow sequentially here in the September quarter? And you guys also talked about overall bookings for the company, improving July and thus far here in August. Does this include auto bookings as well?

So short answer is yes. We expect that the automotive part of our business will grow in the September quarter as compared to the June quarter. And yes, in order to do that, automotive bookings have contributed towards some of the bookings strength that we have seen, as OEMs and Tier 1s start to finalize what they're going to build and how many they're going to build and they're working through some of that over the last couple of months as well. So -- yes, I'd say yes on both questions.

Great. And then maybe now stepping back and sort of looking at your auto business from a longer-term perspective. So you provided us with a great snapshot of the opportunities in the product portfolio, on the -- and the focus in the auto markets and the portfolio has clearly grown over the past few years, right, more networking connectivity, more analog, more power management and complementary nature to your market leadership, microcontroller, microprocessor product lines, you guys have always talked about total system solution or your TSS strategy. So to drive more Microchip products per opportunity over time. I think the last time that Steve updated us, you guys were driving sort of low to mid-teens percentage year-over-year increases in the number of Microchip products per customer programs across the entire business. I guess the question is, within auto, is the auto content capture on new opportunities in line? Higher? Lower than the corporate average? And the second part of that is, what's your average dollar content capture per vehicle?

Okay. Great questions. So our TSS methodology is end market-independent. So what you see in our trends includes automotive and automotive has its share of TSS growth that comes about. So the methodology works independent of the end market. Our dollar content per vehicle has a such a pretty wide range and it depends on the manufacturer, the specific vehicle model, its features that are there, either standard or optional as a cake might be. So from time to time, we take specific vehicles and we look to see, so how is it that we're represented. And it's a little hard for us because we don't sell to the carmakers, we sell to the Tier 1s. And so it's a little longer process to go and piece together what could we sell to a Tier 1 supplier or customer, who then was a supplier to an OEM and what went into which models. But through those specific ones that we have looked at, what we have shown is that in these specific car models, we have what we believe is north of $100 of content. Now to be fair, many of the cars that we took apart and tried to put the pieces together for, were the more feature-rich cars. And so I would expect that the average for us is under $100, probably somewhere in that $50-ish kind of range. But it's -- we don't have a precise number to track carmaker by carmaker because we don't really sell anything directly with carmakers.

Got it. So if I think about a lot of the opportunities, the 3 megatrends that you guys -- the 3 megatrends within the auto market that you talked about, some of them being faster-growing segments in the market, right, like EV and networking, connectivity and security and ADAS. How does the team see its auto business growing over the next 3 to 5 years versus your overall sort of top line growth trajectory?

So 3 automotive megatrends are all built on our foundational products, right? The foundational products that go across just about all applications are microcontrollers, microprocessors, some of the mixed signal, linear power, timing, memory and all that. So those are there in all of these. And what I then think of what is incremental that is coming from these 3 automotive megatrends. The first one, connected and secure car, incrementally exploits our capabilities with USB products, USB hubs, in particular, our Ethernet solutions, our most networking solutions and some of the older technologies CAN and LIN, which are going to live for many, many years rather there. And any time you have networking, all of the security product we bring in and these include what we call trust anchors. Think of trust anchors as a way to retrofit security on existing systems as well as microcontrollers with hardware security built in for new designs that are there. So those are drivers that are there for the first of the auto megatrend. In car electrification, incrementally, it exploits our portfolio of digital power conversion, motor control, microcontrollers. And then on the power side, the silicon carbide chips, these are diodes as well as MOSFETS and related chips. And then we also sell the silicon carbide products in modules in many applications where there are multiple MOSFETS that are needed. We also have inductive position sensors and in an electric car within the magnetic fields, the inductive position sensors have substantial advantages that come with them. And then last but not least, there's a lot of our high-voltage products, high-voltage power management products that go into that. And the third is in the area of automated driving. Incrementally, this exploits our portfolio of PCIe switching solutions. So these are devices which we originally created for storage and for the networking inside storage, now having finding places in automobiles as well as automobile converts to basically a server on wheels, where it's -- some of the precise timing because it becomes very important as you're doing autonomous and automated driving, the timing is absolutely precise both timing as well as synchronization and then some high-speed video technology we have with a networking capability called CoaxPress. So these are all the areas that we would drive incrementally besides the baseline of what we do in all automotive.

Got it. And then just one more thing as it relates. You've given us a really nice, I think, a really great profile of the automotive business. Can you just give us one more piece of the pie there? Which is a snapshot of your automotive business by geographical exposure, in other words, China, Japan, European, North American automakers, can you sort of rank order your sort of exposure?

So it's difficult to do. One, we don't track it internally by the geography of the world; two, where we ship the product to doesn't necessarily translate to where that product ends up. So you could have a North American car that has got a module that is built in China or Japan that comes out to us. So we don't have a good way to do it. We don't run the business that way. And so we don't have a good way to provide you with that level of specificity. What we can tell you is at the design phase, we are very well engaged with the key automobile makers who are driving the designing of new cars, next-generation technology in Europe, in the U.S., in Japan, in Korea and China.

Great. Maybe one question for Eric. The auto business is very sticky. Designing cycles are long. So I view a very stable growth business for the team. But on the profitability profile of the auto-related products, and we hear this from some of your analog more focused competitors, but the auto qualification and reliability testing, what we call burning, for example, more streaming and testing requirements and so on, much like your A&D business can dive maybe higher product costs. So is it the same for Microchip where your automotive products because of these additional requirements do have maybe a slightly lower gross margin profile relative to the rest of the business? And then maybe what are some of the initiatives that the team is looking at, maybe improve some of these margins?

So Harlan, we don't break out our gross margin profile by our different end markets. Our ownership of significant manufacturing capability is absolutely advantage for us in driving down costs. And we combine that with our discipline around pricing. This really enables us to achieve the desirable gross margins that you've seen from Microchip and even more recently, have we been able to maintain our gross margins in a very tough environment. So we're also very selective about what applications that we play in. And suffice it to say, we are extremely happy with the profitability of our automotive business. You're aware of the various things that we're doing to continue to improve our cost structure, continuing to in-source some of the assembly and test activities, restructuring, one of our historical fabs in Colorado, that's on 6-inch and moving a lot of that high-volume production to 8-inch. So those are just ongoing things that we do. But in terms of breaking out gross margin by end market, we just don't do it.

Got it. And a product-related question around networking connectivity, right? We know Microchip team for the microcontroller leadership, the analog leadership, the power management leadership, but networking connectivity, you guys have built a pretty strong portfolio of products and in terms of things like ADAS and autonomous driving bandwidth, latency are all important, especially for safety-related applications. You guys have a plethora of auto connectivity solutions CAN, LIN, Ethernet, advanced PCI switching capabilities. Ganesh, do these diverse set of connectivity solutions complement each other? Or does one technology lend itself better in terms of scalability, bandwidth, latency for next-generation automotive? How do you guys view this connectivity market for auto?

Great question. So there are many networks in a car and each of which requires different capabilities. Now in one sense, we believe that Ethernet as a technology is directionally where that convergence is likely to take place for some of the networks in the car. And that is why it's a high focus for us to be able to enable that, all the way from slow speed Ethernet, which will begin to replace CAN and LIN in the medium-term to higher speed Ethernet to switch for Ethernet, et cetera. And so there are many different capabilities within Ethernet that we're bringing to the market to do that. It's also not a hardware business alone, right? Networking has a substantial software component to make sure that it meets the spec, it's able to inter-operate, et cetera. So these are very sticky designs because the software solution is, in many cases, as important as the hardware side of the solution. You mentioned PCIe express, and that's a critical requirement as we look into kind of the advanced networking in cars, particularly for autonomous type of driving. So that's another part of what we bring, again, significant software content there as well. And then in the meanwhile, on the legacy side, we still continue to have a significant business with the most network. It does very well in infotainment. And despite people thinking most was going to be heading out, it's doing very well, and it's winning new designs away from some other technologies like A2B which is an audio network in the car switching to using most in some applications as well.

Great. Well, we're just about out of time. Ganesh, Eric, thank you very much for the insights on the automotive business and the summary of the just recent -- the past quarterly results. Best of luck for the second half. And again, thank you for attending our auto conference.

Thank you, Harlan.

Thanks, Harlan. Appreciate it.