Microchip Technology Incorporated (MCHP) Earnings Call Transcript & Summary

I guess we're live. I'll just -- I'll start flapping my guns because I guess that's what I'm best at being a sell sider. Hopefully, everybody can hear me out there. Thanks for joining us. I'm Chris Danely, the semiconductor analyst here at Citigroup. It's our distinct pleasure to have next, one of our top picks in semis, bi-rated Microchip. We've got the dream team, both the CEO, Steve Sanghi; and the CFO, Eric Bjornholt. Why do we like Microchip so much? Quite simply, it's got one of the best, if not the best, and most consistent earnings growth in the space. And then if you also couple that with their diversified business model and their high margins, we think it's a particularly attractive stock. We've had a buy on it for quite some time. Guys, you were nice enough to put out an update on how the quarter is progressing earlier today. If you could just briefly encapsulate that for the audience, and then we'll take it from there.

So thank you, Chris. Yes, we put out an update this morning, which we [indiscernible] down 8% and we narrowed it to be down 2% to 6% with an unchanged midpoint of minus 4%. We similarly narrowed the guidance on earnings per share for both GAAP and non-GAAP and really kind of unchanged midpoint, but really just shaved it from the top and the bottom. Overall commentary is that the bookings have been strong for July and August. If you recall in the earnings call, we mentioned that our May bookings were lower in June but even lower, and then we wrote a letter in early July informing our customers that we need them to give us more visibility in addition to the shorter-term turns. We also need some midterm and longer-term bookings so we can be more efficient in building the product for them. The result of that letter has been just perfect. It was perfectly timed. It was perfectly written. It was perfectly executed, and the output has been perfect. The bookings are up substantially, and all the increased bookings are for medium-term and longer-term, meaning that we're already getting bookings for October and November and some bookings even going into December, January, February, longer term. So all that has been very good. From an end market perspective, we said that the end markets of data center and computing that benefited significantly last quarter from work-from-home initiates, they have weakened in the current quarter because those initiatives have been fulfilled. And the business sector, which was very weak last quarter with automotive and a little bit industrial also, those markets are starting to recover. So that's roughly what we said.

Thanks, Steve. I guess just to unpack that a little bit, let's start with the stronger end markets. Between auto and industrial, actually, now that we have some time, maybe you could just give us kind of how the automotive end market has trended for you this year. And is it bouncing back just as hard as it declined a few months ago? Or do you still think we have room to go on the recovery there? We'll just, I guess, progress through the other end markets, but maybe start with automotive.

So automotive went down like jumping off a cliff last quarter, and it has seen a V-shaped recovery. Every company, every customer being a little bit different regarding how they came back, but largely consolidated. The automotive market has certainly seen a V-shaped recovery. And the big question is really what happens the next quarter. I certainly don't know. I don't think the customers know themselves, whether the entire full production is sustainable. Is there a full demand for all the cars? And still a lot of people have been laid off, and there's still some demand disruption. So short term, the dealers will have enough cars to sell. But as that demand gets made up probably by the end of this quarter, does the rate stay the same or does it moderate down a little bit? I don't really know that yet.

And with the automotive end market, Steve, and COVID and then also this big push in electric cars, what's your sense on the content increase for semis and autos this year and going forward? Do you think that it's accelerated, decelerated? I'd appreciate any of your sort of comments on how the overall end market is doing.

So I think COVID-19 and electric vehicle trends are 2 different phenomena. They're apples and oranges. The COVID has not accelerated or decelerated anything towards that trend. It's just the overall green trend. Automotive vehicles are doubling probably year-over-year, but they're a really small portion of the overall market. So even though the electronic content -- semiconductor content in electric vehicles is about twice as much as the other vehicles, it's really not just making a meaningful dent in the overall curve because the overall fluctuation in the number of units have been that high. If units were to become constant year after year, then the switch to electric vehicles will increase the semiconductor content. But the volatility has been too high.

Okay. And then switching gears to the industrial market. It seems like we're maybe not quite a V-shaped recovery, but a nice recovery there, but it doesn't seem like it weakened as substantially as automotive did earlier in the year. Maybe just talk about the trends in bookings from the start of the year until now on the industrial side.

So industrial market overall didn't weaken that much as automotive. Just like you said, the heavy industrial market of moving equipment and others did see some slowdown during COVID, but medical took off and we wrapped medical into industrial. So the need for ventilators, digital thermometers, forehead temperature scanners, various pumps to pump air or oxygen into a patient and all that stuff using that product. 5 months ago, I didn't know what a ventilator was, and then I found out we were in every ventilator around the world. And that demand went up 100x, where a hospital that had 2 ventilators wanted 2,000, and it has taken us through this quarter to satisfy some of that demand. So a combination of increase in medical made up for some of the other drop in industrial. So we do overall see that much demand disruption, and that's why there is not that much V-shaped recovery either. Also on the medical front, while the ventilators and thermometers and all of that demand spiked up, the demand for medical equipment went down like the ultrasound, MRI, X-ray machines and others. That demand went down because elective surgeries went to as near 0 and all the diagnostics and all the regular maintenance went to 0 because the entire effort shifted towards COVID. So overall, the medical business shifted from one kind to the other kind. So as you look at this quarter, the ultrasound, the X-ray machines, the MRIs, all those are coming back as people are going back to running their medical diagnostics and colonoscopy and everything else, while the demand for ventilators, digital thermometers and others really has been saturated. Everybody who wanted one has one, and that demand is going down. So that's moderating.

Got it. And can you point to either of those end markets as being either stronger than expected or stronger than the other right now?

Which of those end markets?

In -- between auto and industrial, which one would you say is stronger than the other? And then have either of them recovered a little quicker than you thought?

Well, the -- I would say the auto is more visibly stronger. Industrial is very large so it's very hard to get your arms around it. Gas pumps is industrial, up moving equipment is industrial and digital thermometers is industrial. So that's tougher to get arms around. But I would say automotive is easier to get your arms around, and that market is strong. And the pace of recovery actually has been remarkable. It has been V-shaped.

Great. And so switching gears to the data center and the PC end markets. You were one of the first companies to call out some weakness there. Now we've got some other notable companies, Intel, for example, calling out some weakness in data center. The PC weakness, maybe we haven't seen that too much in some of the other companies. So can you just talk about sort of the trends in those markets? And then is there any reason why you would be seeing PCs a little bit weaker than some of the other companies out there?

So if you go back [indiscernible], we had employees that had PCs and they often carried their PCs either home to work or they had a different PC at home and a different at PC work. And then there was a fair amount of staff that actually just only had a desktop at work. When they left, they didn't have a work-given PC to them because they work in customer service or whatever and they work from their desk. So all these people around the country had to be fitted with a PC to be able to work from home. So PC demand spiked, and we had the best products shipping into office automation segment last quarter. And it's not only the PCs. It's PCs, cameras, broadband, faster routers, printer, being able to print the stuff. So it's really bigger than just PCs. So that business was very, very strong. And with the onetime demand to satisfy that thing, everybody is now set up to work from home and have been working from home for several months. So that demand is seeing a major headwind in the current quarter, and that's why it's soft. And data center, data center is soft because of 2 reasons: One is general data center demand got pulled in because as everybody was working from home, it was easier to have data in the cloud than to have the data on your server at work, and the demand just substantially went up. And that part of the demand is now moderating. And the second part is the Huawei effect. [indiscernible] much larger portion of the business. For us, it was only 1% or 2% of the business. And after September 30 -- after September 14, which is another 5 days, we can't really ship anything to Huawei. So Huawei demand was 0 [indiscernible].

Thanks, Steve. You broke up there a little bit towards the end. If either you or Eric could just repeat the numbers on Huawei. What's the percentage of revenue? And do you think that it's going to create a bit of a headwind to the December quarter revenue now that you won't be shipping to them?

Yes. So Huawei was 1% to 2% of our business overall. Overall, out of 100%, there was a larger business for data center, which is out of 18% data center business, and you can do the math. So the impact on data center in December quarter is much larger than the overall impact on Microchip. But shipping 0 to Huawei would create a headwind for data center business as well as for overall Microchip.

That's helpful. On that vein, Steve, you've been around even longer than I have surprisingly. Do you think that we will face more bans on Chinese companies? And is there anything that you are doing? Is there anything you can do? Is there anything you think you should be doing to insulate yourself from that or prepare the company for that?

So we attract all markets, all customers, all end markets everywhere. Any product around the world, if there's power applied to it, either plugged-in or battery, then it uses a Microchip part -- should use a Microchip part, that's kind of our model. That's how broad we are. Even the simplest application from a light pin to a complex application like a data center can use intelligence of our parts, the microcontroller and your -- the power management or something. So we already serve all the markets. And I think -- so if there are further constraints on shipping into China, you can simply reinvest that energy elsewhere and put more focus elsewhere. You can't find other new markets because we already serve all the markets.

Yes. Are you seeing any shift in your demand trends maybe away from Chinese customers or certain Chinese customers to other customers? Or is it still a little bit too new yet?

We're not seeing it yet. I think the talk sort of began when there was an embargo on ZTE 2 or 3 years ago, and I do recall talking to a Chinese customer at that time. And they were saying, well, there will be a desire on the part of Chinese customers to design [ models for ] non-American [ carriers ] because there's a concern that they could put embargo on China on ZTE, they could put an embargo on somebody else. And I was arguing with the customer. I said, "Don't you think ZTE deserves that because they violated the U.N. arms embargo [ when they ] shipped the product to Iran?" Then the customer's response was Chinese customers don't care. They don't have a beef with Iran. The U.S. has a beef with Iran. We don't have any beef with Iran, so why should we take the risk that something could happen to our business? But we continue to do all the business with that customer. They haven't designed that sale. They haven't really -- so nothing has happened. It's a talk, it's in the background, but we make good product. And all the product we made is proprietary product. You can't really plug anybody else's product simply in. So over a very long term, 5, 10 years, it could move a needle. But right now, there's really nothing.

Yes, that makes sense. One question I get that's sort of related to that from several investors even today is, do you think that there's any possibility or do you see any trends developing from this trade war, where your Chinese customers will look elsewhere to, let's say, a Japanese or a European supplier?

Well, that's what I was just answering, where this customer -- conversation with the customer was why should we take a risk for designing an American product. We can design a Japanese, Korean or a European product. And that's when I said to him, "Well, don't you think ZTE deserved it," and their answer was, "Well, we don't care." So I think the sentiment is entirely American, but it has not been enacted because there's really just not as good supply line available to do it. There is -- we are incumbent. We have a large amount of software, people trained, development tools and others. And on microcontroller and analog, it's not easy either. We make 8,000 different microcontrollers. We make 20,000 different mask sets on analog products. An average analog part makes $400,000 a year. So you have to design thousands and thousands of parts to make any meaningful difference. So -- and therefore, I think there'll be a lot more focus on trying to do SoCs, microprocessors and other higher-end chips than it would be to really design a few cents' worth of analog or microcontroller. So we don't really see a major thrust to replace that, no.

Yes. I have to say that most of my -- people that I talk to say that the pro business belief is a lot stronger than the anti-American belief over there for whatever that's worth. Maybe just talk a little bit about on that, how your geos have trended so far this year. Some other semis are talking about China almost back to where it was before the downturn. Are you seeing similar patterns? And it sounds like Europe is still in recovery mode and the U.S. is maybe somewhere in between. Is that basically what you guys are seeing?

Pretty much, yes. I think we publicly said that China, after the Chinese New Year -- extended Chinese New Year because of COVID-19, where China came back, and they have been sort of normal. And then the U.S. and Europe both went down. And U.S. and Europe are now seeing some recovery.

And then you also talked about your bookings filling in nicely in July and August. How do you feel going into the final month of the quarter now versus going into the final month of the June quarter? Do you feel a little bit better or a little worse, about the same?

So bookings are very strong compared to the June. The final month last quarter was June. And June to September, there is just not even a comparison. June to September, bookings are up. September is only like -- it's 9th of September. But June to September, entire month of June versus 9 days of September, bookings are up 74%.

Yes. And I think I'd just like to point out that investors tend to translate bookings into immediate billings, and there's obviously aging that goes along with those bookings. In June, the majority of the orders we were receiving were very short term in nature. And yes, we're getting short-term bookings today, but we're also getting much longer term -- midterm, long-term backlog, which is extremely helpful for us in terms of running manufacturing and supporting our customer needs.

And that's exactly what I said. So from June, we were seeing longer booking -- very short [indiscernible], and bookings were quite low. And now in September, post the letter, we've been getting strong bookings, not only for the current quarter, for the next quarter and some even further after. So while June to September bookings are up 74%, the quarter is still headed for minus 4% compared to the last quarter. So bookings do equal to billings for the current quarter because bookings can be longer aged.

Yes. So the December quarter is not going to be up 74% sequentially. Is that what you're saying, Steve?

Exactly.

That's a joke. Sorry, I had to throw that in there. By the way, just as I sort of think about our conversations over the years, the September quarter does seem to be a little bit back-end loaded because I think you say Europe goes to sleep or everybody goes to sleep in the month of August. Is that also true of this quarter? Or am I little bit off-base on that?

Much less so. Like in an ordinary year, August would be a very low bookings month. This time, August was not a low bookings month. August bookings were very strong, and there were stronger bookings in July. So wherein early July will be okay, August would be [indiscernible] and September would be a big recovery. So this year, it's not as back-end loaded as we have seen in the -- historically.

Okay. Great. And then let's talk about the letter, I guess. We've seen these from time to time. Steve, do you see a change in customer behavior after you put out these letters? Or did things stay the same? And have your lead times changed at all this quarter or since the release of the letter?

Our lead times haven't changed. The letter was intended to inform the customer that our lead time on every product is in 2 weeks. We're holding most of the inventory in the [ die farm ] and it will take 4, 5 weeks to just give them the product. And if they have a larger demand, then we have to go back to [ die ] and they may take 12, 16 weeks to give them the product. Customers somehow erroneously assumed that because of COVID-19 and some demand disruption we have lots of inventory and every part is available off the shelf, and that really wasn't correct. So the impact of the letter has been just exactly what we expected, exactly what we wanted. The letter was perfectly timed, perfectly written, perfectly executed. And the output of the letter has been perfect. Our short-term bookings -- we kept getting the short-term bookings we were getting in May and June, and that's why the current quarter has stayed on track. But in addition to that, we're also [ seeing ] the medium-term and longer-term bookings. So today, we're already building product for October and November in our fabs based on backlog. In the past, we'll be building it based on forecast. And based on forecasts, that's accurate compared to if we're building based on backlog. So we're getting more efficient, and that has been very, very good.

The second piece of your question related to lead times, Chris, and lead times remain quite short. So our lead times have not extended at this point in time. I mean, obviously, there's some exceptions to that product by product. But generally, lead times are quite short. Our inventory is in our target range. We expect inventory days to go up a little bit this quarter based on the midpoint of our guidance, and we continue to have quite short lead times.