Microchip Technology Incorporated (MCHP) Earnings Call Transcript & Summary

Greetings, and thank you for attending the first day of JPMorgan's auto conference. My name is Harlan Sur. I'm a semiconductor and semiconductor capital equipment analyst here at the firm, very pleased to have the team from Microchip here today. This is their second year presenting in our auto conference. We have Ganesh Moorthy, President and Chief Executive Officer; and Eric Bjornholt, Chief Financial Officer. Microchip is a leader in embedded systems, semiconductors and software, things like microcontrollers; analog; and a broad portfolio of application-specific semiconductors targeting a very diversified set of end markets, including automotive. The team reported solid June quarter results and September quarter outlook last week. Ganesh and Eric will kick us off with a presentation then we'll go ahead and kick off the Q&A. So with that, gentlemen, thank you for joining us today. And Ganesh, let me go ahead and turn it over to you.

Great. Thank you, Harlan. And good afternoon, everyone. If you would please advance the slide to Slide #2 before I get into the presentation. During the course of this conference call, we will be making projections and other forward-looking statements regarding the 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. And we refer you to our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. With that, let's go to Slide #3, please. So this is a summary of what our recent results were and our guidance for the next September quarter are. So bookings were strong in the June quarter, continuing what we saw in the March quarter. All bookings, et cetera were at record levels. The Preferred Supply Program that we kicked off to give customers preference for our shipments in exchange for long, noncancelable orders continued to gain momentum. Over 50% of our backlog now is in this program; and in certain very constrained areas, it's 100% of our backlog. Inventory continued to come down. It came down another -- a couple of days to -- or a day to 111 days on our balance sheet, a couple of days on the distribution inventory to a record low of 20 days. Looking into our guidance looking forward for the September quarter. The guidance we provided last week was to be up between 3% and 7% sequentially with record non-GAAP gross margins at the midpoint or at 65% and record non-GAAP operating margins which at the midpoint are at 42%. So both those, at 65% and 42%, effectively meet the long-term targets that we have set and shared just about 9 or 10 months ago. And we will review how we go going forward once we hit those numbers and somewhere later this year and provide an update. The non-GAAP diluted EPS guidance was between $2.05 and $2.17, so a midpoint of $2.11. We declared a record dividend, another 5.8% (sic) [ up 5.8% ] sequentially, up 18.8% year-over-year, for $0.437; paid down $388 million more of our debt last quarter; paid down almost $4 billion of debt over the last 12 quarters. And exiting the June quarter, our net leverage was down to 3.34%. Move to the next slide, Slide #4, please. This is just to show you the progression of our revenue. Right now, if you take the actual for the June quarter plus the guidance for the September quarter, [ multiply it by 2 and annualize that ], we're growing almost [indiscernible] between fiscal year '21 and fiscal year '22. And so it's on a good growth path and it's 123 consecutive quarters of profitability through the June quarter of this year. Move to Slide #5, please. This is our revenue by end market. And in particular, because this is an automotive conference, I wanted to give you some sense of what does automotive represent in the mix of our end market exposures. And it's about 15% of our revenue, about the same as what it was a year ago. And we had the same data, but we had accumulated it. But we do have a large presence in related areas like industrial, like communications infrastructure, defense and aerospace, all businesses which have consistent growth, long-term life to what they do. Next slide, please. We have 6 major market megatrends that shape where we're going and how we're driving growth for Microchip. Those 6 megatrends are the 5G infrastructure rollout, and it's got a 5- to 10-year runway of growth ahead of it; Internet of Things and also edge computing and more specifically around how the industrial Internet of Things begin to roll out; data centers. That's represented by storage; compute; and in many cases, telecom data centers as well. So how we take advantage of growth in those areas. The advent of electric vehicles, which every day there's a news article about more investment, more commitments that people are making, but going -- from single-digit type of electric vehicles as a percentage of the total, going up into the 20s and 30% over a 5- to 10-year range of time. Artificial intelligence and machine learning; and finally, in [ driver ] automation, ADAS, autonomous, et cetera [ on this ]. So these are the 6 trends that we find to be very interesting and offering significant growth opportunities as we look forward. And we'll now dive into the automotive part of these things. So go to the next slide, please, Slide #7. So we look at 3 major megatrends that are inside of automotive, and they really crisscross with our other megatrends I just spoke to. So the first of the automotive megatrends is around connectivity and security. And it connect -- it crisscrosses across 5G, data centers, IoT. They all come into play with how this is developed and deployed. I'll go into the second and third in more detail, but just to summarize: The second megatrend is around [ driver ] automation, crisscrosses many of our other megatrends as well. And the last one is around electrification both in the car but also in the infrastructure [ itself ]. So let's go to Slide #8, please. So in the area of connectivity and security, the value shift that's taking place, the paradigm shift in value that's taking place is how our customers and car OEMs are looking from just hardware alone. [ And ] hardware used to be how well is a car handled, the power it has, the torque it has -- to really how software is being applied to offer capabilities around advanced driver assist, infotainment, connectivity to different devices and all that. And features are being added through software, sometimes over-the-air updates, upgrades and all that. And that whole service, software as a service, becoming a revenue stream for carmakers and a way for them to improve the car's capability out in time. The standardization of computing is taking place at the hardware level, and we'll speak to some of those here in a minute. And then the value add is taking place with the software. And one example of that is how the driving software stack in an autonomous vehicle is being deployed. Also different from the past is carmakers are building more computing power than is needed today because they're trying to anticipate how to have headroom for the future and how new capabilities may be deployed in this existing platform from today. So [ as software improvements are made ] that provide more capability [ in either ] ADAS or infotainment, the computing power is ahead of time to be able to handle that. Usage of standard interfaces, so getting away from any proprietary interfaces. Most of these have been created in the computing domain, but using these standard interfaces like Ethernet, USB, PCIe, et cetera reduces the software complexity because they're using standard interfaces. And these interfaces are where Microchip is already a leader and bringing these technologies into automotive. And finally, cars are being equipped with sensors that are in excess of what a car, when it's originally sold, is being utilized. And those sensors by default are able to enable services, and you can activate services for a fee. I happen to have a Tesla car. And after having bought it, I get notices from Tesla asking if I want extra features, and it takes advantage of the same hardware that's built into my car. That is becoming more of how carmakers are thinking in terms of the value shift that they're going through. So let's go to Slide #9. And when you look at this now kind of at a car's overall architecture level, the architecture enablers are these 3 technologies of Ethernet, PCIe and USB. And it doesn't matter what configuration, whether you have lots of little computers; a few small, centralized computers. Any one of these architectures are going to be possible. And different people are taking different tacks, but the end result is that there are going to be lots and lots of sensors. And every one of these sensors is going to need a microcontroller, is going to need analog, is going to need security. It's going to need connectivity. And then from that, it goes into a zonal ECU, going into central compute, et cetera. So many, many opportunities in the different connectivity architectures to the car to allow for growth in microcontroller [ growth in analog ]. Switching to the second part of megatrends, so going to Slide #10, which is in advanced driver assist or automated. Going to Slide #11: On the right-hand side, you'll see a whole range of assist systems that -- if you have been buying cars in the last 5 to 10 years, incrementally more and more of these have been made available not only in the luxury cars but in the mid-range and even the lower end of the cars. And so, a lot of these, you will be able to identify it for your own car, what you have. And if you don't have it today, you're going to be having it in the next car that you buy. And this is the important part of how ADAS is developing. And in time, it's not only the individual systems but how these systems work together. And the essence of this is you need something to process the sensors. You need some communication to be able to take it to a compute center and then the computing that will drive as well. I'm going to take one example, which is if you look to the left-hand side, on the steering wheel itself. And as we go to where there's automated driving or any kind of driver assist, you're going to find that a -- hands-off detection on a steering area is becoming an important thing so that drivers don't remove their hands completely off the steering wheel. And then if you go to Slide #12. I want to show you how one of our total system solutions works. So here a solution we offer is capacitive sensing that can be built into the steering wheel to detect, hands-off detection. And to deploy this solution is -- you can see a block diagram at the bottom right, but in effect what it has is 2 different microcontrollers with touch capability. It's got 2 different power management products. It's got a LIN transceiver to do some of the communication capability. And through it all, it requires functional safety, which is a combination of hardware and software in safety-critical applications in it. So that's an example of total system solutions for hands-off detection, which is one part of what happens in ADAS. Moving to Slide 13, talking about the third megatrend in automotive. It's about electrification. And if you go to Slide #14, you'll find these are the breadth of opportunities that Microchip has in electric vehicles that are incremental to anything which is normal that is in a gasoline-powered car or an electric car. So for example, touchscreen is common to both. I don't really list that over here; and seat control and garage door openers. Those are all common to both, so that's not what I'm referring to. Each of these here that's listed is something unique on an electric vehicle that is above and beyond what we would have in a normal gasoline vehicle. And just to go through the gamut of this. It's from battery management to charging, to making sound when you're in low speeds to give warning to pedestrians, the motors, the regenerative braking, lots and lots of opportunities in the power and charging-related activities that are going to be in a car. And to take one example of how this can be deployed, if you go to Slide #15, is [ I'm just taking ] the electric vehicle charger. And so this is onboard the car itself. What does it need? And it needs a whole bunch of products that come from different product lines at Microchip: processors, controllers, clocks, USB or Ethernet as the case might be and so on and so forth. And it gives you a way to think about how do we approach this application from a total system solutions standpoint. And like this, for all of the other ones as well, we have similar constructs for bringing complete solutions for electric vehicles. And then separate from in the car, we're also very much in the charging infrastructure and providing solutions that go into that end, which is really a more industrial application than an automotive application. Finally, I wanted to talk about the 3 megatrends but one more area which is [ a fun ] area that all of us can identify with in which we play a major role, the human-machine interface. And so if you go to past Slide #16 but on to Slide #17: This is a car from circa 2013, and you can see its human interface has a significant number of buttons and switches [ kind of there ]. It's not very long, though. This was 7, 8 years ago from where it's at. And if you take that same cockpit view and if you go to Slide #18, that's what it looks like in the most recent car announced by Mercedes-Benz, their electric S-Class vehicle itself. And you can see a dramatic shift between what there was in Slide #17 and Slide #18, a lot more touch surfaces, a -- larger screens, a lot more continuity of the different displays that are there. And this is all, if you go to now Slide #19, providing us substantial new opportunities for Microchip. And each of these boxes here shows you the different touchscreen controllers, gestures, hands-off detect, touch buttons, touch surfaces. They're all possibilities where we're designed into. And each of these application nodes has a minimum of it needs a microcontroller. It needs power management of some sort. It needs connectivity of some sort. And in certain cases, if it's -- well, in all cases, it needs some form of a touch sense firmware capability itself, so lots and lots of opportunities that are coming from the improvements in the human-machine interface or the human interface into the car itself. I want to conclude this with kind of 2 slides which will kind of tell you sometimes a picture is worth a thousand words. And so if you can advance to Slide #20. We are in many, many places inside of the car. This is a German luxury car. And every one of these boxes is a box in which one of our Microchip products is there. There's about close to 55 to 60 components from Microchip in this car spread across micros, analog, USB, connectivity, et cetera. And lest you think that this is all just only in a German luxury car, if you go to Slide #21: This is an Asian luxury car. This one happened to come from a Korean manufacturer. And you can see likewise there's a whole range of applications in which you'll find Microchip content and about the same number of chips as in the German luxury car in the 55 to 60 range. So I think that's the way we view, is it's the automobile is a target-rich environment for many, many things that electronics brings value: in safety, in convenience, in driver interface, et cetera, for what's being done. And Microchip plays a significant role in that. And my last slide is to say thank you and to hand this back to Harlan for the rest of it. Harlan?

All right, perfect. I'll kick off the Q&A. [Operator Instructions] So in last week's earnings call and today, you gave us a good profile of the trajectory of the overall business and that the demand-supply gap had widened from the March quarter to the June quarter. And the expectation is that the demand-supply gap will continue to widen as you exit the September quarter. I know you don't keep track of products by end market, but given the unique sort of reliability testing requirements of your automotive products, I think you maybe have a little bit more traceability but wondering if you can just give us a sense of if the demand-supply gap in automotive is actually wider than the overall business, number one. And then you also mentioned last week supply potentially catching up with demand sort of middle of next year. Do you see a similar normalization in auto, or will that be more extended?

Great. Thank you. So as you mentioned, we don't really keep track of the business results by end market. It's just so fragmented that we don't. And many of our automotive products are not unique in their testing requirement. They undergo many of the other segments', so those products undergo the same stringent testing that industrial, aerospace and defense and communications infrastructure require as well. Now my sense is that the demand-supply gap in automotive was much larger 6 to 9 months ago. They were in the early phases of discovering how big of an issue it was. And at this point, it's [ not discernably ] different, but what automotive customers have done is they were among the earliest participants and at a much higher rate in the Preferred Supply Program. And so they have, out in time, placed the orders that they need to be able to catch up. And so in that sense, I think their gaps are likely to be smaller in the coming months as the full effect of the PSP program takes effect, which is starting about September. October is when it will begin to take effect in its full form and all that. On your second point, just to be clear: While -- we don't really have a line of sight for when the supply-demand imbalance comes into balance. I think what we said is that we think this imbalance is going to be with us for at least the next 4 quarters through the middle of 2022 and possibly longer, so I don't really have a sense that it comes back into balance as much as it does not come into balance for the next 4 quarters.

Got it, okay. And then on the topic of PSP, I know that, as you mentioned in your slide, that PSP program as a percentage of your total backlog was 50% exiting the June quarter. I know, back in June, you had said that backlog PSP coverage within automotive was actually around 80%, so did the automotive PSP coverage actually grow exiting the June quarter? Or is it still at around that 80% range?

Good question. I don't think we've looked at it quite that way, but I think in that is a sense of what I was saying earlier on because automotive recognized the benefits and the importance of PSP. So as we went through the quarter, they were earlier to be able to take advantage [ of it ]. I suspect what has happened over time is other people have also placed more PSP backlog, so from an early start standpoint, automotive as a percentage likely has gone down, but I don't have that for a fact.

Okay, great. Well, let's turn to the products and the automotive-specific subsegments of your business. You provided us with a great snapshot of the opportunities in the product portfolio you go after in the auto markets. And the portfolio has clearly grown over the past number of years, more networking connectivity, more analog, power, software content. You talked about your TSS or total system solution strategy. And the team continues to drive year-over-year increases in the number of Microchip products per customer program across your entire business, right? And so the question is, is auto content capture on new opportunities in-line, higher or lower than sort of the corporate average capture rate? And how much does the role of your software portfolio play in automotive TSS?

Yes. So I believe it is in-line, maybe slightly ahead. We don't track the TSS by end market, but we do approach automotive applications with a TSS mindset. As you saw in my presentation, there were 2 or 3 examples I showed up where we were. And especially where we are the primary brains of the system, and in many, many automotive applications we are, [ we get an early look-up ] at the system architecture and the requirements. And we get to look at what will be needed in addition to the brains, whether that would be a controller or processor, FPGA, et cetera. And so we get an early lead to position our TSS offerings to the customer by bringing the rest of the Microchip solutions, and that is not only in hardware but also in software. We also have reference designs that we make available. And all of these reference designs and solutions have both hardware, software, firmware. And these absolutely strengthen our positions because we provide validation. We provide warranty when the complete solution is used with what we have done, and we have tested it to [ how we're making ] sure that all pieces play well together. And it ties the hardware and software inherent in our TSS offering more strongly together.

And on the last couple of -- I really liked the last couple of slides, the German luxury car and then the Asian car; 55, 60 chips per car. What is the sort of average dollar content capture per automobile, you think, with your products?

So the average would need to comprehend kind of a low-end car as well as a mid-range and a high-end car. The examples I showed were more on the high end, right? So I think rules of thumb are that an average car is about $400 of -- and not -- a regular internal combustion engine car has about $400 or so of semiconductor content. It almost doubles from that for an electric car. On that $400 average [ per ] car, I would estimate -- and this would be a guess, more than anything else, is -- we're probably in the $35 to $50 range, depending on what exactly is a combination of products that are being used. It's much higher than that on the high-end cars. It could be a little lower than that in some of the low-end cars, but that's probably a good proxy for the -- for a mean.

So then on the -- okay. The -- I appreciate the average range. And so on the German luxury car, for example, just give us a sense for, on the upper end of the content capture, how much could that be.