Microchip Technology Incorporated (MCHP) Earnings Call Transcript & Summary

Good morning, everybody. My name is Rajvi Gill, Head of Global Semiconductor Automotive Technology Research for Needham & Company. Welcome to our Seventh Annual Global Automotive Technology Conference. We're very pleased to have Microchip with us. Microchip was the first participant in our conference all the way back in 2017, and so we're pleased to have them again this year. In terms of the format, this will be a fireside chat for folks that are online, and I see a number of folks. If there are questions that you have, there's a chat box, just type of question, and I will relay the question over to Eric and Matthias, and we'll take it from there. But with us from Microchip is Eric Bjornholt, CFO; with Matthias Kaestner, VP of the Automotive Division. So gentlemen, welcome to our conference.

Thanks, Rajvi. Appreciate you hosting us.

Absolutely. Maybe, Eric, if we could just start a little bit with kind of the near-term earnings. And I wanted to get your thoughts as well. So on your recent earnings and guide, they were kind of in line after guiding kind of essentially 2 quarters. You also mentioned on the earnings call that you expected growth in June and the September quarter, you talked about that quarter potentially being flat not down. Now is that kind of still the right way to think about it? That you're expecting perhaps flat growth in September. That is kind of the deviation from the other large kind of analog Microchip controller company. So any thoughts on what you're seeing in the near term?

Sure. Well, let me give my normal safe harbor here and just say that as Matt and I are going through this discussion, we will be making certain projections and forward-looking statements about performance of Microchip, and we refer you to our filings with the SEC that identify important risk factors about the company. That being said, as you said, we've guided the current quarter to up 2.5% at the midpoint of guidance, and the quarter is tracking towards that. So nothing's changed since our May earnings call. We continue to believe that it is highly unlikely that our September quarter is going to be sequentially down. So that is really based on where we're seeing the business, the backlog that we have in place, what our customers are requesting from us and our ability to service those orders. So clearly, we operate in a cyclical industry, and we're not immune to business cycles, but we are performing quite well, and we are navigating our business to what we hope to be a soft landing. And to that, that really means for us that if we are faced with the situation where there is a semiconductor cycle or an inventory correction, that Microchip manages to maintain very high gross and operating margins as well as free cash flow. And we've done that throughout various cycles in the past. So I think there's various reasons why we are set up to even do a better job of that through the current cycle. We've highlighted for investors that we don't see a situation where our trough non-GAAP operating margins could fall below 40%. And honestly, we believe that it's going to be significantly higher than that. So we remain cautiously optimistic about our ability to navigate to a soft landing. We have experienced relatively soft bookings quarters for the last couple of quarters. And that is just a function of lead times coming down. So capacity in the industry is improving. Our internal capacity, the capacity at our foundry partners and subcontractors. And with that, lead times are coming down and customers are not really required at this point in time to give us as much backlog visibility. So that is really within our expectation.

Your lead times have been coming down, as you mentioned, and your bookings and backlog trends are a function of that those lead times. What are your current lead times, do these very much by nodes or end markets? Are you seeing any variation across the different markets or nodes?

Yes. So we have a wide variety of lead time. We've got probably 100,000 SKUs in the portfolio. So we have inventory that's in stock that we can ship in very short order. And we've got other pieces of inventory that have 52-week lead times. And so we do have several capacity corridors, both internally and externally that are still constrained. And we still have a lot of backlog sitting on the books. So we have still an unusually high level of backlog compared to what is normal, whatever normal is anymore. But with that, we do still have extended lead times. Average lead times today are above 26 weeks, but we proactively told our customers that we believe in the second half of 2023, our average lead times will fall below 26 weeks, which will be more competitive.

Got it. As the kind of backlog continues to decrease and lead times come down, the quarter becomes more turns-based rather than shipping from the backlog. Any sense of kind of what percentage of the quarter is now coming from turns where you actually have to go in the market and get business versus, say, just shipping from the backlog? And what would that say a couple of quarters ago?

Well, I'll just make a comment on the June quarter. The June quarter, we really didn't need any turns entering the quarter. So our backlog has been significantly high for a long time. We've had a lot of -- what you've heard us refer to as unsupported backlog, essentially backlog that customers have requested sooner than we've been able to deliver. But we're balancing that now with various customer requests for pushout activity, and we are accommodating that where we can. So it's a mix right now with 125,000 customers that we serve, there's going to be customers that are still scrambling to get the inventory that they need and other customers that are potentially in an over-inventory position or expecting to be in one based on the backlog that they had in place before.

Got it. So -- but in the September quarter and looking out, do you anticipate that shift, that mix of turn versus backlog to kind of change, significantly? We've seen other IoT companies or other microcontroller companies where in the quarter, it's 60% turns business versus the [indiscernible] say, a couple of quarters ago. You anticipate that shifting more to turns and getting back to more of a normalized bookings quarter.

So that will happen. We're not going to pinpoint the quarter that, that specifically is going to happen. But we've had very short lead times in our business, historically. And even when we get below 26 weeks, which we're shooting for in the second half, that will still be significantly higher than where we've been historically. Historically, we've had 90% of our products that have had very short lead times, 8 weeks or less. And so when that happens and we get back turn, and eventually, we likely will. We'll likely have a higher level of turns in the quarter. We've had some of the best quarters in Microchip history, entering a quarter needing 50% turns, and that's just the nature of short lead times.

Can you just give us some sense of what you're seeing in terms of the end market? You're fairly diversified. You don't have as much exposure to consumer IoT, some other folks. Is there any kind of softness that you're seeing in some of the 4 secular markets that have been strong in the last couple of years, whether that's data center in core industrial, automotive, or are those end markets continue to stay resilient?

So the 3 markets that you mentioned have absolutely been our strongest markets for some time, and we've really only highlighted consumer as being weak. But there's definitely a shift that is happening. And we have got more and more requests for pushout activity from customers across the Board. That's not just in one geography. It's not just in one end market. Matt can speak to what he's seeing in automotive. But even there, where that portion of the business has been quite strong, you're going to have certain customers that are requesting some relief in terms of their backlog position.

So you mentioned that your unsupported backlog was greater than what we shipped in the quarter, and that's allowing your customers flexibility. And you've been -- you guys have been very kind of smart about this preferred supply program to help you kind of manage this potential soft landing that you're anticipating. Can you talk about your backlog versus what's being shipped? And can you give us some sense in terms of what's happening with the customer order push-outs. Are you seeing order cancellations? Are you seeing order rescheduling? Obviously, the lead times come in, customers don't need to place long lead time orders anymore. Trying to get a sense of how you expect to manage a kind of a soft lending when you see kind of this order volatility. I get the fact that you're providing targets on the gross margin and the operating margin. And I think that's very helpful for folks to understand, look, we're not going to go below a certain margin or operating margin. But the top line is also of interest as well.

Well, the bottom line is the top line is the hardest thing to predict, right? We don't know what the next few quarters is going to bring from an overall economic backdrop, right? There's definitely some uncertainty out there. And so we are managing our business appropriately to be able to adjust to whatever the situation that's thrown at us. But yes, we are getting some requests for cancellation. You know we have this preferred supply program and under the PSP program that is noncancelable and nonreschedulable backlog. We are not kind of coming back on the noncancelable piece of that. But on the nonreschedulable piece, we are willing to work with customers. The last thing we want is for customers to be in a significant over inventory position, but we also want them to know that they have skin in the game with this program. Because we've gone out and made commitments on purchases from foundries and our suppliers, significant capital commitments, hired people to run activities through our factories. And with that, this can't be a one-sided situation where heads, you win and tails, I lose. So we're working through it the best that we can, and there's definitely a higher level of requests for push-outs than we've seen over the last few quarters. But we're not necessarily surprised at that. We've got an economic backdrop that is not nearly as strong. And with the supply situation improving that's giving customers the ability to say, hey, I don't need to have 52 weeks of coverage. And with that -- or their backdrop for their business has changed from when they originally placed those orders. And so we're working individually when customers self-identify inventory positions to help them with that.

And just a couple of more topics on the overall market before we go into the automotive stuff and bring the bias in. So you mentioned that the PSP, the Preferred Supply Program accounts for over 50% of the backlog. In the last earnings call, you mentioned that the current backlog is still in significant excess of sales, and you're kind of working to bring that down, move to a more turns-based business. And so I would be curious to see how you -- how we should expect the PSP program to kind of migrate over the next several quarters as a percentage of backlog as we kind of move through this transition.

So that is difficult to predict. I mean what I would say is customers that have participated in the PSP program have been serviced very well. Most of them have really liked the program and realize the benefits that have come with it. That being said, the percentage of our backlog with PSP has gotten to a much higher percentage than I think any of us internally at Microchip anticipated, at the start of the program. And that percentage of total backlog has remained pretty consistent over the last 18 months or so. And so we still are seeing people place orders under PSP. We've talked a little bit about these long-term supply agreements that some of our customers are entering into. Obviously, all those customers have been PSP participants also, and they are seeing value there. I think from a customer's perspective, this last upcycle in the industry has been so painful on the supply side that, particularly when a customer sells an end product that has a very high dollar content. They don't want to be caught short in not being able to get $20 semiconductors or a $2 part, preventing them from shipping an $80,000 automobile or a piece of expensive medical equipment or data center or whatever it might be. So I think the program will continue for some customers. But I also think when we get back to what I would call normal lead times that it will be a smaller percentage of the overall backlog. So we'll see how it trends over time. If this was put in place to be a tool for our customers to use, and it's an optional program. And again, I think it will come down in its participation level, but I think there will be some customers that are committed to it longer term.

On the automotive side, the PSP ratio still very high as the carmakers really suffered badly from lack of supply of individual even $0.20 components. So they want to know that their suppliers, our customers are well stocked and they're asking them really place long-term orders ahead. So the ratio on the automotive side is much higher than corporate line.

That is very [indiscernible]. And we're going to get into that. I just want to have one quick question on the capacity. So you mentioned that you're running the fabs through the downturn, even kind of while you're lowering the inventory. And the utilization has been kind of very high over the last year and it continues today. How do you anticipate maintaining that utilization level through a potential downturn despite the elevated inventory and it really goes back to the fact of -- and we're seeing this, I guess, across a lot of companies is that a lot of chip companies are carrying a lot of inventory on their balance sheet for a potential upturn in demand, while at the same time reducing the inventory that they have into the distribution channel. And so -- could you maybe talk about your capacity expansion plans and your CapEx plan through a downturn? How does that affect utilization? And the inventory that you're carrying on the balance sheet relative to the distribution channel, any thoughts there? And is there a risk there of potential, holding too much inventory?

So we did end this last quarter with what I would call an elevated level of inventory. We were at 169 days. Now you know the products that we manufacture and sell have very long life. So there's no real obsolescence risk with inventory levels. We are targeting to reduce inventory by about 5 to 10 days in the current quarter and expect in the September quarter, we'll take similar actions to reduce inventory. What I'd like to highlight on the inventory side though is that our internal fab generated die banks is still very low. There's a number of reasons that inventory is high, and we're proactively working on those, but I'll give a couple of examples of that. When foundry capacity started to free up in the December and March quarters, our business units and our operations team and customers we're starved for that inventory. So we took in a lot of product from foundry in both the December and March quarters. And we are going to moderate that in the current quarter and bring some of that down. We've also had to buy about 7 days' worth of inventory related to last time buys from our foundry partners. Where they are end-of-lifing processes where we see 10-plus years of runway from a sales perspective on very high-margin products. So we've made that investment in inventory. It's the right thing to do. And with some of the supply constraints going away, we are actively managing the brand like raw material levels down, which we've strategically built up when things were really tight. And as things are normalizing, we're going to be able to do that. So bottom line is that our intention would be to continue to run our internal factories hard. As I said, our internal die banks, internally fab generated die are quite low. And that's how we get to having very short lead times is having that inventory position in die bank and then being able to turn it through the assembly and test process quite quickly. Now if there is an extended downturn, again, that's not what we're forecasting, but if there is, you might have to look at fab utilization at some point in the future. But we are fortunate today that the percentage of our wafer fab that we do internally is less than 40%. And that's different than what it's been historically. We've got graphs on our website to look at gross margins over the last 15 years at various points in the cycle. And you'll see a 200 to 300 basis point decline in margins at weaker points in the cycle. But during that time period, we had a higher percentage of internal manufacturing. And additionally, we were typically integrating companies or purchasing companies with lower gross margins, which were impacting kind of the troughs that you'd see there on gross margin. So gross margins are positioned extremely well today. I think 68.4% is the midpoint of our non-GAAP guidance, and I'd anticipate that margins stay high.

Great. Matthias, just following you in terms of getting your views on the automotive market. Just broadly, how would you characterize the supply chain shortages in automotive? The industry obviously has been played by capacity shortages, semiconductor shortages for 2 years. Is there any signs that that's easing up? If it is easing up, are there any particular areas of semis that where you see more capacity coming online? And then from your vantage point, how do you look at distribution inventory, dealer car inventory at the OEM level. Are we still seeing relatively low levels of inventory at the dealer car ship? Or are we starting to see that open up a bit?

I think starting with this point, dealer inventory, this is getting replenished and a good measure for that are the lead times, the waiting times for new cars. In the U.S., people go to the dealer and just pick a car that's sitting there. In Europe, we are ordering the car and depending on the model still waiting for more than a year to get the car delivered. But those times are coming down and getting better. From a semiconductor supply perspective, I think it's getting a lot better. There's still some technology corridors, very specific ones that are constrained, but overall, the supply situation is easing quite a bit. And a good measure for that is the time that I spent on escalation calls. This has come down quite significantly over the last quarter.

And this might not be an apples-to-apples comparison. But obviously, a lot of investors are concerned of kind of an inventory correction. We've seen a large inventory correction in smartphones and PCs and consumer and IoT, as those industries overbuilt, double ordered during COVID, during the supply chain shortage situation and demand has slowed down dramatically. And then you've seen basically this large inventory correction that's been going on now for about 18 months. So there concerns that, that situation will replicate itself in the automotive industry. Now the automotive industry is different. Obviously, the lead times -- design cycles for longer, you have secular trends with EV and ADAS systems. But there is this still little concern that this is the next shoe to drop in the automotive industry. Were there signs of potential double ordering or overbuilding the last year. And the second thing in terms of demand, the OEMs have been prioritizing premium vehicles over mass mainstream vehicle. That carries higher semiconductor content. It's interest rates go up for leases and things of that nature, do you see kind of a mix shift down to more mass market vehicles where there's less in content? Or is that still...

I think the high-end vehicles demand for them still remains strong. There's not a big change. But what carmakers didn't build where the lower-end cars which they now started to produce as well again because, why is there -- and so it's a natural mix shift, but not because the higher-end cars are getting smaller in quantity. It's because they're now starting to produce the lower-end cars again as well that don't have all the features and not fully equipped. From an inventory position, we do see it, as Eric mentioned before, we do see some pushout requests from customers, and we do see some very limited cancellation requests. Cancellation requests mostly when there was a unexpected or unanticipated end of model, for example, that they didn't see 12 months before when they ordered the parts. But those cases are relatively rare. What is more common that we see customers asking for some pushouts just to manage their cash position themselves. [indiscernible] suppliers are not in a very strong cash position at the moment.

Is the capacity -- you mentioned that there is more capacity coming out of the foundries. Is that -- in particular semiconductor component, whether that's more MCU wafers coming out, analog, power, is there certain areas that are still heavily constrained by the foundries?

I think there are specific selected process technology nodes at the foundries that are still constrained. It is not the most advanced process technology. It's not the 3 to 6-nanometer technologies that are usually not get used in cars. So it's, let's say, 28 or 40 nanometers and upwards, including the power technologies and technologies that are used for in-vehicle networking and for the smaller type of microcontrollers that we're selling into the automotive market. So it is not that the industry brought up a tremendous amount of new capacity in those older technology nodes. It is that other market segments like consumers are weakening and this capacity is shared on a wafer foundry level, there's no automotive fab as such. So they are across the different market segments. That's why there is more available for the automotive market segment right now.

Got it. As these other end market get weak, there's more capacity freeing up for auto, okay. So that's interesting. So just maybe a quick question on silicon carbide. This obviously is tied to electrification of vehicles. You announced a $888 million investment for silicon carbide and silicon production, so both of those areas. Converting kind of the 6-inch Atmel site into an 8-inch site, and that was going to become silicon carbide capable. So Matthias, could you maybe talk about the rationale for that investment? And what kind of applications are you targeting for silicon carbide and for the 8-inch wafers?

So let me start with the application. So the main application automotive for silicon carbide is for the traction inverter but there are many other applications that are in our focus, like, for example, smart fuse boxes, so electronic fuses, the disconnect battery in case of an accident or another unforeseen event to maintain safety of the vehicle. The onboard charger itself that converts the AC current to DC current that's needed to charge the battery. But also on the infrastructure side, the high-speed chargers that are built along the road side that charge the vehicles up to 300 kilowatts an hour, they all benefit from silicon carbide technology, and those are the focus areas from an automotive perspective. But silicon carbide, we've been telling silicon carbide in smaller quantities for many, many years in industrial applications, including semiconductor manufacturing applications like implanters, et cetera, that need high voltage and high current. So we do see opportunities for silicon carbide, not only in automotive but also in the renewable energies and those type of applications.

So the competition -- so maybe just take a step back, the competitive landscape in silicon carbide. So it's relegated to 3 or 4 players. You have ON Semi that is making a very big bet in silicon carbide, but as you know, they're trying to be vertically integrated through kind of acquisitions. Then you have Infineon, ST Micro and then [ Wolfspeed ] and then some other players on the peripheral. Other companies like [ Renesas ] decided not to get going to silicon carbide. So these are entrenched players, they're making fairly sizable investments in terms of CapEx. In the case of ON, the vertically integrated, some -- or some were vertically integrated, some are not. You made an $880 million investment in silicon carbide and silicon production. So I'm curious, are you -- how do you intend to kind of compete with those silicon carbide players? Is it that you want to -- you mentioned target certain niche applications outside of traction inverter where you feel you can kind of carve into that market? Or are you going to go compete head-to-head on the traction inverter...

Matt, before you can answer that, I just want to clarify that Colorado expansion of $880 million. The larger piece of that for Microchip is the 8-inch expansion compared to silicon carbide. Silicon carbide is significant and a really nice growing opportunity for us, but we are not investing $800 million in CapEx for silicon carbide. Go ahead, Matt.

The applications that we're targeting, you mentioned are more niche applications that have specific product requirements. And we do have a very good track record, for example, in robustness, radiation robustness as well as those parts are already used in avionics, for example, to control the flaps of the planes. So we capitalize on those robustness characteristics of the product to enter those applications like, for example, smart junction boxes that I say relevant.

Got it. Okay. And then in terms of the automation, the ADAS, the evolution to kind of L1 to L5. If you look at a company like [ Mobile ID, ] they tried to change the taxonomy moving away from kind of these ambiguous L1 to L5 categories and basically try to break it down into kind of 3 categories: one being eyes on, hands-off applications, the second category being where both your eyes are off the road and your hands are off the road. And then third, ultimately down the road, no driver -- front driver needed. So I guess my first question is, how do you view that taxonomy. How do you view where you're positioned in terms of more microcontroller, power management, LIN transceivers in each of those kind of evolutions of ADAS systems?

Okay. So whether it's 5 levels or 3 levels difference is not that big. It's just a final granularity. Below the hands off, is an important section today, which is -- you either the hands on the steering wheel, if you don't the car beeps. The car is capable already holding the lane, et cetera, but you still have to have the hands on. And there's a lot of technology that needs to supervise the driver, et cetera. So there is probably an L2 application as it's in the 5-scale taxonomy. There's still a lot of growth for our products. If you look at the car basically is becoming a data center on wheels. There are tons of data information from CMOS sensors, from radar sensors, from LIDAR, et cetera, that all are getting captured, being get transferred and then processed, process in big SoCs that we don't provide. Those are the known SoC makers that also invested in the processing stack. But there's not only one SoC in the car. There are several SoCs in the car, and they all need to share data and when they need to share data, it's like in the data center. That's why we call an autonomous car or a heavily assisted card data center on wheels to interconnect those SoCs and to hook them up to a high-speed memory, for example, and to hook them up to an Ethernet switch that has a PCIe connection. PCIe is the connectivity of choice because it's native to the SoCs. It's fast, it's ultra-low-latency and because of our presence in the data center market, we are one of the big players in the PCIe connectivity business, and we're bringing this into automotive and are developing dedicated PCIe parts for automotive and are qualifying data center-centric parts for the automotive market as well for exactly this type of application. There won't be an autonomous car without PCIe connectivity and PCIe -- inside the car. So that's one of the big focus areas. LIN is probably not the most important and cannot the most important for those autonomous cars. If you look at zonal computing or centralized computing, there's a very strong push towards Ethernet because Ethernet helps to simplify the software complexity that we currently have in cars because there are so many different standards used from CAN, LIN, FlexRay, Ethernet, A2B, MOST, et cetera and they all come with their own software protocol and their own language that needs to be translated to each other adding latency, et cetera. The beauty of Ethernet is that the upper layers, the upper software layers are the same regardless of the physical layer and the speed grade below. That's why we're also heavily investing in 10 megabit Ethernet that can be used in a bus configuration like CAN today but with the beauty that it just connects to an Ethernet switch and to the same switch, you can connect 100 megabit, 1,000 megabit or gigabit, 2.5, 5 or 10 gigabit with -- and the switch itself is connected to a PCIe connection to an SoC. So it really helps us simplify the software architecture and the software complexity, which is becoming the biggest hurdle to launch a new car. Software complexity is the biggest, biggest issue and Ethernet being used throughout the car is an important element to break this down.

We hear from some customers that the Ethernet spend will be bigger than the microcontroller spend in the future, not including the SoCs.

The Ethernet spend. That's what you're seeing -- a data point there. We just have like 2 minutes left. I just want to get one quick question on -- you mentioned about the architecture of the car, potentially changing with domain controllers and zonal computers. The domain controllers that have kind of specific compute elements for each automotive system, whether that's a body electronic or ADAS or drivetrain. Do you envision a new architecture having any impact on your microcontroller business, the number of microcontrollers that are needed to sell. I get the PCIe, I get the Ethernet interconnectivity. But what about your kind of core microcontroller business, do you see any impact, positive, negative with these changes in the architecture of the vehicle?

I think with the consolidation of individual control units into larger domain, there will be a reduction in microcontrollers. But at the same time, the number of edge nodes, which are the sensors growing [indiscernible] and each of the sensors need some intelligence, need some -- for safety purpose, for example, a watchdog, does it still work, what is the temperature, can I rely on the data, et cetera. This is usually done by small microcontrollers, which is our home turn. So I'm quite confident. If we were a big supplier of, let's say, gateway controllers that translate between all the different, let's say, 5, 10 nodes for LIN and et cetera, and back and forth, I'd be more worried. But I think for the type of microcontrollers that we do, I'm quite confident. The same when it comes to microcontrollers that have dedicated peripherals, it's more analog functions, the PSP functions to control, for example, borders. This will not be done by a large central microcontroller in domain architecture. This will be done by specialized controllers that have exactly those peripherals. So we're quite confident that it doesn't impact our microcontroller business in automotive.

Fantastic. We'll leave it there. Thank you so much, Eric, Matthias. Thank you, everybody, for joining. I greatly appreciate it.

Thanks, everybody. Bye.