Microchip Technology Incorporated (MCHP) Earnings Call Transcript & Summary

All right. Good morning, and welcome to JPMorgan's 52nd Annual Technology Media and Communications Conference. My name is Harlan Sur. I'm the Semiconductor and Semiconductor Capital equipment analyst for the firm. Very pleased to have Eric Bjornholt, Chief Financial Officer of Microchip here with us today. We also have Sajid Daudi, Head of Investor Relations. Microchip, top 5 microcontroller supplier globally, #1 market share in industrial market MCUs, solid analog and FPGA portfolio. It's been a busy earnings season. So I've asked Eric to maybe start us off with the summary of the March quarter and June quarter outlook, and then we can go ahead and kick off the Q&A. So gentlemen, thank you for joining us this morning. And Eric, let me go ahead and turn it over to you.

Great. Thanks, Harlan, and good morning, everybody. So just a quick summary of March quarter earnings and our guidance for June. So March was a difficult quarter for us. We produced $1.326 billion in revenue. That was down significantly year-over-year and down almost 25% in the quarter. We are going through a pretty extraordinary inventory correction at this point in time. We have guided the June quarter to be down again about 6.5% at the midpoint to $1.24 billion in revenue, but we are starting to see some very positive green shoots in the business. Harlan will have some Q&A that we'll cover that in a little bit. We are maintaining our gross margins on a non-GAAP basis at about 60% and our operating margins this quarter are expected to be about 31.5%. Cash generation is still good. We're committed to our capital return program. We're managing this difficult environment pretty aggressively. On the expense side, we've taken our operating expense is down about 24% from where they were a year ago in the June quarter and done that without laying off employees. We've done it through a shared sacrifice program with everybody in the company on a pay reduction. We're managing inventory through shutdown activities in our factories. And we are going to be well positioned to grow coming out of this cycle when things rebound, which they definitely will. We've got inventory in place, short lead times. We've got capital in place to be able to respond quickly as things get better. And we are focused on areas of the market that we think will provide outsized growth for Microchip. We call those the megatrends. We probably talk about those a little bit in the Q&A. Also then have a focus on servicing our customers better through our process, we call TSS, the Total System Solutions, where we are trying to get more share of semi vector content in each customer Application that we're selling into a with our vast array of micro controllers, microprocessors, FPGAs, analog solutions, security, timing, memory and being a higher-valued service provider to each of our customers. So with that, I will turn it over to Harlan.

Yes. Thank you for the participation. So in terms of the team's view on June quarter, being the bottom right, back at the earnings call, you cited a number of different green shoots. One of them is up until the beginning of this quarter, positive bookings trend so far to the beginning of the quarter, push out cancellations, subsiding, expedites increasing. We're 2/3 of the way roughly through the June quarter. Has the team continued to see these positive trends here so far quarter-to-date?

So we have. And the bookings were really weak last fiscal year. We went through a period where we entered 2023 with 52 week plus lead times for the vast majority of products. And when we ended calendar '23, lead times were roughly 8 weeks on average for our product. So a big correction there, and bookings are as many times a function of where lead times are, but in today's environment, with customers having inventory, it's also a function of those lead times, then matching up with where customers are in getting their inventory to an appropriate level. So February, we saw the strongest month of bookings that we've seen in 8 months. March improved from that and was the highest booking month in fiscal '24, which ended in March for us. April then again was better than March and May, we're still in the middle of, but the positive signs have continued their on the bookings front.

And despite the lead times being 8 weeks or less, you are getting customer bookings 3 to 6 months out. So you are getting backlog coverage for the September quarter, maybe even some for the December quarter as well. But how those, the longer-dated order trends also continue to improve and have the level of turns business the team requires for this quarter continue to come in as expected?

Okay. So I mean every customer is kind of different in how they place their orders. We have a 90-day cancellation policy today. And so anything that's placed outside of 90 days, customer has complete authority to push it out or cancel it. But now we definitely are seeing more short-term orders in line with lead time, and that's a guess sign that a portion of the customer base is kind of working through their inventory issues and longer-term bookings, there's been less of that -- there's been less of that from what we saw when lead times were longer, but there are certain customers that pipeline their orders out in time and that continues. And so the last part of your question was kind of on turns. And what we're seeing, and this is some of the green shoot activity is not only are we getting turns orders that are short-term oriented turns in line with our lead times are. We are also getting much fewer requests for cancellation pushouts. And we are also getting pull-in activity. So a customer might have an order that's placed to be delivered in the middle of July, and they say, "Hey, I actually need that now in the middle of June. And so if our manufacturing team can support that. And generally, they can because we've got lots of inventory in the balance sheet, we respond to them.

Asia, much of which -- you guys break out your Asia segment, much of which is China continues to be your weakest geography, right? It was down 47% year-over-year versus the total business is down 41%, Chinese New Year's was later this year, right? So you didn't get the post-Chinese New Year sell-through read until after the February earnings call. You didn't talk about it on the last earnings call a couple of weeks back, but what were the demand/disti sell-through trends you saw post Chinese New Year's. And is the China domestic customer base contributing to some of the monthly bookings and turns improvements that you're seeing?

So China post -- post-Chinese New Year, it was not gangbusters by any needs. We had a pretty difficult quarter in March. We met guidance, but it's pretty difficult. But China was really the first geography to go into this down turn and so we are seeing some positive signs there that sell-through is improving, and that's a great sign because I would think that the other geographies will follow at some point in time. So we are seeing some positive things out of China. On the bookings front, I can't really differentiate. I mean, we are it's -- we've got 125,000 customers that we service and it is not tied to one geography or one end market. What we're seeing on bookings improving is pretty broad-based.

In March, direct customer shipments were down almost 30% sequentially, your disti shipments were down about 20%, which maybe suggest that excess inventories were a bit more pronounced at direct customers. And I think the challenge there, it's always difficult to figure out like your direct customer inventories, right, because you don't have as much visibility. Obviously, the best way is to monitor the bookings trends, but are you also seeing the positive bookings trends out of the direct customer base as well.

So we absolutely are. So the one quarter activity where direct was down more than distribution. I think it should take too much from that. What we see in distribution is generally, they are sitting on elevated inventory levels, but what they're sitting on many times is out of mix from what their customers need and so they are having to place orders. And so it may take some time to completely correct their inventory to where they'd like it to be. And they tend to be pretty thinly capitalized, low margin and working capital is a challenge for them. So with higher interest rates, some of our distributors are definitely struggling. But when that product is out of mix and the customer needs product, they're placing orders in short term. On the direct side, definitely are seeing the bookings activity that I talked about are applying to both direct and distribution customers.

Perfect. And we've been wondering about this for many of our broad-based companies, including Microchip, right, which was that during the post-COVID supply tightens in 2020, 2021, 2022. I'm wondering if you, like some of your peers took advantage of the supply constraints to exit from more commodity segments of the market, right, consumer white goods, consumer electronics, client PCs, right? Longer term, it should obviously help to increase your through-cycle gross and operating margin profile. But maybe near term, I'm wondering if this is impacting your business as it potentially maybe magnify the peak to trough revenue decline in this cycle and as maybe potentially muting the recovery profile going forward because typically, these more commodity segments are the ones that maybe typically tend to come back first.

So I don't really think that's a large factor for us. I mean, if you -- we broke out some information on end markets and the consumer piece of our business, which, as you mentioned, is primarily white goods, was down like 1% year-over-year, I think, is the number [indiscernible]. And so some minor changes there, but we focus on areas of the market where we can drive consistent margins and design activity that tends to last for a very long time. So we had a pretty small consumer exposure in the first place and didn't really manage our business much differently in the up cycle, right? We have -- all our customers are important to us. We had orders placed on us and we try to support them as their demand requirements required us to do.

But the Microchip team has always been, as you said, very prudent and always focused on profitability, product mix. And you're right, through cycle, I think the team is always looking for opportunities to improve the mix. It just felt like maybe doing the COVID supply tightness period of time that maybe there were a bit more opportunities for the team to maybe move away from lower more commodity segments of the market? Well, was that the case or not really?

Not significant. Like I said, we have tried to avoid those types of markets. Anyway, we have little exposure there, and that's what's allowed us to drive the margin structure that we've had over time.

Looking back on the PSP program. In hindsight, I mean, it was the right business arrangement in a tight environment, right, because helped you plan your supply requirements, SKU builds, drove a high level of customer responsiveness. Despite that, maybe it did augment your customers' ability to maybe potentially build too much inventories. And maybe with the 45% peak to trough decline this down cycle that is a reflection of that. But what is looking back, I mean, what is the team's assessment of the PSP program?

So the PSP program was successful. It supported customers in a time period where we saw our lead times expand to an extent that we hadn't seen in our history and customers were asking for a solution to that. And so we introduced this program that most of you understand was kind of a 12-month NCNR noncancelable, nonreturnable program. It worked great. The issue is when the market started to change, did Microchip respond quick enough and making changes to that program. And with hindsight, you could say maybe we should have taken the foot off the gas pedal a little bit earlier. But if you talk to most of our customers, they would say PSP was absolutely a success. We changed the program from a 12-month program to a 6-month program back in August of last year, and we did away with the program in its entirety in February of this year. So I think that we would consider doing a program like PSP, again, if we have this time of lead time push out, but I think we've learned some things through this cycle and it probably could be managed a bit differently.

So I'm going to transition to some of the product and share dynamics. But before that, I wanted to see if there are any questions from the audience. If you do have a question, raise your hand, and we'll get a mic over to you.

So one of the good things about your business model is that in the downturn, you protect the margins by taking the working capital hit. And on the upside, you can avoid increased pricing at foundries. But is there anything anecdotally you can tell us that your customers have said to you through this down cycle or anything quantifiable about building long-term relationships with your customers, which show that they really appreciate this business model.

Yes. So the really one positive benefit of this last cycle is our customers at a higher level within the customer, so at the C-suite or even out of our customers' customers now understand the complexity of the semiconductor supply chain. And there was lots of C-suite to C-suite discussions that were more strategic than you might have had if you're talking to purchasing, as an example. So I think those things are all good. And so I think those relationships will continue. Clearly, and today, when there's excess capacity in the industry and customers have higher levels of inventory. Those discussions have not really continued at the same level as they were when CEOs were calling [indiscernible] because, "Hey, I need product tomorrow, so my manufacturing operations are shut down. But I think those relationships will pay dividends over time. Customers have a better understanding of what all Microchip brings to the table, which has changed pretty dramatically over the last decade with all the acquisitions and the products that we've added the portfolio. So I think that is absolutely a positive from this last cycle as the customer relationships that we have built at a deeper level.

I'd be curious how you'd characterize the auto end market. I know you said that the improvements have been broad-based. That end market had seen maybe relatively more stability through the beginnings of the inventory correction in the industry. I'm just curious if you think that may pretend a longer road to recovery in that end market or if you feel like the strength in the end demand and content is enough to have it fall through with improvement consistent with the other end markets.

Okay. So a question on the auto market. So we tend to not track end markets on a quarterly basis. We provide information to the Street once a year in terms of what our end markets have done. I think the automotive market was relatively stable year-over-year in percentage of revenue, maybe it was up in -- but anyway, I think that automotive probably went into the cycle a bit later, right? They had some pretty significant supply challenges early on, post-COVID when they weren't buying anything and inventory got drained down and some of these deeper customer conversations that I talked about in the last discussion absolutely applies to the automotive market. But there's lots of discussion today in terms of what's happening with EVs, and it was really hot a few quarters ago, and now it's not as hot as it was. But in longer term, that EV and ADAS or trends that we are focused on that we see as long-term opportunities for our business where we're continuing to invest. But industrial and automotive kind of went into this a little bit later. But we were talking about starting to see signs of weakness in industrial automotive as early as last summer, and that clearly has come to fruition. And today, they are part of what we're seeing in these increased customer orders. Automotive is a part of that, but it's a relatively smaller piece of our business and some others in the industry, it's 17% or 18% of the total.

Yes. And I'll just add to that is just over the longer term, content growth story remains kind of the key driver from our perspective. And you're seeing kind of even mid-tier cars have higher levels of content today than a few years back. So longer term, still very positive.

Any other questions? Let's turn to more of the products market share portfolio strategy. So the third-party market share numbers are out for calendar '23. It's always hard to discern true market share in downturns, right? Given you and your competitors, they all shipping below consumption trends to varying degrees, right? But Microchip team did continue to remain a top 5 global microcontroller supplier, #1 share in industrial market, MCUs, #1 share in 8-bit microcontrollers, you're a top 5 MCU player in the auto markets. You've got your total systems solution strategy or TSS and you're levered to the 6 megatrends, which we'll talk about in a second. But as you emerge from this downturn, I mean, how well positioned is the portfolio? Maybe you can just talk about the design win momentum on MCUs, you've got a strong portfolio of different architectures, PIC, AVR arm. Any potential, and then any potential to expand the portfolio at some point to support other architectures like risk 5 on the MCU side.

Okay. So the product portfolio is in great shape. We've been investing heavily through the last up cycle. Again, our approach to a downturn is different than many of our competitors, where we don't do layoffs. And we take out a lot of OpEx in a downturn like we just have 24% reduction. But keeping everybody engaged on new product introductions is key for us to drive market share in the future and our customer support activities to make sure our customers, we are working with them on the next design. So the design pipeline is super, super full today. We're actually seeing momentum there during the up cycle when customers were scrambling just to get parts design activity actually increased a little bit because everybody was having to take maybe a part that was a bit different from Microchip or one of our other competitors, and that's what was available, so they could tweak the design to get the products still to market. Today, we are seeing true design activity. We're getting great signs from like our catalog distribution houses, [indiscernible] masters of the world that the design activity is quite high. So that's good. The second piece of your question was on architecture and Risk 5. So we were one of the early adopters of Risk 5, but that was not in our MCU business that was actually in our FPGA business and clearly, they have brought that. That team has brought that into the company for evaluation by our MCU group. So we are fairly core agnostic, right? It's everything that goes around the core that makes the product to needs to do from a customer perspective. But Risk 5 has some benefits to it. And so we're continuing to evaluate it by our team, but have not made any significant investment in Risk 5 and our MCU product line today but FPGA continues to use it, and we're still kind of in an evaluation phase. I got to add and Sajid should kicked me over to the table. I didn't kind do the typical safe harbor when I started and during this, we were going to talk about forward-looking statements. I refer to our SEC filings that highlight important risk factors about the company. So sorry about that.

No, I appreciate that. Sajid, you did bring up a good topic, which was content growth, right? And that's where Microchip's total system solution or TSS strategy come into play. And the whole idea is driving more dollar content per customer engagement given your broad portfolio, right? I asked this question every year. But I mean, any metrics you can share with us? And if not, qualitatively on a year-over-year basis, is the team continuing to drive increasing dollar content per customer engagement.