Q1 2026 Earnings Call Transcript

Good afternoon, ladies and gentlemen, and welcome to the Microchip Q1 Fiscal 2026 Financial Results Conference Call. [Operator Instructions] This call is being recorded on Thursday, August 7, 2025. And I would now like to turn the conference over to Mr. Steve Sanghi. Thank you. Please go ahead.

Thank you, operator, and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press releases of today as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations.

In attendance with me today are Rich Simoncic, Microchip's CEO; Eric Bjornholt, Microchip's CFO; and Sajid Daudi, Microchip's Head of Investor Relations. I will provide a reflection on our fiscal first quarter 2026 financial results, Eric will go over our financial performance, and Rich will then review some product line updates. I will then provide an overview of the current business environment and our guidance for second quarter of fiscal year 2026. We will then be available to respond to specific investor and analyst questions. Microchip employees are often referred to as chippers.

I will begin with a question for all of you and then I will provide the answer. How many chippers does it take to deliver a good quarter? The answer is that it takes quite a few, but they all showed up to deliver an outstanding quarter like we produced in the June 2025. And that is the point I want to make. 18,000 employees of Microchip worked all last year on a pay cut, have not received a bonus or a salary increase in 1.5 years and suffered through a gut-wrenching global layoff earlier this year in March. These employees working with high morale came together to deliver an outstanding quarter.

I tip my hat to all 18,000 employees of Microchip worldwide. I will highlight a few salient points of our financial results. 10.8% sequential sales growth. Net sales were up sequentially in all geographies. Sales from our microcontroller and analog businesses were both up in double-digit percentages sequentially.

Non-GAAP gross margin was 230 basis points sequentially and incremental non-GAAP gross margin was 76% sequentially. Non- GAAP operating margin was up 670 basis points sequentially and an incremental non-GAAP operating margin was 82% sequentially. Inventory went down by $124 million sequentially. Our target for the whole fiscal year is a $350 million reduction.

So we are off to a very good start. Inventory days were 214 days. Our inventory over 2 quarters has gone down from 266 days to 251 days to 214 days. We expect inventory at the end of September quarter to be between 195 and 200 days.

The inventory write-off in the June quarter was $77.1 million down from $90.6 million in the March quarter. The inventory write-offs are expected to decrease again in the September quarter. Underutilization in our factories in the June quarter was $51.5 million, down from $54.2 million in the March quarter. We expect the underutilization will modestly decrease again this quarter with a more significant decrease in the December quarter.

Adding $77.1 million of inventory write-off and $51.5 million of underutilization charge makes a total of $128.6 million of charges, divide that by the net sales of $1.075 billion and you get a non-GAAP gross margin impact of 12 percentage points, adding it to the reported non- GAAP gross margin of 54.3% indicates that the product gross margin was 66.3%. The point is as inventory write-off in underutilization charges decreased, we believe our long-term non-GAAP gross margin target of 65% is achievable. We have accrued about $5.5 million from the upside profit to provide a small bonus to our 18,000 employees who deserve it very much.

The net impact from this accrual is less than $0.01 per share. And with that, I will pass it on to Eric Bjornholt, who will take you through a more detailed financial performance last quarter. I will come back later to discuss the business environment and provide guidance for the second quarter. Eric?

Senior Corporate Vice President & CFO Thanks, Steve, and good afternoon, everyone. We are including information in our press release and on this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations page of our website at www.microchip.com and included reconciliation information in our earnings press release, which we believe you will find useful when comparing our GAAP and non-GAAP results. We have also posted a summary of our outstanding debt and our leverage metrics on our website.

I will now go through some of the operating results, including net sales, gross margin and operating expenses. Other than net sales, I will be referring to these results on a non-GAAP basis, which is based on expenses prior to the effects of our acquisition activities, share-based compensation and certain other adjustments as described in our earnings press release and in the reconciliations on our website. Net sales in the June quarter were $1.075 billion, which was up 10.8% sequentially and $5.5 million above the high end of our updated June quarter guidance provided on May 29. We have posted a summary of our net sales by product line and geography on our website for your reference.

On a non-GAAP basis, gross margins were 54.3%, including capacity underutilization charges of $51.5 million, new inventory reserve charges of $77.1 million. Operating expenses were at 33.7% of sales and operating income was 20.7% of sales. Non-GAAP net income was $154.7 million, and non-GAAP earnings per diluted share was $0.27, which was $0.01 above the high end of our updated guidance. On a GAAP basis in the June quarter, gross margins were 53.6%.

Total operating expenses were $544.6 million and included acquisition intangible amortization of $107.6 million, special charges of $22.2 million, which was primarily driven by foundry contract exit costs and our activities associated with the closure of Fab 2, share-based compensation of $45.2 million and $7.5 million of other expenses. The GAAP net loss attributable to common shareholders was $46.4 million or $0.09 per share. Our non-GAAP cash tax rate was 11.25% in the June quarter, and we expect to record a non-GAAP tax rate of about 9.5% in the September quarter. Our non-GAAP tax rate for fiscal year 2026 is expected to be about 10.25%, which is exclusive of the transition tax and any tax audit settlements related to taxes accrued in prior fiscal years and was positively impacted by the impacts of the recently passed one Big Beautiful Bill.

Our inventory balance at June 30, 2025, was $1.169 billion and down $124.4 million from the balance at March 31, 2025. We had 214 days of inventory at the end of the June quarter, which was down 37 days from the prior quarter's levels by our inventory reduction actions is what drove this. Included in our June ending inventory was 16 days of long life cycle, high-margin products whose manufacturing capacity has been end of life by our supply chain partners. Inventory at our distributors in the June quarter was at 29 days, which was down 4 days from the prior quarter's level. Distribution sell-through was about $49.3 million higher than distribution sell-in.

Our cash flow from operating activities was $275.6 million in the June quarter. Our adjusted free cash flow was $244.4 million in the June quarter. And as of June 30, our consolidated cash and total investment position was $566.5 million. Our total debt decreased by $175 million in the June quarter, and our net debt increased by $30.2 million.

Our adjusted EBITDA in the June quarter was $285.8 million and 26.6% of net sales. Our trailing 12-month adjusted EBITDA was $1.167 billion, and our net debt to adjusted EBITDA was 4.22 at June 30, 2025. Capital expenditures were $17.9 million in the June quarter, and we expect capital expenditures for fiscal year 2026 to be at or below $100 million. Depreciation expense in the June quarter was $39.5 million. And I will now turn it over to Rich, who will provide some commentary on our product line innovations in the June quarter.

Rich?

Thank you, Eric, and good afternoon, everyone. I am pleased to share our operational progress this quarter, highlighting strong momentum across aerospace, defense, AI applications and network connectivity. As a leading semiconductor supplier to the Department of Defense and our NATO allies, our aerospace and defense business continues to strengthen amid increased global defense spending driven by geopolitical tensions and NATO monetization. With over 60 years of aerospace and defense heritage, including from our acquisitions, we have recently achieved significant defense industry device qualifications and continue to expand our product portfolio to support commercial aviation, defense systems and space application.

Microchip plays a key role supporting products to many modern defense platforms. Also, our radiation-tolerant FPGA solutions can deliver up to 50% power savings while maintaining the highest levels of security and reliability. We have recently expanded our FPGA portfolio by introducing cost-optimized solutions that deliver up to 30% cost reduction while maintaining industry-leading performance and security. This positions us firmly across both high-reliability defense applications and broader industrial markets.

Microchip continues to be a leader in the microcontroller industry and enabling customers with our AI coding assistant aiding customers to achieve up to a 40% productivity improvement in programming our microcontroller devices. At Masters, our major technical conference this week, we previewed further advancements for the attendees with the inclusion of AI agents into the AI coding assistant that will be released into the market in September this year, further improving productivity and reducing time to market for our customers. The AI build-out continues to create substantial opportunities across our portfolio.

We have secured design wins in data center infrastructure, spanning AI acceleration, storage and network infrastructure with tier 1 cloud providers and enterprise leaders. We have strategically expanded our connectivity, storage and compute offerings for AI and data center applications as well as intelligent power modules for AI at the edge. Security remains paramount as defense and AI deployments proliferate. We have made significant advances with embedded controllers that feature immutable post-quantum cryptography support, which was recently mandated by the NSA.

This support enhances the security of platforms using our digital signing for secure boot and secure firmware over-the-air updates. These capabilities are essential enablers to protect our defense, industrial and AI applications well into the future in compliance with critical standards such as CNSA 2.0 and the European Cyber Resiliency Act. With that, I will pass the call to Steve for comments about our business and guidance going forward. Steve?

Thank you, Rich. During the last quarter's earnings conference call, I talked about a trifecta effect on our revenue growth. We saw that effect in action last quarter. First, our distributors' customers' inventory is getting corrected, and we saw the first sequential increase after 2 years in distribution sales last quarter.

Certainly, the distributor sell-in versus sell-through gap shrunk from $103 million in the March quarter to only $49.3 million in the June quarter. So distribution sell-in is rising to meet the sell-through, and we believe there is more to go. And third, our direct customers' inventory is getting corrected, and we saw the first sequential increase in direct sales in 2 years. This trifecta effect led to a 10.8% sequential growth in our net sales in the June quarter.

We believe that this dynamic is still in effect. Importantly, we believe that we are seeing what -- we believe what we are seeing represents structural demand recovery as we remain below normalized end market demand levels. After 2 years of correction, we believe we are filling a supply chain deficit rather than experiencing any significant pull-forward activity. The second effect I have spoken about is the impact on gross margins.

As the inventory comes down, our inventory write-off will decrease, thus growing our gross margin percentage. And as the inventory comes down and we start to grow the factories again, our underutilization charge will decrease and will further grow the gross margin. We saw these 2 effects in action last quarter. Our inventory write-off decreased from $90.6 million in the March quarter to $77.1 million in the June quarter.

Our factory underutilization charge dropped from $54.2 million in the March quarter to $51.5 million in the June quarter. This combined effect is adding to our gross margin. We expect the increase in gross margin percentage will continue as the inventory write-off continues to decrease and we ramp the factories, which will lower the underutilization charge. We currently plan to start increasing wafer starts in the December quarter.

Now the market environment. We are seeing some recovery in our key end markets, automotive, industrial, communication, data center, aerospace and defense markets and consumers are all looking somewhat better. While we have not seen any material tariff-related pull-ins in April and May, we saw some selective acceleration of orders from Asia, which appear to be tariff related. We believe that such pull-ins amounted to only mid- to high single-digit millions.

However, it is important to provide context on pull- ins more broadly. We are still shipping below normalized end market demand across most of our markets after 2 years of inventory correction. This deficit to normal demand levels means that any pull-in we are seeing represents underlying demand where the inventory has run out at the customers rather than borrowing from future quarters. Now let's go into our guidance for the September quarter.

We believe substantial inventory destocking has occurred at our customers, channel partners and downstream customers and the trifecta effect is in play. Our backlog for the September quarter started higher than the starting backlog for June quarter. And as of this time, the backlog for September quarter is comfortably higher than the backlog for June quarter at the same point in time. The bookings for July were higher than bookings for any month in the last 3 years.

I will make a comment about lead times. While lead times for products have been 4 to 8 weeks for some time, we are experiencing a lead time bounce off the bottom and increases on some of our products. While we have sufficient inventory, it is mostly held in the die form. We still have to package and test the products.

We're running into challenges on certain kind of lead frames, substrates and subcontracting capacity. While these challenges are isolated to specific areas, we expect them to broaden and lead times go from the 4 to 8 weeks range to more like 6 to 10 weeks range out in time and on certain products, they are likely to go to 8 to 12 weeks range. The customer and distributor inventories have begun to run low on many products. We are increasingly getting short-term shipment requests and pull-ins of the prior orders.

Our customers will be well advised to manage their backlog and have 12 to 16 weeks of their needs on backlog, so they are not cut short. The emerging lead time pressures and increasing customer requests for expedited shipments reflect the reality that inventories have run too low on certain products. This dynamic supports our view that we are seeing demand normalization from a severely corrected starting point rather than speculative buying on any -- or any significant pull-forward activity. Taking all of these factors into account, we expect our net sales for the September quarter to be $1.13 billion, plus or minus $20 million.

We expect our non-GAAP gross margin to be between 55% and 57% of sales. We expect our non-GAAP operating expenses to be between 32.4% and 32.8% of sales. We expect our non-GAAP operating profit to be between 22.2% and 24.6% of sales. We expect our non-GAAP diluted earnings per share to be between $0.30 and $0.36 per share.

I want to again highlight the leverage in our business model with a $54.5 million sequential increase in net sales at the midpoint, we would expect to see approximately 77% of such amount to go to the bottom line as non-GAAP operating profit. As the inventory drains further and inventory write-offs decrease, we expect our gross margin recovery will accelerate. And with the incremental profits going to the bottom line, we will have tremendous leverage. Finally, a comment on our capital return program for shareholders.

After this September quarter, we expect our adjusted free cash flow to exceed our dividend payment driven by increasing revenue and profitability, low CapEx and liberating cash from the inventory. Therefore, we do not expect to have to borrow money to pay our dividend after this quarter. In future quarters, we intend to use this excess and adjusted cash flow to bring down our borrowings. With that, operator, will you please poll for questions.

[Operator Instructions] Your first question comes from the line of Vivek Arya.

Steve, many of us equate better than seasonal sequential trends as a sign of recovery. So when you look at your September quarter outlook, sales up 5% or so sequentially. Would you call that seasonal, above seasonal? I think basically what we're all trying to get our hands on is that yes, there is a recovery, but are we done with that stronger recovery as in a lot more above seasonal quarter.

So just how would you describe September seasonal, above seasonal? And then what does that kind of inform us as to how December could shape up in kind of similar terms?

So thanks, Vivek. September quarter guidance of 5.1% up sequentially would be considered well above seasonal. Our seasonal increase usually per quarter are really in the 3% range in the September quarter. And December quarter usually is the weakest quarter of the year.

And in ordinary times, totally normal inventory times, December quarter will be sequentially slightly down and March quarter will be up again. So we were strongly above seasonal in the June quarter. We're strongly above seasonal in the September quarter, and I would expect that we'll continue to be above seasonal in December and March.

All right. And when we look at several of your peers, they had a strong June they kind of guided September linage, but they expressed some caution as they looked at December onwards, mainly because there seems to be kind of this renewed threat about the delayed impact of tariffs and whatnot. What's your read, Steve, of the macro environment? Do you think that as you look out beyond September that the recovery is as strong as you thought 3 months ago?

Just how would you kind of contrast the kind of recovery you are seeing versus the slightly more conservative tone that some of your Analog peers have indicated on their earnings calls.

So Vivek, our sales went down much more significantly than others because of really excessive inventory at the direct customers as well as channels driven by our PSP program, which was launched during the COVID years and continued well afterwards. Many of our competitors and peers got after noncancelable, nonreturnable treadmill. I think a year earlier than Microchip did and we -- therefore, we continue to ship large amount of products to our customers and distributors in accordance with the PSP rules. So therefore, when we eventually corrected, our sales went down much, much harder than others.

So what we are seeing right now is the trifecta effect we talked about. Inventories going down at our distributors' customers. They're going down at distributors. Our sales-in catching to sales out from distributors, our direct-to-customer inventory is going down.

So we believe the dynamics that are taking place at Microchip are more driven by those kind of factors and not any kind of tariff-related pull in. We have done substantial analysis on the tariff question. So part of our normal process each quarter is to ask our distributors to explain any significant fluctuations in their customers' quarterly sales. This is done at a very forensic level, so covering a large percentage of our customer base.

We did this, and we identified a small number of customers that identify tariffs as a reason for the sequential change in their revenue. When we extrapolated this data, we believe the impact came out to be only mid- to high single-digits, $7 million, $8 million, $9 million range. We have no direct customers that indicated that tariffs was the reason for the increase in revenue. I also want to remind investors that a very high percentage of our direct customer exposure in China actually is manufactured in free trade zones that are not impacted by tariffs.

So therefore, the phenomena we're seeing at Microchip is really related to inventory digestion than any kind of tariff plan activity.

And our next question comes from the line of Harsh Kumar.

Steve, I've got 2 as well. Steve, I was hoping that for September quarter, you could help us understand the growth between the 2 key end markets, auto and what I would call as pure industrial. And why I'm seeing pure industrial is because you're in defense and defense is very strong for obvious reasons, and it's skewing things for the industrial category. So I was hoping that just outside of defense, if you could just talk about in September, which ones -- how do you see auto versus pure industrial playing out?

So with such a strong growth of 10.8% sequentially, which we annualize it, it's a phenomenal enormous rate of growth. So with a very, very strong June quarter, we actually saw growth across all of our product lines, end markets, microcontrollers, analog. So it was very, very broad-based in all geographies. So therefore, I think my simple answer would be, we saw a recovery pretty much in all end markets.

Okay. Fair enough. Can I ask you, Steve, at this point, you feel like sell-through is equal or higher than the sell-in at your distributors? And if there's a gap, what kind of gap are -- to the best of your knowledge, I know it's a difficult one to answer.

What kind of gap exists. And your inventory dollars came down, I think, about $124 million, which is a big number. How far do you think you are from where you want to be in terms of optimal inventory level?

I think we gave you the number in our prepared remarks, let me put it out again.

Maybe I missed it, Steve.

Senior Corporate Vice President & CFO Sell-through and distribution was $49.3 million higher than what sell-in was. And that's just the distribution piece of our business, which is a little less than 50%. We absolutely believe that our direct customers are draining inventory too and consuming more that we're shipping to them, but we just don't have real-time data to show you. But that $49.3 million compares to $103 million the quarter before.

So the gap is shrinking, but there's still a gap.

There's still a $49.3 million gap. So sell-in is rising to meet sell-through. We closed half the gap last quarter, and we don't know it could take a couple of more quarters to close the rest of the gap.

Senior Corporate Vice President & CFO Progress we're making towards inventory, right? The inventory target overall. And Steve, do you want to address that or do you want me to?

No, I'll address it. So we are bringing inventory down in days of sales in pretty heavy chunks. It was 266 days of inventory at the end of December that came down to 251 days at the end of March, came down to 214 days, very large drop at the end of June, and we are forecasting that we'll break the 200 and be between 195 and 200 at the end of September. In dollars of inventory reduction, we reduced inventory last quarter by $124.4 million.

So we're making massive progress by shutting down one of our fabs, the Tempe Fab 2 and a substantial scaling down of our other fabs. We are producing products in our factories, which is well, well below the rate of consumption. That's why the inventories are dropping by a very large amount, and that essentially will continue. We will start growing wafer starts in December quarter, as I said in my remarks, and not that our inventory has fully come down.

But if we wait until our inventory is totally normal to then start growing the fabs, we're going to have to grow the fabs by 30%, 40% in a single quarter, and that's not possible. So therefore, we have to start early and asymptotically reach the number where the fabs need to run.

And your next question comes from the line of Chris Caso from Wolfe Research.

I guess the first question maybe following on some of your prior comments is just getting a sense of how far below end demand you think you're really shipping now. And I recognize you have your best data with distributors, and you talked about how low point of sale is. And I guess the quick math, it would seem like -- I guess, you're about maybe 10% below point of sale and distribution. But the distributor inventory is also not at bad levels.

Do you have a sense of how much, by how much you might be under shipping real end demand to your direct customers?

We have a sense, but the sense is not audit proof and really can't be discussed outside. The number that we could share and we have shared is the gap between sell-in and sell-out because those are 2 actual numbers. Other than that, how much inventory our distributor customers have is very anecdotal by asking our distributors, by asking some of the customers that we jointly visit. And since the customer base is so broad, having 110,000-plus customers, even if you do the analysis based on larger customers, it's really -- it's not audit proof.

And then when you get to your direct customers, the analysis even more difficult. Many of our large industrial customers buy 900 different line items and produce the product in 26 different factories around the world and some products have inventory and some products are short and they're expediting those products. So to get a total feel for it is very difficult. But anecdotally, as we do the analysis, we know many, many line items that have a run rate, and they are not buying because they still have inventory.

And on other line items, they were not buying 2 months ago or 3 months ago, and they're buying now, which means their inventories are running low. So I think when I put it all together, I believe inventory correction will continue for some time and our sales will continue to grow towards the more normalized levels. Exactly how far are we? And when will that end?

I don't think I can put a number with very high confidence.

Great. I mean it sounds like -- and maybe if I could ask a different way, which would be easier to answer. Do you think that you're undershipping the direct customers by more or lesser -- more or less than the distribution customers based on the rough analysis you've been able to do?

Again, just directionally during the GoGo days, we prioritized shipping to direct customers more than to distributors. So direct customers got a more than fair share of the product. And therefore, direct customers, in most cases, build a higher amount of inventory than the distributors were able to do. So I think just by that statement, I would say the inventory at direct customers is probably higher than the inventory at distributors.

And your next question comes from the line of Blayne Curtis from Jefferies.

I wanted to -- maybe I missed, I just wanted to know the timing. You talked about lead times extending from 48%, 6% to 10%, 8% to 12%. Is that now or is that where you expect it to go?

So lead times, broadly on most of our products, lead times of 4 to 8 weeks. But on certain products, like I said, in certain pockets, the lead times have gone longer and some of them are 6 to 10 weeks and some are even headed towards 8 to 12 weeks. And those are cases where we are short of lead frames or short of substrates or in a given pocket, given package type, our subcontractors are overbooked, we're trying to find and negotiate a place. So this always starts partly like this.

And we have a substantial recovery to go through in our sales still because we're shipping so much below the end consumption. So this is just a warning shot to our customers to really bring their backlog healthy because lead times ensure you get very short-term booking, you get very short-term visibility. So it's a message to our investors, but more than that it's a message to our customers to make sure that they look at their demand for 12 to 16 weeks and give us that backlog so we can buy lead frames and substrates and start wafers and do everything in the right mix to be able to meet their needs.

Got you. So I think you kind of answered it, but you said that you had more bookings at this time versus last time, the same time frame last quarter. I guess, lead times is kind of the duration of the part we don't know. Is the -- when you look at how you set the guide. Is it the level of turns you're looking for in the quarter the same? Or is it different?

Yes. So July bookings were the largest bookings for any month in the last 3 years. Any month of June quarter, but any month of the prior 3 years. So we had a very, very strong month of July.

Now bookings every quarter are different based on how much backlog you begin with and what the lead times are. If the lead times are short, you get high turns, if the lead time are longer you get less turns. And our backlog started in September quarter stronger than June quarter and the turns requirement is about the same. And with the same kind of turns requirement roughly, I think we'll have a good quarter.

And your next question comes from the line of James Schneider from Goldman Sachs.

I was wondering if you could maybe comment on any end markets that you think are materially lagging in terms of end demand, Steve, I know you talked about a number that are -- they're doing well as most of them, I believe, any of them that are lagging? And do you see any improvement in the ones that are lagging. The reason I ask the question is because I believe your other products didn't really grow much sequentially and I think they were down slightly sequentially. Just trying to understand what happened there.

I would say -- this is Rich Simoncic. I would say automotive is still lagging more than any of our other markets today. If you wanted to be specific about that, AI data centers or data centers are doing very well and recovering. Industrial, some of the smaller and medium-sized customers are starting to recover.

It seems that the one that's probably lagging the most is automotive at this point in time.

Senior Corporate Vice President & CFO Yes. And that other category of revenue that you're referring to is everything other than the microcontrollers and analog and includes licensing and some other things that tend to be a little bit more lumpy. So that can drive some of that fluctuation quarter-to-quarter, Jim.

Okay. That's helpful. And then maybe just as a follow-up, relative to the President Trump's press conference yesterday where we talked about tariff exemptions for companies with U.S.-based investment or increased U.S.-based manufacturing investment. Just wanted to confirm, is it your understanding that your existing U.S. manufacturing investments qualify you for that exemption?

Or do you have to do more? Or do you not know yet?

Yes. So I think anything President Trump says is never clear and often changes a week or 2 weeks later. But the way we understand what he said is it's not by products that are made in U.S. and the products that are made overseas. So we make some products here, and we make some products overseas in TSMC and other places.

So it's not that you have to pay a tariff on the products that are made overseas, but you qualify as a company. Now as a company, we make a large amount of manufacturing in the U.S., and then we also buy wafers from foundries outside. So because we make so many investments in U.S. and large amount of our manufacturing in U.S. Our interpretation is that we will qualify to be exempt from tariffs.

And if that is the case and if that holds, then I think we are okay. And maybe in better shape than some of our competitors like the Japanese competitors and others.

And your next question comes from the line of Timothy Arcuri from UBS.

Steve, you said bookings are the highest since July 2022. But in reference to another question, you're guiding up 5%. Yes, it is better than seasonal, but it's not that much better. And then you just said that turns are about the same in Q3, unless I misunderstood what you said. So to me, that kind of implies that a lot of these bookings are filling in Q4 as indeed December rather than calendar Q3. So is it fair that you can say at this point that December should be another really good quarter?

Yes, I think I'm not willing to get that far. I think I said in my commentary that I expect us to continue to be above seasonal in September, December and even into March. Good quarter is anybody's definition, I don't know without numbers what that means. But what happened in -- on July 1, our backlog for the September quarter was meaningfully higher than our backlog for the June quarter on April 1. And if we get about the same amount of turns this quarter as we got last quarter, then we'll have a good September quarter.

Having said that, there are strong bookings this quarter, some are turns and some are going into the calendar fourth quarter.

Okay. And then you did say that lead times are lengthening, and you actually said you're encouraging customers to expedite orders? I think a lot of us see what happened last cycle hand worry that when we hear that, that it could scare customers off a little bit because of the potential to get back into like a PSP sort of a dynamic. So if lead times are already sort of doubling for some products and you've barely even come off the bottom.

How are you managing this messaging to customers to avoid what kind of happened last cycle?

So first of all, we're not asking any customers to expedite orders. We're simply asking them to place the order with a scheduled backlog. So today, a lot of the orders are very short-term orders because lead times are very short. And what they need in Q4, they think they can place the order in late September and still get the product.

And we're simply saying, look a little bit further ahead and layer in the backlog for every month going out 4 months, which is not the same as expediting orders. We're not asking them to take the product early. We're not trying to ship above demand. We're simply asking them to place the orders.

Secondly, we're not changing the rules of cancellation. So if they give us a higher visibility and their demand changes, higher or lower or they want to change the product. The product is cancelable. It's not noncancelable order.

So they have complete flexibility. Therefore, there is no comparison to a PSP environment here.

Senior Corporate Vice President & CFO Right. The other thing that we are seeing from customers, and Steve kind of alluded to this earlier, is we are seeing them. They'll have an order already on the books and then they asked to pull that in. And sometimes that can be challenging without visibility to be able to meet their new request to date.

So having better backlog visibility helps us better service the customer. So that's really all we're seeing here.

Yes. And at least having the extended backlog, even if they do wind up pulling that in, that is still better for us because it allows us to plan capacity and purchase materials that we may need to build that product.

Your next question comes from the line of Harlan Sur from JPMorgan.

Steve, on the accelerated demand signals from Asia, Asia was up about 14% sequentially versus Europe and North America at about 8%. Even if I exclude the mid- to high single digits millions of dollars, which may be pulled forward, Asia was still up strongly at about 12% or 13% sequentially. And then on a year-over-year basis, Asia in the first half was down only about half of what the U.S. and Europe was through the first half of the year. So what's driving the relative strength in Asia, both sequentially and through the first half of this year?

I think a lot of the Asia strength is a proxy on what's happening in U.S. and Europe because we build. Our customers -- European and U.S. customers build a lot of their product in Asia. So we report sales by where we sell -- where we ship the product, not where it is designed or where the origin of the customer is. So a lot of our U.S. customers are asking us to ship the product in China or Taiwan or Vietnam or Asia or wherever.

So I don't think you can quite look at it by numbers, you could say, Asia is stronger, but a lot of that strength is coming from U.S. and European customers.

Senior Corporate Vice President & CFO Yes. I think another impact that we see and saw in the June quarter is you're comparing it to the March quarter, which has the Chinese New Year, right? So there's some of that effect that's reflected in the June quarter results.

That's true. More shipping days.

Yes, that makes a lot of sense. Okay. And I apologize if I missed this. I think you did mention something about turns business, but in addition to the strong rising orders that you saw in March, June and a cyclical recovery, we typically do see stronger turns business, right?

Orders placing fulfilled in the same quarter. I know your current business rose as a percentage of sales in March. Did that turns percentage grow in the June quarter? And what are you guys seeing thus far here in the September quarter?

Senior Corporate Vice President & CFO Yes. So I would say that turns were strong in the June quarter, and that's not surprising because we obviously beat on revenue, so turns were higher. And lead times are really short for the vast majority of products, and we would expect turns to continue to be a pretty high number for us, given where lead times are today and obviously, if lead times stretch that will change over time.

And your next question comes from the line of Quinn Bolton from Needham & Co.

I just wanted to ask on the gross margin guidance. Can you give us some sense what total charges for underutilization and write-offs you're assuming in that 55% to 57% range.

Senior Corporate Vice President & CFO So we don't break that out. We did say that we'd expect the underutilization charges to be modestly lower, and I would say that is mainly driven by activities increasing in our back-end factories that's driving most of that. The wafer starts, as Steve indicated, are really planned to go up in the December quarter. And we expect the inventory write-offs to be lower.

It's a hard number to forecast quite honestly, but we do expect it to be lower as the comparison because we start this by looking at 12 months of trailing demand for the calculations, and that is getting to be a bad metric for us with the revenue increases that we're seeing. And then obviously, our overall inventory dollars are coming down also, which helps with that. So it will be lower, but giving you an exact number is difficult to do.

We shipped hundreds of thousands of SKUs in the quarter. So -- and this write-off -- this inventory write-off is SKU by SKU. Looking at every SKU, where its inventory is and comparing it to last 12 months of shipments. So it's a complicated calculation and we can't make an accurate forecast of it.

Understood. Okay. And then the second question I have is just on those products where you're seeing lead times stretch out to as high as 6 to 12 weeks. How much of that is sort of substrate or packaging related versus wafer related?

And if it's wafer related, is it mostly outsourced wafers or internal wafers. Because obviously, wafers take probably the longest in the manufacturing cycle. So I'm kind of wondering at least on those products where you're seeing lead times extend why you wouldn't be increasing the wafer starts now rather than waiting to December?

Majority of that is in substrate or packages, and that's typically how that all starts as business starts to turn around. We still have quite a bit of die stores or die inventory on many of our devices. So it tends to be a matter of just pulling that product out of die stores and ensuring that the substrates and the rest of the assembly materials are in place to bring that out. And that's what shifted.

A few weeks at a time.

No. We're not seeing shortages on our internally produced product yet. It's mostly back-end like Rich said, and there could be 1 or 2 places where -- we have our products coming from a large number of fabs at foundries because this company is built up of acquisitions with Microsemi and Atmel and SMSC and everybody bought product from different fabs. So we buy product from a large number of fabs.

And I think there are a handful of fabs where certain nodes are constrained. So just very, very spotty, there are a few places where external die is constrained, and we're trying to beef that up. But all the rest of it in foundry and all of the technologies internally, we have plenty of capacity and plenty of die.

But it sounds like it's more back end and front end at the current point in time?

You're correct. Yes.

And your next question comes from the line of Joshua Buchalter from TD.

Maybe to follow up on Quinn. Can you maybe speak to us about what you're looking for that's going to give you the signal that it's all clear to raise utilization rates? Is there a certain inventory target? Is there sell-through demand that you're looking for?

I guess I'm curious to hear why there's so much conviction that December will be the right time, given you are seeing some cyclical signals improving and -- while at the same time, inventory levels are elevated. Just curious how you're thinking about that holistically.

So I think the fact is that our current production output from our 2 fabs with third fab closed is so far below our shipment rate that if we do not start increasing utilization in the fabs then there will be a point where we'll have to double the capacity just to get to the shipment rate. And fabs take a long time to ramp. You can grow certain percentage every quarter. So therefore, we have a forecast over the next 2 years and how much die value will be needed for that bounce off the die inventory, how long will it take for that to deplete.

And then what is the rate of growth by which we can grow our both Oregon and the other fabs and then this is solving a math problem on when we need to begin. You just have to begin well before your die inventory goes too low because once the die inventory goes too low, then you get in trouble very rapidly because we're producing only half the product that we need every quarter.

Okay. And I guess on that note, I understand you don't want to break out the underutilization and write-down charges by quarter. But any rules of thumb that we should think about as to how those charges should unwind? Is there a certain revenue level or any other factors that we could think of, again, as we think about modeling those charges coming out of the model?

We gave you incremental gross margin, didn't we really give you incremental gross and operating margin.

Senior Corporate Vice President & CFO We did. But maybe it would be helpful to say that we expect those underutilization charges to take longer to come out of the system than the inventory write-downs. I think the inventory write-downs happen quicker, and the ramping of our factories will be gradual over time. So hopefully, that helps a little bit.

And your next question comes from the line of William Stein from Truist.

Product gross margin, as you highlighted, was 66.3% and your long-term target is lower than that at 65%. And I wonder, does that imply that there's -- that you are somehow exceeding your long-term target because of mix or pricing? Or maybe help us reconcile why product gross margin once these unusual charges go away would decline from where it is now?

Well, number one, charges don't ever go to 0. There's always some mix issues where certain product is built and the demand went away. Number two, when you're 12 percentage points away, I wouldn't quibble about 1% here and there. What I'm simply trying to say is many investors ask us how are you confident that you'll get to 65% gross margin. And we're saying that, that is achievable based on the math.

But is -- I'm really trying to ask is mix or something else going to change such that perhaps it's the defense end market exposure that's quite high now. And as that mix normalizes, does that have an effect of dragging gross margins?

We ship hundreds of thousands of SKUs every quarter. We have 20 business units. The mix changes every quarter. Some of our -- so I think you're making too much of that 65% versus 66%. I don't differentiate those 2 numbers.

Senior Corporate Vice President & CFO Yes, I would agree with that. And you shouldn't look at this as long term, we think that our product gross margins are going to go down. We're introducing lots of really high-margin products. We talk about 10-BASE-T1s, our Ethernet products.

Those are going to be higher than corporate average. We have a lot of confidence in how our FPGA business is going to grow over time. That's higher than corporate average. So it's -- there's a lot of moving parts there, Will.

I understand your question. But as Steve said, we're really just trying to frame this, that we have confidence in getting to our long-term model. And the mix will have some effect over time. But we've got high confidence that we can get there, and it's just going to take us some time.

That helps a lot. If I can squeeze one more in. If sell-in and sell-through sort of continue in September as they did in June, you should be pretty well aligned by the end of the quarter. Is that the right way for us to think about this such that maybe by the time we get to December, we're looking at sell-in being aligned or maybe even higher than sell-through?

I would not think that. I think there is a lot of slow-moving product in distribution. We call it sludge and it's just not perfect mix. The product -- it was bought 2 years ago in certain mix and demand always comes out in a different mix.

So I think this will take more than just the September quarter to close. We're not telling you that September quarter will be -- sell-in and sell-through will be equal.

Senior Corporate Vice President & CFO Yes, there'll be a difference still. And I've kind of been saying, I think maybe by the end of the fiscal year, we're pretty much aligned, but that's a guess.

And your next question comes from the line of Chris Danely from Citi.

Just real quick on the incremental gross margins, Eric, I think you said 76% for the September -- excuse me, for the June quarter. For the December quarter, since you guys are turning the fabs back on or at least increasing utilization rates, would that incremental gross margin go up? And if so, roughly how much?

Senior Corporate Vice President & CFO No, I think it will be roughly in that same ballpark. If you look at our guidance, you look at the revenue change and where we've guided gross margin, too, I think it will be about the same. And I think our fall-through to operating profit too would be in a similar range to what we saw in the June quarter.

Great. That's super helpful. And then a question for Steve. So Steve, now that you've been back in the front of the Microchip mini-van for a good 9 months.

How would you describe Microchip's competitive positioning, especially on microcontrollers? Are you -- have you seen any improvement? Has it been better than you thought, worse than you thought? How do you see your share going forward?

Maybe talk about a path to gaining back market share, anything there?

So I think market shares are kind of hard to decipher when you're dealing with such a large inventory change. When you simply measure by revenue divided by the total revenue of the industry, it would seem that the market share is much lower. But if some of that revenue comes back when our customers' inventory goes away, and if you grow higher than the overall industry, which seems to be the case, I have compared our numbers against semiconductor industry's June ending report for microcontrollers and we grew substantially more in microcontroller, it will we grow double digits roughly. Yes.

And the industry was up only about 6%, 6.5% sequentially. So that means we gained share in the June quarter. So some of that share gain is coming back. I think it's going to take a little longer for us to go down this journey before we can really tell what happened.

But one of the things which we have corrected is, we were weaker at the very low end of 32-bit microcontrollers because we were serving those functionalities with 8-bit microcontrollers. And as customers wanted to be in 32-bit microcontrollers, we had a good portfolio of midrange parts and high-end parts but we didn't have entry-level parts. We were competing with 8-bit on that. And I think that's one thing I corrected after a return.

And there are a couple of very, very good low end 32-bit parts that we're developing at a very, very good price point. So first one of them gets introduced to the market at nearly the start of the next calendar year. So those would be -- those will strengthen our position further. But I think more than that, there are a few things we have done.

One of the thing was -- for 8-bit and 16-bit, we had our own proprietary architecture, PIC architecture. We didn't use ARM or anybody, any industry standard architecture. So therefore, all the tools were ours, we developed our own tools. So when we went to 32-bit microcontrollers and adopted ARM as well as MIPS architectures to build it, our internal strategy remained that we brought those parts on our own tools, which were proprietary tools.

And ARM has a substantial market share at a 32-bit level and all of the competitors build on based products. And many of those companies don't even build the tools because they just simply send their customers to more industry standard tools from like IAR and SEGGER and others, Kyle and a number of other companies. So basically, when we compete with -- at a customer, we're trying to jam our proprietary tool where the customer already has an industry standard tool. And if our products will simply work on that industry standard tool, we'll have a lower resistance level.

So I think that's one thing we have changed in the last 9 months where we have enabled all of our 32-bit products to be able to run on industry center tools and we're even working with 1 company at least who will even support our 16-bit dsPIC on industry standard tools. So there are things we are doing to make alliances more competitive, make it easier for our customers to do business with and adopt our products. The other thing that Rich talked about was coding assistance that we have developed, which is a first in the industry, and we're giving it to our customers, it saves almost 40% time for development, it basically writes the code for you and nobody else has come up with a tool like that.

So everybody would, but we're the first. So I would say, I think our position is still good, still very competitive. But we did lose share with our PSP strategy. And we hope that some of it is not permanent.

And as our sales are growing, we will come back.

And your next question come from the line of Tore Svanberg.

I had a question on the pace of the decline of the -- on the utilization charges. So I appreciate you're going to start increasing utilization in the December quarter. And I think right now, obviously, those charges are coming down by a few million dollars, obviously, because you still have inventory. But when do we see more step function declines in the utilization charges?

Is that going to be when you get to that part of 130, 150 inventory day target? Or could we potentially already see it before you get to that level?

It would happen well before that. As I said, if we wait until the inventory comes down to between 130 to 150 days, then we're going to require a very large step function increase in our fabrication output in the following quarter, which is impossible. So therefore, you have to grow over 5, 6 quarters, then we have to start much earlier. So utilization will start improving well before our inventory gets to those kind of levels.

I think you should see a substantial improvement in utilization probably in December quarter and then continue every quarter after that.

That's great color. And then on your cash flow. So great to see the cash flows are now going to be big enough to cover the dividend. You did say that any excess cash flow is going to be used to pay down debt. What's sort of the new target level for that so that we can try and understand when the buybacks are going to start to pick up again?

So I think what we have said is -- and I have this only number as approximate. Eric may have more numbers. I think we have borrowed about -- through this quarter, we would have borrowed about $300 million.

Senior Corporate Vice President & CFO It's about $350 million.

About $350 million. $350 million to cover the dividend in the last x number of quarters since our cash flow became less than the dividend. So next $350 million of excess cash flow over dividend will go to bring that debt back to where it really was. So that's factor number one. Factor number 2 is -- our leverage is still very high.

We just finished the quarter with a leverage of 4.2. And if you recall, when we started to increase the dividend and started to buy back stock and all that, we had said we want the leverage to be 1.5 or lower. So it's quite a way to go before we get back to that kind of leverage and a very strong investment-grade rating. So I wouldn't look for a stock buyback in the near term.

Your next question comes from the line of Vijay Rakesh from Mizuho.

Eric and Steve. Just a quick question on the underutilization. I think your inventory write-downs and underutilization is kind of running 50-50. Do you guys think most of the inventory write-downs get done by the September quarter?

Senior Corporate Vice President & CFO I don't. I think it takes longer than that, Vijay. But what we expect is that the amount of the inventory write-downs will continue to decline as we move through the fiscal year. So it's going to take some time, but the charge dropped from $90 million to $77 million last quarter.

We expect it to be lower than the $77 million this quarter and that cadence to continue now for multiple quarters as we see into the future. And underutilization, I think we've talked about a little bit more in response to some of the other analyst questions, it's going to go down modestly this quarter. And when we increase wafer starts in the factories in the December quarter, it will take another step function down, but that one's going to take a little bit longer is because we are significantly underutilizing our factories today. And we'll grow it back over time as inventory declines and revenue improves.

Got it. And Steve, in response -- in your Section 232 on some of the exemptions that Microchip could get with investing in the U.S. Is your understanding that it puts you at a much better position versus like this STMicro and Infineon and S and some of your peers there.

Well, I would hope so. I don't really know fully what the rules are, but I think we produce a higher percentage of our product in U.S. than some of the companies you mentioned do. But I don't know whether it makes a difference what percentage it is. I think it's going to be more black and white.

If you do some manufacturing in the U.S. and you qualify for no tariff. I don't know what the rules will be. I think some of those companies have fabs in U.S., some others don't. And I don't know the rules if they're clear enough to be able to interpret that.

I hope we have an advantage, but I'm not sure.

And your next question comes from the line of Christopher Rolland from Susquehanna.

Just maybe a clarification or just understanding tone here. I guess, first of all, typical seasonality for December and March? I know it changed since the addition of Atmel. I think the last update was maybe down 5% in December and negligible for March, but down a little bit.

Maybe if you could update there us on that. And then, Steve, you said you thought you'd be better than seasonal, but I think TheStreet was at plus 5% or something like that for the December quarter. So like is that tone as much as 1,000 basis points better than seasonal? If you could update us there, that would be great.

Senior Corporate Vice President & CFO Let me maybe start by saying I don't think seasonal in December is down 5% for us. I think maybe it's down a couple percent and then maybe seasonal. It's been a long time since we've been seasonal and maybe seasonal in March would be up a couple of percent. So maybe start with that.

And we are not at a point where we want to provide any guidance or able to provide any guidance yet for December. We think our business is trending in the right direction, but we're not ready to provide guidance. So I'll start with that and see if Steve wants to add anything to it.

I think exactly I wanted to say that your numbers have a larger bracket on it. I think December is usually down a couple and March is up 2 or 3 maybe -- I'm sorry, up by 2 or 3. And my expectation is that the business would be better than seasonal in both quarters without being able to put numbers on it.

Okay. And then secondly, maybe on AI. I know there was some stuff in the prepared remarks, but if you guys had an dates on the percentage or the dollars contributed from AI and if there were any products that are just going gangbusters just above your expectations, whether they're like PCIe switches or retimers or FPGAs or timing products, just anything that's significantly outperforming your expectations around AI, that would be great.

We haven't broken that out, but we are seeing more and more uptick from our customers using the tools. It's still relatively new. We just launched this in the February time frame in terms of AI code support. It's being used behind our firewall for over a year by our internal engineers and our support engineers supporting customers and it's improved productivity within our own engineering force quite a bit.

On the FPGA front, we're seeing most of the uptick or use of AI is in vision, detection, our vision systems for detecting people or visual inspection and factories are probably the fastest growing areas that we're seeing AI and acceleration used in our products.

Yes. Any data center products, not the AI coating tool, I apologize.

No. We have not put out data in terms of pertaining to the AI coding tool in terms of what it benefits. Right now, the only number that we've given is that typically customers and engineers that are using it and are reporting about a 40% productivity improvement, which, in the end, translates to time to revenue improvements.

And your next question comes from the line of Janet Ramkissoon from Quadra Capital.

Congratulations and a nice turnaround, guys. Most of my questions have been asked, but just a couple of little things. Given the recent decline in the U.S. dollar, how does that affect you? And if we see higher budget deficits and higher need to sell more debt and which may lead to a further decline in the dollar. How is that likely to affect you in the next couple of quarters?

Do you want to take that?

Senior Corporate Vice President & CFO Yes. So the foreign currency fluctuations don't have as large as impact on us and some of our competitors that are not as U.S.- based with us. We really sell 99% plus of our revenue is in U.S. dollars. A lot of our assets are going to be U.S. dollar-based.

So I think the impact to us is smaller than what you would see with some of our European competitors as an example.

Okay. And secondly, if I may, any comment about your Chinese business or trends? Any insights on what's going on in that market?

Chinese business. I think our business in China was very strong. It bounced back very strong from March quarter, which is a Chinese New Year quarter to June quarter, up, I think, 14% or something. So our business is doing very, very well.

Everybody is talking and concerned about what's going to happen with tariffs. And I think that's dominating the agenda. But on a business level, it's not really having impact today.

There are no further questions at this time. I will now hand the call back to Steve Sanghi for any closing remarks.

Well, I want to thank all the investors and analysts for hanging in with us. I think we're on our way, making a very, very strong recovery from the lows in the business environment. And we'll see many of you at a number of conferences we'll go to starting early September, I think.

Senior Corporate Vice President & CFO Yes. We actually had a conference as early as next week. So we'll be -- we've got a lot of conferences this quarter, and we look forward to further discussions with everybody.

Thank you.

This concludes today's call. Thank you for participating. You may all disconnect.