Microchip Technology (NASDAQ:MCHP) Q2 2027 Earnings Call

0:00 As a reminder, this conference is being recorded. I'll now turn the conference over to Eric Bjornholt, Senior Vice President and CFO. Thank you, Eric. You may begin.

0:13 All right. Thank you 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 Steve Sanghi, Microchip's President and CEO, and Sajid Daudi, Microchip's Head of Investor Relations. I will comment on our second quarter fiscal year 2027 financial performance and then Steve will provide commentary on our results and discuss the current business environment as well as our guidance. We will then be available to respond to specific investor and analyst questions.

1:05 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 gap to non-gap 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 gap and non-gap results. We have also posted a summary of our outstanding debt and 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 effect 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.

1:57 Our non-GAAP financial results met or exceeded the guidance we provided on August 6, 2026. Net sales in the September quarter were $1.622 billion, which was up 9.2% sequentially and up 42.2% from the September 2025 quarter. We had several infrequent items that positively impacted net sales by about $53 million in the September quarter that we do not expect to repeat in the December quarter. These items were all at 100% gross margin and included approximately $21 million impact of our pricing change on inventory in the distribution channel, $22 million in licensing revenue from patent licensing transactions in excess of what we expect in the December quarter, and a $10 million benefit from a long-term contract with a customer.

2:50 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 66.5%, including capacity underutilization charges of $26.6 million. Non-GAAP gross margins were positively impacted by higher licensing revenue in the quarter, as well as the impact of our pricing change that was implemented in the September quarter. Non-GAAP operating expenses were at 27% of sales, and operating income was 39.5% of sales. Non-GAAP net income was $559.2 million, and non-GAAP earnings per diluted share were $0.97, which was $0.04 above the midpoint of our guidance. On a GAAP basis in the September quarter, gross margins were 65.9%.

3:39 Total operating expenses were $603.5 million and included acquisition and tangible amortization of $90.2 million. Special charges of $7.9 million, which was primarily driven by our activities associated with our closure of FAB II and acquisition-related expenses. Share-based compensation of $62.2 million and $5.3 million of other expenses. The gap net income attributable to common shareholders was $373.6 million, or 68 cents per share. and included a tax benefit of 13 cents per share related to evaluation allowance release on tax attributes. Our non-GAAP cash tax rate was 5.7% in the September quarter and we expect to have a tax rate of about 6.5% for fiscal year 2027.

4:30 Our tax rate is down from our previous forecast for a variety of reasons including the impacts of a reduction in inventory reserves, and a higher percentage of our taxable income being in jurisdictions with lower tax rates. Our inventory balance at September 30th, 2026 was 1.117 billion. We had 184 days of inventory at the end of the September quarter, which was up nine days from the end of the June quarter. Inventory increased in the quarter as we received some high dollar value wafers from our foundry partners in anticipation of future growth and built some finished goods inventory. Included in our September quarter ending inventory was 12 days of long life cycle, high margin products whose manufacturing capacity has been end of life by our supply chain partners.

5:17 Inventory at our distributors in the September quarter was at 25 days, which was flat compared to the June quarter, and at the lower end of what we have experienced historically. Our cash flow from operating activities was $419.2 million in the September quarter, Our adjusted free cash flow was $377.1 million in the September quarter. As of September 30th, our consolidated cash and total investment position was $457 million. Our net debt decreased by $31.7 million during the September quarter, and this is after funding the acquisition of Halo. Our adjusted EBITDA in the September quarter was $705.4 million and 43.5% of net sales. Our trailing 12-month adjusted EBITDA was $2.162 billion. Our net debt to adjusted EBITDA was $2.36 at September 30, 2026.

6:14 We expect our net debt to adjusted EBITDA to continue to reduce as we progress through fiscal year 2027. Capital expenditures were $23.1 million in the September quarter, and we expect capital expenditures for fiscal year 2027 to be about $100 million. Depreciation expense in the September quarter was $36 million. I will now turn it over to Steve, who will provide some additional commentary on our September quarter results and our guidance for the December quarter. Steve?

6:45 Thank you, Eric, and good afternoon, everyone. I will reflect a bit on our performance in the September quarter. The September quarter was an excellent quarter for microchip with broad-based growth as we beat the high end of our guidance in Net Sales, and our non-GAAP financial metrics like gross margin percentage, operating expense percentage, operating profit percentage, and earnings per share all met or beat our guidance. Our industrial and data center end markets were the two biggest drivers of our growth. Across our end markets, new design wins are increasingly supporting that growth.

7:31 Our end market split for the September quarter as a percentage of net sales excluding licensing revenue was industrial at 34.6%, data center at 16.7%, aerospace and defense at 16.1%, automotive at 14.2%, communication at 8.2%, Consumer Appliances at 7.3% and Compute at 2.9%. From the September quarter 2025 to the September quarter 2026, net sales from industrial grew 50.3%, data center grew 55.7%, aerospace and defense grew 41%, Automotive grew 19.3%, communication grew 43.5%, consumer appliances grew 26.7%, and compute declined 1.6%. Net sales from our data center business unit was over $250 million in the September quarter and is well on its way. to be $1 billion in calendar year 2026.

8:59 For calendar 2026, about half of our data center business comes from our standard products and about half comes from our data center solutions business unit. On the standard product side, design wins are building across many products in power Our digital power controllers are winning across AI data center power applications from server power supplies to battery backup units. In system management, we offer the parts that sense, control, and connect a server or rack, and our gigabit Ethernet switches and USB hubs are gaining design momentum in management networks.

9:49 With respect to our Gen 6 PCIe switch and retimer products, we had 19 design wins at the end of September quarter, up from 12 design wins at the end of June quarter. As of today, we now have 24 total design wins. These incremental wins will begin to ramp net sales next year and help position us across a growing range of next-generation data center platforms. As these deployments scale, so does our opportunity across the broader data center portfolio, including timing, security, and networking. I would like to give one more organizational update.

10:36 As you know, after my return to Microchip as CEO two years ago, I reorganized the company into five pillars. These pillars were microcontrollers, Analog and Power, Networking and Connectivity, High Performance Compute, and AI on the Edge.

11:00 There's a senior vice president heading up each of these pillars. Our data center solutions business unit reports into the networking and connectivity pillar. Because of our focus on our data center solutions business unit, called the DCS, I have decided to pull up the DCS business unit to report directly to me at the executive staff level. The head of that business unit is Brian McCarson, who has spoken at these earnings calls before and will now report directly to me. Our design wins are not limited to data centers. In aerospace and defense, we're winning designs across regions, products, and applications from satellite communications and laser terminals to unmanned systems by adapting our commercial technologies for space and defense.

12:02 In one recent case, a defense technology company selected our radiation-tolerant secure FPGA over its incumbent supplier for two space avionics programs. As defense production rates ramp, so does our opportunity. Security requirements are also growing across our markets, from data centers to defense to the edge. At the edge, a leading enterprise network provider recently selected our security solution to protect its wireless networks where quantum resistant encryption became a requirement.

12:49 Together, data center, aerospace and defense, industrial, robotics, automotive, and the intelligent edge are the secular trends we see driving growth over the long term. I will now talk about our business environment and the guidance going forward. Our bookings are very strong in the September quarter, and our book-to-bill ratio remained well above one. We started the December quarter with a higher backlog compared to when we entered the September quarter. The September quarter saw a pivot in the business environment with customers completing their inventory digestion to shortages appearing in certain areas because of lengthening lead times at foundries, OSEC suppliers, and in our own fabs.

13:43 Lead times for the majority of our standard products Historically have been four to eight weeks, but now with our dye inventory substantially reduced and foundry and OSET capacity constraints, we are seeing lead times broadly stretch out on many of our products. Our customer requests for expedited shipments have increased significantly from a few quarters ago. We are receiving many orders for requests inside the lead time and they're going unsupported in the quarter. We're advising our customers to give us longer term backlogs to help better match our new lead times, which vary a lot across our product lines.

14:30 Our new lead times are anywhere from six weeks to 32 weeks. Eric just explained three infrequent items in the last quarter. First, it was an unusually strong quarter in our licensing group with a couple of large deals closing in the September quarter. Our licensing business is usually lumpy. The second item was the one-time effect of our recent price increases, which raised the value of our distribution inventory. The third was a revenue recognition from a long-term customer contract. Those infrequent items are not present in the December quarter. Our December quarter is also our weakest quarter seasonally because there are a lot of holidays in the quarter.

15:22 Therefore, the guidance for December quarter should be viewed in that context. Our December quarter also includes the impact of two small acquisitions that we completed, Halo in the AI on the Edge space and Virago in the A&D space. We expect that Halo will add about $4 million to our sales in the December quarter, and Virago will add about $6 million to our net sales in the December quarter. Taking all of these factors into account, we expect our net sales in the December quarter to be between down 3% and up 1% with the midpoint of minus 1%.

16:14 At the midpoint, this would be up 35.4% from the year-ago quarter. December quarter is usually seasonally down 3% to 5%. This seasonal effect combined with the infrequent items we experienced in the September quarter puts our December quarter guidance about 5% to 7% above normal seasonality. We expect our non-GAAP gross margin to be between 64% to 65% of net sales. This is because of several reasons. First, the three infrequent items in the September quarter were all at 100% gross margin.

17:03 Secondly, our net sales guidance is lower than what we would have expected a quarter ago. Thirdly, we have substantial unsupported backlog on high margin products that our supply chain cannot fulfill. And finally, we're running lower level of utilization internally than what we were planning a quarter ago. All these factors are impacting our gross margin guidance. We expect our non-GAAP operating expenses to be between 26.5% and 27% of sales. We expect our non-GAAP operating profit to be between 37% and 38.5% of sales.

17:51 We expect our non-GAAP diluted earnings per share to be between 87 cents and 95 cents per share. At the midpoint, non-GAAP earnings per share would be up 107% over a year-ago quarter. Regarding our long-term model, we maintain our long-term model on a non-GAAP basis to be 65% gross margin, 25% operating expense, and 40% operating profit. With that, operator, will you please call for questions? Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad.

18:38 A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. So that we may address questions from as many participants as possible, we ask that you limit yourself to one question and one follow-up. If you have additional questions, you may re-queue and time permitting those questions will be addressed. One moment please while we poll for questions. Thank you. Our first question comes from the line of Timothy Arcuri with UBS.

19:23 Please proceed.

19:25 Thanks a lot. Steve, I was wondering if you could help unpack a lot of these, you know, puts and takes. It seems like You said that December revenue is a little lower than what you would have thought three months ago and FAB utilization is also a little lower, yet bookings are stronger. Is this due to constraints that are downstream from you? And maybe does that give you more visibility into March? So you could maybe give us a sense, maybe, you know, normal seasonal, I think in March is up like three. So sounds like maybe you feel a little bit better about March as a result of all this. If you can just unpack that for us, that'd be great. Thanks.

19:59 Yeah, so I think if you look at the last quarter, it was kind of noisy. The three items that we talked about were in our guidance. The licensing deals were in our guidance. The recognition of $10 million of customer contract was in our guidance, and so was the price increase. So the upside last quarter came from product sales, so we did very well. Now, when you look at the current quarter, Lead times have stretched out and a lot of the high margin bookings we received on a lot of advanced products in pretty much every business segment cannot be fulfilled in this quarter. So some of them are scheduled for next quarter.

20:49 So as a result, I think we're guiding the December quarter to be a tad lower than we would have thought about a quarter ago. The backlog for March quarter today is much better than December quarter was at the same point in time. So, you know, currently we're optimistic. We're not giving any guidance for the March quarter. But I think, you know, I think some of the constraints we're talking about are now scheduled into March quarter. So we are hopeful that March quarter will be a stronger quarter.

21:32 Thanks a lot. And then just as a quick follow-up, so on the PCIe Gen 6 wins, I think, Steve, you said 14 design wins coming out of June, and it's now up to 24. Sounds like you're building some high-value inventory for that stuff, too. So when does that start to become really big revenue? And if you can kind of size what the income model could be from those wins, if possible, that'd be great.

21:56 So we were unable to dollarize the wins. The part went into production last quarter, and we have a small amount of shipments in the current quarter, and they will increase every quarter from here on. Actually, there is sizable shipment this quarter, and they start increasing then from the next quarter on. The design wins are very strong and they're, you know, they're turning on at various times next year. So by the start of the 2028, you can expect almost all 24 designs to be in production. And we're winning, you know, essentially design a week almost.

22:41 Yeah, just one clarification to the way Tim asked that question is he said PCIe Gen 6 and the 24 design wins is both PCIe and the retimers. So just wanted to clarify that.

22:52 That is correct. I think we are basically keeping them together. They're very much in the same application. Many times retimer goes with the PCIe. We don't always win the both. In some cases, customer doesn't need the retimer. They only need the PCIe switch. but they're, you know, very much products are in sync. In the past, we have broken out how many on PCIe Gen 6 and how many on Retimer and I don't have that today but we have no problem in breaking that out. Okay, Steve. Thank you very much. Thank you. Our next question comes from the line of Matthew Prisco with Cantor Fitzgerald. Please proceed.

23:42 Hey guys, thanks for taking the question. I guess to start, if you could maybe discuss order linearity in the quarter and maybe what you've seen through October and November thus far, and any color you can offer on those booking trends across end markets would be appreciated. Thanks.

23:59 So I think bookings were quite strong all the way through October. September, so nothing really to point out there. And then October was another good month of bookings where overall backlog continued to grow. November's just been a few days, but nothing odd to report.

24:20 Yeah, so bookings have continued well. The backlog has continued to build. The best way to look at our December quarter is to take the $53 million out of the September quarter, which were the three infrequent items. And if you do that, then our December quarter is up about 2.3% from our September quarter, versus normal seasonality for December quarter is down 3% to 5%. So therefore, I think we got no issues in how the quarter is. How the product chip backlog is, how the bookings are, all that continues well. But the two licensing deals, a unique customer program that added $10 million in revenue recognition last quarter, and this strange effect of when you ship the inventory to distributors, you assume there's a certain amount of district price protection on that.

25:27 and then the rest of it you recognize as revenue. When you increase the price, then that price protection becomes less and you have to capture that as a one-time revenue in the quarter. And that was about $21 million. So, you know, those items made it very noisy, but if you peel through all that and we're giving you complete visibility, you know, if you take those out, then the quarter is up 2.3 million. 2.3%. Now in that 2.3%, there's $10 million from two acquisitions, $4 million from Halo and $6 million from Virago. We broke that out too, so take that out too if you like.

26:12 And the 2.3 will go down to maybe 1.5 or something. Versus, you know, down 4% at the midpoint. So there's no problem in how the business is doing and We remain optimistic for the next quarter. Backlog is good. Bookings are coming in. That's how you should view the quarter in that context. Very helpful. Thank you. And then maybe you can offer some more color on what you're seeing in terms of those constraints today, how those foundry OSAT constraints changed over the last 90 days. And I believe you added internal constraints this quarter. So how are you responding to these constraints overall, and how do you expect that situation to evolve as we look into 2027. Thank you.

27:00 So, you know, incrementally we have additional capacity allocation, you know, every quarter, you know, which will continue to provide growth. But we could use more than that. So on various different nodes, you know, we have more capacity the following quarter, therefore, Some of the orders from this quarter are scheduled into next quarter. And I believe some of the orders from the next quarter will move into the June quarter where we have more capacity. You know, we're not unique. I think the entire industry is seeing it. Demand is stronger than the capacity available. Whatever is happening in the market right now with data center, AI infrastructure, concerns whether they will all be built or not built, I think there's a silver lining in it. You know, the whole thing was just too much hot air. And if some air comes out and capacity becomes available at OSOTs and foundries for broad-based business, I think there is silver lining in it.

28:12 Thank you. Our next question comes from the line of Joe Quattrocchi with Wells Fargo. Please proceed. Yeah, thanks for taking the question. You saw a nice acceleration in the industrial demand of this quarter. I was wondering if you could just talk about, you know, what you're seeing there and maybe just on that last line you said, you know, how do we think about your exposure to just everything around the data center infrastructure build, like maybe outside of the data hall?

28:47 When it comes to industrial, industrial is the broadest market segment there is. What is industrial? It's not a narrow set of things. Industrial is factories, cities, hotels, lighting, robotics, medical. Industrial is very, very broad and we're seeing opportunities in industrial. Some of it got driven by Industrial was sort of the last one to recover, I think, two or three quarters ago. So, you know, it's seeing substantial recovery from that point. And a lot of new design wins in every single area, robotics, medical, process control, factories, farming, equipment, appliances, you know, everything is growing. So it's very, very difficult to kind of explain industrial beyond that because it's so broad.

29:42 The second point of your question is on the data center. So, you know, we are early in the data center penetration, you know, because we didn't have a lot of Gen 5 switch revenue, and you have known from past that we were very late to market on it, and therefore we lost the Gen 5 business. So our, you know, with Gen 6, we are regaining a lot of the market share, and a lot of it is not in our revenue. So for us, it's all upside. Where if it slows down, it could be downside for the people who have a lot of that business. In terms of other half of our data center exposure, which is through microcontroller, analog, power, switches, security, USB, Ethernet, these are very broad-based products where data center is really a small portion of the overall shipments to all the end markets.

30:45 And if certain data centers won't get built, a lot of that upside is not in our forecast. Thanks. And as a follow-up, as we're thinking about just kind of the gross margin put in takes into the December quarter, how should we think about this underutilization charges as a nice improvement this quarter? Do we keep thinking that's somewhat linear as we move forward?

31:14 So, you know, it will not be linear. This quarter, we are not anticipating any sort of big improvement. We actually built finished goods last quarter and don't really want to do that again this quarter, so we're slowing down some of the assembly and test operations. We're still doing the ramp in our wafer fabs where Steve had mentioned in his prepared remarks the diametory is getting low in certain cases, so it's a balance, but you will not see... The large reduction in utilization or underutilization charges this quarter that you saw last quarter, but that's still upside in front of us in future quarters.

31:53 December quarter historically is kind of weak, so we took the ramp cautiously, but it will accelerate again next quarter because then we go into good March quarter followed by two strong September and June and September quarters before we get the Another week, December quarter of next year. So utilization should start to improve, but not linearly. Thank you. Thank you. Our next question comes from the line of Chris Casso with Wolf Research. Please proceed.

32:32 Yes, thanks. Good evening. The question is on pricing. and the impact on the December quarter from some of the pricing actions that you took previously. What was the magnitude of that in December quarter? And I seem to recall from last quarter, that was one of the factors you had expected to be an offset because again, as you said, you knew Some of those three items that would not recur in the December quarter. I seem to recall that pricing was going to be one of the offsets for the December quarter.

33:14 So you are correct. We expected that to be offset. And the remaining pricing is being effective this quarter because pricing change was done in the middle of the last quarter. you know however because of what we described before some of the fairly large dollar item you know products with very high margin supply chain cannot fulfill this quarter which is kind of offsetting the improvement we would have seen.

33:48 Right okay so and I guess then going forward it would it be right to assume that As supply improves, as you get the ability to supply some of these higher margin products, perhaps some of the products where the price has gone up but you can't ship it right now, that you would see some of that benefit as you go into calendar 27. Is that the right way to think about it?

34:20 Are you talking about benefit in revenue or benefit in something else?

34:25 Well, I guess benefit in revenue from obviously being able to ship the product and the higher price. And then I guess more importantly from the margin side, because I think I understand what you're saying is that you didn't see as much of the pricing benefit that you had expected in the December quarter because you couldn't ship those products. So therefore, as you finally were able to ship those products, do you get that margin benefit?

34:54 We suddenly get the revenue benefit and we get some of the margin benefit, but the pricing in the industry is, you know, from our suppliers is continuing to go up. There's another round of price increase across the industry, you know, starting basically in January from, you know, most major foundries and OSATs. So some of that will You know, because some of that we countered in our price increase when we did the price increase. So that's why you're seeing a very good gross margin for the September quarter and pretty good gross margin in December quarter. If you're expecting it to go back to 66.5, we're currently not projecting that. Our long-term target is 65.

35:42 And we think we're going to have to fight that price increase with the suppliers and figure out how we deal with it, whether You know, whether there is a check on our gross margin or we pass it on to the customers further, we haven't figured all that out yet. Okay, thank you. Thank you. Our next question comes from the line of Vivek Arya with Bank of America Securities. Please proceed.

36:14 Thanks for taking my questions. Steve, I wanted to start with more of a macro question based on your industry experience. You know, when you look at all these, you know, the volatility in semiconductor stocks, do you think that signals to you there are, you know, earnings cuts coming? Are we at peak demand? Just kind of what is your crystal ball telling you in terms of where we are in the cycle? And, you know, do you think all these worries are justified based on what you are seeing on the ground? Well, Vivek, I think there is data center and non-data center.

36:49 There is nothing to worry about in the non-data center. You know, industrial is doing fine. You know, automotive is continuing to recover. Its unit count is not growing as much. Low single digit, but, you know, the content is growing significantly. And we're winning across, you know, new car architectures across the board. We're doing very well. Aerospace and Defense is doing well, industrial is doing well, automotive is doing well, communication is doing well. The issues in data center, it was, you know, all that just, I've been kind of saying it, it could not be true, you know. It just, the demand was, you know, explosive.

37:34 You can't just have that large of a percentage of economy that everybody expected it to grow. So I think, some of that is coming in check whether it comes in check that the real estate of the other centers can't be built or the power can't be supplied or the new Congress wouldn't let it happen or you know circular financing finally you can't do it anymore it's not cost effective or people can't monetize whatever the reason is or a combination of reason is you know the The second derivative on data center has to come down substantially. And I think you see market voting on it. To me, it's not new. I think it was predictable.

38:24 So what do you think that means for microchip? Because I think in your commentary, you use the phrase that you thought September was a pivot, right? And you're seeing lead times. get stretched out. Do you think a lot of that demand is coming because there's a crowding out from the data center or do you think there's kind of real kind of demand upturn? So more specifically, if you look at the next several quarters of microchip, do you think there is still the possibility of above senior growth?

38:58 Yeah, I think yes. Like I said, there is data center and non-data center The non-data center demand is normal. It's doing well. Data center demand has been explosive. If that comes down, its effect on us would be very small because we're very much in the early stage. We're not doing billions of dollars of revenue in the data center. And all of the rest of the markets are growing. And data center is 16.7% of our business, not 100%, like many of the other companies. Where the crowding out is, is not in demand. The crowding out is in capacity. Data center has been crowding out capacity for trailing edge nodes because of power requirements and analog requirements and all these other things, microcontrollers and others. So data center has been crowding out capacity at the OSAS.

40:00 And in many cases, we have lost capacity. Thank you. Thank you. Our next question comes from the line of Vijay Raik with Mizuho Security. Please proceed.

40:45 Hi, this is just a quick question on the aerospace defense side. It's kind of grown in line with Microsoft's overall growth. When do you actually see aerospace defense orders start to come back? Are these long lead orders where you have good visibility? And a quick follow-up.

41:07 Well, so, you know, aerospace and defense grew 41%, you know, September over September. So we think it's, you know, growing very well. The demand for aerospace and defense is very strong at the primes, but primes have to build up capacity, some starting from real estate. Some of them are being asked to You know, increase the missile production by 5x or 4x. Well, they don't have the floor space to ramp the production to 4x. So they're adding capacity, buildings and machinery and all that. And, you know, we're starting to get the orders, but they're scheduled out when they need it. So I think it's, you know, aerospace and defense is not a, you know, data center kind of business.

42:03 You know, 10 million today and 200 million tomorrow. It will grow consistently, but it's not a hockey stick because the industrial complex cannot grow at that rate. Got it. And then on the price increases, you mentioned foundry or set price increases. How much flexibility do you have to kind of pass through? What are you anticipating in terms of the impact of those as you look at 27 in terms of margin or any headwinds there? Thanks.

42:46 Well, we consider our gross margins very healthy. I mean, our last quarter, because of some Infrequent items was higher than target. Otherwise, it's very close to target, you know, within 100 basis points of that. And, you know, we don't want to take a second price increase to our customers so quickly when we just did a price increase in the middle of August. So just like we did that last time, we absorbed it for a while. And if the, you know, cost kept going up, then we passed the price increase. I mean, we're kind of doing similar. Right now, we're planning to not do a price increase and absorb it. And at these kind of growth margins, we don't feel that there are growth margins are low.

43:34 Got it. Thanks. Thank you. Our next question comes from the line of Harlan Schur with JP Morgan. Please proceed.

43:46 Yeah, good afternoon. Thanks for taking my question. Book to Build is strongly above one. Your backlog, even now, continues to grow. And I assume that this strong demand profile is across not just advanced foundry-based products, but across your internally manufactured products as well, right? Your overall lead times are extending. So your front-end utilizations, I would have expected to move higher this quarter, especially with your commentary on low-die banking inventories as well. So why wouldn't front-end utilization increase? I understand back-end utilizations might be stepping down a bit, but why aren't front-end utilizations continuing to increase here in December and therefore lower underutilization charges?

44:34 So, Harlan, the front-end is reducing in the current quarter, but the back-end is not going to be as fully utilized as it was the quarter before. It's the combination of those things, and we don't expect a material change in the overall underutilization charge in the court.

44:55 I think one of the points is that there's a perception that on in-house built products, there should be no constraint and there should be no lead time issue. The problem is The inside produced wafers also go through the OSAT. Some of it goes through our internal factory, but some of the packages we don't do, it goes through OSAT. So it sees the same constraints that our foundry wafers see. And in a lot of cases, some of the capacity at our major OSAT suppliers has been displaced. AI companies, you know which ones, came in and took over the whole factory.

45:42 they pushed everybody out. We brought some in, we brought it some to other OSAT manufacturers, but that is the crowding lot of AI. It's affecting processing of inside wafers as well as outside wafers in assembly and tests. And we are rapidly improving that situation. You know, ordinarily we do an inside versus outside analysis When there's a payback to do inside, you know, not everything we can do cheaper inside. Sometimes we cannot keep the tool fully busy because, you know, we cannot fully utilize the tool, so therefore we keep it outside. But when we get displaced outside, we can't produce it.

46:30 You know, a very good margin product, then cost doesn't matter, then we want to bring it in and produce it. So we're making those moves, but those moves take six months. and some of this displacement only happened, you know, just a couple of months ago. So those are the things we are struggling with and that's why I said that, you know, some deceleration of the AI demand actually would be quite positive early on.

47:00 Got it. Okay, I appreciate that. And then as my follow-up, Steve, we are seeing a lot more adoption overall of integration of machine learning and AI capabilities into all of these sort of embedded applications across industrial, automotive, even consumer, right? And for many of these applications, you don't need a standalone MTU like your acquired product family from Halo, but you could leverage embedded MPU accelerators, right? Can you just remind us your 32-bit MCU product lines, do you have product families with embedded MPU and are you seeing accelerated adoption of MPU-based MCUs for these types of embedded like machine learning AI applications?

47:48 So our in-house

47:51 Microcontroller and microprocessor product lines did not have AI acceleration in them. No hardware acceleration. We had some software acceleration. We did have some hardware acceleration available on our FPGAs and our data center solutions business units, but not on our microcontroller business units. and the microprocessor business unit, we did not. When we bought Halo in our microprocessor business unit, we were developing products. The first of those products was going to be available in about two and a half, three years. And the second of them was going to be available in about four, four and a half years because they were serial in nature.

48:43 The product line that Halo brought to us Accelerates the roadmap by five years. So therefore we have canceled the two products that we were developing in the MPU business unit because they have been replaced by Halo. In fact, I have merged the Halo and MPU business unit together and we are advancing the Halo roadmap and we have canceled our MPU roadmap in the microprocessor business unit. That's how Important halo has been for us.

49:21 I see. Okay. That makes a lot of sense. Thank you, Steve. Thank you. Our next question comes from the line of Jim Snyder with Goldman Sachs. Please proceed.

49:36 Good afternoon. Thanks for taking my question. I was wondering if you could maybe broadly characterize the OEM customer willingness to build Inventory on the balance sheet at this point, given the extended lead times, is that something that some customers and some verticals are willing to do? Or is it more broad based than that? And maybe just give us a sense about are they even able to do that, given the supply constraints you've talked about?

50:04 I mean, you know, right now, in broad base of customers, we do not see a desire to by them to build inventory. We can hardly get them to place orders with our new lead time. Seems like number one lead times are moving rapidly. Secondly, semiconductor manufacturers are always telling their customers, I want more backlog, I want more backlog. It kind of becomes a broken record, you know, like the wolf is coming, the wolf is coming, and they don't respond to it. They don't. And they don't respond to it until they get in trouble. where lead times rapidly go out. They don't have the product.

50:49 They try to expedite it. We cannot serve it. The lines are down for eight weeks and that's when there is a fire behind them and they start to place orders. We're not seeing that yet. That's helpful, Culler.

51:07 And then this is a follow-up. Just going back to the gross margin question, it seems like Previously, you talked about some of the higher margin products, what you thought would benefit you in the December quarter. You talked about the reasons why those are constrained. Just wanted to make sure that I understand, is the new piece of information that those higher margin products will come back into the mix over the next couple quarters, but perhaps the input cost increases are not going to be offset on the broader base of products? Do I have that right?

51:45 Yeah, I think our assessment last quarter that we can keep the gross margin in the 66% range by more high-margin products coming in, the rest of the price increase kicking in, and completely offsetting the high licensing revenue and a couple of other infrequent items, I think that was That turned out to be more aggressive than the reality has turned out. So we have backed off from that assumption. Now, we still told you always that a long-term gross margin was 65%. And there'll be times in the good times when it will go over.

52:31 There'll be times in the bad times when it will go under. But we didn't guide you to a higher than 65% gross margin. But we did say that we could maintain it in the December quarter. Now, various things have happened, you know, partially driven by some of the high margin products pushing out because of constraints. We can't quite get there. Question is, and why are we not getting there in March or June? Because some of the further price increases from our suppliers is kicking in, whether we're able to offset that or not, we're not able to model it today. So that's why we're basically resetting that and saying, you know, think of 65% as a long-term gross margin, and we will work very hard to get there and maintain it, but not any higher than that.

53:26 Very clear. Thank you. Thank you. Our next question comes from the line of Blaine Curtis with Jefferies. Please proceed.

53:37 Hey, good afternoon, guys. I wanted to ask on the trigger to pull back the utilization. Is there a certain level of inventory you don't want to grow it on an absolute basis or a certain number of days you're targeting? Just trying to understand that trigger. I think most people, I know the stock market's terrible lately, but expect a continued recovery. So I'm just trying to understand how you're thinking about managing that. I think the equation is very, very complex.

54:05 We build hundreds of thousands of SKUs. Our product, including internal fabs and outside foundries, come from almost 40 different factories around the world. And it's a very complex equation. On some nodes, we have plenty of capacity. On other nodes, we are heavily constrained. Some of the nodes where we have enough capacity It's the kind of product that goes into packages like BGA and others where the capacity is constrained. In some cases, we cannot get the substrates. In some other cases, we don't have the assembly capacity. In other cases, our test capacity has been confiscated by the AI crowd.

54:51 So it's a very, very complex equation. And despite that, I think we're growing. Our business is up nicely. We'll be up again next year. for solving these problems, bringing some inside, some moving it from foundry to foundry. It's noisy, I get it. I'm frustrated by it too, and with the kind of questions you guys are asking, I get it. The only thing that's gonna help is AI decelerating.

55:27 Thank you. And then I wanted to ask on the auto channel, I think there's some hope that maybe that could be better. I'm kind of curious what you're seeing, any evidence of restocking in any areas of strength in auto. So, you know, our auto business is up 19.3% year over year.

55:48 I mean, for auto, you know, that's very good. For auto, that's excellent. Auto is never going to grow 100%, 50%, 40%. You know, the auto unit volume grows 2% or 3% best case. And, you know, and our auto was up 19.3%. We're getting lots of auto design wins. And when you get a design win, it goes to production in three years. So we are harvesting. Some of that was designed two or three years ago. And There's a good amount of growth coming in with future designs next year and year after. But don't expect any more out of auto. It grew 19.3%. In fact, that's more than entitlement in auto.

56:37 Thank you. Thank you. Our next question comes from the line of William Stein with Tourist Securities. Please proceed.

56:48 Great. Thanks for taking my questions. First quick one is I'm wondering if there's any meaningful influence of the two acquisitions on either cost of goods or OPEX in the near term?

57:08 So there is. I mean, there's OPEX that come along with both of these acquisitions. We aren't going to break out profitability for either of these small acquisitions, but Halo is investing pretty significantly in their R&D efforts, and we are definitely doubling down on that. The Borago products are good products in aerospace and defense with high gross margins, and we're excited about the opportunity on that. But there absolutely is an impact on OpEx in the current quarter by having a full quarter of Halo and almost a full quarter I think we can give you a little more color.

57:53 Virago gross margin is higher than microchip, but with $6 million revenue contribution, it doesn't move the needle in the current quarter. Halo margins are lower than microchip, but with $4 million in revenue, that doesn't move the needle either. In the area of OPEX, Virago OPEX is small and gross margins are very high. So Virago is actually very profitable. So that's doing very well. But with such a small revenue, it doesn't move the needle. Halo doesn't make money yet. They have very high R&D and small amount of revenue. And we're seeing huge opportunity. There is a multi-hundred million dollar funnel on it already in a very quick period of time.

58:44 So we will do very well in Hilo over time, but short-term, we're having to absorb its higher op-eds.

58:53 Yeah, that's very helpful. Thank you. Steve, I wanted to follow up on another question you answered earlier. You didn't quite say that, hey, we've been in an AI bubble, but effectively what one might infer from what you said about all the various challenges with data center and when you when you responded about how to think about the influence on your business okay I'm sorry no no that okay that's that's good I appreciate that but in terms of how to interpret how to think about the go forward model you you encouraged us to think about data center versus not and you talked about the silver lining but I wonder if you consider or if you think your business may be influenced from a couple of other factors.

59:45 For example, you know, data center drives some industrial demand probably for your business. You know, probably it's certainly responsible for some of the price inflation we've seen. And by the way, there's a similar dynamic in aerospace and defense. If you consider a lot of what's going on now, the unwind, you know, potentially related to lower spending in aerospace defense to which you're highly exposed. So if we were in a bubble in AI data center, couldn't this be more broadly problematic for your business? No, I don't think so.

1:00:26 Data center is 16.7% of our business and half of that 16.7 is broad-based products and half of that are The Data Center Solutions Business Unit. The Data Center Solutions Business Unit is in the retooling phase, having lost the Gen 5, regaining market share with Gen 6. So there, it's all upside. And in the broad-based business that we have, that would be roughly 8% of our business out of the 100. So I think I think this is a time if the data center were to correct, you know, our broad-based exposure in industrial and automotive and aerospace and defense in appliances and consumer and computing would be very, very helpful.

1:01:24 And microchip should outperform in that kind of environment compared to the companies that are kind of all data center. Got it. Thank you.

1:01:36 And yes, I... If I didn't say it, I'll say it again. I have been saying it, that data center is in the bubble. There we have it. Thank you. Our next question comes from the line of Joshua Buchalter with TD Cowen. Please proceed.

1:02:01 Hey, guys. Thanks for taking my question. I guess Steve, you mentioned sort of a reluctance to raise pricing so close to the previous increase. In the spring, you were also mentioning, given some of the relationships you were trying to rebuild after PSP, that reluctance. I guess big picture, you are seeing pressure from input costs. How are you philosophically thinking about pricing from a high level? How should we expect you from a competitive standpoint to react as a lot of your competitors are raising prices? Thank you.

1:02:43 So I think we were very careful in raising prices. We immediately didn't jump on it back in January, February. We were Thank you for joining us. We're not greedy. We are comfortable and happy with the gross margins we have.

1:03:30 The other point I would make is our operating margins are higher than some of our competitors' gross margins. I mean, look at FT Micro. So, you know, it's not that our product prices is low. You know, we are a premium price company. We make very good product, high quality. We fight for every cent. You know, our margins are very high, which means, you know, I don't know if our costs are lower than those companies. You know, actual costs are very hard to compare. We don't really know. But if the costs were to be equivalent, our prices are very good. You know, our operating margin is higher than STMicro's gross margin. You've got to give us some credit for that.

1:04:17 I hear you on that. Maybe for Eric... Leverage is down below 2.4x. How should we be thinking about when's the right time when you'll be able to start returning cash to investors via raising the dividend and repurchases again? Thank you both.

1:04:38 Yeah, it's a good question. We get it a lot, and it is a discussion in the boardroom, but the board definitely wants us to continue to take Thank you. Thank you. Our next question comes from the line of Christopher Rolland with Susquehanna.

1:05:26 Please proceed. Thanks for the question. So Steve, you're always good with insights like on the cycle. This one seems hot and maybe getting hotter, but if you could probably talk about You know how you see or when you see the cycle perhaps ending. Doesn't seem like we have inventory builds and safety stock building and stuff like that that we had in COVID. So probably we have some to go. and maybe adding in there, if the AI data center bubble does flow here, in your words, is that gonna be enough to prolong this cycle?

1:06:27 I will go back to data center and non-data center.

1:06:32 I do not see any issues in non-data center. Like I said, even our current quarter on a product basis is sequentially up 2.3%, where seasonality is down three to five. So I don't see any issues. And we have a very good March backlog. I think cycle continues on the non-data center. On the data center side, You know, like I said, on our solutions business unit, data center solutions business unit is in the retooling phase. I mean, they are winning lots of designs. You know, if we had those designs all on Gen 5 and we're re-winning them on Gen 6, it will not be incrementally as positive.

1:07:22 We would have gotten revenue before it would be a lot higher. But we lost them two years ago. And now we are winning it. We have won 24 designs on Gen 6. So for us, I think it's incrementally positive. And if, you know, the cycle decelerates, much of that, you know, upside and bubble is not in our numbers. It's in everybody else's numbers. It's not in our numbers. Understood. So, you know, given the constraints that you guys have in the expanding lead times, it does seem like this is from external manufacturing as opposed to internal.

1:08:16 Does any of this give you reconsideration on the mix of external versus internal and It was a long time ago that you were potentially considering a 300mm FAB, but would you consider even at the front end perhaps planning for a new FAB?

1:08:48 We are an IDM, Integrated Device Manufacturer. Our bias always is What we can produce inside, we produce inside. But let's take package first, and I'll take the fab. We largely do packages where we do not have enough volume to do it cost-effectively inside. In some cases, the volume as such, we can't even keep one set of tools, one pilot line busy. And if you can't, then your utilization will be very low and the cost will be higher. So those are the ones we do outside. We never had an issue with it. This is sort of the first time where AI is crowding it out and having us think through even bringing some things inside, which may be slightly higher cost, but at least we'll have the capacity.

1:09:48 Now, if you come on the fab side,

1:09:54 When we were considering a 300 millimeter fab during the post-COVID years, our plan was to do it under a license with a major foundry. Because all our wafers ran in that foundry, and the foundry was saying they will not add any trailing edge capacity. And therefore, they were agreeing to give us a license at 300 millimeter to bring those processes inside. Thank you for joining us. to build a 300-millimeter fab and seek a license again.

1:11:00 We're not thinking that because we don't think the problem is that long. It's just a short-term issue.

1:11:09 Yeah, I just want to add one piece of clarification to the way you asked the question. We do have capacity constraints with some of our internal production also. There are certain products where Thank you guys. Thank you. Our last question comes from the line of Tory Savinberg with Stifel.

1:11:57 Please proceed.

1:11:59 Yes, thank you. So Steve, I had a question on, you know, the OSEP capacity, the external capacity that's impacting your front end capacity. How much visibility do you have there? I mean, is it a matter of just being on a location and waiting to get the allocation? Or do you have a fairly good feel for when That's going to open up so that you can actually start, you know, ramping your own front end utilization.

1:12:30 You know, there are multiple answers to that question. In some cases, our allocation at that OSAT is not increasing. So we are qualifying a different OSAT in a different country and some of that is scheduled to be in production in the middle of next quarter. So we'll get some incremental for half the quarter and then have more even in the June quarter. In some other cases, the current OSET is, you know, is asking us to load it with a minimum batch size because, you know, when the batch sizes are smaller, You know, it takes more capacities, less efficient for the manufacturer.

1:13:18 So they're asking us to do minimum batch sizes. Our volume on those packages is small and we cannot meet the minimum batch size. So therefore, either you pay the extra price for breaking the batch size or you load it infrequently, you know, once every two weeks so you can bundle up and meet the minimum batch size. which again then pushes some revenue outside the quarter because you can't meet the batch size. In some other cases, we're tooling up that capacity inside and several different programs and some are in production next quarter, some will even take a quarter longer. So it's like, it's all over the place.

1:14:08 But more capacity becomes available next quarter, June quarter and from there on.

1:14:15 That's very helpful. Thank you. And as my follow-up and maybe back to the sort of AI bubble and rebalancing of, you know, data center across, you know, your seven segments, is there anything that you could, you know, give us confidence that, you know, if data center does slow down, you know, I understand that it won't impact you as much as others, but what about, let's Are they still going to go to production? Any sort of color you could share with us there to give us that confidence?

1:14:52 Yeah, so 24 design minutes will go to production. But its volume could be slightly lower than if the bubble were to continue. And we don't always know. The customer who we have design wins with, when they go to production, are they shipping into a data center which already exists? Or are they shipping into a data center in Ohio that the local governor is going to put on hold? We don't know that, right? It's all over the place. But it's a much smaller portion of our business. So the impact on us from that slowdown would be a fraction of what it would be compared to somebody who's 100% business is in data center.

1:15:45 Yeah, that's fair. Thank you very much. And the fact that on many of the products like the Gen 6 switch and retimer, it's largely all outside for us because we have no business in it. The other comment I'm going to make is If you conservatively model fiscal year 28 that begins on April 1 with whatever assumptions you have, you know, even in the extreme conservative case, I come up with over $4 of earnings. The stock is at 15 times earnings.

1:16:37 That's good. Thank you. I tell you, I'm tempted to bite myself and might. Thank you. That concludes today's question and answer session. I'd like to turn the floor back over to Mr. Sanghi for closing comments. So thank you for attending our conference call.

1:17:04 I think next conference we go to will be UBS,

1:17:09 right? Sajid's at a conference next week. But yeah, we'll have a large microchip presence at UBS with a larger group of executives.

1:17:19 We'll see some of you there. Thank you very much.

1:17:22 Thanks, everyone. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.