Conference Transcript - MCHP 2026-09-09

Atif Malik, Analyst — Citi

Good afternoon, everyone. Welcome to day two of Citi Global TMT Conference. My name is Atif Malik. I cover U.S. semiconductors and semiconductor equipment stocks. It's my pleasure to welcome Eric Bjornholt, Senior Vice President, Chief Financial Officer at Microchip. I'll kick it off with my fireside questions. If you have a question, save it towards the end. I will send the mic to you and you can ask your questions. Welcome, Eric. Yeah, thank you for having me. Hi, everybody. Harik, I'll have to start with a customary kind of cycle question. Microchip has now delivered roughly six consecutive quarters of above-seasonal growth. One of your peers is talking about this above-seasonal growth continuing into next year. That's ADI. And your guidance suggests a seventh consecutive quarter of above-seasonal growth. So the question is really, where are we in this recovery cycle today? and what are you seeing in terms of traditional drivers like channel restocking and inventories?

Eric Bjornholt, CFO

Okay. So before I start, I will be making certain forward-looking statements as part of this discussion and refer you to our filings with the SEC that identify important risk factors about the company. So we've been in a period of growth for quite some time. If you look at where we're guiding the September quarter to at the midpoint, it's up 40% year over year. Obviously, during that time period, margin profile has changed significantly and doing quite well. But customer order patterns have been very strong. Bookings activity, we mentioned that the June quarter was the strongest bookings quarter that we've seen in about four years. And that has continued here into the current quarter. Both July and August bookings were good. So backlog continues to grow. Lead times are staying pretty steady for us. We've seen some pushouts on lead times for some of the outsource capacity, and that always leads to the question of what are customers doing with inventory. But from what we see, we don't see that there's any significant inventory that's being built at this point in time. Actually, distribution inventory is quite low for microchip at 25 days. And, you know, the order patterns continue to come in strong, sell through through distribution strong. And since lead times have stayed very competitive at this point in time and we are delivering to customers when we say we're going to deliver, we don't think that there's really any significant stocking that has happened yet or restocking at customers.

Atif Malik, Analyst — Citi

Great. That's good to know. You talked about the strongest booking quarter in roughly four years. Can you help us understand the end markets with the bookings strong across all end markets or there are certain regions or products that are seeing above stronger bookings?

Eric Bjornholt, CFO

Yeah, but bookings have been strong across the board. It's really all product lines, all business units, all geography. There's not really anything to point out as being unique or different or weak in any way. It's been across-the-board strength in bookings.

Atif Malik, Analyst — Citi

And how would you characterize the underlying demand trends across automotive and industrial?

Eric Bjornholt, CFO

So from our perspective, the industrial and automotive recovery was delayed compared to what we've seen in data center and aerospace and defense. But as it stands now, we think that those customers have corrected their inventories from the last cycle, are placing higher levels of orders on us. You know, we produced information last quarter on a quarterly basis for the first time. We used to just do it annually in terms of breaking out end markets. And we showed in that slide that's posted on our website what the growth has been buy-end market year over year. And automotive grew like, you know, 29%, something like that. industrial grew quite nicely. So really all end markets are growing very good at this point in time and industrial and automotive are really no different.

Atif Malik, Analyst — Citi

Eric, you guys make thousands of parts, microcontrollers, and we noticed that in periods of time when the oil prices started to go higher, the analog stocks, they start kind of stalling because the market thinks that it's going to have some effect on your businesses. So in your kind of conversations with your customers, does this topic of oil pricing or this inflationary environment that comes up and do you think it has an effect to a certain level on your business?

Eric Bjornholt, CFO

I think on most customers, it really doesn't have an impact, right? They're looking at their business outlook. And if oil prices impacts their business outlook, maybe they pump the brakes a little bit. But we haven't seen that as of yet. Like I said, the bookings activity has been really strong. Design win activity with customers continues to be very robust on some of the new products that we've been talking about publicly, which I'm sure we'll talk about in future questions that you have. So I am not seeing that impact from customers today in terms of what they're giving us in terms of orders and what they're giving us in terms of their outlook over the next year.

Atif Malik, Analyst — Citi

Yeah, we clearly didn't see when the Iran war started in terms of your demand profile. I'm curious if you can rank order the regional strength across North America, Europe, and Asia for industrial and auto markets.

Eric Bjornholt, CFO

So we have a little bit less exposure in China, particularly in EV, and you would have seen that when some of our competitors saw that rise in revenue and then the drop in revenue. We really don't have any significant EV exposure in China. North America and European business and automotive is, I would say, trending equally with each other. I don't really see a difference, and we have a little less exposure, particularly in China.

Atif Malik, Analyst — Citi

All right. One of the lens clients are looking at at the analog stocks is their ability to supply more in this very strong demand environment. And you mentioned on your last call, you're not at 100% utilization, and you have additional tools that can be brought online as demand recovers. But you're also seeing pockets of tightness across the supply chain, particularly OSATs. Where are those constraints showing up most today? And if demand surprises through the upside, can you flex between internal fabs and external partners?

Eric Bjornholt, CFO

So first of all, on internal capacity, we are in a very good position. Even though we closed one of our wafer fabs, our Arizona fab, last year, we had expanded our clean room capacity significantly in the last upcycle. We'd invested in tools that you had mentioned before that haven't been deployed yet. So our capital expenditures for the next several years, I expect to be quite low. They have been last year and this year, and I expect that to continue as we grow back into the capacity that we put in place. We have seen tightness in some of our foundry partner process technology nodes and also with some of the assembly and test vendors, as you'd mentioned. I think a lot of that is driven by what's happening in AI and that's squeezing out some of the capacity. So we are doing the best that we can to have forecasts from our customers, provide forecasts based on history, and essentially scratch and claw for the capacity that we need to support our customers. and generally have been doing a pretty good job, but we have seen some lead times extend because of what's happening on some of the outside production activities.

Atif Malik, Analyst — Citi

If you can just kind of dive into, you shut down Fab 2, which was 25% of your eight-inch capacity. Remind us how much of your manufacturing in-house was the external, and then also on the back end, how much capacity headroom is left?

Eric Bjornholt, CFO

So as I mentioned, You know, we shut down Fab 2 last year, which was the smallest of our three large fabs. We do not believe that we've limited our growth in any way from that. We do about 35% of our production in-house. The other 65% of the wafer fab is done externally. We took the tools out of Fab 2 that we could use in the Colorado and Oregon fabs or other two large factories. And with that, we think that we can get back to, you know, peak revenue plus in our existing fab footprints and are in a very good position from that perspective. On the assembly and test side, we do more internally. We do about 70% of our production in-house and facilities in Thailand and Philippines and have good capacity growth capabilities there also from kind of a floor space and land perspective that we have to expand very cost effectively.

Atif Malik, Analyst — Citi

Great. The pricing environment has been strong this year. Microchip implemented pricing adjustments effective from mid-August to early September. If you can just talk about what's driving the pricing environment and if you're seeing utilization rates and lead times continue to drive pricing higher.

Eric Bjornholt, CFO

So we had an issue as part of the last cycle and how that was managed with customer relationships. And that was one of Steve's, one of his nine points in his nine point plan when he came back was rebuilding customer relationships. So we were very cautious about going out and raising prices on customers, although we were seeing supply chain increases over the last nine to 12 months. So we absorbed those for a period of time. I would say investors didn't really see that because we had cut capacity so much that our gross margins had fallen quite a bit all the way down to 52% last March, and then we're growing quite nicely, but we were absorbing some costs in that. we feel that our customer relationships are in a very good spot today and so we decided with some of the ongoing price increases that we were seeing from our supply chain coming through that it was time to increase prices on on customers and we did that in the current quarter various effective dates but kind of mid-august to early september is when most of that went into place and that was factored into the guidance that we'd given the street that price increase went very, very well from a customer perspective. Many of our competitors were on their second and third price increase already, and that was our first, and it was quite modest. So well-received. We are not using this as a way to amplify gross margin percentage. It's a way to maintain that and pass on the costs that we're seeing from the supply chain to customers. And again, they received that price increase very well.

Atif Malik, Analyst — Citi

Eric, you and Steve have done a great job in expanding gross margins, but our investors are greedy. They want to see more upside to the gross margins, particularly from the faster growing data center and aerospace and defense segments. So as you look at your gross margin kind of projection, you're remaining flat at 66 to 67 percent through fiscal 27.

Eric Bjornholt, CFO

What are the biggest puts and takes around the gross margins? yeah so i want to point out that in the current quarter when we're guiding to a 66 and a half percent gross margin we have a couple of one-time benefits that aren't repeatable one of those is we have a an expected higher licensing revenue this quarter within that business we do some sales of intellectual property and that's happening this quarter that's the expectation which will be 100 gross margin business that doesn't repeat after that and also when we increased pricing, which we did the middle of this quarter, there is essentially a write-up that has to happen on the product that's sitting in the distribution channel. When we recognize that revenue when we sold it in, it was based on old pricing. And when the quotes were increased, that causes a one-time benefit in revenue increase with no offsetting costs. So that's not repeatable. But the good thing is, is we expect, because we'll have the price increase in place for all of next quarter, as well as continuing to ramp our factories and our underutilization charges coming down, that pricing, excuse me, gross margins can stay relatively flat in the December quarter and in that range of 66 to 67%. So I've been getting lots of questions from investors today as why can't gross margins go higher? And what I would like to say is we've put out this target of a 65% non-gap gross margin and 40% non-gap operating margin is kind of what we'd like to achieve through cycle and drift above that in the good times of the cycle and hopefully not drift too far below that when times are more difficult in the cycle. And we believe we'll be able to do that through proper inventory management, which we weren't able to achieve in the last cycle, but I think we're set up well to be able to do that. So margins are really healthy today. I think you also have to see that we're in competitive markets. Our margins compared to most of our peers are quite high, And we want to make sure that we are pricing our products appropriately in the marketplace where we can gain share and drive operating margin dollar improvement as fast as we can.

Atif Malik, Analyst — Citi

Awesome. Let's talk about the data center market. We, the salesciders, appreciated you guys kind of breaking out data center revenue, expected to grow 69% to around $1 billion this year, about 17% of sales. So we appreciate all the exercise you went to count all the parts that participate in the data center market. If you can just help us understand why you're seeing such a strong inflection and hopefully separate the general purpose data center from AI.

Eric Bjornholt, CFO

Yeah. OK. So, you know, we used to break out end markets only once a year. And now we have moved to be able to do that on a quarterly basis, which investors have been asking for. We also used to combine data center and compute together, and we've broken those out separately. And compute's only about 3.5% of the overall business. So with that, we broke the data center into two different categories. We have a specific business unit called Data Center Solutions, which purely focuses on products that service the data center market. And that business is growing nicely this year. We'll end this year at about $500 million in revenue for the calendar year. And within that, we've got our PCI Gen 3, 4, 5, 6 products. We've got our recently introduced retimer products. We've got storage controllers, and we've got memory controllers. So those are pure play data center products. We have another section of what we'd call our standard product portfolio, whether it's microcontrollers, analog, timing, security, et cetera, that sell into the data center market. We also expect that business to be about $500 million in calendar 26. And those two combined are going to grow about 69% this year. So we've given that breakout. That's a breakout that you will continue to see on a quarterly basis on an end market perspective. And we're excited about the gross possibilities within that end market for microchips.

Atif Malik, Analyst — Citi

Eric, you mentioned the PCI products. So we were at the Hot Chips Conference a couple of weeks ago. and we certainly heard a lot of buzz around the PCIe Gen 6 design wins. You guys, I think, spoke about 14 design wins and 100 million opportunity at least at one program in 27. So just on the PCIe switch and retimer market, how do you see the opportunity? What is your market share right now? If you can just give an assessment on, like, are there multiple hyperscalers that you're engaged and where is the momentum coming from?

Eric Bjornholt, CFO

Okay. So I think you summarized it well. We have 14 design wins on Gen 6 so far. 12 of those are on PCIe, and two of them are retimer. We've sized that market in 2030 based on external sources at about a $10 billion opportunity on PCIe and about $2 billion on retimers. We're relatively small players today. Back in Gen 3 and Gen 4, we had a pretty heavy footprint in PCIE. In Gen 5, we missed the market opportunity. We were very late to market. We had done some internal development, and we're working to develop our own certies, and we were just late to market. We were like 18 to 24 months late. Because of that, we missed out on a lot of the large opportunities when that market was really taking off. So now we're reentering with a very competitive product in Gen 6. We are the only Gen 6 PCIe product that is on three nanometer. That's with TSMC. Customer reaction to that product is very good and what it can provide from a power consumption savings standpoint. And we're excited about the opportunities and we're targeting hyperscalers, enterprise ODMs, et cetera, with these products, but we haven't really broken out any specific customers. We did mention that one opportunity that you mentioned was about $100 million annually in calendar 27. I should point out that there's really no revenue from PCIe Gen 6 and retimers in the calendar 26 forecast that we provided of a billion dollars of total data center as these design wins are really coming to production next year.

Atif Malik, Analyst — Citi

All right. Just stepping back and looking at the total data center opportunity, ADI has discussed an opportunity of roughly 1 billion to 1.5 billion of analog content per gigawatt of AI infrastructure deployment. Given your differentiated exposure to timing, power management, connectivity, PCIe fabric, is it fair to frame that your content opportunity per gigawatt is larger than that number?

Eric Bjornholt, CFO

So we don't look at it in that way. I think maybe our power opportunity is a little bit less than what ADI has just based on the mix of the portfolio that we have. We more tend to tie the growth of kind of our standard products that are going into that data center market more tied to hyperscaler CapEx growth, which is a big number. But we haven't tied it to gigawatts or per blade or anything like this that some of our competitors have. Okay.

Atif Malik, Analyst — Citi

Let's talk about the aerospace and defense. Sales doubled from $600 million in 2022 to roughly $1 billion today. what's driving your share gains in the market, and where do you think your portfolio is most differentiated?

Eric Bjornholt, CFO

So we have a very rich history in the aerospace and defense market. A lot of this business came to us through the Micro Semi acquisition back in 2018, where they brought us all sorts of products that are radiation tolerant, radiation hardened, have really high reliability, and things that make you successful in those markets. And we've expanded on that, continued to invest over the course of the last eight years. That business was pretty steady through the down cycle. It did experience a little bit of the down cycle, but held a lot steadier. And so it jumped, I think, from fiscal 24 to 25, from like 11% of the business to like 17% of the overall business. So with all that's happened around the world with the conflict and whatnot, you know, the armaments have been really depleted. And so we think we have a multi-year cycle in front of us as those things get rebuilt. And we are really the largest supplier to the Department of Defense of semiconductor products today. And it's not just U.S., but with NATO's increased investment, the NATO country's increased investment in defense, I think Microchip is really well positioned for multi-years of growth here.

Atif Malik, Analyst — Citi

I know you guys don't break out within aerospace what is like satellite or LEOs, but when you look at what SpaceX, you know, plans to do, can you kind of expand on your exposure to the satellite and the terrestrial side of things?

Eric Bjornholt, CFO

So you're right, we don't break it out. What we say is of the aerospace and defense business, defense is the largest, followed by space, followed by commercial aviation, and they all have, you know, various growth drivers behind them. You know, we historically, with the micro semi business that I mentioned, have been more kind of deep space versus low orbit but we have products that absolutely can play there and we're known because we're known for the reliability and the radiation tolerant and hardened products i think we are kind of go-to for certain customers in terms of who they want to utilize for these products so we're well positioned some of the lower orbit guys are using more automotive and industrial grade type products and just putting redundancy in place but we play well there also So we've got good exposure that is growing and view that as a nice opportunity for us.

Atif Malik, Analyst — Citi

Great. Let me pause here and see if there are any questions in the audience. If you have a question, please raise your hand. Right. Let's keep going. Eric, there has been a kind of string of M&A activity in the physical AI edge, AI space on synaptics. Then, you know, ADI, I think there was some news today. and you guys made an acquisition of Haleo. So my question is really around the strategic rationale behind acquiring a Tuck-in type Haleo acquisition. And is edge AI and physical AI really the next phase of AI deployment?

Eric Bjornholt, CFO

Yeah, so when Steve Sangy came back to Microchip 18, 21 months ago, we formed a separate product division that we called AI ML or AI on the edge. and we have been working on new products in that area we are excited about this halo acquisition it hasn't closed yet so we're probably not going to talk in depth about it but we actually had some of the halo management participate in our annual master's conference which we hold in arizona in the middle of august where nobody wants to come to arizona in august but the engineers do because they get training on the products and the feedback from customers and distributors was really positive. And we think this accelerates our product roadmap in that product division by three to five years. So we're excited about the opportunity. There'll be more disclosure on that once the deal closes later this month and definitely on our next earnings call.

Atif Malik, Analyst — Citi

Okay. But is there something structurally you're starting to see across with the AI model companies or there's a lot of discussion on wearables using AI? Is it something that you think that The ball is going to be here in three years, five years, or are you starting to see some action from your customers?

Eric Bjornholt, CFO

We are starting to see action from customers today that they're asking for these types of products. And again, Halo is going to accelerate our product roadmap pretty significantly. Feedback that we've recently got from customers about the acquisition is very good, and we'll be integrating our teams together. Halo brings a lot of very talented engineers to us, and we're excited, and there'll be more to come on that in future earnings calls.

Atif Malik, Analyst — Citi

Sounds good. Then just broadly speaking on the capital allocation, obviously, the AI data center opportunities are once in a lifetime kind of an event. Is that changing your kind of capital allocation strategy across dividend and token acquisitions and all those sort of things?

Eric Bjornholt, CFO

So it's really not. We've been very focused on getting the balance sheet right after the depths that we went through in the last cycle, and leverage has come down significantly. We've started to pay down the debt on the balance sheet, and that is going to continue to be the focus, is keeping the dividend flats where it's at for a period of time. I believe that we will end the current quarter with a net debt to EBITDA of under two and So heading in the right direction, but we want to take it lower, and the board is focused on that, getting it much lower before we start back doing any stock buyback or increasing the dividend. And we have plenty of capital available to us if these small tuck-in acquisitions continue to come up, whether it's Halo or something else, and we'd be willing to do that. But you should not view Microchip as doing some mega scale acquisition at this point in time that's more transformative in nature. There'll be tuck-ins to help accelerate product roadmaps.

Atif Malik, Analyst — Citi

And then the topic around China, it doesn't come up as much, but are you seeing increased competition in China? Is there a threat from domestic competitors in China? And just comment on your China sales. Are they growing kind of in line with the rest of the market?

Eric Bjornholt, CFO

Yeah, they really are. I think our China revenue is like 17%, 18% of revenue, and it's been pretty consistent at that level recently. There is some increase in competition, but the bottom line is customers want to design with Microchip because we've got high-quality products, good support, track record of support, having inventory in place for them, and they don't want to change. So we're going to continue to support those customers. Longer term, will competition continue to increase? It probably will. And with that, we're deploying resources throughout the world in areas that we think is going to give us the biggest return on those investments, whether that's in India or other emerging markets.

Atif Malik, Analyst — Citi

And then I think you guys, I mean, when Steve puts his focus in mind on fixing things, he does it. And we've seen that he's delivered on those multi-point program that he's talked about. But from here onwards, where are the priorities for Steve? You guys have gotten to your gross margin, healthy level, and you're trying to get more supply going, and the market is super strong. So what is his focus from here onwards?

Eric Bjornholt, CFO

Yeah, so I mean, we are pretty much done with the nine-point plan. We aren't quite at the operating margin level yet, but we're very close. We'll be there very shortly. So you can almost consider that plan being done. And he is really focused on day-to-day execution, right? Product lines, making sure the investments are being made in the right areas are going to drive growth for us, making sure we're managing capacity appropriately, whether that's internal capacity, external capacity, focusing on customers and, you know, growing the business. So, you know, doing the normal things that a CEO does. But, you know, the very difficult work that he laid out when he first came back is really completed at this point in time.

Atif Malik, Analyst — Citi

Sounds good. Let me see if there's questions in the audience before we wrap it up. One second, let's get the mic on.

Speaker 2

You talked about the design wins in PCI Retimer. How should we think about that translating to revenue?

Eric Bjornholt, CFO

So those design wins, there's really nothing happening in the short term. It's more calendar 27 and calendar 28 for all of the PCI wins that we talked about, both Retimer and the switch.

Speaker 2

And is there a market share aspirations to size the market to be roughly about $12 billion?

Eric Bjornholt, CFO

So we have our internal aspirations. It's a large market. We have a long ways to go. And that's not something that we're going to disclose publicly. But we're going to go after every customer that we can and grow the business as quickly as possible.

Speaker 2

Is the fact that you were in PCIU 5 an impediment to you getting share? or because you were strong in PCIe 3 and 4?

Eric Bjornholt, CFO

So we are well-known from the customer base because we've been around in that market for quite some time. This is another business that came to us through MicroSemi, and it was their acquisition of PMC Sierra years ago. Very strong in Gen 3 and Gen 4. And it's not that the Gen 5 product is bad. It was just late to the market, right? And that does stick with customers. So we have customer repair and kind of prove it to me that we need to do, that we are going to be on time with our products in the future. And I think our Gen 6 PCIe switch product is proof of that to customers, but we have to say, hey, this is what we're doing with Gen 7 and this is what our goals are from a timing perspective and then we have to hit those goals. So it's a continuous process. Just because we have a really good product on Gen 6 doesn't mean we're going to win. We have to go out and continue to execute.

Speaker 2

Thank you.

Eric Bjornholt, CFO

You're welcome.

Atif Malik, Analyst — Citi

All right, we can wrap it up here, Eric. Thank you for coming to the Citi Conference.

Eric Bjornholt, CFO

Thanks for having me.