Microchip Technology Q3 2022 Earnings Report

Microchip Technology EPS Results

• Actual EPS: $1.11
• Consensus EPS: $1.08
• Beat/Miss: Beat by +$0.03
• One Year Ago EPS: $0.72

Microchip Technology Revenue Results

• Actual Revenue: $1.76 billion
• Expected Revenue: $1.75 billion
• Beat/Miss: Beat by +$11.81 million
• YoY Revenue Growth: N/A

Microchip Technology Announcement Details

• Quarter: Q3 2022
• Date: 2/3/2022
• Time: After Market Closes
• Conference Call Date: Wednesday, February 2, 2022
• Conference Call Time: 9:15PM ET

Microchip Technology (NASDAQ:MCHP) (NASDAQ: MCHP) develops and manufactures semiconductor products for embedded control and connected applications. Its portfolio includes microcontrollers, microprocessors, analog and mixed-signal devices, power-management products, timing and connectivity solutions, memory products, field-programmable gate arrays (FPGAs), and security components.

The company also provides development tools, software, reference designs, and technical support that help customers design and integrate embedded systems. Its products are used across automotive, industrial, aerospace and defense, communications, computing, consumer, and other markets, with operations and customers spanning global geographies.

Microchip was formed in 1989 after the semiconductor business of General Instrument was spun off. The company is headquartered in Chandler, Arizona. Steve Sanghi, who previously served as Microchip’s longtime chief executive and executive chairman, returned to the chief executive role on an interim basis following Ganesh Moorthy’s retirement.

Microchip Technology Q3 2022 Earnings Call Transcript

Key Takeaways

• Record Q3 Results: Revenue rose 6.5% sequentially and 30% year-over-year to $1.76 billion, with non-GAAP gross margin at a record 66.1% and EPS of $1.20.
• Supply Constraints Persist: Record unsupported backlog and ongoing factory and supply challenges mean Microchip expects to remain supply-constrained through 2022 and potentially beyond.
• Cash Generation & Debt Paydown: Free cash flow reached a record $762.7 million (43.4% of sales), funding a $362.7 million debt reduction and driving net leverage down to 2.58.
• Investment Grade & Capital Return: Achieved investment-grade ratings, reduced convertible debt from $4.48 billion to $903 million, and returned 50% of free cash flow to shareholders through dividends and buybacks.
• Capacity Expansion: Plans $390 – 400 million in fiscal 2022 CapEx and is acquiring an assembly-test facility in the Philippines to boost internal manufacturing capacity.

Presentation

[Operator]

Good day, everyone, and welcome to Microchip's Q3 fiscal 2022 financial results. As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Microchip's Chief Financial Officer, Mr. Eric Bjornholt. Please go ahead, sir.

[Eric Bjornholt, CFO at Microchip Technology]

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 Ganesh Moorthy, Microchip's President and CEO, Steve Sanghi, Microchip's Executive Chair, and Sajid Daud, Microchip's Head of Investor Relations. I will comment on our Q3 fiscal year 2022 financial performance.

[Eric Bjornholt, CFO at Microchip Technology]

Ganesh will then provide commentary on our results and discuss the current business environment as well as our guidance, and Steve will provide an update on our cash return strategy. We will then be available to respond to specific investor and analyst questions. We are including information in our press release 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 for our website at www.microchip.com and included reconciliation information in our press release, which we believe you will find useful when comparing GAAP and non-GAAP 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.

[Eric Bjornholt, CFO at Microchip Technology]

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 press release. Net sales in the December quarter were $1.76 billion, which was up 6.5% sequentially and up 30% compared to the December quarter of fiscal 2021. We have posted a summary of our GAAP net sales by product line and geography, as well as our total end market demand on our website for your reference. On a non-GAAP basis, gross margins were a record at 66.1%, and operating income was a record 44.6%. Non-GAAP net income was a record $681.7 million.

[Eric Bjornholt, CFO at Microchip Technology]

Our non-GAAP cash tax rate was 6.7% in the December quarter. Non-GAAP earnings per diluted share was at the high end of our guidance and was a record $20. On a GAAP basis in the December quarter, gross margins were a record at 65.6% and include the impact of $8.4 million of share-based compensation expense. Total operating expenses were $638.3 million and include acquisition intangible amortization of $215.7 million, special income of $0.3 million, $3.2 million of acquisition-related and other costs, and share-based compensation of $42.5 million.

[Eric Bjornholt, CFO at Microchip Technology]

GAAP net income was $352.8 million, or $0.62 per diluted share, and was negatively impacted by the GAAP loss on the convertible debt exchanges we executed in the quarter, which were not included in our guidance. Our December quarter GAAP tax expense was impacted by a variety of factors, most notably the tax expense recorded from truing up estimated taxes to actual amounts based on tax returns filed during the quarter. Our inventory balance at December 31, 2021 was $768.2 million. We had 116 days of inventory at the end of the quarter, which was up 4 days from the prior quarter's level.

[Eric Bjornholt, CFO at Microchip Technology]

Our levels of raw materials and work in progress increased in the quarter, which helps position us for increased production we are expecting from our internal factories and helps buffer us against unexpected shortages or changes in material lead times. The days of inventory on our balance sheet go up with our gross margin improvement, with each 100 basis points of gross margin improvement translating into approximately two to three days of increased inventory on our balance sheet. The carrying cost of our inventory has been and will be increasing due to rising input costs from our supply chain. We are continuing to ramp capacity in our internal and external factories so we can ship as much product as possible to support customer requirements.

[Eric Bjornholt, CFO at Microchip Technology]

Inventory at our distributors in the December quarter was at 19 days, which is a record low level and in line with where it was at the end of the prior quarter. During the December 2021 quarter, we achieved the milestone of becoming an investment grade rated company. This is a goal we have been pursuing since we acquired Microsemi in May of 2018, and it positions us well for our capital return strategy that we detailed for investors at our Investor and Analyst Day back in November. In the December quarter, we exchanged a total of $96.2 million of principal value of 2025, 2027, and 2037 convertible subordinated notes for cash and shares of our common stock.

[Eric Bjornholt, CFO at Microchip Technology]

We used cash generation during the quarter to fund the principal amount of the convertible debt exchanges, and we believe that these transactions will benefit stockholders by significantly reducing share count dilution to the extent our stock price appreciates over time. The principal amount of convertible debt on our balance sheet at December 31st was $903 million, compared to $4.481 billion at the beginning of calendar 2020, putting our overall capital structure in a much better long-term position. During the December quarter, we also refinanced a revolving line of credit to be in line with our investment-grade rating and decrease the size of that facility from $3.6 billion to $2.75 billion. Our cash flow from operating activities was a record $853.4 million in the December quarter.

[Eric Bjornholt, CFO at Microchip Technology]

Our free cash flow was a record $762.7 million, 43.4% of net sales. As of December 31st, our consolidated cash and total investment position was $315.5 million. We paid down $362.7 million of total debt in the December quarter. Over the last 14 full quarters since we closed the Microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down almost $4.8 billion of the debt and continue to allocate substantially all of our excess cash beyond dividends and stock buyback to bring down this debt.

[Eric Bjornholt, CFO at Microchip Technology]

We have accomplished this despite the adverse macro and market conditions during the earlier years of this period, which we feel is a testimony to the cash generation capabilities of our business as well as our ongoing operating discipline. We continue to expect our debt levels to reduce significantly over the next several years. Our adjusted EBITDA in the December quarter was a record $869.4 million and 49.5% of net sales. Our trailing twelve-month adjusted EBITDA was also a record at $3 billion and 46.5% of net sales. Our net debt to adjusted EBITDA was 2.58 at December 31st, 2021, down from 2.99 at September 30th, 2021.

[Eric Bjornholt, CFO at Microchip Technology]

Our dividend payment in the September quarter was $128.7 million, and we repurchased $166 million of stock during the quarter. Capital expenditures were $90.7 million in the December quarter. Our expectation for the March 2022 quarter's capital expenditures is between $135 million and $145 million. Our capital expenditures for fiscal 2022 are expected to be between $390 million and $400 million. As a reminder, our fiscal year 2021 capital expenditures came in lower than originally planned due to longer equipment lead times and deliveries pushing out as a result of overall industry conditions. We continue to prudently add capital equipment to maintain, grow, and operate our internal manufacturing operations to support the expected long-term growth of the business.

[Eric Bjornholt, CFO at Microchip Technology]

We expect these capital investments will bring gross margin improvement to our business and give us increased control over our production during periods of industry-wide constraints. Depreciation expense in the December quarter was $64.9 million. I will now turn it over to Ganesh to give his comments on the quarter, on the performance of the business, as well as our guidance for the March quarter. Ganesh?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Great. Thank you, Eric, and good afternoon, everyone. Our December quarter results continued the string of strong growth quarters, with revenue growing 6.5% sequentially to achieve another all-time record at $1.76 billion, breaking through the $7 billion annualized revenue milestone. On a year-over-year basis, our December quarter revenue was up 30%, registering the fifth consecutive quarter of rising year-over-year revenue growth rate. Non-GAAP gross margin was another record of 66.1%, up 80 basis points from 65.3% in the September quarter and above the midpoint of our guidance as we continue to ramp our internal factories and benefit from improved fixed cost absorption as well as product mix changes.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Non-GAAP operating margin was also a record at 44.6%, up 210 basis points from 42.5% in the September quarter and well above the high end of our guidance. The large increase in operating margin percentage was helped by the rapid growth in revenue and the additional time it is taking to hire new employees, thus delaying expected operating expenses. At 21.5% operating expenses, we're 100 basis points below the low end of our long-term model of 22.5%-23.5% in operating expenses. Our long-term business model will continue to guide our actions to enable the long-term growth and profitability of our business. Our consolidated non-GAAP diluted EPS was a record $1.20 per share at the high end of our guidance and up 49% from the year ago quarter.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Adjusted EBITDA at 49.5% of revenue and free cash flow at 43.4% of revenue were both very strong, continuing to demonstrate the robust cash generation capabilities of our business. This in turn enabled us to pay down another $362.7 million in debt, which brought down our net debt by $422.1 million, driving our net leverage ratio down to 2.58 in the December quarter. This reduction in net debt and net leverage ratio was achieved despite our also buying back $166 million of our shares under our $4 billion stock buyback program, which we initiated soon after we achieved investment-grade rating for our debt in November.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

The December quarter marked our 125th consecutive quarter of non-GAAP profitability, and I would like to thank all our stakeholders who enabled us to achieve these outstanding and record results, and especially thank the worldwide Microchip team whose tireless efforts are what made these results possible. Taking a look at our revenue from a product line perspective, our microcontroller revenue was sequentially up a strong 8.7% as compared to the September quarter and was an all-time record. On an annualized basis, our December quarter microcontroller revenue at $3.9 billion is closing in on $4 billion. On a year-over-year basis, our December quarter microcontroller revenue was up 33.9%. All microcontroller product lines, 8-bit, 16-bit, and 32-bit, had over 30% year-over-year revenue growth in the December quarter, with 32-bit microcontrollers having the highest year-over-year growth.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

8-bit microcontrollers and 32-bit microcontrollers, both of which are about the same size in revenue, each also achieved record revenue milestones. Microcontrollers represented 55.3% of our revenue in the December quarter. Coming off strong sequential growth in the September quarter, our analog revenue increased 1.9% in the December quarter, setting another record in the process. On an annualized basis, our December quarter analog revenue broke through the $2 billion mark for the first time. On a year-over-year basis, our December quarter analog revenue was up 34.3%, almost the same year-over-year growth rate as our microcontroller revenue. Analog represented 28.5% of our revenue in the December quarter. While we no longer break out our FPGA or licensing revenue, they both remain a key focus for Microchip's long-term growth.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

In the December quarter, our FPGA revenue hit an all-time record by a wide margin, and our licensing royalty revenue also hit an all-time record. Taking a look at our revenue from a geographic and end market perspective, Americas was up 4.6% sequentially. Europe was up 11% sequentially, which is significantly better than typical seasonal performance for a December quarter. Asia was up 5.8% sequentially, and all end markets were strong and supply constrained. Business conditions continued to be exceptionally strong through the quarter. Our preferred supply program, our PSP backlog, continues to grow and is well over 50% of our aggregate backlog and 100% of our backlog in the most constrained capacity product areas. Demand far outpaced the capacity improvements and increased shipments we achieved in the quarter.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

As a result, our unsupported backlog, which represents backlog customers wanted shipped to them in the December quarter, but which we could not deliver in the December quarter, continued to climb significantly as compared to the unsupported backlog exiting the September quarter. To illustrate the magnitude of the demand supply imbalance, despite our December quarter revenue having grown 30% as compared to the year ago quarter, we exited the December quarter with the highest unsupported backlog ever. We continued to experience constraints in all our internal and external factories and their related manufacturing supply chains. We are also experiencing some adverse impact from the rapid rise in the Omicron variant cases of the COVID-19 virus.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We continue to ramp our internal factories as fast as possible, and we are working closely with our supply chain partners who provide wafer foundry, assembly, test, and materials to secure additional capacity wherever possible. Looking at the magnitude of the demand supply imbalance, the size of our non-cancelable backlog, and the rate at which we're able to bring on new capacity, we continue to expect that we will remain supply constrained throughout 2022 and possibly beyond that. We believe our backlog position, especially the proportion of PSP backlog is giving us a solid foundation to prudently acquire constrained raw materials, invest in expanding factory capacity, and hire employees to support our factory ramps.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Our planned capital spending continues to rise in response to growth opportunities in our business, as well as to fill gaps in the level of capacity investments being made by our outsourced manufacturing partners in technologies they consider to be trailing edge, but which we believe will be workhorse technologies for us for many years to come. In the December quarter, we signed a definitive agreement to purchase an assembly test factory shell in the Philippines, near where we already operate our manufacturing facilities. As we facilitize and build out this shell with equipment, we will be able to grow our internal back-end capacity for many years to come. We believe our increase in capital spending will enable us to capitalize on growth opportunities, improve our gross margins, increase our market share, and give us more control over our destiny, especially for trailing edge technologies.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We will of course continue to utilize the capacity available from our outsourced partners, but our goal is to be less constrained by their investment priorities in areas where they don't align with our business needs. Now let's get into the guidance for the March quarter. Our backlog for the March quarter is very strong, and we have more capacity improvements coming into effect. However, our supply in the March quarter is expected to be adversely impacted by the COVID-19 Omicron variant, which has increased the level of factory workforce absenteeism. We also have challenges in staffing several of our factories at the rate we would like to. Taking all these factors we have discussed on the call today into consideration, we expect our net sales for the March quarter to be up between 2% and 5% sequentially.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Our guidance range assumes some capacity additions, as well as continued capacity constraints, some of which we expect to work during the quarter and others that we will carry over to future quarters. At the midpoint of our revenue guidance, our year-over-year growth for the March quarter would be a strong 24%. For the March quarter, we expect our non-GAAP gross margin to be between 66.2% and 66.6% of sales. We expect non-GAAP operating expenses to be between 21.8% and 22.2%, and we expect non-GAAP operating profit to be between 44% and 48% of sales. We expect our non-GAAP diluted earnings per share to be between $1.22 per share and $1.28 per share.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Given all the complications of accounting for our acquisitions, including amortization of intangibles, restructuring charges, and inventory write-up on acquisitions, Microchip will continue to provide guidance and track its results on a non-GAAP basis, except for net sales, which will be on a GAAP basis. We believe that non-GAAP results provide more meaningful comparison to prior quarters, and we request that analysts continue to report their non-GAAP estimates to First Call. Finally, at our Investor Day on November eighth last year, we unveiled our Microchip 3.0 strategy, which builds on our Microchip 2.0 strategy that we successfully executed over the last decade, employing serial acquisitions to give us a solid foundation to build scale and breadth of solutions while significantly improving our gross and operating margin model.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

To summarize, the essential elements of Microchip 3.0 we announced were an organic growth target of 2x the industry growth by focusing on total system solutions and the six key market megatrends. Long-term non-GAAP operating margin target of 44%-46% and free cash flow target of 38%. Increase capital return to shareholders to 50% of free cash flow and further increase this every quarter to return 100% of free cash flow to shareholders as net leverage drops to 1.5x. Increase our CapEx investment to 3%-6% of revenue and invest in 130-150 days of inventory over the business cycles. Finally, to maintain a strong company foundation built on culture and sustainability. As you can see from our December quarter results and the March quarter guidance, we are laser-focused on executing our Microchip 3.0 strategy. Let me now pass the baton to Steve to talk more about our capital return to shareholders. Steve?

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

Thank you, Ganesh, and good afternoon, everyone. Today, I would like to reflect on our financial results announced today and provide you further updates on our capital return strategy. Reflecting on our financial results, I continue to be very proud of all employees of Microchip that have delivered another exceptional quarter in making new records in many respects. Namely, record net sales, record non-GAAP gross margin percentage, record non-GAAP operating margin percentage, record non-GAAP EPS, record cash flow from operations, and record adjusted EBITDA. The board of directors announced an increase in the dividend of 9.1% from last quarter to $0.253 per share. This is an increase of 29.7% from a year ago quarter. Last quarter, we received an investment-grade rating from both Moody's and Fitch.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

After receiving such rating, we initiated our enhanced capital return strategy that we described at our Investor and Analyst Day on November 8th, 2021. During the last quarter, we purchased $166 million of our stock in the open market. We also paid out $129 million in dividends. Thus, the total cash return totaled $295 million. This was 50.1% of our free cash flow projection at the start of the quarter of $589 million, consistent with us targeting 50% of free cash flow as return to our investors. However, our cash collections in the final month of the quarter were exceptional due to a very strong and linear shipping quarter and record non-GAAP growth and operating margins and record adjusted EBITDA being well above our forecast.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

Our actual free cash flow last quarter was $763 million, which was $174 million higher than our projection. Towards the end of the quarter, the stock buyback window had already closed, so we used the extra free cash flow towards further paying down the debt. This extra pay-down of debt, as well as record adjusted EBITDA, drove down our December net leverage to 2.58 from 2.99 at the end of September. Our strategy for cash return to the shareholders was to execute it based on forecast and then true up in the following quarter because of the unpredictability of the free cash flow, we are simplifying the process.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

Going forward, we will use the actual free cash flow for the prior quarter and return our target percentage of that free cash flow to shareholders in the current quarter. Based on this revised process, we will use our last quarter's actual free cash flow of $763 million. This quarter, we plan to return 52.5% of this $763 million, which is $400 million, to the shareholders. Out of this $400 million, the dividend is expected to be approximately $141 million, and the stock buyback is expected to be approximately $259 million. I will also like to note that on January 13th, 2022, Moody's further raised Microchip's unsecured debt credit rating from prior Baa3 positive to the current Baa2 positive. As Moody's Baa2 rating is equivalent to BBB on the rating scale of S&P and Fitch. With that, operator, will you please poll for questions?

[Operator]

Absolutely. Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Due to time constraints and in order to accommodate as many questions as possible, we do ask that you please limit yourself to one question before reentering the queue. Once again, that's star one if you'd like to ask a question. We'll take our first question from John Pitzer with Credit Suisse.

[John Pitzer, Managing Director, Global Technology Strategist, and Semiconductor Analyst at Credit Suisse]

Yes, good afternoon, guys. Thanks for letting me ask a question. Ganesh, just relative to the supply issues that you're seeing in the March quarter, any way to quantify that? As you think about the balance of the year, do you have enough visibility of backlog and scheduled supply growth to make the argument that you should be able to grow sequentially every quarter in the calendar year 2022?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

The supply issues in the March quarter are comprehended in our guidance. There's nothing more to say other than we are working through it. They're just natural issues that come with COVID and some of the disruptions that happen with it. Our backlog position, as I mentioned, is extremely strong. We have much of 2022 backlog already on the books. Really it's bringing supply on that we expect will continue to drive the growth. There's no shortage of demand that we're working on. Every quarter, we continue to leave more of the backlog that is unsupported has happened five quarters in a row. If you look at the size of the imbalance, the size of the non-cancelable backlog, the rate at which we're bringing on new capacity, we expect we're going to be constrained throughout 2022.

[John Pitzer, Managing Director, Global Technology Strategist, and Semiconductor Analyst at Credit Suisse]

Thank you.

[Operator]

Thank you. We'll take our next question from Pradeep Ramani with UBS.

[Pradeep Ramani, Analyst at UBS]

Hi, thanks for taking my question. I just wanted to follow up on the prior question. In the past, you talked about visibility being solid for four quarters of sequential growth. How should we interpret your comments, that you just made in terms of whether you have that visibility now, both in terms of demand and supply?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We have visibility in terms of demand that exceeds four quarters. We have supply coming on every single quarter. we're trying to guide you a quarter at a time, but at this point, there is no demand signal that has any concern for us. The PSP backlog makes it all non-cancelable. That's a very high percentage of our backlog. Some of the PSP backlog is going well beyond 12 months at this point in time. It's really a supply-driven equation for at least all of 2022 and likely into 2023.

[Pradeep Ramani, Analyst at UBS]

Thank you.

[Operator]

Thank you. We'll take our next question from Gary Mobley with Wells Fargo Securities. Gary, we're unable to hear you. Please check your mute function.

[Gary Mobley, Senior Analyst at Wells Fargo Securities]

Apologize for that. Thanks for taking my question, guys. As your unshipped backlog continues to grow each and every quarter, I'm presuming that you're having to make tough decisions with respect to supporting perhaps or not supporting some lower margin products in the strategy for maximizing the mix and whatnot. Longer term, does that deferred product shipment go into backlog? Is it temporarily or permanently lost? What are the long-term considerations in terms of mix contribution from the supply constraint environment that we're in?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Well, a constrained environment clearly gives us an opportunity to richen the mix and use the capacity we have. You can't just be short-term oriented in that. You have to look at who the customers are, what markets they're in, what the long-term prospects are that go with them. As demand goes unfulfilled in any quarter, it remains, for the most part, non-cancelable backlog. Anything in 90 days with or without PSP is already non-cancelable. What we do is we just squeeze out some into the following quarter, some into the quarter after that. Capacity is coming on, and we're able to respond to some of it with that. There could be on the fringes some of the demand that eventually does not materialize. The vast majority of the backlog stays as non-cancellable backlog, but serviced at a later point in time.

[Eric Bjornholt, CFO at Microchip Technology]

The biggest decision maker now in terms of what we're shipping is based on the PSP backlog that we've had in place and how long it's been in place.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

I think, Gary, your question was more like, are we not shipping the low margin backlog, and when we eventually ship, is that a negative to gross margin? I think operations don't know what the gross margin is. They look at units and backlog and dollars, and they ship and allocate. There's a much lower level of emphasis to not ship the low margin backlog. It's much more to do with who the customer is, what the market segment is, who the strategic accounts are. We're shipping the PSP backlog and constraining the non-PSP backlog. I think your concern is really not well-placed there.

[Gary Mobley, Senior Analyst at Wells Fargo Securities]

All right. Thank you, Steve.

[Operator]

Thank you. We'll hear next from Toshiya Hari with Goldman Sachs.

[Toshiya Hari, Managing Director and Senior Equity Research Analyst at Goldman Sachs]

Hi, thank you so much for taking my question. I wanted to get your thoughts on industry supply demand. Clearly, as of today and as you guys say, for the rest of the year, things most likely stay very tight. At the same time, you're seeing pretty significant increases in CapEx from most players, including yourselves, your peers, with capacity coming online late 2022 and definitely into 2023. Is it way too early to be concerned about supply demand going into 2023, or how do you think about that internally, and what would you need to see for you to pump the brakes on CapEx decisions? Thank you.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

After five quarters and now into the sixth quarter, there's really no line of sight to having demand-supply coming back into some form of a equilibrium. The gap between demand and supply, despite adding supply, continues to grow. We know that's not a permanent factor, but it is at this point in time. Demand continues to be strong. Every customer I speak to every CEO that expresses their needs, continues to see strength in their business is in fact, many, many of them wanting to go into something more of non-cancelable nature into 2023, in many cases into 2024, as they see their business. There are many, many factors driving semiconductor growth beyond the short-term supply-demand.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

There are secular factors that we've talked about with the mega trends with how digitization is taking place. At some point, it will have a supply-demand balance that does occur. We don't see it in 2022. We don't see it in our numbers that we see for 2023 at this point.

[Toshiya Hari, Managing Director and Senior Equity Research Analyst at Goldman Sachs]

Thank you.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

You're welcome.

[Operator]

Thank you. We'll take our next question from Vivek Arya with Bank of America Securities.

[Vivek Arya, Analyst at Bank of America Securities]

Thanks for taking my question. Ganesh, I wanted to ask this supply-demand question in a different way. Can you increase supply every quarter for the next three or four quarters, obviously barring any macro issues? Because if you can increase supply and demand is not an issue, then growing sales every quarter should be doable, or what part of that equation am I missing?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We are absolutely increasing capacity every single quarter. You're not missing any part of that equation.

[Vivek Arya, Analyst at Bank of America Securities]

Got it. That's what I wanted to confirm because I thought there was some confusion that, are you still sticking with the potential for improving revenue every quarter, all else being equal?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We're driving in that direction. We got plenty of demand, so demand side is not the issue, capacity is. We are building capacity that will continue to grow, throughout 2022 and into 2023. We're trying to provide you more, general direction of where are we going, without trying to make this an every quarter, what are we trying to do. Clearly the guidance we're providing specifically is for this quarter. The demand supply equation driven by the demand we have, the supply we're bringing on continues to have many quarters of legs.

[Vivek Arya, Analyst at Bank of America Securities]

Got it. Thank you, Ganesh.

[Operator]

Thank you. We'll take our next question from Harlan Sur with J.P. Morgan.

[Harlan Sur, Analyst at JPMorgan]

Good afternoon and congratulations on the solid results and execution. Over the past earnings season, all three of the large U.S.-based semi equipment suppliers have been coming up a bit short on shipments to their customers because they're being constrained by component availability, logistics, and labor issues and well, and they all expect to slightly undership their customers' manufacturing requirements, at least through the first half of this year. I'm wondering if this is maybe slowing your ability to improve your internal front-end wafer capacity or even capacity plans by your outsourced wafer fab partners, maybe just a little bit versus what you expected maybe 60-90 days ago.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

It is true that equipment in general, and we've been saying this on prior calls as well, lead times have been stretching. Some part of that is just the equipment manufacturer's imbalance between supply and demand. Some of it is semiconductor shortages that feed into the equipment that is built for semiconductor manufacturers. Yes, our lead times for receiving equipment have continued to stretch.

[Harlan Sur, Analyst at JPMorgan]

Thanks, Ganesh.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

You're welcome.

[Operator]

Thank you. We'll take our next question from Harsh Kumar with Piper Sandler.

[Harsh Kumar, Analyst at Piper Sandler]

Hey, guys. A lot of people have asked about supply. I wanted to ask a question about demand. This is the fifth of the sixth quarter, Steve and Ganesh, of exceptional demand. I understand at the beginning of the COVID-19 timeframe, there was some particular, mismatch, but can you help us understand what is fundamentally going on with the end markets that this demand continues to strengthen and now you're looking at a year's worth, years plus worth of non-cancelable orders? Help us with that, if you don't mind.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Demand in all geographies, in all end markets, continues to be strong, and I think they're driven by different requirements, and at different times. If you take automotive, some of it was shortages, and then as they have tried to solve some of the shortages, there's content, and there's a richening mix of the cars that is driving consumption of semiconductors. You take office automation, there was the return to the work from home at first, and now there's some amount of returning to the office and what needs to be done. Segment by segment, when you go into that, what we find is that the demand drivers, some of those are the mega trends we have talked about.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Some of that is still catch-up demand that people are trying to put in place. Demand continues to be extremely strong, as reflected in the bookings we see, the backlog we have, the period of time over which people are willing to place backlog, and the percentage that they're willing to have as non-cancelable.

[Harsh Kumar, Analyst at Piper Sandler]

Appreciate it, guys. Thanks.

[Operator]

Thank you. We'll hear next from Tore Svanberg with Stifel.

[Tore Svanberg, Analyst at Stifel]

Thank you, and congratulations on the results. One of your competitors just had a call this morning, and they're talking about some pretty big CapEx numbers, basically regardless of the economic climate. I'm just wondering philosophically, as you think about your capacity additions over the next few years, it does sound like, the plans are a bit more measured. Then also, do you have a CapEx number for fiscal 2023? Thank you.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We don't have a CapEx for fiscal 2023, if that was your question. We will share some of that when we have a May call itself. CapEx decisions are long-term decisions. They're not driven by just, what does the next calendar year look like. It's decisions about capacity that we want to be able to serve a 5-10-year window of time as we look at it. Perhaps we have been more measured, and we do want to be, thoughtful in what capacity and what capital we are bringing online.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We have also been aggressive over the last year, as you have seen in the level of capital expenses that we have put in the raising of the CapEx targets that we have had, into capacity that we believe is long-term good capacity for Microchip to have, both to be able to serve customers, but also to be able to replenish some of the inventory we think we need to, as some level of normalization in demand and supply come about.

[Tore Svanberg, Analyst at Stifel]

Thank you.

[Eric Bjornholt, CFO at Microchip Technology]

As Ganesh says, we're not going to give you a fiscal 2023 capital plan today. We'll put that together as part of our annual operating plan process we go through this quarter. I think investors should expect that, given the environment that we're seeing, our intention to increase the percentage of manufacturing that we do internally, that CapEx will continue to be on the high end of our guidance that we've given on a long-term basis next year, and we'll give you a more firm number next quarter.

[Tore Svanberg, Analyst at Stifel]

Sounds good. Thank you, Eric.

[Operator]

Thank you. We'll hear next from William Stein with Truist Securities.

[William Stein, Analyst at Truist Securities]

Great. Thanks for taking my question. I'll add my congratulations to the very strong execution. There's a comment in the press release that I don't know if you've touched on during this discussion. I don't quite understand. I certainly understand we're capacity constrained. Microchip is, the whole industry is. Demand's very strong. Revenue's going up next quarter. I think the press release noted that inventory days you expect to increase next quarter. Are you building inventory for product that has demand in future quarters that just happen to not be required to be delivered during Q1, or is it WIP versus finished goods? Can you help me understand that? Thank you.

[Eric Bjornholt, CFO at Microchip Technology]

Yes. We're ramping our factories. We're seeing input costs increase through the supply chain, and all those things are impacting our costs. We demonstrated in our analyst and investor day that we want to increase the days of inventory in the balance sheet to be able to better support customers. Raw materials, work in process is absolutely going up. Input costs continue to rise, and we're positioning ourselves to be able to continue to grow the business, as Ganesh has described before.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

If we can build it, we're shipping it. We're not trying to build inventory and hold shipments back. Clearly there's more WIP, work in progress. There's more materials that we're going to need. We're in a growing environment, so what we have to have internally is to be able to feed forward-looking demand, not just backward-looking demand.

[Eric Bjornholt, CFO at Microchip Technology]

Right. Also, as I mentioned in my prepared remarks, as gross margin improves, that essentially increases the days of inventory on the balance sheet, just the way the math works there.

[William Stein, Analyst at Truist Securities]

Yes, I understand. Great. Thanks, guys.

[Operator]

Thank you. We'll take our next question from Christopher Danely with Citi.

[Christopher Danely, Managing Director and Semiconductor Lead Analyst at Citi]

Hey, thanks, guys. Sequential revenue growth is slowing down a little bit. You said that there's some Omicron issues and other hiring issues. Assuming that gets fixed in the March quarter, does that mean that revenue growth should accelerate in the June quarter? Will you be able to start to catch up and maybe try and reduce this unsupported backlog if that happens?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Chris, the limitation is not on the demand side, it's on the supply side. We're working like heck to address the supply constraints. COVID was a extra factor that we had not built into our plans. Obviously, no one knew about it until the December timeframe. We will hopefully, clear through some of that going through this quarter. There are also challenges. Earlier on, we talked about getting equipment in on time has been a challenge. Hiring all the people has been a challenge. We're running like heck. We expect that the June quarter will have more favorable capabilities, barring any unknowns in terms of where we might go.

[Christopher Danely, Managing Director and Semiconductor Lead Analyst at Citi]

Okay. Thanks, Ganesh.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

You're welcome.

[Operator]

Thank you. We'll hear next from Chris Caso with Raymond James.

[Chris Caso, Managing Director at Raymond James]

Yes, thank you. My question's on pricing, and I know, as input costs were rising last year, you were quick to pass along those price increases. Well, just three sub-questions to that. One, do you believe that the input price increases are behind us now, or is there potential for those to go higher as the year goes on? Are those price increases now fully baked into the quarterly results now that you're guiding for the March quarter? Then, at what point do we start to anniversary these price increases? I'm guessing you're not going to want to give us the magnitude of how much pricing has gone up. At what point is that no longer a factor in year-on-year comps?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Let me try and parse your three questions and see how best to answer it. Firstly, input prices for us. Our costs continue to go up. They are happening from different suppliers at different points in time with different magnitudes. What you see reflected in our COGS, our days of inventory and all that is in fact an aggregation of what is taking place every quarter. Our costs are going up and will continue to go up as we go through the year, as there are structured cost increases built into 2022. For pricing, we have done them at specific points to try and not have a price increase every time there is a cost increase on us. That will also continue at some.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

As we collect cost increases that we have incurred and pass them on as price increases to a customer. Our intention is to be able to make sure that we're able to cover the increase that we have taken on. It's hard to know in the current environment when does adjustment mechanisms that we have stop. It's an inflationary environment. We know that our suppliers are facing that inflation. They are passing on that inflation to us, there are large capital costs that they have incurred. There are large capital costs we are incurring that are building into the cost structure. The labor costs have gone up quite significantly. The material costs have gone up quite significantly. That hasn't stemmed as of yet.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

I don't know if a year from now, we might be in better times from an inflationary standpoint, but as long as that inflation is there and cost increases are passed on to us, we will pass them on as price increases.

[Chris Caso, Managing Director at Raymond James]

Yes. Very helpful. Thank you.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Great. Thanks, Chris.

[Operator]

Thank you. Once again, that's star one if you'd like to ask a question. We'll hear next from Joseph Moore with Morgan Stanley.

[Joseph Moore, Managing Director at Morgan Stanley]

Great. Thank you. I wonder if you could talk about your customer level of inventory. I know we're dealing with these shortage situations, but seems like in the past, we get into incomplete kitting where we maybe have inventory of other people's components waiting for yours. Do you have any sense for that? Are you the bottleneck component in enough of these cases that you feel pretty confident that the inventory is as lean as it looks?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We get inventory visibility through our channel because they report that on a regular basis to us. To our OEM customers, we really don't get inventory visibility. They don't report to us. We might be able to look through their balance sheets as they report them and see where it's at, but it's really not specific to us. The intensity of customer escalations has not really, backed off. Every single day, I am involved in 6 or more personally, which means that the rest of the company has, an order or two magnitudes higher than that are involved. Those are all the places where something that Microchip provides them is holding up that customer's ability to complete what they're doing.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Now, we're, of course, aware of this, what has been termed the golden screw syndrome, where customers may be building inventory on product they can get shipments of while they await shipments of the product that they need to complete the bill of materials. It's reasonable to assume there's some part of that that it would apply to us as well. Given our 90-day non-cancelable terms for standard backlog and a minimum of 12 months of non-cancelable for PSP backlog, we believe there are significant disincentives for our customers to order meaningfully more than what they need.

[Joseph Moore, Managing Director at Morgan Stanley]

Great. Thank you very much.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

You're welcome.

[Operator]

Thank you. We'll take our next question from Ambrish Srivastava with BMO.

[Ambrish Srivastava, Analyst at BMO]

Hi. Thank you. Ganesh, I had a question on tax. You mentioned that you're below the long-term target range of 22.5%-23.5%. Should we expect OpEx then to catch up to the lower end, at least to the lower end of that range as we go through the next few quarters?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

It will go slowly. You can see we topped it up in this quarter. Eric, maybe you want to talk a little bit more about how the rate at which we would do that.

[Eric Bjornholt, CFO at Microchip Technology]

Yes. I think it's very much dependent on our hiring success. We're challenged in getting the labor that we need throughout the company. That's just the market right now. We're working hard with our HR teams to make that happen. I think it's going to be a gradual increase, but the way we want you modeling long term is within our long-term model, which is 22.5%-23.5%, and we're below that this quarter.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

There's wage inflation as well, which is higher than historical, and we expect that will continue for some time.

[Ambrish Srivastava, Analyst at BMO]

Great. Got it. Thank you.

[Operator]

Thank you. We'll hear our next question from Christopher Rolland with SIG.

[Christopher Rolland, Equity Research Analyst at SIG]

Hey, guys. Thanks for the question and one for Ganesh or Steve. We are coming off of the TI update, and they're going to have somewhere between 5-8 300-millimeter fabs, which is pretty unbelievable. But do you guys worry about a flood of super efficient analog and embedded product hitting the market eventually here, I guess, first of all? They're not the only adding 300-millimeter fabs. Secondly, does this change your thinking about getting your own 300-millimeter fab to compete? Thanks.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

If you look over time, capacity has come on at different points in the industry. At this point in time, we're not feeling a particular concern about 12-inch capacity and what it might do to our analog business. We do build some analog products through our foundry partners that are on 12-inch. A 12-inch fab at some point might be in Microchip's future. It isn't one that we're looking at today. We'll just have to evaluate where the situation is and what makes sense.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Today we're focused on the technologies that we build in-house, the work that we're doing to ensure that trailing edge technology, which is really a limitation not just in our growth, but actually part of the industry's growth, is not enough investment going in to those product lines that limit, large end equipment. We want to make sure that we have our capacity well lined up to participate in that growth and help our customers as well. Do you want to add anything else to?

[Christopher Rolland, Equity Research Analyst at SIG]

Thank you.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

Well, I would just add that, based on what we know, the number of fabs being added, by the company that you named, there is going to be a period of substantial underutilization and substantial underperformance and a significant headwind to their gross margin delivered by all that cost that they have to absorb. I think, you're talking about very low-cost capacity. I think I look at it just the opposite. I think there's going to be significant cost problem for them. Not having all that, 12-inch capacity, we're making enormous gross margins. our operating margins are higher than our long-term target, almost already, right?

[Eric Bjornholt, CFO at Microchip Technology]

It's getting close to it.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

It's getting close to it. We're continuing to make further improvements with bringing test inside the technology we licensed last quarter, which we'll be producing inside. We got plenty of buttons on ourselves to push, and I'm really not concerned about somebody else's capacity coming in. I recently learned of a report that there is $150 billion of investment that would be required to bring the trailing edge capacity online for the next five years. The capacity is that much short on the trailing edge. Why? Because no foundry is putting additional trailing edge capacity. They're only putting leading edge. Trailing edge has to be done by whoever. Given that, there is not $150 billion of capital being put into trailing edge technology in the coming 5 years. I think I see this capacity to be short, as far as the eyes can see right now.

[Christopher Rolland, Equity Research Analyst at SIG]

Insightful. Thanks, Steve.

[Operator]

Thank you. We'll take our next question from Nikolay Todorov with Longbow Research.

[Nikolay Todorov, Equity Research Analyst at Longbow Research]

Thanks for giving me the opportunity to ask the question. I have a little bit more philosophical question. How would you characterize the level of trust in the supply chain between suppliers, customers, the channel? Do you think there's been damage sustained and given all the disruptions, and what impact is that potentially having?

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Trust is built over many, many years. It isn't something that you either gain or lose in the course of a short period of time, which is what I would refer to the last 6, 12 months. Trust is a function of communication, managing expectations, treating each other with respect. All of those are consistent with how, we work with our customers and we work with our suppliers in what we do. No, I don't think trust has been a thing. I think there's clearly, stress points. People are looking to grow more. We're looking to grow more. We want more. Our customers are looking to grow more. They want more.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

There's a realistic sense that we're doing the best that we can within the constraints that we have, just as our suppliers are working as best as they can within the constraints that they have. We both share some responsibility in how we manage the path going forward. I don't see any trust issues on either the customer side or the supplier side, that's an issue.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

Well, it's also a relative equation. If we were not shipping everything a customer needs, but they were getting all the product from our competitors, whenever they're designed with our competitors, then it would be a bigger problem for us in losing trust because, we're letting them down more than anybody else. But that's not the case. It's actually just the obvious opposite. Customer after customer, we are being told that despite the constraints, we have enabled their success in the last year, two years, more than the others have. Our constraints are. There are many competitors who won't even take an escalation call. They would say, "Don't bother us. There's nothing we can do. That's all we can give you."

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

At Microchip, we are on numerous calls all day, every day of the week, and taking customers' calls, explaining to them the situation, improving where we can, but giving shoulders, giving a shoulder to cry on for the customers. That empathy is helpful. I think in general, we are building trust relative to our competitors rather than destroying trust.

[Nikolay Todorov, Equity Research Analyst at Longbow Research]

Got it. Thanks, guys.

[Operator]

Thank you. We'll take a final question from Harsh Kumar with Piper Sandler.

[Harsh Kumar, Analyst at Piper Sandler]

Hey, guys. A tactical one here. Ganesh, I believe when you gave the commentary, you may not have provided any color on how you expect the segments to perform in the March quarter. I was curious if you would take a second to just give us whatever words of wisdom you can and how you expect the microcontroller analog business to perform in March.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

We don't break out our product line for each quarter in terms of the guidance. They all work together on it. Right now, all of them are supply limited. All end markets are supply limited. It's really how effectively we can bring capacity on, fight through some of the COVID issues and all of that. The demand is there in all product lines, all end markets for what we need to do and for at least many more quarters. That's really what determines what the strength is as seen in a product line or in an end market.

[Eric Bjornholt, CFO at Microchip Technology]

I think it's probably helpful to way back to-

[Harsh Kumar, Analyst at Piper Sandler]

Appreciate it, guys.

[Eric Bjornholt, CFO at Microchip Technology]

We had a few quarters last calendar year where, microcontroller analog outperformed each other, but overall for the year, Ganesh gave year-over-year numbers, they've really performed right in line with each other in terms of growth.

[Steve Sanghi, Executive Chair at Microchip Technology Inc.]

Almost exactly the same.

[Harsh Kumar, Analyst at Piper Sandler]

Got it. Okay, fair enough. Thanks, guys. Appreciate it. Congrats.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Thank you.

[Operator]

Thank you. That does conclude today's question and answer session. I'd like to turn the conference back over to Mr. Moorthy for any additional or closing remarks.

[Ganesh Moorthy, President and CEO at Microchip Technology Inc.]

Great. Well, thank you everybody for attending. We do have meetings and conferences and all that coming up in the next several weeks, and we look forward to speaking to you at some. Thank you. Good afternoon.

[Operator]

Thank you. That does conclude today's conference. We do thank you all for your participation. You may now disconnect.

Participants

Executives

• Eric Bjornholt, CFO
• Ganesh Moorthy, President and CEO
• Steve Sanghi, Executive Chair

Analysts

• Ambrish Srivastava, Analyst at BMO
• Chris Caso, Managing Director at Raymond James
• Christopher Danely, Managing Director and Semiconductor Lead Analyst at Citi
• Christopher Rolland, Equity Research Analyst at SIG
• Gary Mobley, Senior Analyst at Wells Fargo Securities
• Harlan Sur, Analyst at JPMorgan
• Harsh Kumar, Analyst at Piper Sandler
• John Pitzer, Managing Director, Global Technology Strategist, and Semiconductor Analyst at Credit Suisse
• Joseph Moore, Managing Director at Morgan Stanley
• Nikolay Todorov, Equity Research Analyst at Longbow Research
• Pradeep Ramani, Analyst at UBS
• Tore Svanberg, Analyst at Stifel
• Toshiya Hari, Managing Director and Senior Equity Research Analyst at Goldman Sachs
• Vivek Arya, Analyst at Bank of America Securities
• William Stein, Analyst at Truist Securities