Microchip Technology Inc (NASDAQ: MCHP) reported Q2 fiscal year 2027 net sales of $1.622 billion, up 9.2% sequentially and 42.2% year over year, driven by strong growth in its industrial and data center end markets. In this earnings call transcript, CEO Steve Sanghi and CFO Eric Bjornholt discuss PCIe Gen 6 design wins, the Hailo and Vorago acquisitions, extended lead times from foundry and OSAT capacity constraints, and December quarter guidance.
Operator Introduction
OPERATOR: As a reminder, this conference is being recorded. I will now turn the conference over to Eric Bjornholt, Senior Vice President and CFO. Thank you, Eric. You may begin.
CFO Eric Bjornholt’s Opening Remarks
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: 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.
We are including information in our press release and on this conference call on various GAAP and non GAAP measures. We have posted a full GAAP to non GAAP reconciliation on the Investor Relations page of our website at www.microchip.com and included reconciliation information in our earnings press release, which we believe you will find useful when comparing our GAAP and non GAAP results. We have also posted a summary of our outstanding debt and leverage metrics on our website.
Q2 Fiscal 2027 Financial Results
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.
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 the customer. 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, 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%. Total operating expenses were $603.5 million and included acquisition intangible amortization of $90.2 million, special charges of $7.9 million which was primarily driven by our activities associated with our closure of Fab 2 and acquisition related expenses, share based compensation of $62.2 million and $5.3 million of other expenses.
The GAAP net income attributable to common shareholders was $373.6 million or $0.68 per share and included a tax benefit of $0.13 per share related to a valuation 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. 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.
Inventory, Cash Flow and Balance Sheet
Our inventory balance at September 30, 2026 was $1.117 billion. We had 184 days of inventory at the end of the September quarter, which was up 9 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 lifed by our supply chain partners. 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 30, 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 Hailo.
Our adjusted EBITDA in the September quarter was $705.4 million and 43.5% of net sales.
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?
CEO Steve Sanghi on September Quarter Performance
Steve Sanghi, President and CEO – Microchip Technology: 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.
End Market Breakdown
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%.
Data Center Business and PCIe Gen 6 Design Wins
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. 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 win momentum in management networks.
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.
Organizational Update
I would like to give one more organizational update. 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. 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.
Aerospace and Defense and Security Wins
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. 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 that 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. 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.
Business Environment, Bookings and Lead Times
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, OSAT suppliers, and in our own fabs. Lead times for the majority of our standard products historically have been four to eight weeks. But now with our die inventory substantially reduced and foundry and OSAT 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 request inside the lead time, and they’re going unsupported in the quarter. We’re advising our customers to give us longer term backlog to help better match our new lead times, which vary a lot across our product lines. Our new lead times are anywhere from 6 weeks to 32 weeks.
Infrequent Items and December Quarter Guidance
Eric just explained the 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. 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. Hailo in the AI on the edge space and Vorago in the A&D space. We expect that Hailo will add about $4 million to our sales in the December quarter, and Vorago 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%. 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. 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 are 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. We expect our non GAAP diluted earnings per share to be between $0.87 and $0.95 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 poll for questions?
Question-and-Answer Session
OPERATOR: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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. Our first question comes from the line of Timothy Arcuri with UBS. Please proceed.
Timothy Arcuri, Analyst – UBS: Thanks a lot. Steve, I was wondering if you could help unpack a lot of these 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, normal seasonal, I think, in March is up 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.
Steve Sanghi, President and CEO – Microchip Technology: Yeah. So I think if you look at the last quarter, it was kinda 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 lot of the high margin bookings we received on lot of advanced products in pretty much every business segment cannot be fulfilled in this quarter. So they… Some of them are scheduled for next quarter. So as a result, I think we’re guiding the December quarter to be… It had 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 currently, we’re optimistic. We’re not giving any guidance for the March quarter. But I think some of the constraints we’re talking about are now scheduled into March quarter. We are hopeful that March quarter will be a stronger quarter.
Timothy Arcuri, Analyst – UBS: Thanks a lot. And then maybe 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 kinda size what the incremental could be from those wins, if possible, that’d be great.
Steve Sanghi, President and CEO – Microchip Technology: So we were unable to dollarize the wins. The part went into production last quarter, and we have 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 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 essentially, design a week almost.
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: 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.
Steve Sanghi, President and CEO – Microchip Technology: 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 pretty 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.
OPERATOR: Our next question comes from the line of Matthew Prisco with Cantor Fitzgerald.
Matthew Prisco, Analyst – Cantor Fitzgerald: 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.
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: So I think bookings were quite strong all the way through September. So nothing really to point out there. And then October was another good month of bookings where backlog overall backlog continue to grow. November has just been a few days, but nothing odd to report.
Steve Sanghi, President and CEO – Microchip Technology: 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 of revenue recognition last quarter, and this strange effect of when you ship the inventory to distributor, you assume there’s a certain amount of dispute price of protection on that, and then the rest of it you recognize as a revenue.
When you increase the price, then that… This deep 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 those items made it very noisy. But if you peel through all that, and we’re giving you complete visibility, 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 Hailo and $6 million from Vorago. We broke that out too. So take that out too if you like. And they will… The 2.3 will go down to maybe 1.5 or something. Versus down 4% at the midpoint.
So there is… There’s no problem in how the business is doing in. 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.
Matthew Prisco, Analyst – Cantor Fitzgerald: 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?
Steve Sanghi, President and CEO – Microchip Technology: So incrementally, we have additional capacity allocation every quarter, which will continue to provide growth. But we could use more than that. So on various different nodes, 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.
We’re not unique. I think the entire industry is seeing it. Demand is stronger than the capacity available. With 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.
The whole thing, there was just too much hot air. And if some air comes out and capacity becomes available at OSATs and foundries for broad based business, I think there is still silver lining in it.
Matthew Prisco, Analyst – Cantor Fitzgerald: Thank you.
OPERATOR: Our next question comes from the line of Joe Quatrochi with Wells Fargo. Please proceed.
Joe Quatrochi, Analyst – Wells Fargo: Yeah. Thanks for taking the question. You saw a nice acceleration in industrial demand this quarter. Was wondering if you could just talk about what you’re seeing there. And maybe just on that last line you said, how do we think about your exposure to just everything around the data center infrastructure build, maybe outside of the data hall?
Steve Sanghi, President and CEO – Microchip Technology: So I think when it comes to industrial, industrial is the broadest market segment there is. I mean, 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 it’s seeing substantial recovery from that point. And lot of new design wins in every single area, robotics, medical, process control, factories, farming, equipment, appliances, everything is growing. So it’s very, very difficult to kinda explain industrial beyond that because it’s so broad.
The second point of your question is on the data center. So we are early in the data center penetration 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… 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 our 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. And if certain data centers won’t get built, a lot of that upside is not in our forecast.
Joe Quatrochi, Analyst – Wells Fargo: Thanks. And as a follow-up, as we’re thinking about just kind of the gross margin puts and takes into the December quarter, how should we think about this underutilization charges? There’s a nice improvement this quarter. Do we keep thinking that’s somewhat linear as we move forward?
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: So it will not be linear. This quarter, we do not… 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 that die inventory is getting low in certain cases. So it’s a balance, but you will not see the large reduction in utilization or under utilization charges this quarter that you saw last quarter. But that’s still upside in front of us in future quarters.
Steve Sanghi, President and CEO – Microchip Technology: I mean, December quarter historically is kinda weak. So we took that in 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 weak December quarter of next year. So utilization should start to improve, but not linearly.
Joe Quatrochi, Analyst – Wells Fargo: Thank you.
OPERATOR: Thank you. Our next question comes from the line of Chris Caso with Wolfe Research. Please proceed.
Chris Caso, Analyst – Wolfe Research: 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.
Steve Sanghi, President and CEO – Microchip Technology: 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. However, because of what we described before, some of the fairly large dollar item, products with very high margin, supply chain cannot fulfill this quarter, which is kinda offsetting the improvement we would have seen.
Chris Caso, Analyst – Wolfe Research: Right. So… Okay. So… And I guess then going forward, it… Would it be right to assume that as you… As supply improves, as 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?
Steve Sanghi, President and CEO – Microchip Technology: Are you talking about benefit in revenue or benefit in something else?
Chris Caso, Analyst – Wolfe Research: Well, I guess benefit in revenue from obviously being able to ship the product the higher price. And then, I guess, importantly, 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?
Steve Sanghi, President and CEO – Microchip Technology: We suddenly get the revenue benefit and we get some of the margin benefit, but the pricing in the industries from our suppliers is continuing to go up. There’s another round of price increase across the industry starting basically in January from most major foundries and OSATs. So some of that will… 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.
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 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.
Chris Caso, Analyst – Wolfe Research: Okay. Thank you.
OPERATOR: Thank you. Our next question comes from the line of Vivek Arya with Bank of America Securities. Please proceed.
Vivek Arya, Analyst – Bank of America Securities: Thanks for taking my questions. Steve, I wanted to start with more of a macro question based on your industry experience. When you look at all these the volatility in semiconductor stocks, Do you think that signals to you there are 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 do you think all these worries are justified based on what you are seeing on the ground?
Steve Sanghi, President and CEO – Microchip Technology: Well, Vivek, I think there is data center and non data center. There is nothing to worry about in the non data center. Industrial is doing fine. Automotive is continuing to recover. Its unit count is not growing as much, low single digit, but the content is growing significantly. And we’re winning across new car architectures across the board, and 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… All that just I’ve been kinda saying it. It could not be true. It just… Demand was explosive. You can’t just have that large of a percentage of economy, the rate 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 data centers can’t be built or the power can’t be supplied or the new congress wouldn’t let it happen or 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, 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.
Vivek Arya, Analyst – Bank of America Securities: So what do you think that means for Microchip? Because I think in your commentary, you used 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 for Microchip, do you think there is still the possibility of above seasonal growth?
Steve Sanghi, President and CEO – Microchip Technology: 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 our 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 OSAT, And many cases, we have lost capacity where some of it we have to bring it inside, some of it we have to move it elsewhere, and it takes time to requalify and therefore, the backlog could not be served and will be served some in the next quarter, some in the quarter after. So I think a deceleration on the data center will probably have a positive effect on our business because some of that capacity frees up.
Vivek Arya, Analyst – Bank of America Securities: Thank you.
OPERATOR: Thank you. Our next question comes from the line of Vijay Rakesh with Mizuho Securities. Please proceed.
Vijay Rakesh, Analyst – Mizuho Securities: Yeah. Hi. So just a quick question on the aerospace defense side. It’s kind of grown in line with… With Microchip’s overall growth. When do you actually see aerospace defense orders start to come back? Like, are these long lead orders where you have good visibility? I have a quick follow-up.
Steve Sanghi, President and CEO – Microchip Technology: Well… So aerospace and defense grew 41% September over September. So we think it’s 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 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 we’re starting to get the orders, but they’re scheduled out when they need it.
So I think it’s… Aerospace and defense is not a data center kind of business, $10 million today and $200 million tomorrow. It’s… It will grow consistently, but it’s not a hockey stick because the industrial complex cannot grow at that rate.
Vijay Rakesh, Analyst – Mizuho Securities: Got it. And then on the price increases, you mentioned foundry OSAT price increases. How much flexibility do you have to kind of pass through or how much… 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.
Steve Sanghi, President and CEO – Microchip Technology: 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 pretty close to Target, within 100 basis points of that.
And 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 cost kept going up, then we passed the price increase.
I mean, we’re kinda doing similar. Right now, we’re planning to not do a price increase and absorb it. And at these kind of gross margins, we don’t feel that our gross margins are low.
Vijay Rakesh, Analyst – Mizuho Securities: Got it. Thanks.
OPERATOR: Thank you. Our next question comes from the line of Harlan Sur with JPMorgan. Please proceed.
Harlan Sur, Analyst – JPMorgan: Yeah. Good afternoon. Thanks for taking my question. Book to bill 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 bank inventories as well. So why wouldn’t front end utilization charges continue to decrease this quarter? 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?
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: 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. So it’s the combination of those things, and we don’t expect them a material change in the overall underutilization charge in the quarter.
Steve Sanghi, President and CEO – Microchip Technology: I think one of the point is that there’s a perception that on in house built fab 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 says that… It sees the same constraints that our foundry wafers see.
And in lot of cases, some of the capacity at our major OSAT suppliers has been displaced. AI companies, which ones came in and took over the whole factory and they pushed everybody out. We brought some in. We brought it some to other OSAT manufacturers, but that is the crowding out of AI. It’s affecting processing of inside wafers as well as outside wafers in assembly and test.
And we are rapidly improving that situation. Ordinarily, we do an inside versus outside analysis when there’s a payback to do inside. Not everything we can do cheaper inside. Sometimes we cannot keep the tool fully busy because we cannot fully utilize the tool. So therefore, we keep it outside.
But when we get displaced outside, we can’t produce it. 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 just a couple of months ago. So those are the things we are struggling with, and that’s why I said that some deceleration of the AI demand actually would be quite positive early on.
Harlan Sur, Analyst – JPMorgan: Got it. Okay. And 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 stand alone NPU like your acquired product family from Hailo, but you could leverage embedded NPU accelerators. Right? Can you just remind us your 32-bit MCU product lines? Do you have product families with embedded NPU? And are you seeing accelerated adoption of NPU based MCUs for these types of embedded machine learning AI applications?
Steve Sanghi, President and CEO – Microchip Technology: So our in house microcontroller and microprocessor product line 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 unit, but not on our microcontroller business units and the microprocessor business unit. We did not.
When we bought Hailo, 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. The product line that Hailo brought to us accelerates the road map 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 Hailo. In fact, I have merged the Hailo and MPU business unit together, and we are advancing the Hailo roadmap. And we have canceled our MPU roadmap in the microprocessor business unit. That’s how important Hailo has been for us.
Harlan Sur, Analyst – JPMorgan: I see. Okay. That makes a lot of sense. Thank you, Steve.
OPERATOR: Thank you. Our next question comes from the line of Jim Schneider with Goldman Sachs. Please proceed.
Jim Schneider, Analyst – Goldman Sachs: Good afternoon. Thanks for taking my question. I was wondering if you could maybe broadly characterize the willingness to build 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?
Steve Sanghi, President and CEO – Microchip Technology: I mean, right now, in broad base of customers, we do not see a desire by them to build inventory. We can hardly get them to place orders with a new lead time. Seems like number one lead time, they’re moving rapidly.
Secondly, semiconductor manufacturers are always telling their customers, I want more backlog. I want more backlog. It kinda becomes a broken record, 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 till they get in trouble Where lead times rapidly go out, they don’t have the product, 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.
Jim Schneider, Analyst – Goldman Sachs: That’s helpful color. And then just as 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 of quarters, but perhaps the input cost increases are not going to be offset on the broader base of products? Do I have that right?
Steve Sanghi, President and CEO – Microchip Technology: Yeah. 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 higher licensing revenue and 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 our long term gross margin was 65%, And there’ll be times in the good times when it will go over. 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, partially driven by some of the high margin products pushing out because of constraints. We can’t quite get there. Question is then why we’re 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 of that or not. We’re not able to model it today.
So that’s why we’re basically resetting that and saying, 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.
Jim Schneider, Analyst – Goldman Sachs: Very clear. Thank you.
OPERATOR: Thank you. Our next question comes from the line of Blayne Curtis with Jefferies. Please proceed.
Blayne Curtis, Analyst – Jefferies: Hey. Good afternoon, guys. I wanted to ask on the trigger to pull back 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 is terrible lately, but expect a continued recovery. So I’m just trying to understand how you’re thinking about managing that.
Steve Sanghi, President and CEO – Microchip Technology: I think the equation is very, very complex. 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 a kind of product 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. So it’s a very, very complex equation.
And then despite that, I think we’re growing. Our business is up nicely. We’ll be up again next year. We’re solving these problems, bringing some inside, some moving it from foundry to foundry. It’s noisy. I get it. I… I’m frustrated by it too. And with the kind of questions you guys are asking, I get it. The only thing that’s going to help is AI decelerating.
Blayne Curtis, Analyst – Jefferies: Got you. 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 kinda curious what you’re seeing. Any evidence of restocking in any areas of strength in auto?
Steve Sanghi, President and CEO – Microchip Technology: So, I mean, our auto business was up 19.3% year over year. I mean, for auto, that’s very good. For auto, that’s excellent. Auto is never going to grow 100%, 50%, 40%. The auto unit volume grows two or three percent best case. 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, 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.
Blayne Curtis, Analyst – Jefferies: Thank you.
OPERATOR: Thank you. Our next question comes from the line of William Stein with Truist Securities. Please proceed.
William Stein, Analyst – Truist Securities: 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?
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: So there is. I mean, there… 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 Hailo is investing pretty significantly in their R&D efforts, and we are definitely doubling down on that.
And the Vorago 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 Hailo and almost a full quarter of Vorago in the numbers, and that… That’s obviously built into our guidance.
Steve Sanghi, President and CEO – Microchip Technology: I think we can give you a little more color. Vorago gross margin is higher than Microchip. But with $6 million revenue contribution, it doesn’t move the needle in the current quarter. Hailo margins are lower than Microchip, but with $4 million in revenue, that doesn’t move the needle either.
In the area of OpEx, Vorago OpEx is small, and gross margins are very high. So Vorago is actually very profitable. So that’s doing very well. But with such a small revenue, it doesn’t move the needle.
Hailo 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. So we will do very well in Hailo over time. But in… But short term, we’re having to absorb it higher OpEx.
William Stein, Analyst – Truist Securities: Yes, 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 responded about how to think about the influence on your business…
Steve Sanghi, President and CEO – Microchip Technology: Let me say no.
William Stein, Analyst – Truist Securities: Okay. I’m sorry to hear that.
Steve Sanghi, President and CEO – Microchip Technology: No. No. That…
William Stein, Analyst – Truist Securities: Okay. That’s good. Appreciate that. But in terms of how to interpret how to think about the go forward model, 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.
For example, data center drives some industrial demand probably for your business. 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 potentially related to lower spending in Aerospace and 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?
Steve Sanghi, President and CEO – Microchip Technology: No. I don’t think so. 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 business solutions business unit. The data center solutions business unit is in the retooling phase, having lost the Gen 5, regaining market share from the Gen 6. So there, there’s all upside.
And in the broad based business that we have, there would be roughly 8% of our business out of the 100. So I think this is a time if the data center were to correct, our broad based exposure in industrial and automotive and aerospace and defense, in appliances, in consumer, in computing would be very, very helpful. And Microchip should outperform in that kind of environment compared to the companies that are kinda all data center.
William Stein, Analyst – Truist Securities: Got it. Thank you.
Steve Sanghi, President and CEO – Microchip Technology: And, yeah, 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.
William Stein, Analyst – Truist Securities: There we have it. Thank you.
OPERATOR: Our next question comes from the line of Joshua Buchalter with TD Cowen.
Joshua Buchalter, Analyst – TD Cowen: I guess, Steve, you mentioned sort of a reluctance to raise pricing so close to the previous increase. And in the spring, you were also mentioning given some of the relationships you were trying to rebuild after PSP, that reluctance.
I guess, picture you are seeing pressure from input costs rising. 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.
Steve Sanghi, President and CEO – Microchip Technology: So I think we were very careful in raising prices. We immediately didn’t jump on it back in January, February. We were in the process of repairing our relationships, which we have done it very successfully. That’s delivering 40% growth year over year.
And when we became comfortable that our relationship was such that we can handle a price increase, We implemented it very carefully. It was small in nature, and we’ve been successful. We haven’t lost customers. And now we’re in the same mode. I think we don’t want to push the luck so much. We’re not greedy. We are comfortable and happy with the gross margins we have.
The other point I would make is our operating margins are higher than some of our competitors’ gross margin. I mean, look at STMicro. So it’s not that our product prices is low. We are a premium price company. We make very good product, high quality. We fight for every cent.
And our margins are very high, which means I don’t know if our costs are lower than those companies. I, actual costs are very hard to compare. We don’t really know. But if the cost were to be equivalent, prices are very good. Our operating margin is higher than STMicro’s gross margin. You gotta give us some credit for that.
Joshua Buchalter, Analyst – TD Cowen: No. I hear you on that. Maybe for Eric, your leverage is down at 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.
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: 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 leverage down. We had a pretty big scare during the last downturn, and leverage went way, way too high.
And so I think we’re going to take a cautious approach, keep the dividend where it’s at for now, and probably evaluate this as we move into next fiscal year, have a good discussion with the board and keep investors abreast of our thoughts. But next couple of quarters, for sure continue to get the leverage metrics down.
Joshua Buchalter, Analyst – TD Cowen: Thank you.
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: You’re welcome.
OPERATOR: Thank you. Our next question comes from the line of Christopher Rolland with Susquehanna.
Christopher Rolland, Analyst – Susquehanna: 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 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 slow here in your words, is that going to be enough to prolong this cycle?
Steve Sanghi, President and CEO – Microchip Technology: So I will go back to data center and non data center. 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 3 to 5. 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, 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. If we had those designs all on Gen 5 and we’re rewinning them on Gen 6, it will not be incrementally as positive. 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 the cycle decelerates, much of that upside in bubble is not in our numbers. It’s in everybody else’s numbers. It’s not in our numbers.
Christopher Rolland, Analyst – Susquehanna: Understood. So 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. 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 300 millimeter fab, but would you consider even at the front end perhaps planning for a new fab?
Steve Sanghi, President and CEO – Microchip Technology: I mean, 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, 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 that 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 be… We’ll have the capacity.
Now if you come on the fab side, 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 the 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.
When the COVID cycle busted and they had enough capacity, then we didn’t want to spend couple of billion dollars or more of CapEx nor did they want to give the license. So that program went away.
So today, the problems are not as big and they’re not as severe and they’re not multi year problems where we have to go back and build a few billion dollars of capital to build a $300 million… 300 millimeter fab and seek a license again. We’re not thinking that because we don’t think the problem is that long. It’s just… It’s a short term issue.
Eric Bjornholt, Senior Vice President and CFO – Microchip Technology: Yeah. I just want to add one piece of clarification to the way you asked the question. We are… We do have capacity constraints with some of our internal production also. Right? There are certain products where we’re behind. We can’t meet customers’ lead times, and we’re working as hard as we can to bring on capacity.
And as Steve mentioned before, even when we bring on that capacity, sometimes if it’s outsourced for assembly test, we’ve got capacity constraints even when it comes out of our fab. So it’s… These constraints have grown beyond just being an outside foundry issue for us.
Christopher Rolland, Analyst – Susquehanna: Thank you, guys.
OPERATOR: Thank you. Our last question comes from the line of Tore Svanberg with Stifel. Please proceed.
Tore Svanberg, Analyst – Stifel: Yes. Thank you. So, Steve, I had a question on the OSAT 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 allocation 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 ramping your own front end utilization?
Steve Sanghi, President and CEO – Microchip Technology: 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 OSAT is asking us to load it with a minimum batch size. Because when the batch sizes are smaller, it takes more capacities, less efficient for the manufacturer. 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, 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. But more capacity becomes available next quarter, June quarter, and from there on.
Tore Svanberg, Analyst – Stifel: That’s very helpful. Thank you. And as my follow-up and maybe back to the sort of AI bubble and rebalancing of data center across your seven segments, is there anything that you could give us confidence that if data center does slow I understand that it won’t impact you as much as others, but what about, let’s say, the 24 design wins you have in PCIe Gen 6, are they still going to go to production? Any sort of color you could share with us there to give us that confidence?
Steve Sanghi, President and CEO – Microchip Technology: Yeah. So 24 design wins 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 they’re shipping into a data center in Ohio, that local governor is going to put on hold?
And we don’t know that. Right? It’s all over the place. But it’s 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 a 100% businesses in data center.
Tore Svanberg, Analyst – Stifel: Yep. That… That’s fair. Thank you very much.
Steve Sanghi, President and CEO – Microchip Technology: And the fact that on many other products like the Gen 6 switch and retimer, it’s largely all upside for us because we have no business in it. The other comment I want to make is if you conservatively model fiscal year 2028 that begins on April 1 with whatever assumptions you have. I… Even in the extreme conservative case, I come up with over $4 of earning. The stock is at 15 times earning.
Tore Svanberg, Analyst – Stifel: Sounds good. Thank you.
Steve Sanghi, President and CEO – Microchip Technology: I tell you, I’m tempted to buy it myself and Mike. Thank you.
Closing Remarks
OPERATOR: That concludes today’s question and answer session. I’d like to turn the floor back over to Mr. Sanghi for closing comments.
Steve Sanghi, President and CEO – Microchip Technology: So thank you for attending our conference call. I think next conference we go to will be UBS. Sajid’s at a conference next week. Yeah. But, yeah, the… We’ll have a large Microchip presence at UBS with a larger group of executives. So we’ll see you… Some of you there. Thank you very much. Thanks, everyone.
OPERATOR: This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.