Q3 2024 Earnings Summary
- Microchip maintained strong margins and cash flow despite revenue declines, with non-GAAP gross margin at 63.8% and operating margin at 41.2% in the December quarter. Adjusted EBITDA was 45.1% of net sales, demonstrating resilience.
- The company is increasing capital return to shareholders, announcing a 25.7% increase in dividend to $0.45 per share and planning a record $386.8 million in share buybacks in the March quarter. Microchip plans to return 82.5% of adjusted free cash flow to shareholders.
- Strength in Aerospace, Defense, and AI markets is a positive, with Aerospace and Defense remaining strong, and their portion of the AI data center platforms doing extremely well, representing pockets of strength.
- Significant Revenue Decline and Weak Demand Across All Markets: Net sales in the December quarter were down 21.7% sequentially and down 18.6% year-over-year, reflecting weakness in all regions and most end markets due to customers pushing out or canceling backlog amid increased uncertainty.
- High Inventory Levels Leading to Under-utilization and Margin Pressure: Inventory days increased to 185 days and are expected to rise to 225-230 days, causing the company to implement factory shutdowns and reduce utilization rates. This under-utilization is negatively impacting gross margins and profitability.
- Limited Visibility and Uncertainty About Future Demand: The company has very limited visibility into future market conditions and is unable to provide forecasts beyond the current quarter, increasing risk for investors due to the unpredictability of demand recovery.
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Revenue Decline and Recovery Outlook
Q: How steep is the revenue decline, and what's the recovery outlook?
A: Our revenue from peak to trough is declining by over 40% within the same fiscal year , an extreme rate comparable to the 36% decline during the global financial crisis. We have limited visibility into market conditions and cannot predict the slope of the recovery. We are significantly under-shipping to end demand but can't provide guidance beyond this quarter. -
Gross Margin Impact and Utilization
Q: What's affecting gross margins, and how will utilization impact them?
A: The biggest factor impacting gross margins is lower factory utilization due to continued attrition, reduced production rates, and two-week shutdowns in our large factories. Under-utilization is absolutely impacting our business and gross margins this quarter. We're also taking large charges for inventory reserves, but the main impact is from utilization. It will be difficult for capacity utilization to increase in the June quarter. -
Inventory Levels and Reduction Plans
Q: What's the status of inventory levels, and when will they realign?
A: Inventory levels are high and somewhat obscure to us; we're under-shipping consumption to help reduce them but can't quantify how much inventory will be drained. We're taking actions we can control, like lowering utilization and shutdowns, to reduce our inventory. However, without clearer demand visibility, we can't predict when inventory levels will realign. -
Demand Visibility and Cancellation Rates
Q: Are cancellation rates stabilizing, and what's the demand visibility?
A: Cancellation rates are still at a relatively high rate; customers and distributors feel they have excess inventory and are pushing out or not placing backlog. We have limited backlog visibility beyond this quarter, making it hard to predict future demand. -
PSP Program Discontinuation
Q: Why didn't the PSP program buffer volatility, and what's its status?
A: The PSP program aimed to discourage speculative demand by making orders non-cancelable, but strong OEM demand and long lead times led customers to over-order. Customers couldn't accurately predict demand 12–18 months out, leading to more backlog than necessary. We're ending the PSP program as the reasons for it no longer exist; no new PSP orders are being accepted, and existing backlog is naturally winding down. -
CapEx Plans and Capacity Management
Q: What are your CapEx plans and capacity additions for 2024?
A: Our capital expenditures for fiscal '24 are $300–$310 million. We expect CapEx to be quite low in fiscal 2025. We have equipment on hand not yet in production, which we can deploy as the market normalizes. Our responses include utilizing built inventory, increasing factory utilization, deploying existing equipment, and adding more if needed. -
Pricing Stability
Q: Is pricing erosion contributing to revenue decline?
A: Pricing is stable and not contributing to revenue declines. The revenue decline is due to volume decreases, not pricing. -
End Market Strength
Q: Which end markets are holding up better than others?
A: Our Aerospace and Defense markets are strong; commercial aviation and defense remain robust. Our portion of the data center market around AI platforms is doing extremely well, though not significant enough to impact overall results. -
Manufacturing Strategy
Q: Will you change your manufacturing strategy amid current challenges?
A: We're committed to our strategy of producing products cost-effectively within our manufacturing footprint, maintaining a balance of roughly 40% internal and 60% external production. Over time, this strategy has led to higher gross margins and better performance across cycles, and we see no need to change it. -
Employee Pay Reductions
Q: What's the plan regarding the 10% employee pay reduction?
A: We have informed employees of the pay reduction but haven't shared all details yet. This is not new to us; we've done this multiple times, emphasizing shared sacrifice and rewards. We believe our team understands and will support this measure.