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    MCHP
    Earnings call· Dec 2024(Q3 FY25)

    MICROCHIP TECHNOLOGY INC MCHP

    Feb 6, 2025 Source

    Executive summary

    Microchip Q3 FY25 — Navigating Inventory Correction with Strategic Restructuring

    Microchip is actively addressing a significant inventory correction following a post-COVID super cycle, with CEO Steve Sanghi implementing a 9-point plan including manufacturing footprint resizing and inventory reduction. Despite continued broad-based weakness and low visibility, the company is focused on strengthening customer relationships and winning new designs, aiming for above-market growth once excess inventory is consumed. Management is committed to the current dividend, expecting free cash flow to exceed it as inventory liberates cash.

    Highlights

    4

    • Aggressive inventory reduction plan targeting $250 million reduction by end of FY26.

    • Refinancing of $1.2 billion debt maturity in September 2025 taken off the table.

    • Strong non-GAAP gross margin guidance of 52%-54% for Q4 FY25 despite low factory utilization.

    • New generation of 64-bit RISC-V processors with AI capabilities showing strong initial customer response.

    Concerns

    5

    • Net sales down 11.8% sequentially to $1.026 billion and down 41.9% YoY due to inventory correction.

    • Inventory days increased to 266 days at end of December 2024, up from 247 days.

    • Non-GAAP diluted EPS guided to $0.05-$0.15 for Q4 FY25, significantly down from $0.20 in Q3 FY25.

    • Non-GAAP operating expenses expected to increase to 37.7%-40.5% of sales in Q4 FY25 due to employees coming off pay cuts.

    • Adjusted free cash flow currently less than dividend, requiring borrowing in certain quarters.

    Guidance & targets

    12
    CategoryTargetConfidence
    Net sales
    $920 million and $1 billion
    high materiality
    High
    Non-GAAP gross margin
    52% and 54% of sales
    medium materiality
    High
    Non-GAAP operating expenses
    37.7% and 40.5% of sales
    medium materiality
    High
    Non-GAAP operating profit
    11.5% and 16.3% of sales
    medium materiality
    High
    Non-GAAP diluted earnings per share
    $0.05 and $0.15
    high materiality
    High
    Non-GAAP cash tax rate
    approximately 14.5%
    low materiality
    High
    Inventory balance
    decrease from December 31, 2024 levels
    high materiality
    High
    Inventory days
    decrease from December 31, 2024 levels
    high materiality
    High
    Inventory balance reduction
    approximately $250 million
    high materiality
    High
    Capital expenditures
    about $135 million
    medium materiality
    High
    Capital expenditures
    lower than fiscal year 2025
    medium materiality
    High
    Dividend
    kept flat
    high materiality
    High

    Segment performance

    1
    SegmentRevenueYoYQoQMargin
    All segments and geographies
    Microcontroller, analog, FPGA, and other businesses were all down sequentially. Geographically, business was down sequentially in all major regions: Americas, Europe, and Asia.
    		——down sequentially—

    Operational metrics

    25
    Net sales
    $1.026Bdown 11.8% sequentially, down 41.9% YoY
    Q3 FY25

    Net sales in the December quarter.

    Non-GAAP gross margin
    55.4%
    Q3 FY25

    Includes capacity underutilization charges of $42.7 million.

    Non-GAAP operating expenses
    34.9%
    Q3 FY25

    Operating expenses as a percentage of net sales.

    Non-GAAP operating margin
    20.5%
    Q3 FY25

    Non-GAAP operating margin for the December quarter.

    Non-GAAP net income
    $107.3M
    Q3 FY25

    Non-GAAP net income for the December quarter.

    Non-GAAP earnings per diluted share
    $0.20
    Q3 FY25

    Non-GAAP earnings per diluted share for the December quarter.

    GAAP gross margins
    54.7%
    Q3 FY25

    GAAP gross margins for the December quarter.

    GAAP total operating expenses
    $530.5M
    Q3 FY25

    GAAP total operating expenses for the December quarter, including various adjustments.

    GAAP net loss
    $53.6M
    Q3 FY25

    GAAP net loss for the December quarter.

    GAAP loss per share
    $0.10
    Q3 FY25

    GAAP loss per share for the December quarter.

    Non-GAAP cash tax rate
    19.9%
    Q3 FY25

    Non-GAAP cash tax rate for the December quarter, exclusive of transition tax and prior-year audit settlements.

    Distribution inventory days
    37 daysdown 3 days from prior quarter
    Q3 FY25

    Inventory at distributors at the end of the December quarter.

    Distribution sell-through vs sell-in
    $118M higher
    Q3 FY25

    Distribution sell-through was $118 million higher than distribution sell-in in the December quarter.

    Consolidated cash and total investment position
    $586M
    as of Dec 31, 2024

    Higher than normal due to timing of commercial paper maturities in early January.

    Debt retired
    $665.5M
    Nov 2024

    Retired convertible bonds that matured in November 2024.

    Investment-grade bonds issued
    $2B
    Q3 FY25

    Issued $1 billion in investment-grade bonds with a 4.9% coupon maturing in March 2028 and $1 billion in investment-grade bonds with a 5.05% coupon maturing in February 2030. Proceeds used to retire $750M term loan and pay down commercial paper.

    Net debt
    increased by $33.6M
    Q3 FY25

    Net debt increased in the December quarter.

    Adjusted EBITDA
    $274.9M
    Q3 FY25

    Adjusted EBITDA in the December quarter.

    Adjusted EBITDA margin
    26.8%
    Q3 FY25

    Adjusted EBITDA as a percentage of net sales.

    Trailing 12-month adjusted EBITDA
    $1.64B
    TTM Q3 FY25

    Trailing 12-month adjusted EBITDA.

    Net debt to adjusted EBITDA
    3.78xup from 1.27x at Dec 31, 2023
    as of Dec 31, 2024

    Net debt to adjusted EBITDA ratio.

    Capital expenditures
    $18.1M
    Q3 FY25

    Capital expenditures in the December quarter.

    Depreciation expense
    $40.4M
    Q3 FY25

    Depreciation expense in the December quarter.

    Dividend
    flat
    Near-term

    The company will keep the dividend flat, not increasing or decreasing it.

    Pricing
    low to mid-single digits reduction
    Near-term

    Some price reduction is appropriate in the near term, following price increases over the past 3-4 years.

    Industry KPIs

    7
    MetricValueDetails
    Lead timesvery short
    Backlog order booklower
    Fab capacity utilizationvery low
    Bookings net order intakelow
    Design wins socket pipelinestrong
    Inventory channel inventory266 daysdays
    End market segment revenue mixdown sequentially

    Orderbook & backlog

    1
    Backloglower for the March quarter than it was at the start of the December quarterstart of March quarter

    down sequentially

    requires a lot of turns to take for the March quarter and visibility remains low

    Product announcements

    6
    ProductTypeDetails
    64-bit RISC-V processorslaunch
    Wi-Fi portfolio expansionexpansion
    Smart Touch controllerlaunch
    ASA Motion Link technologylaunch
    Radiation-hardened FPGAsmilestone
    Sensor connectivity solution for NVIDIA's Holoscan platformlaunch

    Capital programs

    1
    Tempe Fab (Fab 2) closurein process

    Benefit: reduces manufacturing footprint

    After analysis, we have decided to close our Tempe Fab known as Fab 2. Currently, we are in the process of building the material to provide buffer required before we transfer the processes and products to our other 2 fabs. 70% of this product is already qualified at these other fabs.

    Risks & headwinds

    5
    Broad-based weakness and inventory correctionQ3 FY25

    Net sales down 11.8% sequentially and 41.9% YoY to $1.026 billion

    Mitigation: 9-point plan, including manufacturing rightsizing, inventory reduction, and customer re-engagement.

    Elevated inventory at customers and channel partnersQ3 FY25, ongoing

    266 days of inventory at end of December 2024, up from 247 days; target 130-150 days

    Mitigation: Aggressive inventory reduction plan ($250M by FY26), factory utilization management, channel strategy changes.

    Operating expenses increaseQ4 FY25

    Non-GAAP operating expenses to be between 37.7% and 40.5% of sales in Q4 FY25

    Mitigation: Review of long-term business model and operating expenses to be updated on March 3.

    Adjusted free cash flow less than dividendNear-term

    Adjusted free cash flow ($244.6M in Q3 FY25) currently less than dividend, requiring borrowing in certain quarters due to bond interest payments.

    Mitigation: Liberating cash from inventory reduction and very low capital expenditures expected to bring free cash flow above dividend in future quarters; dividend kept flat.

    Low visibility and low backlog for next quarterQ4 FY25

    Backlog started lower for March quarter than December quarter; requires a lot of turns to meet guidance

    Mitigation: Focus on winning new designs and customer re-engagement.

    What to watch in Q4 FY25

    5

    Inventory reduction progress

    Q4 FY25
    Current266 days (target 130-150 days)
    TargetDecrease in dollars and days from Dec 31, 2024 levels

    Why it matters

    Inventory reduction is key to liberating cash, improving free cash flow, and signaling market recovery.

    At the midpoint of our March 2025 quarterly guidance, we would expect both inventory dollars and inventory days to decrease from the December 31, 2024 levels.

    Q&A highlights

    5

    Where is inventory highest (end market/product)? Is it specific to Microchip or broader?

    Inventory is high across the board, not specific to end markets. Distribution inventory is closer to normal, but direct customer inventory is still high. This is partly due to preferential treatment of large direct customers during the super cycle and Microchip dismantling its non-cancelable program (PSP) later than competitors, leading to higher inventory of Microchip products at customers.

    “The #2 reason for our customers having higher inventory is that we dismantled our noncancelable program called PSP, 2 quarters or so later than our competitors did. So therefore, we continue to ship for 2 more quarters. And when the business had eventually fell at our customers, they had higher inventory of our products than potentially our competitors.”

    asked by Vivek Arya · answered by Steve Sanghi

    2 min read6 chapters

    Detailed Narrative

    01

    CEO's 9-Point Plan Update

    CEO Steve Sanghi, who returned in November 2024, outlined a 9-point plan to restore Microchip's premium performance status. This plan includes resizing manufacturing, reducing inventory, reviewing megatrends, reorganizing business units, strengthening customer relationships, and evaluating the long-term business model and operating expenses. A comprehensive update on this plan is scheduled for an investor and analyst call on March 3.

    02

    Manufacturing Footprint Resizing

    Microchip is closing its Tempe Fab (Fab 2) and transferring its processes and products to Fab 4 in Gresham, Oregon, and Fab 5 in Colorado Springs, with 70% of products already qualified at these other fabs. Fab 4 and Fab 5 are operating on rotating time-off schedules to reduce capacity while maintaining readiness to ramp quickly. Back-end facilities in Thailand and the Philippines are managing capacity through shutdown days and reduced employee hours, while other smaller plants adjust based on specific demand.

    03

    Inventory Management and Cash Liberation

    The company's inventory reached 266 days at the end of December 2024, up from 247 days, significantly above its target of 130-150 days. Microchip plans to reduce its inventory balance by approximately $250 million from December 2024 to the end of fiscal year 2026 (March 31, 2026). This reduction is expected to liberate cash, which will help bring adjusted free cash flow above the dividend in future quarters.

    04

    Channel Strategy Changes

    Microchip has implemented two changes to its channel strategy. First, demand creation registrations for distributors will now convert to demand fulfillment after a set number of years, incentivizing distributors to promote new products. Second, the company has lowered its fulfillment margins for distributors, bringing them to a level that remains competitive but is no longer industry-high.

    05

    Customer Relationship Focus

    The company is aggressively focusing on strengthening customer relationships, particularly with its top 1,000 customers and a critical subset of 256 accounts. Management is engaging with these customers to address past issues, such as pricing or excess inventory from the PSP program, and to support new designs. The goal is to regain trust and secure design opportunities by prioritizing customer needs and support.

    06

    CHIPS Act Engagement Pause

    Microchip has paused its activities related to the CHIPS Act. The company is awaiting the new administration to restaff the CHIPS office and plans to re-engage with the program once the appropriate time arrives.

    AI-generated summary of the company’s earnings call. Not investment advice.