Microchip Technology Inc (MCHP) — Q2 2024 Earnings Call Transcript

Good afternoon, everybody. 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 release as 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, and Steve Sanghi, Microchip's Executive Chair; and Sajid Daudi, Microchip's Head of Investor Relations. I will comment on our second quarter fiscal year 2024 financial performance. 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 and 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 GAAP and non-GAAP results. We have also posted a summary of our outstanding debt and our leverage metrics on our website. 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 effects of our acquisition activities, share-based compensation, and certain other adjustments as described in our earnings press release and the reconciliations on our website. Net sales in the September quarter were $2.254 billion, which were down 1.5% sequentially. 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, gross margins were 68.1%, operating expenses were at 20%, and operating income was a record 48.1%. Non-GAAP net income was $889.3 million, and non-GAAP earnings per diluted share was $1.62. On a GAAP basis in the September quarter, gross margins were 67.8%, total operating expenses were $642.4 million and included acquisition intangible amortization of $151.4 million, special charges of $1.8 million, share-based compensation of $38 million, and $1.1 million of other expenses. GAAP net income was a record $666.6 million, resulting in a record $1.21 in earnings per diluted share. Our non-GAAP cash tax rate was 14.2% in the September quarter. Our non-GAAP tax rate for fiscal year 2024 is expected to be about 14.2%, which is exclusive of the transition tax and any tax audit settlements related to taxes accrued in prior fiscal years. Our fiscal '24 cash tax rate is expected to be higher than our fiscal '23 tax rate for a variety of factors, including lower availability of tax attributes such as net operating losses and tax credits, lower depreciation with our expectation for lower capital expenditures in the U.S. in fiscal '24, as well as the impact of current tax rules requiring the capitalization of R&D expenses for tax purposes. We are still hopeful that the tax rules requiring companies to capitalize R&D expenses will be pushed out or repealed. If this were to happen, we would anticipate about a 200 basis point favorable adjustment to Microchip's non-GAAP tax rate in future periods. Our inventory balance at September 30, 2023, was $1.331 billion. We had 167 days of inventory at the end of the September quarter, which was flat to the prior quarter's level. Although we reduced inventory dollars in the quarter, we were not able to make as much progress as we would have liked, as we continue to accommodate requests by customers to push out delivery schedules for products that were very far through the manufacturing process. We also continue to invest in building inventory for long-lived high-margin products whose manufacturing capacity is being phased out by our supply chain partners, and these last-time buys represented 10 days of inventory at the end of September. We expect dollars of inventory on our balance sheet to reduce in the December quarter. Inventory at our distributors in the September quarter was at 35 days, which was up 6 days from the prior quarter's level. Our cash flow from operating activities was $616.2 million in the September quarter. Included in our cash flow from operating activities was $87.5 million of long-term supply assurance receipts from customers. We have adjusted these items out of our free cash flow to determine the adjusted free cash flow that we will return to shareholders through dividends and share repurchases, as these supply assurance payments will be refundable over time as purchase commitments are fulfilled. Our adjusted free cash flow was $454.3 million in the September quarter. As of September 30, our consolidated cash and total investment position was $256.6 million. Our total debt increased by $45.6 million in the September quarter, and our net debt was up by $60.2 million. Over the last 21 full quarters since we closed the Microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down $6.72 billion of the debt and continue to allocate substantially all of our excess cash beyond dividends and stock buybacks to bring down this debt. In the September quarter, we issued a $750 million Term Loan A and retired $1 billion in bonds that matured on September 1, 2023, with the Term Loan A and proceeds from our line of credit. We also issued $1 billion of commercial paper during the September quarter, taking advantage of about a 90 basis point lower interest rate on the commercial paper compared to our line of credit rate. Our line of credit had $39 million of borrowings against it at September 30, 2023. During the September quarter, we also retired $18.2 million of total principal amount of our 2027 convertible bonds for a total cash payment of $42.7 million. The amount paid above the principal amount essentially works like a synthetic stock buyback, reducing any current and future share count dilution that could result if these convertible bonds were ever converted into shares. The $24.5 million we paid above the par value for the convertible bonds was in addition to our normal share buyback activity that we executed during the quarter, resulting in an additional reduction in the diluted share count outstanding. Our adjusted EBITDA in the September quarter was $1.152 billion, which is 51.1% of net sales. Our trailing 12-month adjusted EBITDA was a record at $4.57 billion. Our net debt to adjusted EBITDA was 1.28 at September 30, 2023, down from 1.84 at September 30, 2022. Capital expenditures were $74.4 million in the September quarter. Our expectation for capital expenditures for fiscal year 2024 is between $300 million and $325 million, which is down from the $300 million to $350 million we shared with investors last quarter, as we are delaying certain capital given the more challenging economic backdrop. We expect that our capital investments will continue to provide us with increased control over our production during periods of industry-wide constraints. Depreciation expense in the September quarter was $47 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the September quarter as well as our guidance for the December quarter.

Thank you, Eric, and good afternoon, everyone. Our September quarter results were about as we expected, with net sales coming in just under the midpoint of our guidance and well within our guidance range. Net sales were down 1.5% sequentially and up 8.7% on a year-over-year basis. Non-GAAP gross and operating margins remained strong at 68.1% and 48.1%, respectively. Our consolidated non-GAAP diluted EPS was at the midpoint of our guidance at $1.62 per share, up 11% from the year-ago quarter. Adjusted EBITDA was 51.1% of net sales, and adjusted free cash flow was 20.2% of net sales in the September quarter, continuing to demonstrate the strong cash generation characteristics of our business. Our net leverage exiting September dropped to 1.28x. We had higher cash flow outflows in the September quarter compared to the June quarter, due to the timing of tax payments and because of record capital return to shareholders in dividends and share repurchases totaling $562.6 million. This is 61% higher than the capital returned to shareholders in the June quarter. Our capital return to shareholders in the December quarter will increase to 77.5% of our September quarter adjusted free cash flow. As we continue on our path to return 100% of our adjusted free cash flow to shareholders by the March quarter of the calendar year 2025. My thanks to all our stakeholders who enabled us to achieve these results despite the increasingly challenging macro environment and especially to the worldwide Microchip team, whose effort and engagement enables us to navigate effectively through the business cycles. Taking a look at our September quarter net sales from a product line and geographic perspective. Our mixed signal microcontroller net sales were down 1.7% sequentially and up 8.5% on a year-over-year basis. Our Analog product line net sales were down 1.7% sequentially and up 8.8% on a year-over-year basis. On a sequential revenue basis, Asia was down, Europe was about flat, and the Americas was slightly up. Our business slowed down as expected, as our customers continue to respond to the effects of increasing business uncertainty, slowing economic activity, and a resultant increase in inventory. The combined effects of persistent inflation and high interest rates, we believe, are contributing to the weak macro environment. All regions of the world and most end markets experienced varying degrees of weakness. We continue to receive requests to push out or cancel backlog as customers start to rebalance their inventory in light of the weaker business conditions and increased uncertainty they were experiencing. We were able to push out meaningful amounts of backlog to later quarters to help many customers with inventory positions. We are seeing customers continue to adjust their demand expectations as they derisk their inventory position whenever possible. Our experience from prior cycles is that at this stage of the cycle, customers tend to overcorrect their inventory and backlog due to their business uncertainty, combined with the availability of product with very short lead times. This is, in effect, the flip side of what we saw during 2021 and 2022 when demand was historically strong and seemingly insatiable. Reflecting the slow macro environment, our channel inventory grew to 235 days. We are working with our channel partners to find the right balance of inventory required to serve customers, as well as to be positioned for the eventual strengthening of business conditions. Most of our internal capacity expansion actions remain paused, and we expect this will result in lower capital investments in fiscal year '24 and fiscal year '25, even as we prepare for the expected robust long-term growth of our business. In the meanwhile, we have been driving our lead times down and have reduced average lead times from approximately 52 weeks at the start of 2023 to approximately 26 weeks at the end of June and exited the September quarter at approximately 13 weeks. We expect to continue to drive average lead times down further, to less than 8 weeks by the end of 2023. During a period of macro weakness and business uncertainty, we believe short lead times are the best way to help customers navigate the environment successfully and improve the quality of backlog placed on us, as it enables our customers and Microchip to engage an uncertain environment with more agility and effectiveness. However, the significant reduction in lead times is also resulting in lower bookings and reduced near-term visibility. Now let's get into the guidance for the December quarter. As our customers take further actions to adjust to a weakening macro environment and uncertain business conditions, we are continuing to support customers and channel partners with inventory positions to push out their backlog. Taking all the factors we have discussed on the call today into consideration, we expect our net sales for the December quarter to be between down 15% and down 20% sequentially. At the midpoint of our net sales guidance for the December quarter, our year-over-year decline for the quarter would be 14.3%. We expect our non-GAAP gross margin to be between 64% and 65% of sales. We expect non-GAAP operating expenses to be between 22.7% and 23.3% of sales. We expect non-GAAP operating profit to be between 40.7% and 42.3% of sales, and we expect our non-GAAP diluted earnings per share to be between $1.09 and $1.17 per share. Given the current macro weakness and resultant business uncertainty, combined with our lower bookings and reduced near-term visibility, we anticipate that our March quarter revenue is likely to decline again sequentially, although to a lesser extent than the December quarter decline. Notwithstanding any near-term macro weakness, we are confident that semiconductors remain the engine of innovation for the applications and markets we serve. Our focus on total system solutions and key market megatrends is fueling strong design win momentum that we expect will drive above-market long-term growth. If you review Microchip's performance on a trailing 12-month basis through the business cycles over the last 15-plus years, which is included in the investor presentation posted on our website, you will observe our consistent and resilient cash generation, gross margin, and operating margin results. We remain confident that our non-GAAP operating margins on a trailing 12-month basis should remain above 40% through the business cycles. With that, let me pass the baton to Steve to talk more about our cash return to shareholders.

Thank you, Ganesh, and good afternoon, everyone. I would like to provide you with a further update on our cash return strategy. The Board of Directors announced an increase in the dividend of 33.8% from the year-ago quarter to $0.439 per share. During the last quarter, we purchased $339.8 million of our stock in the open market. We also paid out $222.8 million in dividends. Thus, the total cash return was a record $562.6 million. This amount was 72.5% of our actual adjusted free cash flow of $776 million during the June 2023 quarter. Our net leverage at the end of the September 2023 quarter was 1.28x. Ever since we achieved an investment-grade rating for our debt in November 2021 and pivoted to increasing our capital return to shareholders, we have returned $3.248 billion to shareholders as of September 30, 2023, by a combination of dividends and buybacks. In the current December quarter, we will use the adjusted free cash flow from the September quarter to target the amount of cash returned to shareholders. The adjusted free cash flow excludes a net $87.5 million that we collected from our customers for long-term supply assurance payments. These payments are refundable when purchase commitments are fulfilled. The adjusted free cash flow for the September quarter was $454.3 million. We plan to return 77.5%, or $352.1 million of that amount to our shareholders, with the dividend expected to be approximately $237.5 million and the stock buyback expected to be approximately $114.6 million. Going forward, we plan to continue to increase free cash flow return to shareholders by 500 basis points every quarter until we reach 100% of adjusted free cash flow returned to shareholders. That will take 5 more quarters; dividends over time, we expect, will represent approximately 50% of our cash returned.

I guess my first question is on the December quarter outlook. I think you gave a little bit of color by GEO but I was hoping you could provide a little bit of context by end market, if any of the end markets stand out with the downside or the upside? And is this mostly volume that's driving the sequential decline in revenue? Or are you starting to see pricing erode a little bit as well?

Sure. So firstly, there is no pricing that is driving the changes. It's all volume. The weakness is very broad-based across the different geographies and across the different end markets, with perhaps the one end market which continues to have reasonable resilience being aerospace and defense, as you might expect. But it's extremely broad-based at this point.

Got it. And then as my follow-up, maybe one for Eric on gross margin and I guess, utilization rates as well. How are your factories running today, both wafer processing and packaging and testing? And as you continue to adjust to the evolving demand environment, how should we see that impacting gross margins beyond the December quarter? How should we think about the trough?

Okay. So on utilization, we have kept the wafer fabs kind of reduced from where they were at the peak when they were running just full out, and that has dropped modestly. We're still not in a situation where we are taking underutilization charges, and that's not anticipated in the gross margin guidance that we've provided, but they are running at lower levels and not as efficiently. On the assembly and testing side, we definitely have reduced the activities in assembly and tests. We'd rather build the product through the wafer fab and then have it ready when orders come in to be able to turn it quite quickly with short lead times to the assembly and test process. So the assembly and test is more kind of in line with where consumption is. We actually reduced finished goods last quarter and will continue to be very focused on that.

Ganesh, you mentioned cancellations in your remarks and I wanted to get more details about that. This is the first time you've brought it up. What percentage of your orders does it represent? Additionally, could you share your thoughts on the year-over-year decline? How long do you anticipate this decline lasting, considering the programs you have implemented? Looking back, it seems you were overshipping in previous quarters. Insights on both topics would be very helpful.

So first of all, inside of 90 days, any orders that a customer has are cancelable. So that's our just standard practice. And then there are the longer-term non-cancelable orders that we have worked, and we don't really work on cancellations there as much as rescheduling and pushing out where that backlog would be. A lot of the backlog that has been placed over the last many quarters was based on very long lead times, and the conditions for the market for many of our customers have changed over that time. What they believe their businesses are going to do and what their businesses are doing today are a little bit different from when they placed those orders. That's where they're making adjustments to what they require. If their run rates come down, then whatever units they have in inventory or they have placed on us are at a higher run rate than they really need. That's what reflects some of the correction you're seeing to bring our shipments and the customer's inventory more in line.

And then the period of year-over-year declines when you compare it to the last few cycles?

Every cycle is different. I don't know about the year-over-year decline necessarily. But when you look at historically how cycles have played out, typically, there's a 2-quarter, 3-quarter period of time over which the digestion of that inventory takes place. Upon that being completed, the consumption, which is normally ahead of the shipments, catches back up, and that's how the cycle gets reborn in what we have seen.

You commented in your prepared remarks that you expect a further sequential decrease in the March quarter. And I would assume that, that would come with perhaps some lower gross margin attached to it. And that puts you pretty close to that 40% operating margin threshold without any OpEx adjustments. So maybe you can just speak to whether or not that lower revenue comes with lower gross margin. And as well, what sort of measures you'd be willing to take to make OpEx adjustments.

In any given quarter, as revenue declines, the operating margin has a very large change in revenue. You can't draw a line and say it will never fall below this line. We look at our operating margins on a trailing 12-month basis. That's what we've always had in terms of the data we've presented, the numbers that we have put out there. We don't know exactly what the magnitude of what might take place in March is, but we're confident that if you look at a 4-quarter rolling or trailing 12 months, we will still be at that 40% threshold as far as we see it going.

I guess I would add that investors and analysts have seen from Microchip over time that when we face these cycles, we are pretty nimble and adjust our business appropriately to the environment, whether that's on the expense side or if we need to do something with utilization. Right now, we're continuing to run the factories at a pretty high level, but lower than they were before. On OpEx, we have some levers that we can pull depending on what business environment we're going to be facing in March and beyond.

Okay. I would like to ask about the distribution inventory, which has increased sequentially. Although I understand you may not have a clear idea of how quickly it's being reduced or how the channel is clearing, could you provide an estimate of when you expect that to improve a bit?

In terms of timing, some of that's going to be based on what the distributors want to take in terms of inventory. And then obviously, what the end market consumption is going to be. So it's hard to forecast. Our distributors are tasked with having the right level of inventory in place to support their customers, and we will work with them to achieve that level. Just like customers, some distributors need inventory and some distributors are over-inventory and are going to work through that, and it takes some time. Don't have a specific way to answer your question, but I imagine over the next couple of quarters that distribution inventory will get more rightsized to whatever the distributors think is the best place for them to be.

You made you a little different than your peers during the upturn was the PSP and your CNRs. The idea was that you don't just let customers push that out and push that out. But it does sound like that's actually what's happening. So are you sort of being a little more proactive in cleaning that out and forcing them to come back and place new orders? I'm just kind of wondering about the discussions that you're having with these customers that have been under these MCRs.

This is not the first quarter in which we have been doing that. We have mentioned that at prior calls as well. When customers are trying to place orders further out in time, they do the best they can, and that conditions change. We will have discussions with them to see what we can do to help and what they can do to help us in terms of what future business is and any business relationship that's give and take. Of course, we have done a significant amount of push-outs to help them out.

Okay. And then Eric, can you give us an idea of inside of December how much of the guidance depends on turns?

We do not break that out, but it's a small number.

Small number. Okay.

Yes, I would say that we still have more backlog on our books in total than what would be typical for us but lead times down.

I had a question about sales and gross margins. On the sales front, Ganesh mentioned that the March quarter might see another decline. I'm curious if there's a way to conceptualize this. If we consider that June and September were the peak of the cycle, would it be reasonable to think of a 25% decline from peak to trough, suggesting mid-single digit sales downturns? Is that a sensible way to approach it? Additionally, what insights does history provide us on this matter?

The history is quite inconsistent. It’s challenging for us to provide clarity, especially considering our low visibility into the March quarter and the number of changes that will occur during that time. The business remains intact, and our customers and designs are still present. We know they are all there. The critical question now is how the macro environment is influencing our customers' pricing, their current inventory levels, and their production plans for the March and June quarters. With a 17.5% decline in the December quarter, this appears to be one of the more significant drops Microchip has faced since the first quarter of the global financial crisis. It's evident that a substantial shift occurred during the December quarter.

Okay. On the gross margin side, I'm trying to get a sense of both the kind of the downside risk from here? And then whenever we get to back to kind of the revenue levels in the next cycle, will gross margins get back to prior levels? So on the downside, I think you're guiding gross margins down about 350 basis points. That's also below what we have seen in prior down cycles. Is there a way to think about what is the kind of the trough is potential level? I think, Eric, you mentioned you're still keeping utilization if I recall. So what happens if you have to start cutting them? So what's the downside risk? And then part B of that is, let's say we come back to these revenue levels sometimes, right? Over the next several quarters. Will gross margins get back to prior levels? Because the 68% right plus/minus was achieved during a period of very strong industry pricing and shortages.

Yes. That's a complex question, and I wish I could provide a precise answer. However, the main point is that we will adapt our operations based on the circumstances we encounter. Currently, we require several turns in the March quarter, which comes with short lead times. While this situation is not unprecedented, it differs from our experiences over the past couple of years and brings some uncertainty. Nonetheless, we have long-term confidence in our business. The products we manufacture have a long lifespan. Sometimes, the balance between reducing utilization and manufacturing products while taking inventory reserves can offset each other. We will assess the situation as we approach March and make necessary adjustments. We believe our gross margins will remain strong. They will decrease this quarter, but they are still exceptionally high. I don't anticipate a significant decline from their current level, though it will depend on whether the environment necessitates a different approach. If there's any unseen factor, we will evaluate it and communicate our findings to analysts and investors at that time. Ganesh, do you want to add anything?

I would say if the revenue was back at the levels that we can, I see no reason why our gross margin wouldn't be back to the levels that we saw earlier.

I know this is a tricky one. We talk about overshipping and undershipping. Do you have a sense for what the true consumption is of your business at this point on a quarterly or annual basis?

Hard question to come up with because our customer demand has also shifted over the last 6 months or so as they are trying to figure out where is the macro going and what is their real demand. I don't know if there's a clear number we could give you that says this is what is consumption, but as we go through this correction, we believe we will be shipping under consumption but to what extent, I can't tell you.

That's fair. And then moving on to the operating margin and not to sort of like focus on the math here, but when you position as a trailing 12 month, I mean 1 quarter could be as low as 25%, right? So I'm just trying to understand just conceptually with your OpEx, how much variability do you have if we continue to see sequential declines in revenues?

We have more flexibility in our OpEx compared to what we've guided the current quarter for. We are not ready to size that for the Street at this point in time. But as I said before, you guys have seen us work through cycles before. If the cycle gives us something that's extreme, we will take more measures in our business. That is not what we're hoping we need to do, but we do have levers that we can pull that we've pulled historically if we're faced with a more difficult environment than we anticipate. OpEx can come down from what you're seeing here in our guidance for the current quarter.

I wanted to follow up on the comments regarding utilization. You mentioned aligning utilizations with the business environment, but it seems you're experiencing weakness with your end customers. What indicators would prompt you to reduce utilization? What would need to happen for that to occur? Additionally, could you elaborate on the reasoning for maintaining high utilization while you're managing inventory both on your books and in the channel?

I'll start and Ganesh and/or Steve can add to this. But again, our products have very, very long life cycles. If we were to cut utilization in the factories significantly, there is a large portion of the cost that you can't take out because of the very heavy fixed cost environment. The balance does it make sense to build the inventory, have that higher inventory, have it available to support your customers when the business environment turns positive, which it will. That's how we're managing it right now. You can obviously get to a point where that inventory is too high, and it doesn't make sense, and we don't think that we're in that position today. We have let fab utilization fall from where it was, and we'll continue to monitor it on a weekly, monthly basis and make decisions as we go.

What I would add to it is ramping a fab after you take it down drastically takes time to get people hired, trained, and get the equipment and the remaining process work done. So as we saw in 2021 and 2022, we put the foot on the accelerator, but it took time to get the ramps going. You want to be careful as you make some of those changes. We are making small changes to get them to where we want to be. Because we have the good fortune of products with extremely long life cycles, and all the inventory is in good shape. All that inventory allows us to do two great things. One, respond quickly when the business changes. When it changes, it will change faster than we expect on the upside. Two, push the capital that is necessary to be deployed to generate those products further out in time. It's good asset utilization in terms of how we manage capacity.

I appreciate all the color there. For my follow-up, I wanted to ask about pricing. I guess it's encouraging to hear pricing still hanging in, but there's a big investor concern that it will roll over. Can you, I guess, provide some anecdotes or what do you think is allowing firmer pricing in past cycles because that's what's allowing margins to hang in better than far given the top line but also a major concern for investors?

The pricing on our product line is characterized by long design cycles and very sticky product lines. In past cycles, there has never been something that rolled over, nor are we trying to use price as a way to leverage any short-term demand change because it doesn't help in where we're going. Our cycles of experience with how we have handled other cycles for pricing, plus where we are and how we're navigating this cycle, lead us to believe we don't expect price changes.

Great. Guys, I know you're only guiding a quarter, but you made this comment on March, I think about a sequential decline. By my math, typical seasonality is down at least a couple of percentage points. To help us sensitize our models, would you anticipate another, as you called it last time, I think, amplified or magnified seasonality in Q1? Or do you think it's possible that we're more like a normal seasonal result?

There is very little visibility that we can use to provide any intelligent answer at this time. We need to move further along in the timeline to understand how the next quarter will develop. We are currently guiding for just one quarter, the December quarter. We have shared some insights regarding our expectations for the March quarter, but we can't provide any specifics about the magnitude that would be useful at this moment.

I have a follow-up question. Could you estimate the sales in the December quarter that you expect to be completed under the PSP program? Also, how much PSP backlog remains after December? With lead times reducing from 13 weeks to what I believe is 8 weeks, it seems difficult to believe that customers are still waiting for that.

You're right. PSP had a time when it was far more important for customers to be enrolled and taking advantage of that priority. As cycle times come down, there are fewer PSP orders that are needed for any customers. It's not that it's gone away. It's still there in a reasonable amount but it's typically the customers who are very long cycle in their design and very high value in their end products. Many parts of the market are concerned about what happens on the flip side of the cycle, whatever that is in the second half of '24. So it's a customer choice. No customer has to use PSP unless they believe it provides them a tool. We've made adjustments to the program to give them more flexibility, have a shorter window of time, etcetera. We'll continue to evolve the program. If there is a need for it, customers will take advantage of it. If there isn't, then they won't.

Question on the geographies, I guess. So in terms of all these cancellations and pushouts in the forecast, have any geographies fared any better or worse as we're going through this correction?

No, because a lot of our customers can be in multiple geographies. They can be headquartered in the U.S. but manufacturing in a different geography. The intensity or the requirements for push-out and help have no geographic distinction that would be different.

Okay. Yes, I know you said North America was flattish in the previous quarter. I was wondering if anything was still holding up or got worse. As my follow-up, so we've seen some of these internal China OEMs finally start to do their own analog or mixed signal chips. BYD doing their own BMS solution is one of them. It seems like they don't really care about quality or cost. Can you give us a sense if you know of roughly how much of your business goes to domestic China? Do you see any risk that the non-China MCU business could kind of issue with this?

The proportion of what goes into China for China of a broad-based product line, I would say, is probably under 5% or in that range. I don't have an exact number, so don't hold me to that. The difference is that this is not new; we have competition in China. The business is extremely fragmented. There are hundreds of thousands of customers and applications that are there. Even previously, we would have had some designs where somebody didn't care about quality and said I'm just going to use this. It's not unusual in where it happened, so it's something we are paying attention to but not something which is creating a dramatic change in the business itself.

Can you guys talk about or give us a rough idea of what percent of bookings coming into any of these quarters are being pushed out each quarter? Is that representative of the December sequential drop that we're getting here? As you guys mentioned, you really didn't have any turns business into the quarter. December has traditionally been somewhat flat. These levels of pushouts, are they increasing progressively as we move along here?

Firstly, new bookings are not the place where people are trying to push things out because if they are new bookings within the last 3 to 6 months of time, those are with much more informed sense for demand, supply market, etcetera. A lot of the pushout requests for backlog that was placed 9, 12 months or longer ago, as time has gone on, the need as they perceived when they placed the orders and the need as they see it today when facing the reality of what the market has changed to are different. New bookings are in far better shape.

What I would add to that is those new bookings have been pretty modest that have been coming in, right? So bookings have been lower. The bottom line is, I think it's very difficult for customers to know what they need, particularly with orders that were placed 9 or 12 months ago. We have had certain instances where customers have asked for a pushout and the next month, they're coming back to us and asking for us to pull it in. There's a very uncertain environment at the customer level, and obviously that causes some churn on our backlog and the requests that we get for pushout activity.

They have the benefit today of knowing that supply is readily available, that lead times are short and they are taking advantage of that which would make sense.

Yes, I think that's a great tie-in maybe to my next question. I guess with hindsight, how do you guys evaluate instituting that 12-month PSP? Was that a good thing, a bad thing? Would you do it again? If so, were there any changes you would make?

It's a question we ask ourselves all the time. But you also have to look at not 12 months as a stand-alone piece of information, right? It is what were the lead times. Even when lead times are 52 weeks, you really can't offer somebody something inside of that because all the capacity within that window is already consumed. Programs have to be designed with a sense of the information at a given point in time and they have to evolve as that information changes. We made adjustments to PSP to provide more flexibility and shorter amounts of time. Each program is designed to create a customer solution and that solution has to be sensitive to what problem we're trying to solve at a given point in time. PSP was a fantastic program for '21 and '22 and parts of '23 when there were long lead times, and customers were very happy with it. Today, it has less value when cycle times come down dramatically and for other than a small set of customers, it is not as important to provide that much visibility.

I've said this to investors time and time again that if we had not had the PSP, I am confident that our backlog would have been higher, but we wouldn't have known what was good backlog and what was bad backlog and we would have made the wrong decisions in terms of foundry orders. The PSP program was designed to service customers in a very long lead time environment where we were capacity constrained and give the customer an option but also have them have skin in the game, so all that risk was not put on Microchip. A lot of good things came with PSP. Obviously, when the cycle changes, customers can feel differently about the backlog that they placed than they did when they placed the order, but there were a lot of happy customers that we served well because of the program.

The question is on the cash return program and the buybacks and understand that the program is really meant to be formulaic. But the question is, is there any flexibility within that program to be more opportunistic at times like these? Obviously, you guys are still generating a good amount of cash, but taking advantage when the downturn in the stock is down, have you contemplated that?

Let me get it kicked off and I think Steve might want to weigh in here as well. The program is something that the Board looks at on a constant basis. There is nothing that would prevent us from doing something which is opportunistic for the right reasons if the Board believes that's the right action for us.

While the main body of the program is formulaic, where we are increasing the cash return to shareholders by 500 basis points every quarter and increasing our dividend by about 7% every quarter and the remaining amount becomes the stock buyback, the program doesn't prohibit us from taking advantage of the environment; if the stock gets into a severe downdraft for any reason, we can certainly have the cash resources and headroom on our credit line to buy the stock from the following quarter and then buy less the following quarter. We haven't stopped doing that so far. I think stocks have been reasonably constant in the range of between $70 and $90. If there were to be a substantial opportunity at a lower stock price, Microchip has the flexibility to do anything we wanted to do.

Of course, we have the headroom and what's the approved buyback. There's over $2 billion of headroom available there, and we have the headroom in our line of credit.

I think that's a key point to look at because if you're looking at your inventory on a backward-looking basis or current quarter type basis and what that drives but you have confidence that 2 quarters, 3 quarters, 4 quarters, 6 quarters out in time that the business is going to go back and exceed prior highs, you're going to take a different action than if you think the business is in decline mode or stagnant. Those are all the things that we need to evaluate when determining how we're going to run our factories and what's the right position for the inventory. We've got our position today, and as I've said, we'll continue to evaluate that based on the environment that we see in front of us.

I was just wondering, is there like a target inventory level that you want to maintain? Or on the flip side of that, at what point do you start to look at reducing back utilization?

Our target levels that we said at our Analyst and Investor Day back in November of 2021 was 130 to 150 days. We are obviously above those levels today, and there's reasons for that. Some of your question I responded to in response to the credit question. We're not uncomfortable with where the inventory is today; we're going to watch it closely depending on the environment. It's going to be what the outlook is in terms of are we comfortable continuing to run the fabs at the levels they are at today or if we need to do something different. We're not at that point today where we're going to do something different. Inventory is above our target levels, but I think we're managing it appropriately and will continue to do so.

I would add that in steady state, the 130 to 150 is where we want to be. If you look back at the last cycle, I think we were down like 108, 109. That was what it was in the place where demand was so high, depleting our inventory. Today, we're at 167, with 10 days of that being really last time buys. So you take that out, we're around 157. We're not dramatically outside of the steady-state range that we would need to be.

Understood. The reason I ask is that revenues are down, which might lead to a spike in DOI. Considering the market conditions, could you discuss the current trends in inventory levels? Are you experiencing any pricing pushback in the supply chain as supply increases, or has demand softened somewhat? Any insights on this would be appreciated.

Firstly, we have insight into the inventory at our distributors. For our customers, we consider their requests for pushouts as a way to gauge the situation. Customers operate across various business units and product lines, so some may want to push out certain products while others might want to increase orders. It's quite varied. There was a second part of your question.

Pricing. Wasn't quite sure if that was customer pricing or supplier pricing. Is it supply chain pricing or customer pricing that you're asking about?

Is customer pricing now part of the discussion as market conditions change, supply improves, and inventory levels rise?

All the purchasing managers are going to ask for a lower price in a softer environment. But these are products where the price elasticity isn't there; if we put a lower price, we get more different this quarter or next quarter, etcetera. These are long design cycles. Prices have stepped 18, 24 or 36 months. When it comes to design, business itself in the short term is not affected by the pricing.

Maybe another one on just the inventories. Last quarter, you talked about the lower-than-expected sell-through in China, which was largely responsible for the rising channel inventories in June? Or do I think days increased, I think it was 5 days back in June, days increased another 6 days here in the September quarter. Was this primarily continued weak sell-through in China? Or was the pickup more pronounced in other geographies?

I'd say that the sell-through was not strong in any geography. So we did not see any significant improvement in distribution sell-through.

China has continued to be weak. We have not seen the level of improvement we expected out of China, and there's plenty of news information about what's happening from an economic standpoint.

Ganesh, you talked about the relative strength in aerospace and defense. Your data center and compute franchise, I think, is probably now about 20% of your business. Mix demand trends here as well, but you guys are exposed to some of the stronger areas like accelerated compute? How is this end market trending for the team?

I think on data center, I think the last breakout there was about 17% or so in that range. But there are many subsegments that go into it. We clearly have a tailwind in anything and everything that goes into the artificial intelligence and the generative AI space, etcetera. But in terms of the volume that that drives and the dollars that it drives, while it is meaningful, it's not big enough to offset some of the other weakness we have in other parts of data center.

Ganesh, you talked about every cycle being different. In this cycle in the upturn, it seemed like the shortages were more severe. You did see prices go up more on a like-for-like basis, and your margins got higher than we've seen before. So I guess as you think about the downturn, is that going to reverse? Do you have a situation where there's more awareness of the supply chain? People want to hold more inventory because of the intensity of the shortages? Can you just tell us how the strength in the last couple of years might portend for the next couple of quarters?

I think different customers have different levels of strategic versus tactical thinking. Last night, I have been with the CEO of one of our largest customers, and they are extremely thoughtful about not just the next one quarter but about the next 3, 4 years of time and how they want to plan for it. I've also had similar discussions with people who were 2 or 3 years suffering with lack of product, and all of a sudden, they've forgotten about all the things they need to be able to do. It really depends on what pressure they're under. Most customers or customers' customers, who build many of the high-value systems, are much more thoughtful about how a small piece of the bill of material is not where they need to save substantially, while they create significant value at the overall system. There's no single answer because we serve 100,000 customers. It's all over the place. Without a doubt, short lead times are giving them more flexibility in terms of what they place on us and how much time they need to provide us in many cases.

With a follow-up. I had a quick one for you, Eric. What's the target days of inventory for distributors?

We don't really have a target. It's been all over the place historically. It's been as low as 17 days, and it's been as high as, I think, 47 over the last 10 to 12 years. It's a broad range. Ultimately, it's the distributor's decision on the product they purchase and how they support their customers. Obviously, they need a certain amount of inventory to effectively serve their customer base. If they don't hold that inventory, the end customer will find another channel to buy that product through. We don't drive it to a certain number of days. I would not be surprised in the current environment that distributors, with interest rates where they are, if they try to take their inventory down to some degree. But where that goes, it's very hard for us to predict.

The distributor business over time has also changed. They do warehousing services for many OEMs, where they carry pipeline inventory for them. They have programs that are not the traditional distribution where they are carrying the product, and the turns rate is not the same when they are pipelining for very large OEMs. Inventory, as Eric said, is something that each distributor has a model for what they're trying to accomplish and what they need when they end up at.

Your business has changed a lot over the years. You have aerospace. It depends on what you don't have several years ago. That's why I was asking. I think you gave a helpful answer a little bit on the target of inventory days. Ganesh, that depend is also you're carrying at the end of life. So you're not that far out of the range on where you are versus your target shared at the Analyst Day.

Okay. I want to thank everybody for participating in the call today. We do have many events that we will be at during the course of this quarter, and we look forward to talking to you more at those events. Thank you.