Microchip Technology Incorporated (MCHP) Earnings

Management highlights

- Overall Q1 Performance * All non-GAAP financial metrics (net sales, gross margin, operating margin, EPS) beat the high end of prior guidance * Non-GAAP gross margin hit 63.8% (up 222 bps sequentially), non-GAAP operating margin hit 35.1% (up 452 bps sequentially) * GAAP net income was $202 million ($0.37 per diluted share); non-GAAP net income was $438.6 million ($0.76 per diluted share, 7 cents above guidance midpoint) * Inventory reduced to 175 days of sales (down 10 days sequentially from the March quarter), approaching the 130-150 day target range. Distributor inventory hit 25 days (down 1 day sequentially), at the lower end of historical ranges * Net debt to adjusted EBITDA improved to 2.85x as of quarter-end, down from prior levels * Adjusted free cash flow was $478.6 million for the quarter, with $13.9 million in capital expenditures - Data Center Business Updates * Management disclosed full cross-segment data center exposure for the first time, confirming broad-based exposure across power management, memory, security, microcontrollers, analog, PCIe switches, controllers and other product lines * The data center solutions business unit now holds 14 total Gen 6 PCIe design wins (12 for Gen 6 switches, 2 for Gen 6 retimers), doubling from 6 design wins last quarter * Calendar Q1 2026 data center sales grew 77.2% YoY, with calendar Q2 2026 (the June quarter) growing 97.8% YoY; significant additional growth is expected in 2027 as new design wins enter production - Market and Supply Chain Updates * The distribution inventory correction is complete, with low distributor inventory creating future replenishment demand; distribution sell-through grew 17% sequentially in Q1 * June quarter bookings were the strongest in four years, with a book-to-bill ratio well above 1 * Supply constraints have broadened beyond isolated product areas: lead times are stretching across many products due to substrate shortages, foundry node constraints, and OSAT/assembly capacity constraints, exacerbated by AI demand crowding out other capacity * The recently announced price increase was successfully implemented, with most price changes effective mid-August to early September 2026 * Management committed to providing quarterly end market revenue breakdowns going forward, per investor request - Capital Allocation Strategy * Management will prioritize paying down debt with all excess free cash flow for the foreseeable future: there are no current plans for share buybacks or dividend increases until debt levels are reduced further * No plans for large M&A; the small acquisition of Israel-based Halo (AI edge technology) is expected to close in September 2026, advancing Microchip's AI edge roadmap by ~4-5 years with minimal near-term revenue impact

Guidance

- For the September 2026 quarter (Q2 FY2027): * Net sales are expected to be up 8% sequentially (plus or minus 1%), equating to a 40.6% YoY increase at the guidance midpoint * Non-GAAP gross margin is guided to 66% to 67% (above the company's 65% long-term target, driven by temporary factors including strong product mix, a high-margin quarter for licensing, captured price increases, lower inventory write-offs, and reduced capacity underutilization charges; management does not expect gross margin to rise above this range going forward) * Non-GAAP operating expenses are expected to be ~27.5% of sales * Non-GAAP operating profit is guided to 38.5% to 39.5% of sales * Non-GAAP diluted EPS is expected to be between $0.91 and $0.95, representing a 165.7% YoY increase and 22.4% sequential increase at the midpoint - Full year fiscal 2027 capital expenditures are expected to be ~$100 million, and the full year non-GAAP cash tax rate is expected to be ~7.5% - Management expects net debt to adjusted EBITDA to fall below 2.5x in the September quarter, with further significant reduction through fiscal 2027 - The December 2026 quarter (Q3 FY2027) is expected to perform better than the typical historical 3-5% sequential seasonal decline - Gross margin is expected to remain in the guided 66-67% range for the next several quarters, with no expected further upside

Segment performance

For the June 2026 quarter (Q1 FY2027), total net sales were $1.485 billion, up 13.2% sequentially and 38% year-over-year. End market segment performance (revenue contribution % and YoY growth): - Industrial: 32.2% of revenue, +24.3% YoY - Data centers: 17.1% of revenue, +97.8% YoY - Aerospace and Defense: 16.7% of revenue, +45.6% YoY - Automotive: 15% of revenue, +29.3% YoY - Communication: 8.2% of revenue, +53.3% YoY - Consumer appliances: 7.4% of revenue, +19.1% YoY - Compute: 3.4% of revenue, +9.6% YoY For calendar year 2025, total Microchip data center net sales were $590.7 million (14% of total annual net sales), consisting of $302.7 million from the dedicated data center solutions business unit and $288 million from cross-segment catalog products. Calendar year 2026 total data center sales are expected to reach ~$1 billion, a 69% YoY increase.

Risks & headwinds

- Broad-based supply chain constraints: Foundry capacity constraints across multiple technology nodes and OSAT/advanced assembly capacity constraints (exacerbated by AI demand crowding out non-AI production) limit near-term revenue growth; lead times are stretching, and many customer expedite requests cannot be fulfilled within the quarter - A&D growth: While strong YoY growth is expected to continue, the 45.6% Q1 YoY growth reflects a low base from depressed levels, and 45%+ growth is not expected to be sustained - Gross margin upside: The elevated Q2 gross margin guidance includes temporary, non-recurring benefits (lumpy 100% margin licensing revenue, one-time distribution inventory pricing benefits) that will not repeat in future quarters - Debt levels: Gross debt remains ~$5.5 billion (net debt ~$5.2 billion), which management considers too high, limiting capital flexibility for share repurchases, dividend increases, or large M&A for the foreseeable future - End market tracking uncertainty: Around 50% of sales go through distribution, creating an approximate 2% error band in end market revenue split estimates

Analyst Q&A

• Q: How long can the current industry upturn last, and what factors support extended growth? /

  A: Steve Sanghi identified four factors supporting a longer-than-usual upturn. Data center growth is significant and expected to continue for multiple years, and aerospace and defense is in the early stages of a multi-year military buildup that is just beginning to translate into orders. Industrial and automotive recovery started later than other segments, so they still have substantial room for further growth. All four major end markets are in expansion phases that can support sustained growth. /n/n

• Q: What should we expect for gross margin after the September quarter, why shouldn't we expect further upside beyond the 66-67% guided range? /

  A: Eric Bjornholt explained that the elevated September quarter margin includes non-repeatable one-time benefits: an unusually large quarter of 100% gross margin licensing revenue (which is naturally lumpy), and a one-time accounting benefit from price increases on existing distribution channel inventory. Foundry and other input costs are also rising, which will offset ongoing margin improvements. Management expects the price increase to fully offset cost pressures after the one-time benefits roll off, keeping gross margin in the current range but not pushing it higher. /n/n

• Q: With supply constraints emerging, is there a cap on revenue growth, and do you plan to build your own 300mm fab to add capacity? /

  A: Steve Sanghi noted that constraint does not mean revenue is capped: the company is getting incremental capacity increases from suppliers every quarter, and has delivered strong sequential growth despite prior constraints. There are no plans to build an internal 300mm fab, as Microchip already relies on foundry partners for 300mm production, and retooling and redesigning all existing 300mm products for an in-house fab would be impractical. The main constraints remain external foundry and OSAT capacity, not internal Microchip capacity. /n/n

• Q: What is the outlook for distributor inventory replenishment over the next 2-4 quarters now that inventory is at the low end of historical ranges? /

  A: Distributors acknowledge their inventory is too low and want to rebuild to normal levels, but they are waiting for end customers to place firm orders before placing replenishment orders with Microchip. End customers have not yet adjusted their ordering behavior despite widespread industry warnings of longer lead times, and typically only increase order horizons after experiencing production line disruptions. Distributors are only willing to place limited preemptive orders for known, long-running designs, so broad replenishment will be gradual until end customer ordering behavior changes. /n/n

• Q: What is the outlook for ongoing aerospace and defense growth, and is the expected weapons stockpile rebuild already reflected in current orders? /

  A: Steve Sanghi confirmed that A&D will continue outperforming the overall company for the foreseeable future, driven by global military stockpile rebuilding. Current strong 45% YoY growth reflects a low base, but most of the expected production ramp is still on the come: primes are still planning for 4X to 8X production increases, and have not yet placed the full volume of orders. Microchip is ready to ramp production as orders come in, so substantial additional upside remains in the segment.