Microchip Technology Incorporated (MCHP) Q3 2026 Earnings Call Transcript
Access earnings results, analyst expectations, report, slides, earnings call, and transcript.
Overview
The earnings call indicates positive momentum with strong backlog, significant growth in key segments like FPGA and data center, and improving gross margins. Despite some uncertainties in achieving mid-60s margins, the company's strategic focus on debt reduction and operational improvements are promising. Analysts' questions reflect optimism, particularly about the June quarter and product line growth. Overall, the positive guidance and strategic developments suggest a likely stock price increase.
Key Financial Performance
Net Sales $1.186 billion, up 4% sequentially and 15.6% year-over-year. Growth driven by networking, data center, FPGA, and licensing business units.
Non-GAAP Gross Margins 60.5%, up 379 basis points sequentially and 800 basis points year-over-year. Improvement due to better capacity utilization and inventory management.
Operating Expenses (Non-GAAP) 32% of sales. No specific year-over-year change mentioned.
Operating Income (Non-GAAP) 28.5% of sales, up 418 basis points sequentially and 800 basis points year-over-year. Improvement attributed to higher gross margins and operational efficiency.
Non-GAAP Net Income $252.8 million. No specific year-over-year change mentioned.
Non-GAAP Earnings Per Share $0.44, $0.04 above the high end of original guidance. No specific year-over-year change mentioned.
GAAP Gross Margins 59.6%. No specific year-over-year change mentioned.
GAAP Net Income $34.9 million or $0.06 per share. No specific year-over-year change mentioned.
Inventory Balance $1.058 billion, down $37.6 million from the prior quarter. Inventory days at 201, with 17 days of long life cycle, high-margin products.
Cash Flow from Operating Activities $341.4 million. No specific year-over-year change mentioned.
Adjusted Free Cash Flow $305.6 million. No specific year-over-year change mentioned.
Consolidated Cash and Total Investment Position $250.7 million. No specific year-over-year change mentioned.
Total Debt Decreased by $12.1 million sequentially. No specific year-over-year change mentioned.
Net Debt Decreased by $26 million sequentially. No specific year-over-year change mentioned.
Adjusted EBITDA $402 million, 33.9% of net sales. Trailing 12-month adjusted EBITDA was $1.23 billion. No specific year-over-year change mentioned.
Net Debt to Adjusted EBITDA Ratio 4.18, down from 4.69 in the prior quarter. No specific year-over-year change mentioned.
Capital Expenditures $22.5 million. No specific year-over-year change mentioned.
Depreciation Expense $37.8 million. No specific year-over-year change mentioned.
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Operating Highlights
Automotive Ethernet Solutions: Microchip has developed a market-leading portfolio of 10BASE-T1S products, switches, transceivers, endpoints, and bridges to support the transition to Ethernet-based networking architectures in vehicles. They announced a strategic collaboration with Hyundai Motor Group to integrate these solutions into next-generation vehicle platforms.
Industrial Ethernet Solutions: Microchip is leveraging its Ethernet portfolio, including single-pair Ethernet and EtherCAT, to replace legacy connectivity standards in industrial applications. These solutions are expected to support Industry 4.0 modernization cycles.
PCI Express Gen 6 Switch: Microchip's Gen 6 PCIe switch, based on 3-nanometer technology, is currently sampling with hyperscaler and enterprise data center customers. The company reported three design wins, including one expected to generate $100 million+ in revenue in 2027.
Automotive Market: Car manufacturers are transitioning to Ethernet-based networking architectures to reduce complexity and improve software reusability. Microchip is well-positioned with its automotive Ethernet solutions and has secured design wins with leading global automotive OEMs and Tier 1 suppliers.
Industrial Market: The industrial sector is undergoing a modernization cycle, replacing legacy connectivity standards with Ethernet-based solutions. Microchip's comprehensive portfolio is helping customers bridge legacy and advanced industrial connectivity.
Financial Performance: Net sales in Q3 FY26 were $1.186 billion, up 4% sequentially and 15.6% year-over-year. Non-GAAP gross margin reached 60.5%, and operating margin was 28.5%. Non-GAAP net income was $252.8 million.
Inventory Management: Inventory levels decreased by $37.6 million, with 201 days of inventory at the end of the quarter. Distribution inventory levels are normalizing, with a sell-through gap of $11.7 million.
Cash Flow and Debt Reduction: Cash flow from operating activities was $341.4 million, and adjusted free cash flow was $305.6 million. Net debt decreased by $26 million sequentially.
Strategic Collaboration: Microchip announced a collaboration with Hyundai Motor Group to integrate its 10BASE-T1S solutions into next-generation vehicle platforms.
Market Positioning: Microchip is leveraging its leadership in Ethernet and PCIe technologies to capture opportunities in automotive, industrial, and data center markets. The company is focusing on modernization cycles in these sectors to drive growth.
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Risk or Challenges
Capacity underutilization charges: Microchip incurred $51.7 million in capacity underutilization charges, indicating potential inefficiencies or challenges in optimizing production capacity.
New inventory reserve charges: The company faced $58.4 million in new inventory reserve charges, reflecting potential risks related to excess or obsolete inventory.
Closure of Fab 2: Special charges of $4.8 million were incurred due to the closure of Fab 2, which could indicate restructuring challenges or operational disruptions.
Debt levels: Despite a decrease in net debt, the company still has a net debt to adjusted EBITDA ratio of 4.18, which may pose financial risks if not managed effectively.
Supply chain constraints: Challenges were noted in obtaining certain substrates, subcontracting capacity, and advanced node foundry constraints, which could impact production and delivery timelines.
Customer inventory levels: Increased customer requests for expedited shipments suggest that some customers' inventories are running low, potentially leading to supply chain pressures.
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Guidance & Outlook
Non-GAAP tax rate: Expected to record a non-GAAP tax rate of about 10% for all of fiscal year 2026.
Capital expenditures: Expected to be at or below $100 million for fiscal year 2026.
Connectivity business growth: Recent industrial connectivity design engagements align with pilot production ramps expected in the second half of 2026 and ramping further into 2027. The connectivity business is expected to be a significant contributor to company growth as modernization cycles accelerate.
Market opportunity for Ethernet connectivity: The TAM for automotive and industrial Ethernet connectivity together represents tens of billions of dollars by 2030.
Net sales for March quarter: Expected to be $1.26 billion, plus or minus $20 million, representing 6.2% sequential growth and up 29.8% from the year ago quarter.
Non-GAAP gross margin for March quarter: Expected to be between 60.5% and 61.5% of sales.
Non-GAAP operating expenses for March quarter: Expected to be between 31.3% and 31.7% of sales.
Non-GAAP operating profit for March quarter: Expected to be between 28.8% and 30.2% of sales.
Non-GAAP diluted earnings per share for March quarter: Expected to be between $0.48 and $0.52 per share.
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Shareholder Return Plan
Dividend Commitment: The company produced free cash flow that exceeded its dividend commitment in the last quarter.
Capital Return Program: The company decreased its net debt balance by $26 million in the last quarter and intends to use excess free cash flow above dividends to continue reducing borrowings.
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Key Q&A
Q:What factors contribute to the above seasonal guide for margin and growth beyond?
A:The distribution inventory is mostly corrected, but some customers are still burning through inventory. There is a strong backlog for the current quarter, and bookings are high. While visibility outside the current quarter is limited due to short lead times, the order book is growing, and discussions with customers indicate confidence heading into the June and September quarters, which are typically the strongest.
Q:How should we think about inventory reserve and underutilization charges rolling off, and what are the levers for gross margins?
A:Inventory reserves are expected to normalize this quarter, with charges continuing to decrease. Underutilization charges, which were over $50 million last quarter, will modestly decrease but remain high. Improving gross margins will depend on ramping factories, product mix improvements, and growth in high-margin areas like data center, Ethernet, and connectivity businesses.
Q:What drove the December upside versus original guidance, and what is expected for the March quarter?
A:The December upside came from stronger-than-expected performance in microcontrollers, analog, FPGA, and other product lines, despite licensing revenue being modeled. For March, the backlog is strong, and most product lines, including microcontroller, analog, FPGA, networking, and data center, are expected to grow, leading to a 6.2% sequential guidance.
Q:What is the timeline to achieve the mid-60s gross margin target?
A:The timeline is uncertain. Inventory charges are normalizing, but underutilization charges will take time to decrease, depending on growth in internally produced products. While steady improvement is expected, reaching the mid-60s target is not anticipated in the near term.
Q:What is the current state of customer inventory behavior?
A:Customers are not restocking but are reducing inventory levels. Some products are being purchased at consumption rates as inventory normalizes. Constraints in foundry capacity are broadening, which may lead to tighter capacity and firmer pricing in the near future.
Q:What is the outlook for the June quarter backlog and bookings?
A:January bookings were exceptionally strong, and the June quarter backlog is higher than the March quarter backlog at the same point in time. This indicates optimism for a strong June quarter.
Q:What contributed to the 18% sequential increase in 'other' product revenue, and will it repeat in March?
A:The increase was driven by licensing, FPGA, memory, and timing systems. Memory business strength is sustainable due to constraints in high-bandwidth memory and flash memory. However, the licensing benefit from December will not repeat in March.
Q:What are the moving pieces in the March quarter gross margin?
A:Gross margin is guided up to 61% despite the non-repeating licensing benefit from December. Inventory reserves are expected to normalize, contributing to the improvement.
Q:What is the current state of fab utilization and OpEx?
A:Fab utilization is low, with significant upside potential as factories ramp up. OpEx is increasing in dollars but decreasing as a percentage of revenue, driven by investments in people, bonuses, and raises to retain and attract talent.
Q:What is the outlook for the Aerospace and Defense (A&D) segment?
A:The A&D segment is benefiting from increased defense budgets in the U.S. and NATO countries, commercial airplane production, and space exploration. Growth is also driven by new defense and aerospace investments, including drones and satellites.
Q:What is the growth outlook for the FPGA business?
A:The FPGA business is experiencing significant growth and gaining market share. While specific numbers are not disclosed, the company is optimistic about continued growth.
Q:What is the status of PCI Express switching and the roadmap for maintaining revenue momentum?
A:Gen 6 PCI Express is in the design phase with customers, and Gen 7 development is underway. The company is working on additional design wins and mega design wins, which could significantly boost revenue.
Q:What is the progress on gross margins and the impact of product mix?
A:Gross margin improvement is driven by both utilization increases and a richer product mix. High-margin products from external foundries are growing faster, contributing to margin accretion.
Q:What is the strategy for debt reduction and use of cash?
A:The company is prioritizing debt reduction over buybacks and dividends due to concerns about high leverage during the last cycle. The goal is to significantly reduce debt and leverage before considering other uses of cash.
Q:What is the current state of turns business and expedite requests?
A:Turns business and expedite requests are strong, with customers pulling in backlog from future quarters. This behavior is indicative of an upcycle.
Q:What is the status of the data center SSD controller business?
A:The company continues to invest in data center SSD controllers for both flash and HDD, benefiting from strong demand driven by AI compute and other use cases.
Q:Review of Unclear Management Responses
A:Management avoided providing specific timelines for achieving the mid-60s gross margin target and did not disclose detailed fab utilization rates. Additionally, they refrained from breaking out FPGA revenue numbers or providing specifics on PCI Express switching applications and customer details, citing competitive sensitivity.
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Earnings Word Cloud
The most frequently occurring keywords in this quarter's earning call
ADAS camera
ASA Motion
ASA camera
ASA standard
Automotive unit
BASE TS
CFO Senior
Center Networking
Connectivity Automotive
Connectivity Units
Corporate Vice
Designs sample
Networking Connectivity
RS
TS standard
Today
Vice President
car
complexity
connectivity speed
connectivity standard
engagement
generation vehicle
legacy connectivity
modernization cycle
networking
platform
segment
software
solution
standard speed
system
vehicle computer
MCHP Transcript
Microchip Technology Incorporated (MCHP) Q3 2026 Earnings Call Transcript
Positive2-5
The earnings call indicates positive momentum with strong backlog, significant growth in key segments like FPGA and data center, and improving gross margins. Despite some uncertainties in achieving mid-60s margins, the company's strategic focus on debt reduction and operational improvements are promising. Analysts' questions reflect optimism, particularly about the June quarter and product line growth. Overall, the positive guidance and strategic developments suggest a likely stock price increase.
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The earnings call presents a mixed picture. Strong financial metrics and optimistic guidance are offset by concerns over inventory write-offs, underutilization charges, and lack of visibility due to dismantled LTSAs. The strategic focus on data center products and expected cost savings from the Fab 2 closure are positives, but substrate capacity constraints and unclear management responses create uncertainties. Overall, the sentiment is neutral, with no strong catalysts for a significant stock price movement in either direction.
MCHP Slides
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MCHP Report
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