Microchip Technology's Q3 2026 Earnings Signal Strong Aerospace Demand

Microchip Technology (MCHP) delivered better-than-expected financial results for the third quarter of fiscal year 2026, ended December 31, 2025. The company’s performance suggests a broad market recovery. Key drivers included robust sales in the aerospace and defense (A&D) sector. Networking and data center solutions also contributed significantly to the upside.

Net sales reached $1.186 billion, marking a 4% sequential increase. This figure surpassed the high end of the company’s original guidance. Non-GAAP diluted earnings per share (EPS) was $0.44, exceeding prior guidance by $0.04. Management cited strong bookings and backlog entering the current quarter. The book-to-bill ratio for December was well above one.

Strong Momentum in Key Segments

Chief Executive Officer Steve Sanghi noted recovery across most end markets. These markets include automotive, industrial, communication, and consumer. The A&D sector was highlighted as one of the strongest contributors to sales performance. This growth is linked to large U.S. defense budgets. It is also tied to increased spending by NATO countries. Furthermore, the segment benefits from the ramp-up of commercial airplane production, such as the Boeing 737 MAX.

Next-Generation Connectivity

Microchip is positioning itself for long-term growth through advanced connectivity solutions. The company reported three design wins for its PCI Express (PCIe) Gen 6 switch. This is a 3-nanometer-based device for hyperscale data centers. One of these wins is expected to generate over $100 million in revenue in calendar year 2027. These high-speed components are vital for modern data-intensive applications. This includes advanced avionics and ground support systems.

In the automotive space, Corporate Vice President Matthias Kastner discussed the transition to Ethernet-based architectures. This is moving away from a multitude of legacy connectivity standards. Microchip announced a strategic collaboration with Hyundai Motor Group. This deal will integrate its 10BASE-T1S solutions into next-generation vehicle platforms. This single-pair Ethernet standard is key for simplified wiring. It supports advanced driver-assistance systems (ADAS) and infotainment. These technologies are increasingly relevant to aviation’s cockpit and cabin systems.

Supply Chain and Financial Strategy

Management indicated that the inventory correction cycle is nearing its end. Distributor inventory averaged 28 days, considered a normal level. Distribution sell-through exceeded sell-in by $11.7 million. However, new supply-side challenges are emerging. CEO Steve Sanghi noted constraints on certain substrates and subcontracting capacity. Lead times are beginning to extend for some products and advanced foundry nodes. Customer requests for expedited shipments have increased significantly. This suggests that some customer inventories are running low.

Non-GAAP gross margin reached 60.5% in the quarter. This included $51.7 million in capacity underutilization charges. It also included $58.4 million in new inventory reserve charges. Gross margin is expected to improve gradually. This will be driven by a more favorable product mix. It will also benefit from lower underutilization charges as factory production ramps up. Management noted a significant upside of about $50 million in gross margin. This will materialize when factories reach full production.

Debt Reduction Priority

Executives signaled a major shift in capital allocation strategy. The focus is now on accelerated debt reduction. This comes after a challenging recent down cycle. Mr. Sanghi stated, "We are honestly spooked by this last cycle, how difficult this cycle was." The company will pause share buybacks. Excess adjusted free cash flow, which exceeded dividend payments, will now be dedicated to reducing net debt. The net debt to adjusted EBITDA ratio was 4.18 at quarter-end, down from 4.69 previously.

Outlook for the March Quarter

Microchip provided strong guidance for the March quarter. Net sales are projected at $1.26 billion at the midpoint. This represents 6.2% sequential growth. This is well above typical seasonal levels. Non-GAAP diluted EPS is expected to be between $0.48 and $0.52. Growth is anticipated to be broad-based. This includes microcontroller, analog, FPGA, and data center businesses. Management is also optimistic about the June quarter. Preliminary trends show rising order momentum and a strong backlog.

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