Microchip Technology Incorporated

Good day, everyone, and welcome to Microchip's first quarter fiscal 2021 financial results conference call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Microchip's president and chief, excuse me, Microchip's chief financial officer, Eric Gerenhold. Please go ahead, sir.

Thanks, Brandon, and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward looking statements regarding future events for the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events results may differ materially. We refer you to our press releases 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 Steve Sange, Microchip's chairman and CEO, and Ganesh Moorthy, Microchip's president and COO. I will comment on our first quarter financial performance and Steve and Ganesh will then give their comments on the results and discuss the current business environment, as well as our guidance. We will then be available to respond to specific investor analyst questions. We are including information in our press release and this conference call on various gap and non-gap measures. We have posted a full gap to non-gap reconciliation on the investor relations page of our website at .microchip.com, which we believe you will find useful when comparing our gap and non-gap results. We've also posted a summary of our outstanding debt and 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-gap basis, which is based on expenses prior to the effects of acquisition activities, share based compensation and certain other adjustments that are described in our press release. Net sales in the June quarter were $1.31 billion, which was down .3% sequentially and above the midpoint of our upperly revised guidance from June 2nd, 2020, when net sales were expected to be flat to down 6% sequentially. We have posted a summary of our gap net sales, as well as end market demand by product line and geography on our website for your reference. On a non-gap basis, gross margins were strong at 61.7%, operating expenses were at 23.1%, and operating income was an outstanding 38.6%, all better than the high end of our upperly revised guidance. Non-gap net income was $401.9 million, non-gap earnings per diluted share was $1.56 and three cents above the high end of our upperly revised guidance from June 2nd. On a gap basis, in the June quarter, gross margins were 61% and include the impact of $6.4 million of share based compensation and $2.8 million of COVID-19 shelter in place restrictions on manufacturing activities. Total operating expenses were $580 million and include acquisition and tangible amortization of $235.4 million, special charges of $0.3 million, $6 million of acquisitionally weighted and other costs, and share based compensation of $36 million. The gap net income was $123.6 million or 48 cents per diluted share. Our June quarter gap tax benefit was impacted by a variety of factors, including tax reserve releases associated with the statute of limitations expiring, deferred tax adjustments related to inter-company movements of intellectual property rights, offset by tax reserve accruals associated with the outcome of the Altura case during the period and other matters. The non-gap cash tax rate was 6% in the June quarter. We expect our non-gap cash tax rate for fiscal 21 to be about 6%, exclusive of the transition tax, any potential tax associated with restructuring the micro-semi operations into the micro-circle of the structure, and any tax audit settlements related to taxes accrued in prior fiscal years. We have many tax attributes and net operating losses and tax credits, as well as U.S. tax interest deductions that we believe will keep our cash tax payments low. The cash tax payments beyond the June 2020 quarter associated with the transition tax are expected to be about $245 million and will be paid out over the next six years, including a payment that we made in July 2020 of $23.2 million. We have posted a schedule of our projected transition tax payments on the investor relations page of our website. Our inventory balance at June 30, 2020, was $657.2 million. We had 117 days of inventory at the end of the June quarter, which was down five days from the prior quarter's levels and right in the middle of our publicly stated inventory target of 115 to 120 days. Inventory at our distributors in the June quarter were 30 days compared to 29 days at the end of March. We believe distribution inventory levels for microchip are still low compared to the historical range we have experienced over the past 10 years, which is between 27 and 47 days. The cash flow from operating activities was $501.8 million in the June quarter. As of June 30, the consolidated cash and total investment position was $380.2 million. We paid down $394 million of total debt in the June quarter. And over the last eight full quarters, since we closed the micro semi acquisition and incurred over $808 billion of debt to do so, we have paid down $2.62 billion of debt. And continue to allocate substantially all of our excess cash beyond dividends to aggressively bring down this debt. We have accomplished this despite the adverse macro and market conditions during most of this period, which we feel is a testimony to the cash generation capabilities of our business, as well as our ongoing operating discipline. We continue to expect our debt levels to reduce significantly over the next several years. Our adjusted EBITDA in the June quarter was $562.2 million. And our trailing 12 month adjusted EBITDA was $2.154 billion. Our net debt to adjusted EBITDA, excluding our very long dated convertible debt that matures in 2037 and is more equity like in nature, was $4.24 at the end of June 2020, down from $4.46 at the end of March 2020. Our dividend payment in the June quarter was $90.4 million. Capital expenditures were $9.5 million in the June 2020 quarter. We expect about $15 million in capital spending in the September quarter and overall capital expenditures for fiscal 2021 to be between $50 and $70 million. We continue to add capital to maintain and operate our internal manufacturing operations, support the production capabilities for new products and technologies, as well as to selectively bring in-house some of the assembly and test operations that are currently outsourced. We expect these capital investments will bring some gross margin improvements for our business, particularly for the outsourced at-mail and micro semi manufacturing activities that we are bringing into our own factories. Appreciation expense in the June quarter was $41.1 million. I will now turn it over to Kinesh to give his comments on the performance of the business in the June quarter. Kinesh?

Great. Thank you, Eric. And good afternoon, everyone. Let's start by taking a closer look at microcontrollers. In a weak macro environment, our microcontroller business performed better than we expected. On a gap basis, our microcontroller revenue was sequentially down .3% as compared to the March quarter, while from an end market demand standpoint, our microcontroller business was sequentially down 2.8%. On a gap year over year basis, our microcontroller business was up 1.2%. We continue to introduce a steady stream of innovative new microcontroller solutions, including the industry's smallest automotive grade max-staff controller family, the first functional safety-ready AVR microcontroller family with a peripheral touch controller, the switch deck advanced fabric generation, generation four PCIe switch family, which enables complex fabric topology with greater scalability, lower latency and higher performance and traditional PCIe switches. And last but not least, the ADAPTEC SmartRAID 3100E RAID, which stands for redundant array of inexpensive disc adapters, designed to provide reliable hardware RAID protection for customer data. In cost sensitive end applications that require low power and high performance. Microcontrollers overall represented .9% of our end market demand in the June quarter. Now moving to analog, on a gap basis, our analog revenue was sequentially up .7% as compared to the March quarter, while from an end market standpoint, our analog business is sequentially down 0.7%. In both scenarios, our analog business performed better than we expected in the midst of a weak macro environment. On a gap year over year basis, our analog business is down 4.2%. During the quarter, we continue to announce and introduce a steady stream of innovative analog products, including an expanded portfolio of over 25 transient voltage suppressor vertical arrays, and a 32 channel high voltage analog multiplexer, further enabling miniaturization of medical ultrasound applications. Analog represented .1% of our end market demand in the June quarter. Our FPGA revenue on a gap basis was down .3% sequentially as compared to the March quarter. From an end market demand standpoint, our FPGA business was sequentially down 6.5%. Our FPGA business in the June quarter had one significant aerospace customer who was shut down hard due to COVID-19 restrictions for pretty much the entire quarter, resulting in lower than expected results. Despite this customer being unlikely to resume production in the September quarter, we are expecting the FPGA business to sequentially grow meaningfully in the September quarter. On a gap year over year basis, our FPGA business was down 4.6%.

During

the quarter, we continue to introduce a steady stream of innovative FPGA products, including the VectorBlock Accelerator software development kit, which enables developers to take advantage of Microchip's PoloFire FPGA to easily create low power neural network applications. FPGA represented .7% of our end market demand in the June quarter. Our licensing memory and other product lines, which we refer to as LMO, was flat as compared to the March quarter from an end market demand standpoint. During the quarter, we introduced a new phase noise analyzer designed for engineers and scientists who rely on precise and accurate measurements of frequency signal generated for 5G networks, data centers, and other data centers. Commercial and military aircraft systems, base vehicles, communication satellites, and metrology applications. LMO represented .4% of our end market demand in the June quarter. An update regarding coronavirus and its impact on our operations. Most of our non-factory employee base continues to work from home. Our global teams have been highly engaged, collaborative, and productive under the circumstances, resulting in strong customer engagement for new designs and effectiveness in our new product development programs. We would like to thank our teams worldwide for adapting as needed to changing conditions while continuing to deliver results. Our manufacturing operations, especially those in the Philippines and our outsourced partners in Malaysia, work through various constraints throughout the June quarter and deliver increased output as reflected in our better than expected results. By the end of the June quarter, we had dug out most of the delinquencies in our shipments that accumulated in April and May when unpredictable constraints from government mandates were in effect. Our customers and our supply chain partners also endured some constraints with their factories and logistics, primarily during the months of April and May. As we progress through May and June, we experienced many short lead time orders from customers, some of which we could not support in the quarter, primarily due to three factors. First, customers whose businesses strengthened due to COVID-19 conditions like work from home initiatives and medical devices. Second, the partial recovery in May and June of some customers' business, which experienced a sharp decline in the March-April timeframe, automotive being the biggest example of that in some industrials. And third, an unrealistic expectation from some customers that orders placed with short lead time can be supported at the supply chain. We are working with our customers to improve the visibility of the backlog so that we may serve them better. Given the current market dynamics, we are providing some qualitative insights into our principal end markets. Now, before we provide commentary for the June quarter, we would first like to share with you our best estimates for our fiscal year 20 revenue by end market. With over 120,000 customers served by microchip and given the complexity of our customers pay, it is laborious to collect this data and we only do so every few years. We remind you that this data is only estimated and it is not something we can track with high accuracy. Based on our analysis done in the June quarter for the fiscal year 20 revenue, industrial remains our largest end market at 28% of revenue. Computing and data center was next at 18% of revenue, followed by automotive 15% of revenue. Communications at 14% of revenue, consumer at 13% and finally aerospace and defense at 12% of revenue. With that backdrop to provide context, here are some end markets and insights for the June quarter that we'd like to share with you. Data center and computing continue to show strength from the shift to work from home requirements. However, we anticipate that these segments may revert to more normal demand patterns in the coming months as the search requirements start to dissipate. Automotive and car sales and production in China recovered nicely to grow sequentially and year over year, benefiting our China automotive business. Our automotive business everywhere else had a very poor quarter as April and May were adversely impacted by widespread automotive factory shutdowns. We began to see recovery in June and believe that the worst for automotive is behind us. Medical devices necessary to treat COVID patients like ventilators, respirators, oxygen monitors, portable ultrasound machines, they were all strong. In addition to a host of other hospital equipment needed for increased patient loads. Medical devices for elective procedures such as hearing aids, pacemakers, defibrillators, some of the large ultrasound MRI machines, those experience a slowdown as individuals in hospitals delayed elective procedures. Even within the broad based industrial and consumer markets, which are generally weak, we can see pockets of strength related to COVID-19. In consumer the strengths that are related to gaming, home improvement and hobbyist projects for people sheltered at home. In industrial the strengths that are related to UV disinfection system, air filtration system, infrared temperature scanners and a generally increasing trend towards touch free controls. Let me now pass it to Steve for comments about our business and our guidance going forward.

Steve? Thank you,

Ganesh and good afternoon everyone. Today I would like to first reflect on the results of the fiscal first quarter of 2021. I will then provide guidance for the fiscal second quarter of 2021. The June quarter demonstrated what the best of microchip culture and its people represent. Our global team of operations, business units, sales and marketing and support groups all came together in the middle of a global pandemic while working with a take out and delivered a superb quarter. I am proud of how rapidly the microchip team adapted to the new constraints we faced so that our employees would be safe, our customers could be well served and our supply chain partners engaged to help ensure mutual success despite the challenges we faced. Despite the COVID-19 pandemic challenges, we delivered net sales of $1.31 billion that was down only .3% sequentially and down only 1% from the year ago quarter. Our original net sales guidance was to be down 6% sequentially at the midpoint. In early June, we revised it to be down 3% sequentially at the midpoint. And we ended at down only .3% sequentially. These are exceptional results against the backdrop of simultaneous supply and demand dislocations. We also delivered outstanding non-GAAP gross margin of 61.7%, 90 basis points above the midpoint of our original guidance from May 7, 2020 and non-GAAP operating margin of 38.6%, 260 basis points above the midpoint of our original guidance. And we did all this while reducing our days of inventory from 122 days to 117 days. I am particularly proud of producing .6% operating margin at near the bottom of the business cycle amidst a global pandemic. Our consolidated non-GAAP EPS was $1.56, 21 cents above the midpoint of our original guidance and 12 cents above the midpoint of our revised guidance. On a non-GAAP basis, this was also our 119th consecutive profitable quarter. In the June quarter, we paid down $394 million of our debt. A total debt payment since the end of June 2018 has been about $2.62 billion, bringing our net leverage ratio down to 4.24. The pace of debt payments has been strong despite the weak and uncertain business conditions, underlining the strong cash generation characteristics of our business, as well as our active efforts to continue to squeeze working capital efficiencies. Now, I will discuss our guidance for the September quarter. After a strong March and April, our bookings were soft in May and June. But the bookings we received in May and June had a much higher mix of near-term requirements as the customers and distributors did not have the visibility to place longer-term orders. While the near-term aged bookings filled up the June quarter, it left the September quarter backlog on July 1, 2020 to be down 8% compared to the backlog for June quarter on April 1, 2020. We also left a large amount of backlog unsupported out of the June quarter because those requirements came inside of our lead time and we were not able to ship them according to customer request dates. This all prompted us to write a letter to our customers and distributors, first informing them of the business environment and our cycle time to build their products. Then we asked them to place at least 12 weeks of backlog for their requirements. We also informed our customers and distributors that if they asked for expediting of an order, we would need to charge an expedite service fee given the disruptive nature of such orders. Through the letter, we were just trying to encourage customers to give us more visibility so that we can better meet their requirements. The expedite charges have never been material in terms of our overall revenue. With another month under our belt now since the letter, we have seen some of the customers and distributors respond. The rate of bookings has increased. Our backlog for the September quarter is still well below the backlog for June quarter at the same point in time, but we believe that the stronger bookings now compared to weak bookings of May and June will continue to improve the September quarter backlog compared to June quarter. From an end market standpoint, as you heard during Ganesha's remarks, we have several cross currents contributing strengths and weaknesses at the same time. The common denominator among them is whether COVID-19 was a tailwind or a headwind during the quarter for a given end market. The diversity of our end market exposure, which we consider to be a strength, gives us the ability to capitalize on whatever strengths there are during challenging market conditions. Taking all these factors into consideration, we expect our net sales for September quarter to be between flat to down 8% sequentially. The relatively broad guidance ranges to help account for the lack of visibility and uncertainty associated with the evolving COVID-19 situation. Based on the much better than expected financial results in the June quarter, we gave our employees half of their June quarter salary sacrifice back in the form of a bonus. However, we are maintaining the salary cuts in the September quarter due to continued uncertainty. Our inventory at 117 days is now right in the middle of our 115 to 120 days target, hence we are also adjusting the factory schedules and removing the rotating timeouts. For September quarter, we expect our non-GAAP gross margin to be between .2% and .2% of sales. We expect non-GAAP operating expenses to be between .2% and .2% of sales. We expect non-GAAP operating profit percentage to be between 37% and 39% of sales. We expect our non-GAAP earnings per share to be between $1.30 per share to $1.52 per share. We also expect to pay down another approximately $300 million of our debt in the September quarter. We believe that despite the near-term pandemic-driven challenges, we are confident in the strength and diversity of the businesses and end markets we are in to achieve long-term growth in excess of the average semiconductor market growth. Given all the complications of accounting for our acquisitions, including amortization of intangibles, restructuring charges, and inventory write-up on acquisitions, Microchip will continue to provide guidance and track its results on non-GAAP bases, except for net sales, which will be on GAAP bases. We believe that GAAP results provide more meaningful comparison to prior quarters, and we request that the analysts continue to report their non-GAAP estimates to first call. With this, operators, will you please pull for questions?

Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question now. If you would please limit yourselves to one question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. The first question will come from Vivek Arya with Bank of America Security. Please go ahead.

Thanks for taking my question. Steve, I think you mentioned bookings somewhat improved in July. Historically, what do August and September bookings do, and what are your assumptions in giving guidance for this quarter? Are you assuming that the bookings trend kind of stays where it is? Does it get better? Does it get worse? I'm just trying to frame the guidance versus some historical trends and what your assumptions are for what the environment does in the remaining months of the quarter.

So Vivek, first thing I would say is that you should not really be looking at any past trends because this is just not a normal environment. Our bookings and backlogs and expedites and customer requests are really all driven by end market by end market, what the effect of COVID-19 is and what the visibility of the customers and distributors are. So really just absolutely, you know, bookings in a quarter would be stronger if you go into it with a weaker backlog, and the bookings often in turn would be lower if you have a strong backlog. That all depends on lead time and visibility. So we went into the start of this quarter with basically dramatically decreased visibility by our distributors and customers. Therefore, we started the quarter with a very, very weak backlog. If you recall the June quarter, we started the June quarter on April 1 with a very strong backlog, you know, from coming from March and return of China from the Chinese New Year and all that. And then the bookings during the June quarter actually declined through May and June, which was a reverse of what happens in a normal year because June is a very strong quarter, and bookings accelerate from April to May to June. It was totally different this time. So again, in July, August and September, July bookings were up significantly from the June runway. June was very low, and August is just starting, but looking at just a couple of days of booking for August, they're also pretty good and even higher than the July average. So our expectation is that August and September bookings would be strong, and near-term turns filled from those bookings will be significant, which will make up for, you know, how the quarter looks against the same point in time versus June. It will improve, and that's really what is included in our guidance.

Thank you. Thank you. The next question will come from John Pitzer with Credit Suisse. Go ahead.

Hi, Steve. Thanks for letting me ask the question. You said in your prepared comments that backlog heading into September is down about 8% from the comparable time period heading into the June quarter, but if I go back 90 days ago, you didn't believe that backlog, and at least your initial guidance for June took a fairly significant haircut to kind of the backlog in bookings. I'm just kind of curious, can you help us understand, you know, relative to the normal backlog coverage you had to your guide, how does sort of the September guidance look today?

So, you know, same thing, John. You know, I think in this pandemic-driven environment, throw all the old graphs away because you will just reach your own conclusion. You know, if you recall, on April 1, a backlog was quite strong, and the guidance we gave, I think a backlog, Eric, was it up 9%? Do I recall it correctly?

I'd have to go back in a sec. I mean, our book to bill was like 1.17 in the March quarter, and so we entered with very strong backlog, and then we saw week bookings and so forth. A very strong

backlog, and we gave a guidance, original guidance, which was actually to be down from 2 to 10% or 2 to 12%. So we basically said that the backlog will deteriorate from being up near 9% to down 6%. This is a reverse quarter where the backlog started lower, and it started 8% lower than April 1, and the midpoint of our guidance is really down 4%. So this time, we're improving, we are expecting the backlog to improve in comparison to the last quarter. Why? Because last quarter bookings declined during the quarter. This quarter bookings are increasing during the quarter, and it's all visibility, pandemics, end market-driven, what's happening in automotive, what's happening in data centers, what's happening in others, and there is really no correlation to what happened in the last five years. So throw all seasonality of the past away.

That's helpful. But Steve, if I could just add on there, we've all struggled, and I think you guys have internally with all the acquisitions, defining what's normal seasonal. Any update on what you can give us of what you think a normal seasonal September quarter would look like sequentially?

Well, first the environment has to become normal, and we haven't seen normal in the last couple of years with all the US-China trade sanctions and then the tariffs and now global pandemic. So once we have to have a stable environment for a year or so to figure out what the new seasonality would be with all our acquisitions, right now would be anybody's guess. And whatever the seasonality would be in future, right now, throw that away.

Thanks,

guys. Thank

you.

The next question will come from Ambrish Sravastava with BMO. Please go ahead.

Hi. Thank you, Steve. I'm going to ask for a clarification as well. I just want to make sure I understand your comments correctly. So as the last quarter progressed, based on how you explained it, it sounds like it deteriorated because you had a lot of short lead time orders that were not met and now heading into the September quarter. Is it fair to assume then that those orders are now struck? But then how do you reconcile with the fact that you still had delinquencies that you could not meet? Should they be coming up in this quarter? I'm just a little bit confused on trying to reconcile all your comments on the

short lead

time orders and the booking trends. That made sense that as the quarter progressed, bookings deteriorated. But then what about the shorter lead time orders that you could not meet in the last quarter?

Well, let me see if I can clear some of the confusion. So, you know, we started the June quarter with a fairly strong backlog. I recall up to 9% or so and, you know, I didn't correct that. And then we got reasonable bookings in April. So April was a good month, so it was still looking good. But bookings slowed down significantly in May and then dramatically so in June. So June was even lower than May. And the bookings were so low that if our orders from those bookings were normally aged in terms of near term and outer term, the quarter would have been very low. But the percentage of bookings that aged into the quarter were quite high. And even though we were not able to meet some of the bookings, some of those orders because of short lead time, we still beat the quarter. From the original guidance of minus 6 at the midpoint, we came in at minus 1.3, which means we did meet a lot of the orders. But we still left a large amount delinquent. And whatever was delinquent last quarter will get shipped this quarter. But since the bookings were so near term, we started the quarter still very much on the whole, down 8% from last quarter. And now the bookings are strengthening. Bookings have largely, the slope of the bookings have been higher. Day after day bookings are increasing all through July. And therefore the backlog versus the same point in time has improved somewhat, but there is a lot more to go. And we think at the rate the bookings are now and continue to increase, the shipments will improve from the minus 8 at the start of the quarter to minus 4 at the midpoint that we're guiding to. Does that make sense now?

It does, Stephen. If I could just ask one more clarification, does that mean then that the visibility as you stand today is better than what was at the same point in the prior quarter?

I don't think visibility is any better. I think visibility is very low. That's why it's improved from May and June, but it isn't improved from March and April. I think March and April were very strong bookings. People had, you know, China had just come back from Chinese New Year and everybody was expecting a quick end to the pandemic. So there were a lot of bookings. People didn't want to get caught short. And the pandemic just went longer and longer and longer. And now there is no end in sight. Nobody knows what's happening. Many states it's re-emerging. Some countries are still going higher every week. So now the customers and distributors are not giving long-term orders. It's slightly better than it was in May and June as I described the bookings are higher and we believe it may continue to improve in August and September.

Okay, that is helpful. Thanks for your patience and good luck and safe health.

I'm just going to add on to what Steve said there just to confirm that 9% that he is quoting in terms of our opening backlog entering the June quarter, that is the accurate number for comparison purposes compared to the minus 8% or down 8% heading into the September quarter.

So that's, you know, that's a good comparison where June quarter started up 9% and September quarter is starting down 8%.

Got it. Thank

you. And the June quarter deteriorated, I'm sorry, improved from minus 9 to minus 1.3. And we believe that this quarter will also improve from, this quarter will go the other way. It will go from minus 8 to minus 4 that we're guiding to.

Right, just to clarify that statement, we entered the June quarter with backlog being up 9% and it deteriorated to the point where we finished the quarter and down 1.3%.

Correct. Thank you.

Thank you. The next question will come from Craig Hettenbach with Morgan Stanley. Please go ahead.

Yes, thank you. Steve, just a question just from a geographic perspective. The initial growth was driven by China and as you mentioned coming back from China New Year. Do you think some of that China strength is sustainable and then also how are you feeling about other geographies like Europe and North America? You should want to take that.

Yeah, so China was certainly stronger last quarter than we expected. But you know, China doesn't live in isolation. China is affected by how other parts of the world do. And so as we go into the September quarter, it is still doing well, but we anticipate that weakness in Europe, weakness in America would have some impact on China. And that's all baked into

the guidance that we have built. Got it. Thank you. Thank you. The next question

will come from Harsh Kumar with Piper Sandler. Please go ahead.

Hey Steve, so I'm going to ask about what everybody else is talking about. So it sounds like there's good demand, but it sounds like towards the end of last quarter you saw short-term demand, but now you're seeing the customer pivot completely and they're starting to place orders. So my question to you, as you guys talk, you guys do a great job. You've got lots of customers. You do a good job keeping up with them. What do you think is making the customer flip in this manner?

I think it's all COVID-19. Customers are not sure. There is a resurgence of COVID in certain countries and certain states in the United States. Customers and distributors have low backlog from their end customers and our direct customers are not really sure what their run rate would be. So we're getting frequent orders for short-term delivery that they have the demand today and they need to build the product to deliver to their customer, but they do not know whether that is sustainable in September, in October, in November. So we're not getting as many longer-term orders to fill the pipeline, but we're getting enough orders to have the strong billings as we go. As we saw last quarter, there was enough strength in short-term orders that the billings were good and we ended fairly good. And for all we know, that could happen this quarter. But we can't say with certainty today, with the backlog being low compared to the same point last quarter, we could get enough turns to fill the quarter, but there is lack of visibility, therefore, we can't guide with that certainty.

Thank you, Stephen. From my follow-up, your revenues are down quite a bit based on your guidance, but your margin is pretty steady, pretty stable sequentially. Just curious if you have any thoughts on that.

Well, you know, so you should look at the results and look at it a little bit year over year. So when you look at it year over year, you know, we'll be kind of much more in the pack overall in the semiconductors and actually year over year guidance for September is better than really most of our microcontroller and analog competitors. So everybody's functionality is different. You know, our automotive business is only about, Ganesh, is it 12 now?

It's probably -14% after the last quarter.

Yeah, so automotive business is about -14% of our business and some of our competitors, it's 40-45. So they took a much larger hit when the automotive went down. Automotive was down, you know, 40% or so in the industry last quarter. And so they're seeing a much larger recovery. Our business, we're seeing a similar recovery, but being only -14% of our business, its impact would be lower. So we did better last quarter. You know, this quarter we're doing worse sequentially, but if you look at year over year, you know, our results are better than all of our larger competitors, you know, TI, NASA and others.

And as far as

the question of the margin is concerned, you know, margin, there have been a lot of moving parts, internalization, more advanced technologies, some restructuring of our factories we have talked about before. So, you know, lots of things we have brought to bear where there's been a tailwind on the margins. And this is really the best gross margin and operating margin performance of any cycle at Microchip because driven by all these self-help kind of things we have done. And when this business recovers and goes back to new record on the top line, I think you will see, you know, record gross and operating margins.

Thank you. The next question will come from Sean

Harrison with Loop Capital. Please go ahead.

Hi, thanks for taking my question. Just a quick clarification and then a follow-up. What was the underutilization in the charges quarter, Eric? The underutilization was about $13.9 million. That's right in line with what it was in the March quarter. So, flat, flat, potentially.

And

then Steve, to kind of beat the dead horse on the demand environment. But are there end markets where you're seeing, you know, sharper contractions in demand? We know automotive production will be up sharply in the September quarter, but where are you seeing maybe a contraction or more volatility in kind of the bookings rated? If you could give an end market perspective, that would be helpful.

Ganesh, I'll give it to Ganesh.

So, in my prepared remarks, I gave you some flavor of by different end markets. What are we seeing in the June quarter? And I think as time goes on, you know, some of these are going to start reverting to normal, which we think, for example, data center and work from home related items. You know, you don't need to continue to be at a high level once you've gotten past the first months of buying what you need. And then those that were below in the initial phases like automotive and industrial should be the ones that begin to recover. We've already seen the automotive part, you know, put a bottom in the June quarter, and we're expecting, you know, September to be good and we're expecting December to be good. And likewise in some of the other segments. So, medical is another example where, you know, some parts of medical did really well because of COVID related items. Other parts, you know, the elective parts got pushed out because people are not willing to go out of their homes or go set up consults for what was elected. Elective will come back. You know, you can't push it out forever. And so that'll be, you know, in general, I think the places that were weaker as time goes on will be the ones that have more strength.

And

some of the things that were stronger could

revert back to normal in the coming months. Thank you. The next question will come from Gary Mobley with Wells Fargo Security.

Please go ahead.

Hey guys,

thanks for taking my question.

I wanted

to start with some questions for Eric.

I wanted to ask about OPEX.

It looks like for your guidance and what you delivered for the first quarter, you're somewhere just south of 300 million per quarter. That's down, I believe, more than 10% from last year. How much of that is the salary cuts and various other OPEX decreases like lower travel? Just trying to get a sense of what normal might look like for you guys on the OPEX side once things begin to turn up. So the salary cuts when at the levels we implemented, we qualified those last quarter being about a $21 million per quarter run rate. Cool boat. And Stephen talked about us giving some of that back to employees this last quarter because the results were really quite good. Things like travel, we haven't quantified them, but they are pretty significant. And what I would say with that is I think some of that is probably more permanent than temporary. I think as we adjusted from working from home throughout the organization and the different functions, people become very effective in doing that. And I think overall travel, although it will come back to a higher level, some of that is going to be permanent savings. So I think we're managing the operating expenses very tightly in the environment that we're in. And the employees are doing a good job of managing that for the environment. But overall, we've taken out a lot of costs. But as the business improves, some of those costs in terms of the level, those absolutely will come back to the P&L and we'll manage that appropriately given where top line growth is. Okay. The follow up I wanted to ask about the debt structure.

You guys refinanced and extended the maturity of a pretty hefty amount of your debt. And looks like as a result, your net interest expense, the new norm might be substantially lower. Can you speak to what the new norm may look like for net interest expense and as well given the low interest rate environment what the additional opportunities

might be to draw down your cost of capital? Sure. So we were active in the debt capital markets in the quarter. We issued $2.2 billion with senior secured notes and paid off a bridge loan, paid off some of our converts and then used the remaining funds to pay off amounts under our line of credit. The guidance that you'll see in the guidance table on the press release for other expense, which is most of that is interest expense, is about $78 million on an on-gap basis for the quarter. And that's a pretty good run rate since all these debt transactions had occurred last quarter and are factored into that guidance. And obviously we're using a significant amount of the cash that we're generating to pay down debt, everything really beyond the dividend payment. And so Steve mentioned in his prepared remarks in the current quarter, we expect to pay down another $300 million of debt. So the debt is coming down nicely. We've done some nice things to remove some of the dilution that comes from those convertibles that we've retired from the structure. And we're pretty happy with the transactions that we have computed built in the March quarter and the June quarter. And that ongoing run rate is probably about $78 million and that will reduce as the interest expense comes down through debt repayments. Gotcha. Thanks, guys.

Thank you for the question. As a quick reminder, if you have a question at this time, that is star one to enter the queue. The next question will come from Chris Caso with Raymond James. Please go ahead.

Yes, thank you. Just a couple of clarifications here. Your revenue guidance is suggesting about a 6% -on-year decline with all of

the puts and takes that we've talked about. Do you think that down 6% year is an accurate reflection of what your customer's consumption really is? Is that sort of the baseline that we should be

using here? And as we look forward into the December quarter, based on what you're seeing in bookings,

does that provide you with any degree of confidence that we'd see a sequential increase as we go into December? Or is that just the too tough to call given the short nature of the orders

that you're receiving now?

I'll take the first part of that question. I think the revenue based on selling that we report, we also tell you the end market demand number, which is based on sell through. They're not that far apart now. Those two numbers have come really fairly well together. They were wide apart when we were correcting for inventory two years ago. So if we're down 6% in September quarter guidance versus September quarter of last year, that basically represents the market demand today. So that was the first part of your question. The second part was, what do we expect for December? Is that what you're trying to say?

Yeah, and given

the fact that it sounded like the orders improved in July, I suppose that some of that's filling into the December quarter. But you also mentioned that the order rates were, the aging of the orders was very short. So perhaps you're not getting the same visibility you'd get in the typical quarter. Perhaps that makes it more difficult to call.

So I would say, you know, in this kind of environment, we can barely call September. We can't really call December. It will depend on what happens in the COVID situation. Does the vaccine come out? Do those fears go away? Does everybody go back to work? All factories remain open, schools open. There is a lot of ground to cover between now and October before the December quarter starts. So I would say I'm not willing to say much about December yet.

Thank you. Thank you. The next question will come from Rajee Gill with Needham and Company. Please go ahead with your question.

Yes, thanks. And you might have answered this in the past question. But just to kind of repeat, so if we entered into the June quarter, we saw kind of a dramatic reversal, you know, plus 9% going to minus 1.3%. And as we're going to September, we're seeing a reversal in the other direction going from minus 8% to about minus 4%. And so those reversals, either positive or negative, if you were to sum it up, it's primarily based on this complete lack of visibility that your customers are getting. And basically operating on very short lead times.

It's basically that. You know, we serve 6-end markets. Every end market is affected differently by COVID-19. You know, automotive being the worst and industrial being the next end. On the other end, the best market was the data center and medical and some of the work from home computing and all that. So each market is affected very differently by COVID-19. And backlog almost by the end markets, how the customers are behaving is quite different. And I think it's really basically all driven by that. So, you know, what we are seeing today is the bookings today are not bad to really what we need to ship this week and next week and next week. But we're not getting, you know, back in May and June, we were not getting enough bookings for August and September and October. So today we're getting good bookings for, in July, we got good bookings for July, August and September,

but

not enough yet for the next quarter. So as we proceed in the quarter, especially when we are in August and September, not only we need to get the bookings to fill the August and September that has a hole in it, we also got to get enough bookings. So on October 1, we start the next quarter correctly. And December quarter is also front-end loaded usually, because December is a short month because of all the holidays. And it's really just COVID-19 is controlling the people's emotions and purchasing managers' habits and everything else.

And for my follow-up, in terms of the gross margin, so with revenue being down 4% sequentially, gross margins are holding flat sequentially despite revenue declining. Even though data center is appearing to kind of revert back to normal patterns, I presume data center might be a higher gross margin product. So can you just talk a little bit about the puts and takes in terms of the mix shift that is happening, utilization rates that are happening, why is margins being flat, which is a good thing despite revenue coming down?

So, you know, Eddie, do you want to take that one?

Sure, I can. So I'll just maybe start by just reiterating that we're pretty proud about how gross margins have held up in the last couple of years with experience of the various things, China trade and now COVID. And even with our $13.9 million in utilization charge, still posted .7% gross margin this last quarter. So there's all those things with product mix that impact gross margin utilization levels and all those things. But we see pretty good stability this quarter. The midpoint of guidance, as you said, is flat sequentially. And we've given a little bit broader range of gross margin guidance than we normally do, between .2% and 62.2%. So a percent range there. But we've got a pretty wide range of revenue also that we're guiding to between flat and down 8%. So, you know, lots of puts and takes, but we're continuing to do all the right things to keep costs under control, bring things in house where we can to improve the cost structure. And gross margin, I think, is really kind of the highlight in this cycle in terms of how well they've been maintained.

Thank you. Thank you. The next question will come from William Stein with Fruits Security. Please go ahead.

Great. Thanks for taking my question. Steve, in the press release and in the comments that you made in your prepared remarks today, you seem

to attribute the slower pace of bookings, at least partly to resurgence in COVID. And I think what investors are concerned about is that instead

the slowdown may be related to customers having overordered, you know, in the recent past, microchips delivery against that, and then customers have to digest it. Meanwhile, you seem to have had some pretty deep conversations with customers to figure out sort of end market expectations for the full year. So I'm wondering perhaps

you have a sense from those discussions what customer inventory levels are like now. It would seem to me if they're ordering on very short lead times, they're probably ordering

for production and not for safety stock.

But any insight in this regard would really help. Thank you.

Well, you know, we are, you know, we do business with 120,000 customers and long tail, you know, well over 100,000 of them buy from hundreds of our distributors around the world. We're not aware of any broad-based holding of inventory by our customers. And our distributor inventories are still in the range of being 15-year lows. You know, with 120,000 plus end customers, we're really not able to assess the inventory situation in each one of our customers. But, you know, we have a generally good sense of the inventory in the market. We've done a good job of keeping our lead time short and maintaining our delivery performance at a reasonable level. If the customers had ordered inventory in the, you know, prior quarter or so, we wouldn't be getting, you know, so many short-term requests. And in some cases, customers are paying, you know, expedite charge to get those parts. And there's no reason customers would be paying expedite charges to get the parts if they didn't need them for production. And in many, many cases, we're delivering right on the factory floor. They are short-circuiting shipment methods and, you know, hey, drop it on my floor because there are lines down situations. So if anything, inventory is not high out there. Inventory is low.

Yeah, that's super helpful. Thank you.

Thank you. The next question will come from Chris Dainley with Citigroup.

Thanks, guys, for squeezing in. Just a quick one. Can you give us approximately what percentage of revenue goes through China and how that's done over the last few quarters?

Chris, you have that?

Yeah, so

it's 21, 22% of our revenue shifts into China. And obviously, there's some of that that's local consumption and some that comes back to the Americas or Europe for consumption. But it's in that 21, 22% range. Okay, thanks, guys.

So Chris, you know, the June quarter, in the June quarter, China revenue snapped back to higher levels, you know, as the COVID-19 situation improved in China. And business activities supporting local consumption appear to be much more normal in China.

Thank you. The next question will come from Harlan Sir with JP Morgan. Please go ahead.

Hi, good afternoon. Thanks for taking my question. In response to the national muted demand environment back in the June quarter, you guys did cut back the number of manufacturing hours for your fab employees in your two US fabs. I think it was, it went from like, an 11, it went from like a 13 week work week, work quarter to like an 11 week work quarter. With the demand trends being muted, are you guys continuing to drive an 11 week manufacturing work quarter? Or are you guys taking down work hours and utilizations further here in the September quarter? And then just as a follow up, it looks like Philippines is reimposing some of the regional lockdowns and a resurgence of COVID-19. Is this having an impact on the Philippines test operations?

So I'll take that first part of the question. You know, I think you may have missed the comment here earlier, but I did say in my remarks that actually our inventory last quarter, you know, came down to 117 days from the 120 days before. Remember we went into the quarter guiding to be down minus six. So if you were down minus six, our inventory would have gone up, which we did not want. So we put the rotating time off in the factory, at least in the two largest fabs, to really have operators take some time off. And so, you know, we did better in revenue with only being down minus 1.3. And we cut back on the production. So the combined effect of that was our inventory actually came down. But with the 117 days inventory, we have now adjusted the factory schedule where we're no longer working the rotating time off in those two large fabs. There are lots of small, small plants we inherited from micro semi around the world in Boston, in Ireland, in Germany, and other places. Those are all small labs and each one has their own schedule. Some of them are working short weeks because, you know, demand on certain products is weak. But the big plants are no longer working short hours. Let me take you to the question about the Philippines. Ganesh, you want to take that one?

Yeah. So, you know, we did, we are aware of the adjustment the Philippines is making. What we have not given you much color on is, you know, at the May conference call, I mentioned that we've had, you know, people who are effectively live in the Philippines factory who run our operations there for a significant portion of, certainly, March and April. And at peak, we had about 850 employees living in our factory to be able to work around the constraints. It has come down since then. We still maintain a force of about 300 people that are there and give us that strategic flexibility on any short-term constraints. And so we have planned for where this might go and what other actions may be taken. And we are not, unless something, you know, different happens, but what we expect is likely to happen, we feel we have the control on what we need to do for keeping Philippines running.

Yeah. Thanks, Steve. Thanks, Ganesh.

Thank you. The next question will come from BJ Rakish with Mzuhho. Please go ahead.

Yeah. Hi, guys. Good execution in a tough environment. Just wondering on your September quarter guide, the downfall of the midpoint, are you seeing any particular weakness when you look at the supply segment? Are you seeing storage, the computer data center being a little bit more weaker or industrial? So we'll give some more color there.

So Ganesh, we answered that question before, but go ahead, take it again.

So as I mentioned, some of the segments that were strong in the June quarter were driven by the work from home and medical type of activities, which had very short surge of demand that was required. That's what had us running in the June quarter, trying to catch up with a lot of new orders that came in as well. We are anticipating and the trends we're seeing is some of that surge subsides and demand begins to revert back to normal at that point in time. So in that sense, I wouldn't call it weak demand, but I would call it, it doesn't have the surge that the June quarter had required as you continue to go on in time. And likewise on the opposite side, some of the things that were really weak, automotive being one example of that, also begins to correct in the opposite direction where it begins to make up for some of that weakness as factories run, as demand returns and that part of the business gets stronger. Got it.

And I know you've mentioned not able to meet all the demand coming through given the short-term need for some of these orders, spurred of orders I guess. Do you see any risk of losing orders or losing share or just wondering if that's part of it or is it just limited visibility on the part of the customers? Thanks. These

are all proprietary products. These are on product that you switch overnight and go between sources and all that. So no, we don't see any risk of losing share in what's going on. And as we have said, we're working constructively with our customers to try and get the best visibility they have to us as well and to be able to serve them in order to meet their demand requirements. So these are short-term issues caused by the demand and supply shock in the system. I don't expect these to be long-term issues. Thanks a lot.

Thank you for the question. The next question will come from Christopher Roland with Susquehanna. Please go ahead with your question.

Thanks for the question and this one's really for Steve. Switching gears, we now have ADI acquiring Maxim. Do you see this changing anything for the analog market and what are your feelings generally on consolidation? Do you expect it to continue at pace or even accelerate during COVID? And if you had a view of valuations for targets in the industry right now, that would be appreciated as well. Thank you.

Okay, well thanks for the question. We ourselves do not see any threat from the proposed acquisition of Maxim by ADI. They're both strong competitors in the analog space and we compete against both of them on a regular basis and when they get combined, anytime an acquisition happens, we always see incremental opportunities arise because sometimes the customer wants two different sources or don't want all their business with ADI and Maxim if they become one. So some opportunities appear that we'll be able to take advantage of it. In terms of the merger environment, it really looks at times that it could slow down and if large acquirers are digesting, at one time looked like it would be difficult to get approval from China, but then we got flurry of approvals. Marvell got approved, IDT got approved, the Mellanoff got approved, and now it is Maxim and Cypress got approved. So if China continues to approve these deals and the actual acquirers are willing to acquire, then the consolidation in the industry would continue. I think that's really for sure. And the fundamental issue is, you know, if you look at it over a long period of time over the last 20 years, the overall growth of the semiconductor industry, you know, has been low to mid-single digits and, you know, that's a tough environment to operate in. Every year people get excited about one thing or the other, but all these various trends have come in, but a consolidated long-term industry has struggled, and any time an industry struggles on the top line, then the stronger will acquire, the weaker, and consolidation will continue. So that's really my view on consolidation. As far as valuation question is concerned, I mean, look at the valuation Cypress went for and Maxim went for. It just kind of keeps going higher and higher. I think for most remaining targets, their stock price already reflects a significant acquisition premium, but you wouldn't convince their boards and their management that the acquisition premium is in there, and that's what drives a very, very high valuation. So, you know, that's a problem.

Insightful. Thank you, Steve.

The next question will come from David O'Connor with Exana B&P Parabox. Please go ahead.

Great. Thanks for speaking in, guys. Maybe just a quick follow-up from a previous question. Steve, can you just remind us what the order mix is? You know, what percentages of orders typically short lead time versus long lead time, both historically versus currently? We don't

have that numeric and I don't think we would be willing to share it. It changes a lot week to week and month to month, and it's a very fluid situation when you're working with hundreds of distributors and 120,000 plus customers. So we wouldn't share that either.

Okay, fair enough. And as my follow-on, last quarter, you said with the US Department of Commerce export ruling, it should be pretty much straightforward for you guys. You called out, I think, military, maybe some attention there. Was there anything that popped up from the implementation that you went through that was unexpected?

Thanks. Yeah,

no, there were no issues. There was obviously administrative procedures that put in place or have our partners put in place. And so all of that is done and behind

us. That's helpful. Thank you.

Thank you. Next question will come from Craig Ellis with B. Riley FBR. Please go ahead.

Yeah, thanks for taking the questions, guys, and good nice job on the execution of the quarter. Steve, I wanted to ask a question. I'll start with you. It may ultimately go to Ganesh, but clearly the company has executed a number of things tactically with COGS management and OPEX management to really protect margin leverage at historically high levels through last year's and now this year's crises. The question is, as we look ahead and think about things that the company might be doing that are those ongoing continuous efforts to drive structural improvement in both COGS and OPEX versus some of the things we'll have some unwind employees going back to full salaries eventually as demand normalizes, how do we think about the gives and takes there? And maybe Ganesh, if you can just list for us what some of the key longer term drivers for COGS reduction and OPEX optimization are, that would be helpful. Thanks, guys.

Go ahead, Ganesh, if you want to take that.

So, you know, obviously there are some costs that are short-term costs that we've taken out. You've listed many of them. Eric commented on them. And as we see revenue return, you should expect that some of those costs will come back. And, you know, historically we have been disciplined about how we bring back some of these costs as revenue returns. And you can go back and look at other cycles in terms of how the percentage of revenue we manage our operating expenses. I think, you know, one thing which we will do different as we come out of this is also look at what did we learn out of this crisis in terms of managing more effectively from an operating expense standpoint. And there we will get into changes in methodology. Eric mentioned to us that we are committed to the long-term targets that we have, which is to get operating expenses down into the 23% range. That's part of our .5% operating margin target that we're working towards. Every bit and every quarter we learn things we can do more effectively to help our customers whether it's in research and development, sales and marketing, or in the overall general and administrative areas that sequentially bring things a bit by bit down. We have been working on the last bit of the integration for micro semi, which is predominantly focused on the business process and IT related items. We're about nine months away from wrapping that up as the last bits of those get done. So there's constant part of our DNA that is working on these in all three areas. And in a crisis you take some of the best learnings and make sure you capture them when you get past the crisis.

Got it. Thanks Ganesh. Thank you. The next question will come from John Pithter

with Credit Suisse. Please go ahead.

Yeah, thanks for taking my follow up. Ganesh, you had mentioned the prepared comments that you talked about. FPGAs would be up pretty significantly in the September quarter. I'm just kind of curious, is that a business that's more exposed to the auto market? And so what we're seeing is, you know, weak June in auto to strong June in September and that's driving it? Are there other drivers there? There are. Can you kind of enumerate please?

So exposure to automotive for the FPGA business is low at this point. It's one of the things that microchips brought to that business with our historical strengths in terms of how we take advantage of each other's end market strengths. So it's other parts of the market that are responding and providing growth in the September quarter. And even as we expect that with one large customer that created a lower revenue in the June quarter, we don't expect they're going to recover in the September quarter. In spite of that, we expect that the other improvements we're making in business are more than offset for that in the September quarter. But it's not automotive.

Thank you. Thank you. I'll now turn the conference back over to Steve Senghi for any closing remarks.

So there is one other indicator I wanted to give you. We hadn't planned on it, but I think with all the questions we got in how the bookings happened in last quarter, versus what's happening in this quarter, I'm going to go on the limb and give you this number. The July bookings were .5% higher than the May bookings per day, this time per day. Every month is not the same. There's minor differences. And July bookings were .6% higher per day than the June bookings. So you could see how last quarter bookings were decreasing in May and then really fell precipitously in June. But the bookings were very short-term oriented, so we made the quarter actually beat the guidance in the quarter last quarter. But it started this quarter in a whole. But now this quarter, July bookings were .5% better than May and .6% better than June. That's why we have the confidence that even though we started minus 8%, we're going to end up a lot better. Hopefully that helps you a little bit. With that, we'll be attending a number of virtual conferences in the coming days and weeks, and so we'll talk to some of you in those conferences. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's event. We now disconnect your line and enjoy the rest of your day.