Microchip Technology Inc (MCHP) — Q4 2020 Earnings Call Transcript

Thank you and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press 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 Sanghi, Microchip's Chairman and CEO, and Ganesh Moorthy, Microchip's President and COO. I will comment on our fourth quarter and full fiscal year 2020 financial performance. 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 and analyst questions. We are including information in our press release and in this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations page of our website at www.microchip.com, which we believe you will find useful when comparing our GAAP and non-GAAP results. We have also posted a summary of our outstanding debt and our leverage metrics on our website. I will now go through some of the operating results including net sales, gross margin, and operating expenses. Other than net sales, I will be referring to these results on a non-GAAP basis, which is based on expenses prior to the effects of acquisition activities, share-based compensation, and certain other adjustments as described in our press release. Net sales in the March quarter were $1.326 billion, which was up 3% sequentially and above our revised guidance for March 02, 2020, but net sales were expected to be about flat sequentially. We've posted a summary of our GAAP net sales as well as end market demand by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were strong at 62%, operating expenses were at 25.4%, and operating income was 36.6% compared to 35.1% in the previous quarter. Non-GAAP net income was $375.5 million, non-GAAP earnings per share was $1.46, which was up significantly from $1.32 for this in the prior quarter. On a GAAP basis in the March quarter, gross margins were 61.4% and include the impact of $5.1 million of share-based compensation and $3.3 million of COVID-19 shelter in place restrictions on manufacturing activities. Total operating expenses were $653.2 million and include acquisition intangible amortization of $248.5 million, special charges of $17.2 million, $15.3 million of acquisition-related and other costs, and share-based compensation of $35.6 million. The GAAP net income was $99.9 million or $0.39 per diluted share. At March quarter, GAAP 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 intercompany movement of intellectual property, tax reserve releases associated with tax audits and other matters. For fiscal year 2020, net sales were $5.274 billion. On a non-GAAP basis, gross margins were a record 61.9%, operating expenses were 25.7% of sales, and operating income was 36.2% of sales. Non-GAAP net income was $1.44 billion and EPS was $5.62 per diluted share. On a GAAP basis, gross margins were 61.5%, operating expenses were 49.2% of sales, and operating income was 12.3% of sales. Net income was $570.6 million and EPS was $2.23 per diluted share. The non-GAAP cash tax rate was 7% in the March quarter and 6.3% for fiscal year 2020. We expect our non-GAAP cash tax rate for fiscal '21 to be between 6% and 7%, exclusive of the transition tax, any potential tax associated with the restructuring with the Microsemi operations in Microchip's global structure and 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 US interest deductions that we believe will keep our cash tax payments low. The future cash tax payments associated with the transition tax are expected to be about $245 million that we pay over the next six years. We posted a schedule of these projected transition tax payments on the IR page of our website. Our inventory balance at March 31, 2020 was $685.7 million. We had 122 days of inventory at the end of the March quarter, down seven days from the prior quarter's level. Inventory at our distributors in the March quarter was at 29 days compared to 28 days at the end of December. We believe distribution inventory levels for Microchip are still quite low compared to historical averages. In the March quarter, we exchanged cash and shares of our common stock to retire $650 million of principal plus accrued interest out 2025 convertible senior subordinated notes. The cash used to pay the principal on this exchange was funded by a 364-day bridge loan. This exchange will significantly reduce your count solution to the extent Microchip stock price appreciates in the future. During the quarter, we also amended our credit facility. As disclosed in our March 21, 2020 press release, the total leverage and senior leverage covenants were favorably modified as part of the amendment, giving Microchip greater financial flexibility. The cash flow from operating activities was $371.7 million in the March quarter. As of March 31, the consolidated cash and total investment position was $403 million. We paid down $236 million of total debt in the March quarter. Over the last seven full quarters since we closed the Microsemi acquisition and incurred over $8 billion in debt to do so, we've paid down $2.222 billion of debt and continue to allocate substantially all of our excess cash beyond dividends to aggressively bring down the debt. We've 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 businesses 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 March quarter was $548.1 million and our trailing 12-month adjusted EBITDA was $2.129 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 $4.46 at March 31, 2020, and our dividend payment in the March quarter was $88 million. Capital expenditures were $11.9 million in the March quarter and $67.6 million for fiscal year 2020. We expect between $12 million and $18 million in capital spending in the June quarter and overall capital expenditures for fiscal '21 to be between $50 million and $70 million. We continue to add capital to maintain and operate our internal manufacturing operations, support the production capabilities for our 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 improvement to our business, particularly for the outsourced Atmel and Microsemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the March quarter was $41.8 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the March quarter.

Thank you, Eric, and good afternoon, everyone. Let's start by taking a closer look at microcontrollers. On a GAAP basis, our microcontroller revenue was sequentially up 5.9% as compared to the December quarter. From an end market demand standpoint, our microcontroller business was sequentially up 2.9%. Microcontrollers in the March quarter represented an all-time record of just over $349 million or 47% of our microcontroller demand. We continue to introduce a steady stream of innovative new microcontrollers, including a new cryptography-enabled 32-bit microcontroller designed to stop malware for systems that boot from flash memory as well as a new high-end microcontroller product family for improved designs in real-time control and connected applications. Microcontrollers overall represented 55.2% of our end market demand in the March quarter. Last month, Gartner released their microcontroller market share report for 2019. We're pleased to report that Microchip retained the number one position in 8-Bit microcontrollers. Once again we gained market share as we grew faster in the overall 8-Bit market. In fact, we are now twice as big as the number two player. In the 16-bit microcontroller market, we remained at number five and continue to gain market share as we grew faster than the overall 16-bit microcontroller market. In the 32-bit microcontroller market, we remained at number six and gained significant market share again as we grew faster than the overall 32-bit microcontroller market. These results are despite Gartner rolling up our 32-bit microcontroller revenues to be about $400 million lower than the $1.2 billion results we actually achieved in 2019. Had Gartner used our actual calendar year 2019 32-bit microcontroller results, we would have achieved a number four ranking. Our 32-bit microcontroller business in the March quarter ran at approximately a $1.36 billion annualized run rate based on end market demand. For microcontroller overall, we remained at a strong position despite Gartner rolling up our revenue to be about $400 million lower than our publicly reported results for calendar year 2019. By using our publicly reported results, we would be approximately 7.5% away from the number two player and 16.5% away from the number one player ahead of us as we continue to relentlessly march towards the number one spot. Our microcontroller portfolio and roadmap have never been stronger. We believe we have the new product momentum and customer engagement to continue to gain even more share in 2020 as we build the best-performing microcontroller franchise in the industry. Now moving to analog, on a GAAP basis, our revenue was sequentially up 1.1% as compared to the December quarter. From an end market standpoint, our analog business was sequentially down 1.8%. During the quarter, we continued to introduce a steady stream of innovative analog products, including the industry's first space-qualified radiation-tolerant Ethernet transceiver as well as an expanded silicon carbide family of power electronics to provide system-level improvements in efficiency, size, and reliability with 700 volt, 1200 volt, and 1700 volt power modules. Analog represented 27.6% of our end market in the March quarter. Our FPGA revenue on a GAAP basis was up 4.6% sequentially as compared to the December quarter. From an end market demand standpoint, our FPGA business was sequentially up 1%. FPGA represented 7% of our end market demand in the March quarter. Our licensing, memory, and other product lines, which we refer to as LMO, were sequentially down 10.7% as compared to the December quarter from an end market demand perspective. During the quarter, we introduced a new miniaturized rubidium atomic clock, the industry's highest-performance atomic clock for its size and power. LMO represented 10.1% of our end market demand in the March quarter. An update regarding coronavirus and its impact on our operations. We have had nine employees who tested positive for the virus with over 18,000 employees worldwide; this was inevitable, but thankfully they're all recovering nicely or have already recovered. Most of our non-factory employee base is working from home as we rapidly transformed business processes to run the marketing. Our global team has been highly engaged, collaborative, and productive under the circumstances, resulting in enhanced customer engagement for new designs and high effectiveness in our product development programs. We would like to thank our worldwide team for rapidly adapting to changing conditions and making the best workflows possible under difficult circumstances to continue delivering results. Our manufacturing operations had varying degrees of constraint last quarter as what started the China shutdown for several weeks expanded to many other locations that shut down. Our operations team minimally adjusted to constraints as they emerged and implemented our contingency plans as needed to ensure that we continue to serve customer needs despite the challenges. In most of our manufacturing locations, we were able to get essential services designation as our products are quite ubiquitous in medical, work from home, defense, and communication infrastructure applications. Our Philippines operations had the largest impact with restriction of people movement, being so strict that we had a large number of our dedicated employees living in our two factories there since mid-March to support production and customer shipments. Our global team also successfully worked through a myriad of ground and air logistics issues throughout the quarter as conditions changed regionally over time. Our customers and our supply chain partners also endure constraints with their factories and logistics, which made the March quarter challenging. We appreciate our global teams’ engagement and efforts to work through the rolling steps of customer and supplier challenges even as we work through challenges and constraints that have been placed on our own factories. Pandemics are inherently unpredictable, and there may yet be other twists and turns to come in the days ahead. We continue to process the news daily as well as monitor information from the Centers for Disease Control and the World Health Organization, and we will adapt our response as needed and focus on the things that we can control. Given the current market uncertainties, we are providing some qualitative insight into our principal end markets. The areas of strength we see are data centers driven by continued strength from the exponential rate at which data has been created and the consequent seemingly insatiable demand for data storage; for computers, printers, monitors, and other accessories enabled by the increased shift to working from home; for medical devices, COVID-19 related items like ventilators, respirators, oxygen monitors, and ultrasound machines, but also a host of other hospital equipment needed for increased patient loads; for contact-free consumer and industrial products like hands-free dispensers or soap and water; for paper, hand sanitizers; for infrared thermometers, as well as barcode readers for retail shopping, all in an attempt to prevent the spread of COVID-19; and then for communication infrastructure in part because of work from home-related network loading changes but also in part due to stimulus investments in infrastructure, especially in China. The areas of weakness we've seen from an end market perspective are automotive, broad-based industrial, consumer home appliances, and aviation or aerospace. Our defense and space business remains relatively stable.

Thank you, Ganesh, and good afternoon, everyone. Today I would like to first reflect on the results of the fiscal fourth quarter of 2020 and the whole fiscal year 2020. The March quarter had unusual business challenges as the effects of the COVID-19 pandemic unfolded in many dimensions. I'm proud of how rapidly the Microchip team adapted to the new constraints we faced so that our employees would be safe, our customers would be well served, and our partners would engage to ensure mutual success despite the challenges we face. Despite the COVID-19 pandemic challenges, we delivered 3% sequential net sales growth as compared to our early March updated guidance, which was for net sales to be about flat. Our final March quarter GAAP net sales came in at $1.326 billion, up 3% sequentially and down just 0.3% from the year ago March quarter. Our end market demand based on sell-through was approximately $3.8 million lower than GAAP sales. After seven quarters of end market demand being higher than selling-based net sales, the March quarter was nearly even for end market demand versus selling net sales. We also delivered outstanding non-GAAP gross margin of 52%, just above the high-end of our original guidance from February 04, 2020, and non-GAAP operating margin of 36.6%, near the high-end of our original guidance. We did all that while reducing our days of inventory from 129 days to 122 days. Our consolidated non-GAAP EPS was $1.46. We did not provide EPS guidance when we revised our net sales guidance on March 02, 2020. Our original non-GAAP EPS guidance provided with our earnings release on February 04, 2020 was $1.35 to $1.51, with the midpoint of $1.43, and we beat the original guidance by $0.03. On a non-GAAP basis, this was also our 118th consecutive profitable quarter. In the March quarter, we paid down $236 million of our debt. Our total debt payment since the end of June 2018 has been about $2.22 billion. 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 efficiency. On a full fiscal year 2020 basis our net sales were $5.274 billion, down 1.4% over fiscal year 2019. Now I'll discuss our guidance for the June quarter. Ganesh, in his prepared remarks, discussed the impact we are seeing on our supply chain as well as our customers. Ganesh also described the end markets where we are seeing strength and those where we are seeing either current or expected weakness. Our March quarter bookings were up double-digit percentage over the December quarter bookings. The book-to-bill ratio for the March quarter was very strong at 1.17. That resulted in our starting backlog for the June quarter being strong compared to the starting backlog for the March quarter. In April, H 2020 press release, we said that we believe that the strength in bookings may be a result of customer concerns about supply chain disruption due to the COVID-19 virus. With economies around the world contracting rapidly with millions of people getting laid off and with customer factory closures due to shelter-in-place ordinances in various countries, we believe that product demand is likely to weaken significantly. With another month under our belt now, we have seen some of the customer order pushouts and cancellations. Our backlog for the June quarter compared to the backlog for the March quarter at the same point in time has now deteriorated somewhat in the last month. We believe the backlog position compared to the March quarter will continue to deteriorate due to the combined effects of supply chain disruption, customer factory closures, and demand destruction. Taking all these factors into consideration, we expect our net sales for the June quarter to be down 2% to 10% sequentially. The guidance ranges help account for the uncertainty associated with the evolving coronavirus situation. We have no way to model how the rest of the quarter will play out for the coronavirus situation and what the consequent business impact may be, but we believe that our guidance range incorporates our best judgment for the possible scenarios. We have prepared the company for a downside scenario by putting the employees on a 10% salary cut and are adjusting the factory by reduced work hours or rotating time-offs. We have also frozen all business travel and cut discretionary expenses. Regarding CapEx, we finished fiscal year 2020 with CapEx of $67.6 million, a significant reduction from fiscal year '19 CapEx of $229 million. This is consistent with what we have said before that our CapEx is divided between growth capital, maintenance capital, and new product and technology capital. In a fiscal year like 2020, in which our net sales declined, the growth capital, which is the largest portion of CapEx, declines to virtually nothing, and therefore the total CapEx declined significantly. We expect CapEx for fiscal year '21 to remain low in the range of $50 million to $70 million. For the June quarter, we expect our non-GAAP gross margin to be between 60.4% and 61.2% of sales. We expect non-GAAP operating expenses to be between 24.4% and 25.2% of sales. We expect non-GAAP operating profit to be between 35.2% and 36.8% of sales and we expect our non-GAAP earnings per share to be between $1.25 per share to $1.45 per share. 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 a non-GAAP basis, except for net sales, which will be on a GAAP basis. We believe that non-GAAP provides a more meaningful comparison to prior quarters and we request that the analysts continue to report their non-GAAP estimates through first call. With that, operator, will you please poll for questions.

Yes. Thank you. Appreciate that. So I guess for the first question, Steve, if you could give us some thoughts about perhaps the magnitude of the downturn that I guess we're all expecting. I realize that's a difficult question with what's going on with the backlog here, but I guess comparing with some of your competitors have compared what we're seeing now to the 2009 cycle. I'm not sure if that's the right way to look at it right now, but I guess Microchip is also a different company as compared 2009, and what you're guiding to is not quite as bad. As we put all that together, how are you thinking about things going forward?

So I think we're really unable to speak about anybody else's business but our own. We mentioned some of the companies; I believe all companies have different end market and customer exposure. We have been building this franchise for many years now through organic efforts as well as acquisitions and have compiled a very large number of very, very good assets and then deployed a program called TSS, Total System Solutions, in which we are garnering larger and larger shares of the customer's board with our product. So, the outperformance that you may be seeing from us in business today is really nothing to do with what we have done today or last year; it's been a result of really many years of effort and new products, organically as well as through acquisitions and our customer support, customer support activities, the distributor relationships and everything else over the past several years. I don’t know if that helps you.

Okay, I guess perhaps you could take us through what you've seen in the order rates and you put through some of that in your prepared remarks about what you've been seeing since March. I guess what's interesting now is that the customers came in, the channel at least came into this crisis with very low inventory levels and that's, I guess, unusual in a downturn in our industry. How does that affect things going forward and what sort of visibility do you have on what customers may be doing with the inventory levels here?

So this is a very unique cycle. We have, for the first time ever, we're experiencing both a demand shock and a supply shock. We have seen demand shocks before, like the 2008-2009 cycle you mentioned. We also saw a major demand shock during the 2001 tech burst and I think we saw a little mini demand shock really even during SARS in 2004 or 2003, whenever it was. And we have seen some supply shocks from our industry. The two that I remember: one was during the tsunami in Japan and Southeast Asia, where a number of our factories were closed down or shut down, and there was a major demand shock; and the other demand shock I recall was during the major floods in Thailand a few years ago, where many of our peers' factories were under water. Microchip's factory was okay, though. So we've seen really either a supply shock or a demand shock. This is the first time ever in my 40 years of experience that I am seeing a simultaneous demand shock and supply shock. The supply shock is driven by the various shelter-in-place ordinances, and Ganesh talked about it extensively, with the Philippines being the worst and Malaysia being the second, where we couldn't get our workers into the factory and, in some cases, the workers are living in the factory because they believe they will not be able to come back and a number of our product lines that ran in those factories produced limited output because the whole workforce wasn't working. That resulted in a supply shortage and a supply shock in some of the lead times running out, and that drove some of the demand further from customers and distributors. And on the demand side of it, our customers' factories shut down, the worst being in the automotive business where I think you guys keep track of the data, and if you look at the data, you'll find that Europe has been the worst and the US the second, and a lot of factories were shut down in Asia also but those factories are coming back in automotive. So the automotive business is going through this demand shock and industrial somewhat. While on the other hand, like you look at the market like data centers, where demand shock is in the upward direction with all the data and work-from-home ordinances, their demand has gone up, and the other area, which is really quite sleepy for us in general, I don’t think it's a very large percentage of our business, is medical. We didn't know what a ventilator was a month and a half ago, and now we found that all the ventilator designs around the world, everyone is using our products, and the demand has gone up 100X, if not more. The hospital will have two to three ventilators only for emergency purposes and now a single hospital is requiring 1,000 to 2,000 ventilators. So that demand has gone up 50X to 100X. Same thing on digital thermometers, automatic soap dispensers, and bathroom products that when you put your hand into the soap falls down; they all use microcontrollers or sensors or many of our products. So that's kind of the end market here. In certain markets, demand is very strong. In other markets, demand is very weak. In some cases, they're impacted because of supply chain disruption, in other cases, the impact is because of stronger demand. So I think you know how do you make sense with all that? We started the June quarter with a very strong backlog and our backlog for the June quarter is still higher than our backlog was for the March quarter at the same point in time, but it has deteriorated significantly compared to where it was on April 1, and at the rate we're seeing customers' adjustments, push-outs, and cancellations, where the customer may have ordered more product really shows up that this deterioration in backlog in June compared to March will continue. We know how much we lost in one month. We got two more months to go, and putting all that into the equation really our crystal ball tells us in the midpoint of minus six and it ends up minus two to minus ten. Sorry for the long answer but the question deserved it.

Lot of details there. Can you focus on the gross margin and just how those understand the dynamics, it's more than hanging in the slide to you actually drawing down lowering inventory on the balance sheet the inventory didn't really go by that but kind of help us understand the factors there seems to be a structural change in Chris asked the question about the difference between Microchip from 10 years ago and all the stuff we've followed you for a while but just talk through the structural changes and then you mentioned that with some manufacturing the CapEx which enable you to bring more Microsemi and Atmel indoor and that will have some positive and this is obviously a longer-term question that I am asking thank you.

So let me ask Eric Bjornholt will answer that question and I'll add something if needed at the end. Go ahead, Eric.

Okay. Gross margins held up extremely well in the March quarter and we closed 62% non-GAAP margin because it was really outstanding. As you know, we've been running our factories at less than optimal levels and we reported an underutilization charge in the quarter of about $14 million. That was actually $3 million better than the prior quarter as we were running our assembly and test factories further than we have in the previous quarters and we were draining finished goods. So the strong gross margins are really driven by a variety of factors, including attainable product mix and our ongoing cost reduction and cost containment activities in our factories. So that, in turn, we're guiding the gross margin to be down at 60.8% at the midpoint. We expect higher underutilization charges in June compared to March due to some of the rotating time off that we're going to be doing in the factories and just lower production output. But we believe we're really well positioned for the long term with gross margin improvement in the future as we grow back into our factory capacity. So there are a number of things that influence that other than factory capacity. We've also been doing a good job of really holding average selling price flat with our customers, and that has long-term gross margin benefits also. So that's the general summary there. Steve, what would you like to add?

No, I think that's good. This down cycle, let me add a couple of sentences. I think we started this down cycle with probably the lowest inventory we had, 122 days at the end of March. I recall prior down cycle when we started with really high inventory and so I think it's such a low inventory and we're keeping the flow by factory rotating time offs and others. So I think when we get on the other side of it and start ramping up factory back up and we're starting with the gross margin in the 60s, I think we'll be very, very well positioned longer term, but it's really good record gross margin.

The second piece of Ambrish's question related to CapEx and we will still focus longer-term on bringing some more assembly and test in-house but we're really locked down capital pretty significantly to see where our forecast is for fiscal '21 of between $50 million and $70 million. So where there are benefits to be gained, we'll evaluate those, but we're being pretty conservative in our posture in terms of making adjustments right now.

In the interest of time, I will ask my questions now. Steve, you shared your thoughts on the recent changes in export control rules and how they might affect the process for owners seeking licenses to shift customers from China or any related limitations. My next question, which reflects the views of many others, is about your perspective on the safety of your dividend. Thank you.

Sure, I'll pass on to Ganesh to answer the question about export control, and then I'll come back and answer the question on the dividend.

As a recent announcement that was made, we're still sorting through what the Commerce Department's rules are. The specific item that we are paying attention to is the possible military use of products and how we can provide confirmation that it is not going to be with those applications. We think it's fairly straightforward to be able to do it, but we have time until the 29th of June to be able to implement it; but at this point in time, we do not expect that it will have an issue in terms of Microchip's business. Go ahead, Steve.

So regarding the dividend, your question was how safe is the dividend? The dividend is very, very safe. We were one company that did not cut our dividend back in 2009 when peak to bottom our revenue went down almost 36%. Today we're so much more profitable on gross and operating margin levels; we have done a stress test on our business. You can't find a number lowering up; you could lose a very, very large amount of sales, and the company would still be cash flow positive, with regard to $1.2 billion of money remaining on line of credit. So I think really we are unable to model a scenario, a reasonable scenario, where the dividend would be at risk, and if we felt that the dividend was at risk, we certainly would not be increasing the dividend, which we are a little bit every quarter.

Question for Steve, just on kind of the downturn playbook and so that the employee cost cuts, pay reduction in CapEx you’ve done it in prior cycles, as you mentioned, this is a very different cycle. So just trying to gauge how you're thinking about the depth of this cycle and similar things you're doing to protect margin as it plays out.

So I think we learn a little bit through every cycle, and one of our goals is to never let a cycle go to waste. What happened in 2008, 2009 was the cycle really hit in the early part of October of 2008, and the business was down very substantially in that December quarter and down a lot more even in the March quarter, and we didn't implement pay cuts and all that until we were well into the cycle where the strength deteriorated. So this time, what we've done in understanding that with 33 million people, I think, already lost jobs in the US alone; I don’t know how many around the world. These people are not going to be buying cars and refrigerators and other stuff that really would have our product. So this time we battened down the hatches and got ahead of time before the storm really hit. So we finished the March quarter actually sequentially up 3%, and we implemented the pay cut starting April 20, and at that time our business really hadn't even weakened. Our June quarter was still backlog higher than the March quarter backlog at the same point in time. So what we have really done is really out of abundance of caution, just thinking that this storm internally at Microchip we have described that to be a category 6 storm waiting in the wings where category 5 is the highest category because we have never seen this before; a simultaneous demand and supply shock, the pandemic, and no place to hide, and 33 million people laid up in the five weeks in the US alone. So we have prepared the company with a cost structure in the June guidance we have given you has the paycheck now pay cuts for June quarter dialed in but not for the whole quarter because we started in the middle of the quarter and September expense will be down even slightly further from that. So we essentially have positioned it for any extreme case that may materialize. It's a lot easier to give the money back, undo the cuts on the salary, change them from X% to Y% lower. It's much easier to do that than to have spent all the money and then really fight and have the supply. So that's really how we're looking at it. We're looking at it as we don’t know; until anybody knows, anybody says they know, they're lying; they don't. So what we've done is really out of abundance of caution prepared the company for a worst-case scenario, and we'll give the money back if we didn’t need it.

Just as a follow-up on the pushouts and cancellations, is it pretty broad-based? Are there any certain products that you're seeing more than others?

It's not by product. It is more by end market. The worst is automotive; the second would be industrial and general consumer like appliances and all that I think that Ganesh described all those areas, where the strength is, the strongest area is data center. I would think the next is really 5G-related, work-from-home related, PCs, printers, computers and all that. Medical is extremely strong. So those are the areas we're not seeing pushouts and cancellations. We're seeing those in the automotive and some general industry.

Steve, you said in your prepared comments that clearly, the June backlog is deteriorating, but at least through the month of April, it would still suggest the potential for sequential growth in the June quarter. So I am just curious when you think about the range of revenue you've given for June. What's the expectation as we go into May and June? Does the rate of deterioration in the backlog need to accelerate from here to kind of hit your midpoint or just kind of give us any sort of color you feel comfortable with helping us understand what you're embedding in further deterioration of the backlog from here?

There is a way to model it. So there are two challenges, maybe three. One is that the existing backlog further cancels or pushes out the following quarter. Second is we still need turns to take. If there is zero cancellation from here on, but we get no more turns for the quarter, that's not a good scenario either. So that would be fairly soft too, and the third is supply, depending on what product demands come on. The products where if you place an order today, the earliest I can give you is July, August, and those are from the most constrained areas or factories that have had a six-week, where for six weeks they haven’t been able to run full production, and now as they're coming back to production, we are so far behind in delinquency. So we will leave the June quarter with a fairly large amount of product delinquent. Same thing happened at the end of the March quarter. So in a way, one day when we catch up on that product and get shipped, it's a good news, but for now we're not going to be able to ship all the backlog in the June quarter, neither will we be able to ship that all in the March quarter. In fact, if just the supply-side shock had not happened and our factories were running, for the March quarter, we would have met or exceeded our original guidance, which was about 5%, 5.5%. We only did three and I was largely because we couldn’t supply the product.

That's helpful, Steve, and you also mentioned that some of the OpEx control that you put in place this quarter or not even for the full quarter, so it will have a positive effect on OpEx declining again in September. I'm curious, are there more levers you can pull on OpEx, and should we take OpEx being down sequentially in September as a sign that you feel like revenue might be down again in September as well?

So the only reason that the September OpEx will be down below June would be because the pickup would be for the entire quarter, and the pickups didn’t kick in until June 20 in the US, and probably May 1 for some of the international geographies depending on the various international laws, but the September quarter we get the full quarter. If your question is what if we didn’t need it and the business does well, then you remodel it and you change the pickup from 10% to 6% to 5% or if you see growth, you make it zero. Anything is possible, but I'm saying right now in the game prepared for the category fixed on we are structured to take the June quarter expenses below the March quarter because of the full quarter's savings, so the December compared to September will be about the same if you don’t make any change, and the pickup and at the end of December, that's currently the case. We've announced to the employees that the pickup ends at the end of December, so the March quarter OpEx will rise again and hopefully, we're well out of the woods from the site and if we're not then we do something different.

Can you just expand on I guess what percentage of your revenue is dealing with the supply issues and are the supply issues worsening as we speak or do you think you got a handle on them and they should get better as the quarter progresses?

Let me have Ganesh comment on it. I don’t think we have quantitative numbers, but Ganesh can talk qualitatively.

We are not facing issues across our entire product line. We manufacture in several countries, including Thailand, the Philippines, and Malaysia, based on our factories and subcontracted facilities. The main challenges we encountered were in the Philippines and Malaysia. Currently, Malaysia is operating at full capacity without restrictions, and they are working diligently to increase their workforce to meet demand. In the Philippines, we have been managing operations under restrictions but have improved our situation from March to the June quarter by having additional staff living in our factories full-time. We have about 500 to 600 employees residing at the factory to enhance utilization. We anticipate that restrictions will ease as we progress through mid-May, which will allow us to increase output. I believe that the manufacturing constraints are easing quickly, although there will still be some catching up required due to the previous limitations, along with continued support.

Just sort of a geographical question back in March when we saw the team downshifted that time the downshift was driven by a shortfall in China rights, it's a country starting to open back up but at a slower pace but you also did point out at that time that orders in business activity at that time in China was starting to pick back up and since then we've seen more cleanup of activity in China leading auto production picking up this order, factories are starting to open up, consumer starting to spend. So have you seen follow through of that China improvement trend as maybe versus the world demand is weakening into the June quarter or are you also seeing degradation and deterioration in China orders and bookings as well?

So I think depending on when you look at monthly or you look at it by quarter, when you look at it by quarter, China was very weak for the March quarter because Chinese New Year, first of all, was extended to two to three weeks from one week and then all these factories were closed. So the China business was horrible. If you really look at it for the quarter, but if you look at it on a monthly basis, as the COVID-19 situation got contained and people went back to work, China business almost seems like it's back to normal. However, the concern is that it may look like back to normal because it's really making up for some of the shortfall and all that it had and once that demand is met, is a steady state demand in China back to normal or not? I think that needs to be answered in the month of May and June, but April, China was very strong and late product margin in China was very strong as if it would be normal or even better.

So the time of the lockdown was really a curfew at night from about 10 PM to 8 AM. It doesn't affect our shifts or our ability to operate our plants, and so under the new logistics or other issues that we run into. Thankfully, kind of the entire episode has been running full steam, no issues.

So I first wanted to talk about automotive. So in auto, which products have shown the greatest strength, and can you talk about traction you've been seeing in silicon carbide?

So I think when you have such a large demand reduction in automotive, there is no segment I can pull out and say this is strong, and so automotive across the board, when we look at our many different product lines, they are going to automatic drill down in this. Now to your question of silicon carbide, it's early days, and silicon carbide is predominantly a new technology that is aimed at electric cars from a high-volume standpoint. Electric cars as a percentage of the total automobiles produced or sold is 1% to 2%, so it's still a small percentage. We're making good inroads with our products to get new designs and new activity that are taking place. So it's really not a factor in any revenue that is taking place for automotive today, but we're making very good progress because the silicon carbide solutions for Microchip are extremely robust and in an automotive environment, which is very harsh, the voltage and temperature standpoint are about as one of the most important factors that take into account for using silicon carbide products.

Team, thanks for all of the detailed information so far. Steve, I wanted to go back to a couple of comments that you made about how unique this environment is and the fact that we've got multiple dynamics and capacity had to contend with those, and the question for you is given how dynamic things are, what's Microchip doing, and what are you doing to kind of assess where we are as demand compresses overall and then potentially reaccelerates and orders in backlog or have you expanded the things that you look at to see when we'll get the turn, and do you have a view on when the turn, whether it be June or September or some of the time?

The management team, Ganesh and I and other members of the management team really keep a very, very strong finger on the pulse of the business. We watch a very large number of indicators, internal and external, on a weekly basis and more often than that if needed on specific indicators. So through that large stack of indicators and graphs that we constantly monitor, we have added a few to really further assess that situation frequently, and some of the things we're looking at more frequently are things like dollars of pushouts and cancellations, numbers of coronavirus cases in various geographies where factories are and customers are. Whether they're peaking, they're stable, they're growing, they're coming down. We're also just watching a number of other indicators related to employment, first-time unemployment claims, and all that. So there is really a large amount of data that we're absorbing, and this certainly will include the data we get from our own customers to our salespeople regularly with monthly bookings and design wins and our customers' comments on whether the business is growing or falling, where it would go and what's happening. So there is so much more intelligence that goes into really before we continue, and we're even more focused on getting all that intelligence today. No, I think that's too early to really have that kind of confidence at the bottom. The numbers are so broad just have a guidance of minus two to minus ten; it's just so broad that we cannot yet say what September will bring. It will largely depend on whether as people go back to work there is the coronavirus that kind of dies down or there's a second wave coronavirus coming back, and we're dealing with it; with our factory shut down even in August and September. If that happens, then the bottom isn’t here yet.

Certainly, if I could ask a follow-up just relating to some of the things that are happening inside of the business given how dynamic things are. One, does it cause the team to think any differently about the inventory that should be stocked to properly to pull customers? And two, given Ganesh's characterization of what's wrong and squeezed, does it cause the team to think any differently about where it's emphasizing incremental R&D on products and that kind of thing?

So long-term target for inventory level is 115 to 120, and we finished the March quarter at 122. I don’t know you get any more precise than that. So inventory is really like that. So inventory is right exactly where we want the inventory to be. I really tell you it got a little bit high earlier during the US-China trade related, and then we have been bringing it down. So March quarter inventory was nearly perfect, and because of this coronavirus situation now, we didn't want inventory to substantially grow. So therefore we put our factories on reduced workload, rotating time offs, or reduced hours of work or whatever. And to call it so that as the revenue in the June quarter is declining, we don't want the inventories to grow very substantially. So I think our inventories are in the right range and we're comfortable with it. In terms of R&D, Ganesh will comment on that.

So I think no one should take short term positive and negative that's the way in which we're investing from an R&D perspective, and that's what we're seeing in this cycle at this point in time. R&D is really a longer-term view of where are the markets going, where are the opportunities, and we're guided by the six megatrends that we have shared with you. We believe over the next 5 to 10 years growth is going to be available at a faster level or higher level in 5G, data centers, autonomous driving, IoT, electric vehicles, and artificial intelligence and machine learning, and so the main product lines at Microchip are working on how they can create complete solutions—total system solutions—for these megatrends, and what may be strong today may not be so strong in six months or 12 months is how we do our R&D spending.

Okay. Thank you, operator, and thanks to all the investors and analysts who were on this call. The travel is really totally banned. So we'll be attending some of the conferences this quarter, but they will all be virtual conferences. We'll do it out of our home. So we'll talk to some of you more at those conferences. So thank you very much.