Good day, everyone, and welcome to this Microchip's 3rd Quarter Fiscal 2019 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 Chief Financial Officer, Mr. Eric Bjornhold. Please go ahead, sir.
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 filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. Attendance with me today are Steve Sani, Microchip's Chairman and CEO and Ganesh Moorthy, Microchip's President and COO. I will comment on our third quarter fiscal year 2019 financial performance and Stephen Ganesh will then give their comments on the results discuss the current business environment as well as our guidance and provide an update on our integration activities associated with the Microsemi acquisition.
Will then be available 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 GAAP and non GAAP results. I want to remind investors that during the quarter ending June 30, 2018, we adopted a new GAAP revenue recognition standard which we requires revenue to be recognized at the time products are sold to distributors versus our historical revenue recognition policy where revenue on such transactions were deferred until the product was sold by our distributor to an end customer. We recently went through a comment letter process with the SEC regarding our non GAAP reporting. As a result of this process, we will now be referring to what we used to call non GAAP revenue as a metric called end market demand and will provide this metric in our earnings release each quarter.
End market demand is the net dollar amount of our products, licensing revenue and other services delivered to our direct customers, non distributors, and buyer distributors to their shipments to their customers and inventory holdings. The value of end market demand from our distributors is calculated as the net transaction value of these shipments. We will continue to manage our business and distributor relationships based on creating and fulfilling end market demand. All of Microchip's bonus programs will continue to work based on end market demand. Therefore, along with our GAAP and non GAAP results based on distribution sell in, we will also provide investors with our end market demand based on distribution sell out, but will not provide a P and L based on end market demand.
So even though we are changing our guidance practice going forward, for transition purposes, today we will provide a review of our Q3 results compared to our non GAAP provided on November 7, 2018 using our historical non GAAP nomenclature. Our guidance going forward will reflect the outcome of the SEC common letter process, which Steve will also comment on during his remarks about our guidance for the March 2019 quarter. I will now go through some of the operating results including net sales, gross margin and operating expenses. Will be referring to these results on a non GAAP basis using end market demand metric as expenses and expenses prior to the effects of above the midpoint of our guidance, which was $1,400,000,000 and down 6.4% sequentially from end market demand of one point $513,000,000,000 in the immediately preceding quarter. We have posted a summary of our end market demand and GAAP net sales by product line and geography on our site for your reference.
Demand and operating income was $530,000,000 37.4 percent at end market demand. Non GAAP net income was $405,600,000 and non GAAP earnings per diluted share was $1.66 and was $0.095 above the midpoint of our guidance of $1.56.5. On a GAAP basis, 6.7% and include the impact of $3,400,000 of share based compensation, $74,300,000 of acquired inventory valuation costs, and $23,800,000 impact from the differences in GAAP revenue and end market demand. Total operating expenses were 584,900,000 and include acquisition and tangible amortization of $193,700,000, special income of $1,300,000, $5,400,000 of acquisition related and other costs and share based compensation of $36,000,000. The GAAP net income was $49,200,000 or $0.20 per diluted share and includes one time tax expense of $400,000 related to a variety of matters, including tax reserve releases due to audit settlements, statute of limitations expiring, tax reform and transition tax refinement, and fiscal 2018, tax provision to tax return adjustments.
The non GAAP cash tax rate was 3.5% in the December quarter, and we expect a similar rate for all of fiscal year 2019. We expect our non GAAP cash tax rate for fiscal 2020 and fiscal 2021 to be 5% or less exclusive of the transition tax, any potential tasks associated with the restructuring of the Microsemi operations into the Microchip Global 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.
Interest deductions that we believe will keep our cash tax payments low. The cash tax payments associated with the transition tax is expected to be about projected transition tax payments on the Investor Relations page of our website. For GAAP purposes, we had a significant tax benefit in the current quarter for a variety of reasons to discussed earlier. Moving on to the balance sheet, our inventory balance at December 31, 2018 was $702,500,000. All of the inventory markup from Microsemi required for GAAP purchase accounting has now been sold through and is no longer reflected in the ending inventory balance.
We had 123 days of inventory at the end of December quarter, up 6 days from the prior quarter's levels. Inventory at our distributors in the December quarter were at 36 days compared to 37 days at the end of September. Believe that our distributors operating activities was $481,500,000 in the December quarter. As of December 31, the consolidated cash and total investment position was $436,200,000. We paid down $377,500,000 of total debt in the December quarter and the net debt on the balance sheet reduced by $349,400,000.
At December 31, our debt outstanding includes $2,743,000,000 of borrowings under our line of credit, $2,713,000,000 of term loan B. $2,000,000,000 in high grade excluding our very long dated convertible debt matures in 2037 and is more equity like in nature, was 4.8 at December 31. Our net leverage metrics significant distribution inventory reductions that were made in the June September quarter for Microsemi which caused our shipment activity to be significantly less than end market demand during these periods The weak economic environment also has negatively impacted our EBITDA in the December 2018 quarter and will continue to do so in the March 2019 quarter. We are committed to using substantially all of our excess cash the next several years. Our dividend payment in the December quarter was $86,300,000.
Capital expenditures were $27,400,000 in the December quarter. We expect about $45,000,000 in capital spending in the March quarter and overall capital expenditures for fiscal year 2019 to be about $235,000,000. We continue to add capital to support the growth of our production capabilities for our new products and technologies and to bring in house more of the assembly and test operations that are currently outsourced. These capital investments will bring some gross margin improvement to our business, particularly for the outsourced to Atmel and Microsemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the December quarter was $47,000,000.
I will now turn it over to Ganesh to give its comments on the performance of the business in the December quarter and provide an update on some of the microsemi integration activities. Ganesh?
Thank you, Eric, and good afternoon everyone. Before I get started, I'd like to clarify that the product line comparisons I will be sharing with you are based on an end market demand metric, which is how Microchip measures this performance internally. 7% compared to the September quarter, reflecting a broad macro weakness in the markets we serve. Microcontrollers, however, were up 13.2% from the year ago quarter. Microcontrollers represented 52.9 percent of our revenue in the December quarter.
During the quarter, we continued to introduce a steady stream of innovative new microcontrollers ranging from the industries lowest power LoRa system and package family to single chip max touch touch screen controllers for screens up to 20 inches in size, to intelligent network interface controller technology, the industry's most efficient automotive infotainment networking solution that supports all data types including audio, video, control and ethernet over a single cable. In my prepared remarks last quarter, I mentioned that our microcontroller business was annualizing at over $3,000,000,000 in end market revenue. Through our subsequent investor meetings, there seemed to be the perception that our 32 bit microcontroller business was not very big. To address this perception gap, we'd like to share with you that over the last two quarters, our 32 bit microcontroller business is annualizing at over $1,200,000,000 in end market revenue. The 2018 microcontroller rankings from Gartner are normally available in April And as we have seen in prior year's results, we expect to see significant market share gains again.
We will report on these results during our next conference call. Now moving to analog, our analog business was sequentially down 6.2% compared to the September quarter. Reflecting the same broad macro weakness our microcontroller business experienced. Analog, however, was up 77.9% from the year ago quarter. Analog represented 29.1 percent of our revenue in the December quarter.
And during the quarter, we continued to introduce a steady stream of innovative analog products as well, including the industry's smallest multi output MEMS clock generator, the industry's smallest five channel temperature sensor and the most robust silicon carbide diodes and MOSFETs in the industry. Our FPGA revenue paid another all time record, even after going back to the Microsemi and Actel history. With 8.7% sequential growth compared to the September quarter. Our low power mid range Polar Fire family continues to garner strong market acceptance, while the prior generations continue to demonstrate consistent growth even in the current market environment. We also unveiled the industry's first risk PHY system on a chip FPGA architecture, combining the industry's lowest power midrange fallofffire FPGA family with a complete microprocessor subsystem based on the open royalty free risk 5 instruction set architecture.
FPGA represented 7% of our revenue in the December quarter. Next, moving to our licensing business. This business is sequentially up 7.9% as compared to the September quarter. Our results reflect the sale of another patent license for a specific set of patents that can be used in non competitive fields of use. We anticipated this patent license to close in the December quarter and included it in our guidance.
We continue to retain indefinite rights to these patents for the fields of use that are of interest to us. Our patent licensing strategy is to monetize portions of the substantial patent portfolio be inherited through our acquisitions by licensing select patents to players in non competitive fields of use. In all cases, we retain rights to youth use patents in our products as well. We had meaningful patent license transactions in September December quarters, Inversus should expect that the revenue contribution in the future from this effort will be lumpy from quarter to quarter. We do not expect meaningful contribution from the patent licensing in the March quarter.
Our memory business was sequentially down 15% in the December quarter, as compared to the September quarter. And finally, our multi market and other business was down 3% sequentially compared to the September quarter. A quick update about the Microsemi integration. Business units, sales, operations and support groups are all making rapid progress. Our thanks and kudos go out to the combined company employees who are working hand in hand to achieve the accelerator synergy results.
Overall, we are ahead of our synergy targets and expect continued synergy gains for many quarters to come. What will take us a long list is the business systems and operations integration, which is being done in phases. The 1st phase for 1 of the business units went live on November 1, 2018, The 2nd phase just went live on February 1 and involved 3 more business units and more phase releases are planned with a steady cadence. We expect the overall business and operational integration will take about 15 to 18 more months to complete. Me now pass it to Steve for some 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 third quarter of 2019, I will then provide update on our progress at Microsemi. I will then provide guidance for the fiscal fourth quarter of 2019. Our December quarter non GAAP financial results based on end market demand exceeded our guidance for net sales, gross margin percentage, operating profit, operating margin percentage and earnings per share. Our consolidated non GAAP gross margin reached an all time record at 62.2 percent of net sales, and exceeded the midpoint of our guidance by about 100 basis points.
Our consolidated non GAAP operating margins were strong at 37.4 percent of sales and exceeded the midpoint of guidance by about 130 basis points. Our consolidated non GAAP EPS exceeded the midpoint of our guidance by $0.095 per share We are pleased with the financial results despite a very unfavorable business environment with the tariffs slowdown in China, European Automotive issues, higher interest rates and under absorption charges from some of our factories. Let me also touch on the performance of Microsemi. Microsemi's non GAAP operating profit reached a record. We are systematically improving Microsemi's financial performance and realizing significant synergies.
At the time of our announcement of Microsemi acquisition, we had guided to $0.75 accretion run rate after the 1st year. After nearly 7 months, we are well ahead of the $0.75 run rate for accretion from Microsemi. On non GAAP basis, this was also our 113th consecutive profitable quarter, want to thank all employees of Microchip, including employees from our acquisitions for their contribution. Now let me provide you some further update on the progress we have made with the Microsemi integration. First, distribution inventory.
After reducing the inventory and distribution channel in the September quarter, Microsemi distribution inventory remained stable at 2 0.6 months in the December quarter. We believe that at the current levels, distribution is holding the amount of inventory it needs to support the end market demand. In last quarter's earnings conference call, we discussed moving several microsemi customers back to being serviced directly that Microsemi had transferred to distribution. We completed this transition during the December quarter. Microsemi internal inventory.
Microsemi's internal inventories are still high as we continue to maintain lower loadings in Microsemi's internal factories as well as subcontractors until the inventory comes in line. As we said from the beginning, Microsemi has very good engineering teams and very good products. The customer sockets are sticky and we continue to believe There are very good end market opportunities for the combined company. Our strategy for the better part of this decade has been to buy businesses and turn them into world class performers in the likes of Microchip. Here, we started with excellent products excellent gross margins and excellent engineering teams, with distributor and contract manufacturing inventory reduced, and with Microchip's operating expense approach, we're optimistic about achieving our long term targets for accretion from Microsemi.
So far, we are ahead of our original targets. Now regarding guidance going forward, beginning with this March quarter, as Eric mentioned, we are changing the information included in our financial guidance in response to comments and discussions with the staff of the Securities And Exchange Commission After the GAAP standard change to sell in revenue recognition, we continued to provide guidance and track our results based on sell through revenue recognition and referred to the sell through revenue as non GAAP net sales. After the adoption of ASC 606, the feedback we received from investors and sell side analysts had been very positive on our continuing use of sell through revenue recognition in our reporting of non GAAP net sales We continue to strongly believe that managing our business on a sell through basis is the appropriate way to run Microchip. Therefore, we would as our non GAAP sales. However, after receiving an SEC comment letter and discussing with the SEC, we have decided to provide net sales guidance based on selling revenue recognition under the new GAAP standard.
We will continue to provide non GAAP guidance for gross margin percentage, operating expense percentage, operating profit percentage and earnings per share, but we will use sell in based GAAP revenue for these calculations. When we report our results, we will also provide information on end market demand so that investors can understand the consumption of our product in the market but we will not use the end market demand for calculation of the non GAAP P and L. Now I will provide you guidance for the March quarter. The guidance we provided for the September December quarters, which reflected our caution on business conditions, turned out in retrospect to be spot on and was a harbinger for broader industry weakness. We continue to be cautious about the outlook for slowdown in China, European automotive issues, higher interest rates, potentially causing U.
S. GDP to slow down, any lingering effect of U. S. Government shutdown and potential for further U. S.
Government shutdown. With all this commentary, we expect our total GAAP net sales based on sell in revenue recognition for March quarter to be up 2% to down 9% sequentially. We expect our non GAAP gross margin to be between 61.2% 61.8% of sales. We expect non GAAP operating expenses to be between 25.8 percent 26.5 percent of sales. We expect non GAAP operating profit percentage to be between 34.7% 36% of sales.
We expect our non GAAP earnings per share to be between $1.26 per share to $1.53 per share. Again, all these ranges for non GAAP gross margin percentage operating expense percentage, operating profit percentage, and earnings per share are based on GAAP revenue and sell in revenue recognition. We also want to give the investors and analysts a sense of how we see the Microchip business past the March quarter. As you know, there's a substantial pending date of March 1, 2019 when if there is no settlement between U. S.
And China, a 25% tariff would kick in for about $200,000,000,000 of Chinese goods shipped into U. S. We think that the 2 governments will make some progress, but it is likely that the date of March 1, 2019 will be extended further out. Bodying any negative barring any material negative development on the trade front. We see the March 2019 quarter to mark the bottom of this cycle for Microchip.
We cannot yet say what the shape of the recovery would be Would the recovery be a V shaped, U shaped, or L shaped? That will depend somewhat on the outcome of the trade talks but we do see a bottom forming and believe that the March quarter will mark the bottom for this cycle for Microchip. 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 basis except for net sales, which will be on GAAP basis. We believe that non 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 operator, will you please poll for questions? Thank
you. We'll go now to Craig Hettenbach with Morgan Stanley.
Yes, thanks so much Steve. I appreciate the color around kind of tariffs and how you're thinking about things kind of post March. Just any signals that you're looking at in terms of calling the bottom here, whether it's kind of run rate of business inventory distribution or customers, just how you're seeing, kind of the business evolve kind of beyond the March quarter?
Well, we look at a variety of factors, including bookings and billings activity, discussion with our direct and distribution customers, distribution sell through activity, customer cancellations, customer pull ins, you know, delivery push outs and pull ins. With the 120,000 plus customers that we service, in a vast range of end markets and applications, we really believe that we get a very broad perspective of what is happening in our business. Today, these indicators are telling us that the environment is still very uncertain, driven by a variety of factors, including the trade situation However, we don't see things getting worse at this point unless something more negative occurs on the trade front. Based on the vast amount of data that we get, we're really seeing a framework for the formation of a bottom for this cycle in the March quarter.
Got it. And then just as
a follow-up, can you talk about so far this quarter to date kind of January into February? What type of linearity you're seeing and how the business has been?
So business is tracking well to the guidance we're providing, we have, we have seen the bookings stabilize and even increased somewhat very recently. But I would say it's a very short duration indicator And it's really not enough for long enough time to really be making calls based on that.
Okay. Appreciate it. Thanks.
We'll go next to Mark Delaney with Goldman Sachs.
Yes, good afternoon. Thanks very much for taking the question. Steve, I was hoping, first, you could give us a better sense. And as you think about the March quarter, if if you think sell through will be above or below or similar to the sell in revenue that you're giving guidance for?
Yeah. So we are we do not really have a good process for forecast thing, what the change in distribution inventory is going to be. That's not how we run our business historically. You know that. That's why we've given sell through information or end market demand consumption historically.
You know, we really feel, as we said, kind of in our prepared remarks, the distribution inventory is in a good position to support what end market consumption is. So, you know, I think at this point in time, We've given a pretty broad range of guidance for the quarter of plus 2 to down 9. So that's probably the broadest range of guidance you've seen from Microchip. In a long time. And some of that is the unpredictability of what the sell in versus sell through is going to be.
Helpful. And then my follow-up question on the completed quarter, revenue and gross margins were above your guidance. Can you just give us a better sense for what enabled the company to exceed its guidance on those financial metrics?
Well, you want to take that is?
Sure. So, I mean, revenue was roughly a percent, a little more than a percent better than our guidance was. And that's just kind of the puts and takes that we saw in the quarter, but it was good that we came in above the midpoint. And then on the gross margin side, we had a very favorable product mix in the quarter. We continue to really focus on cost reductions over manufacturing areas.
You know that we may quite a bit of changes in terms of any discounts that were previously given for the Microsemi portion of the business. On sales to distributors or contract manufacturers, and we're really seeing the benefit reflect itself in the gross margin today. Thank you.
We'll now take a question from Ambrish Sabadra from Bank of Montreal.
Hi, thank you very much. Maybe you can just stick with the gross margin side. Your guidance is on a Q over Q, that's a pretty big delta, but yet your margins are coming in much stronger than what I would have modeled it. Could you just help us understand the dynamics there in the guided 2 quarter, especially in light of your inventory came down as well. And I'm expecting you're not building inventory in the quarter.
And then I had a quick follow-up.
Is your question that the gross margins are coming down, but the operating margins are not as much?
No, my question is gross margin is gross margin is coming in stronger than what I would have modeled given your shortfall in the revenues versus what the Street was expecting?
So I think, the same reason where the gross margins were strong this quarter, we are getting an uplift from a lot of the discounts that were given to the distribution channel and contract manufacturers and others. And a lot of the business that was moved to distribution from the microsemi business, we have completed that conversion back to direct, and therefore, you take out that distribution margin hit. So all that is having a positive effect on ASPs and our margins. We are continuing to reduce cost in all of our factories. There is still a lot of atmel product was outside.
Every quarter, more and more of it is coming in. There is also some microsemi product we're starting to bring in. Some of the expenses have been taken out from the manufacturing overhead in synergy. So there are a lot of moving parts and the product mix is very healthy.
Okay, good. Then my quick follow-up, Steve, usually things don't turn around that quickly. And it's a small piece of your business, FPGA, but memory serves me correct. It was kind of in the $325,000,000 run rate annual. And you posted $100,000,000 quarter.
What's going on? Is there, hopefully not a last time buy, but some design wins that are ramping?
Yes, there are no last time buys in FPGA that are driving that revenue. There has been seats sewn for many quarters on some of the new products the 4th and 5th generation of the FPGA products. There's some of the FPGA, which is exposed to markets, like a defense and aerospace, they have some quarter ending budget that needs to be spent. But it's a stable solid business. And, we see many, many good characteristics for how that can be continued to be built on.
Quarter to quarter, we may have small changes. But overall, if you look at annualized revenue, it's not a nice, good, good growth path for us.
Yep, clearly. Thank you.
We'll take our next question from Vivek Arya with Bank of America.
Thanks for taking my question. Hello, Steve. So, Steve, can you give us some color by end market whether it's industrial or autos or consumer or communications where you are perhaps seeing better or worse trends than what the midpoint of your March outlook suggest?
Yeah, rather than going, segment by segment, I think we have previously indicated that the automotive, industrial and consumer home appliance markets were weaker. In the last quarter, especially as we look at this in the guidance for this quarter, we're seeing, the addition to that, the data center market the communication markets have also started to have some softening that goes with it. So at this point in time, I can't pick any one of them to say this is the main reason why the strength is coming or the weakness is coming. I think we're seeing a broad based weakness and, even some which were stronger last quarter are less strong at this point in time. Defense And Aerospace has continued to be strong.
You know, it could have some impact this quarter from the, the government shutdown and what impacts that may have. But that's all built into our guidance at this point.
I think the data Aerospace And Defense is a market in its own. It's in its own space. And it doesn't really follow the usual what happens in industrial, consumer and other. It's a very different business. We did see some impact from the government shutdown where we couldn't get certain export licenses processed.
Some programs were not released, but we kind of expect it to square up in the quarter and not really have any significant impact going out of the quarter. There is some impact of a budget flush. And there's a lot of budget flush in September December quarters where all these large customers, they have government budgets and they need to spend it. Otherwise, they use it or lose it. And so March quarter is sequentially down in that segment because of the budget flush.
Got it. And for my follow-up, Steve, if the, let's say, do have a trade resolution in the next few weeks, Do you think there is a potential for an inventory refill? Or do you think the industry is shipping to consumption right now? So we should not be modeling any better than seasonal quarters going forward?
I don't know about how everybody else is doing. So I will just speak for microchip rather than the industry, a settlement of trade would be a bonanza. Our customers and distributors are so cautious. There is low visibility they're building bare bones, what they need for the backlog from their customers. Nobody wants to get stuck with anything, depending on what happens.
If the trade talks are settled prior to March 1, this will be a big bonanza.
Yes, I think I'd just add to that as you can, you can tell from our last two quarters of actual results where our end market demand was higher than what the selling revenue was. There's definitely a bleed down of the distribution inventory. And we don't think that the at the end customer is probably any different, although we don't get real data on that.
Yes. So we are not shipping to consumption, as you said. We're shipping well below consumption.
Okay. Bonanza sounds good. Thank you.
We'll take our next question from John Pitzer with Credit Suisse.
Yes, good afternoon guys. Thanks for letting me ask some questions. I guess, Eric, you said in your prepared comments, you made the comment that the guide for the March quarter on the revenue is wider than normal. Help me understand to what extent is that just a reflection of how uncertain this environment is and to what extent Is that just a reflection of having now to guide to sort of a sell in revenue? And as we think about future quarters, is this now the right range of guidance around the midpoint you're going to give us?
Is this just wider because of uncertainty?
I believe it is a combination of both, right. I mean, we haven't given guidance historically based on sell in. So this is new to Microchip and we don't feel that we have a good way to understand if distribution inventory is going to increase or decrease in a period. So that has a but obviously the environment is very uncertain. So I can't parse it out in terms of what percentage is each, but I this is a pretty broad range of guidance Yeah.
So I think, I would just say maybe sticking my neck out a little bit that over time, I think we will learn to have the guidance narrower. We, we have a very broad distribution. You know, we do business with over 100 distributors around the world. Which is not the case with many other semiconductor players that do business with largely 3 or 4 large distributors. We, as you know, in the past, We have large distributors, which we call global distributors.
We have catalog houses. And we have nearly 80 to 100 distributors in China alone. So our distribution network is very, very broad. And to really, you know, figure out what everybody's going to buy those are not the processes we worked on in the past. We don't really care what distributor buys.
We care about what distributor sells out.
Right.
And our processes take care of that. So we will get better at it. We'll very rapidly. We're not seeing years. We're seeing quarters.
We'll get better at it in the guidance will narrow. And the other impact is the uncertain environment. Once the environment gets more certain, I think we'll narrow it also.
And I think another contributing factor is that lead times are very, very short today, right? So backlog visibility is not great.
That's helpful. Then maybe for my follow-up guys, I just wanted to go back to the gross margin. A couple of other questions were asked around I'm just kind of curious, given that, Steve, you mentioned your undershipping demand today in conjunction with sort of the slowdown at the industry level. You were also working through some excesses that the Microsemi business had when you bought it. I'm just kind of curious, how should we be thinking about utilization now?
Have you done all the utilization adjustments you've needed to? And I guess more importantly, as business comes back and you benefit from increasing utilization, and some of the more insourcing activity you're doing. How do we think about kind of that long term target gross margin? Because relative to that 63% you've talked about, you're not too far away and what's a really rather lackluster business environment, is $63,000,000 the right margin to think about or could it be higher?
Good question. As always, you know, just keep that question on the back of your mind. And I think as we get further, as we establish 63, then we will assess further. Right now, especially microsemi factories are significantly underloaded. Because we first collected the distribution inventory.
And then the internal inventories were much higher. The internal inventories from microsemi that we inherited a lot higher than really the level of inventory at Microchip. So we have number of factories running at 50% capacity number of them are running something higher than that. So overall utilization is very low. But and I made this point last quarter, I think only about 10% to 20% of
15%. 15%
of Microsemi business is done in the internal factories. That's come from the foundries. So from foundries, we have aggressively cut the starts and assembly and test loading to really bring that down rapidly at subcontractors. Internal, we have credit in the factory that are earning below capacity. And when the business comes back, we get some improvement from utilization from the internal factories, but they were only 15% of Microsemi business.
They're only probably 5% of our business total Microchip, so just be careful.
Thank you.
We'll take our next question from harsh Kumar with Piper Jaffray. Yeah.
Hey, one for Steve and 1 for Eric. Steve, wanted to ask about your comment about marking the bottom in March. A couple of other broad companies have said the same thing. But they are usually talking about either some sort of stabilization in backlog or some kind of metric, that they are watching and monitoring I'm also when you make that statement, I'm also hearing sort of Ganesh in response to a question, say things are still getting worse in some of the markets. So I'm curious if you have any kind of tangible data in terms of either backlog or orders or something else you could point to, And do you think the China industry China industry sort of flush at this point in time?
And that's where we're basically shipping to true demand or maybe undershipping. And that's the reason why you feel better about it. And then I've got a follow-up for Eric.
So I would say, some of the data center and other business you're talking about, they're also down somewhat seasonally and the weaker seasonally because March quarter is weak compared to September December quarters in which year end shipments happen. But I think the question you're really asking is what gives us the confidence that the March quarter will mark the bottom? Is that the question?
Yes, yes.
Okay. So I think I would say we really can't present you enough data to convince you, and we're not gonna try. What we can tell you is that our current backlog for June quarter is about flat with the backlog we had for the March quarter on November 5, okay? So that may look flat, but then you have to look at after November 5th, we had a bunch of holidays Thanksgiving Christmas and then Chinese New Year in the March quarter. There are no major holidays for June quarter.
So starting with the flat backlog and going into the stronger quarters without the holidays, that's why we say barring any significantly negative from the trade negotiations with China, we believe that June quarter will strengthen, or we're confident that it should not be sequentially down again. But the second point I would say, Harsh, is, and I don't mean this for all the analysts and for all the investors. There are lots of them that have followed us for a long time and believe the calls we make, but, you know, there is a lot about the others who don't. We have made numerous calls in the last 15 years or so for the business environment to turn negative and then turn positive. When we first make a negative call, first it is not believed.
It's even ridiculed a few times. Then 3 to 4 months later, what we say gets confirmed, and everybody goes down, then comes the recovery part of the call, is not believed either. As we go on the road over and over and over, we get the question what gives you the confidence and we answer it. That is not believed either. So to my recollection, we have not been wrong in 15 plus years in calling the downturn.
And we have not been wrong in the same time frame calling the upturn. That's what gives us the confidence. Mike, you're saying your performance is no guarantee of the future reserves. So we don't guarantee anything. So of course, our confidence is subject to some number of risks, but I think, I think that's a narrative I'd like to explain.
No, that's very helpful actually. And then question for Eric was, how much free cash flow do you expect by your calculation to be available for debt payment in March. And if that's the base level number and we expect business to get better, then we can get an idea of what your going to be able to do hopefully going forward if nothing macro changes?
Sure. So we expect somewhere between a $175,000,000 $200,000,000 of debt pay down in the current quarter. The last two quarters were significantly higher than that. I would say that we obviously are coming off where our accounts receivable is down quarter over quarter. We had some very good help from some of our customers and some of our vendors in terms of payment terms and negotiating that and really making significant progress to what our guidance was in the December quarter, but we don't really have those levers to pull in the current quarter.
So I don't think I'd use that 175 to 2 $1,000,000 as kind of an ongoing run rate. We do expect that it will get significantly better from this point forward, but we'll continue to focus really all of our excess cash generation outside of the dividend on paying down debt.
Thanks guys. Thank you for the color.
We'll go to William Stein with SunTrust for our next question.
Hey, thanks for taking my question. Steve, I'd like to maybe take a different approach to sort of cycle and recovery question, acknowledging that you've tended to call these turns early and correct, I just want to understand what's giving you the confidence from the perspective of trade. We have this March 1 deadline hanging over us. And it sounds like you're providing us with some not guidance, but some sense of demand post March quarter that implies this gets resolved constructively. And I'm just wondering why you're why you feel confident to do that?
And then I have a follow-up, please.
I don't know if that's what I'm saying. I'm seeing very clearly that barring any, significant negative developments on the trade front, you know, there was a caveat in what I said. So what I also said was that, I think, with a month to go to March 1, I think the governments are making progress that positive signals coming out of the White House. You recall how negatively signals were coming out regarding Canada during, you know, one of the conferences, I think. And then all of a sudden a week later, it all came out good.
So Trump has used that strategy in a way and then not those negative signals coming about China. So I think the progress must be good. But it's a lot of work to get done. And I'm simply saying it's most likely that there's some positive announcement but the actual settlement gets pushed out further. If settlement gets pushed out further, the environment we're seeing remains.
Our guidance assumes a fairly current environment continuing. And if that current environment continues, then June quarter is still than March quarter.
Okay. Thanks for that. One other question on the Microsemi integration. I know that I recall they acquired Vectron, lower margin business, right before, you acquired the whole company. And that was they'd never been reported a quarter with that asset.
And there were some other things in their portfolio that might not have met microchips, I don't know, view of a great business to be in. I'm wondering if you've made any portfolio adjustments, if you've closed any of their businesses, so that we can think about it, maybe a different margin profile or growth profile, when demand normalizes and all the inventory, adjustments are made? Thank you.
We, we have not. We have not sold any of the businesses. We have not closed any of the Vectron factories. We're running the business. You are correct that the business is at a lower gross margin.
We're using our usual techniques. We are trying to improve the gross margin through ASP management. They're also Microsemi had to cut some expenses and we have cut some. So the contribution to EBITDA is is actually much higher than really what it was originally. But the gross margin, if you only focus on that, then the gross margins are lower.
We have other businesses at Microchip where the gross margins are lower than our corporate margin. There are also many businesses that are higher in 70s 80s. So So at the end of the day, it's a question that was beyond Vectron.
In the last two conference calls, we've also as part of our integration effort, we have reviewed every single business. And while there are many, many, excellent businesses, There were some that, needed improvement. And we have made adjustments in terms of level of investment we're making in those businesses. To be, better overall, results for us as well. So, but that's all largely behind us.
At this point, as Steve mentioned, on Vectron and all the other businesses, we're working on improving what we inherited and making significant progress towards that.
And when the, the factories come back to full production as we take out this excess inventory, the Vectron business will see substantial cost reduction to higher utilization in that factories and numbers are going to start looking much better.
Great. Thank you.
We'll now take a question from Chris Caso with Raymond James.
Yes, thank you. Good evening. Just wanted to ask a question about, revenue geographically and, I guess that we probably anticipate some of the weakness that you've seen in Asia that you talked about before. It looked like from the results, that you saw a downtick in Europe also can you talk about that? And if there's anything specific geographically, you're anticipating as you go into the March quarter?
But I can take that. So I mean, the all geographies were down and we posted this on our website. So it's available for everybody to see and it'll be in 10 Q filing. But all geographies were down. It is not unusual at all for the Americas and Europe to be down in the December quarter just because of all the holidays.
And typically, we see strength from Asia in that time period, prior to leading into the New Year in the current quarter. But I think all geographies were weak. This weakness was not just the China issue. It's kind of spread across the across the globe. And in terms of forecast for the next quarter or the current quarter that we're in, we don't really break out the forecast by product line or geography.
Well, I think directionally, in the March quarter, usually our European business strong. Our China business is weak because of Chinese New Year, even in a normal time. We're also dealing with trade here. And the US business is kind of normal. So I think directionally you can have that.
Okay. Just as a follow-up, the follow-up questions on revenue linearity through the quarter and kind of expectations for March as well. And you mentioned last quarter that, you saw a slight uptick, I guess, in the 1st month of the quarter. I presume that, that downtick toward the end of the quarter? And then how do you typically see linearity as you go through the March quarter again, taking in consideration the Chinese New Year holiday the middle?
Well, so You know, I think the the uptick we talked about in bookings, in a November call, basically did not hold. I think you've heard from everybody that December was fairly weak. That's that's always the problem in making decisions based on very short term data. And I said that earlier, that our bookings have normalized very lately. We have even seen some strength, but don't take it to the bank yet.
I'm not taking it to the bank. We have made the call today at the midpoint down about 3.5 percent sequentially, from GAAP to GAAP revenue, This does not include any dramatic improvement or bookings or improvement of trade or anything like that. Think it just assumes that the market stays in the doldrum.
Got it. Okay, understood. Thank you.
Our next question comes from Harlan
quarter guide and maybe providing the team with a bit more confidence on the June quarter kind of qualitative outlook. Historically, how much hinges upon the replenishment rates both Chinese New Year. And when do you typically get these signals? Is it 2 weeks, 3 weeks after Chinese New Year's?
So, you know, March quarter sometimes lands up very much depending on where the Chinese New Year falls based on the lunar calendar. Earlier the Chinese New Year, the better the March quarter usually lands are being, because Chinese customers kind of go slow before that and they come back and then they see all charged up and ramp up their factories. Chinese New Year is happening this week, which we will consider kinda early because it can be late February, it can even be fairly late. But it has been even earlier sometime in late January, but this is really early to mid. So this is good sign.
And we will see what happens after Chinese New Year.
Okay. And I appreciate the insights there. Know you guys are waiting for the Gartner data, but just looking at the recent SIA data, the MCU segment was down about 4% sequentially in q4 versus your MCBU business, which was down about 9% sequentially. I know you guys look at this data as well. Any reason for the big delta, is it Is it sell in versus sell through?
So not a fair comparison?
I think in any given quarter, you're going to find that the data is more noisy. It's easier to look at these on a 4 quarter rolling basis, and that's what we expect when we'll see the 2018 data. So there is no doubt in our mind we're gaining market share. Quarter to quarter, the numbers can be more noisy.
Our next question will come
from all that you
say, good evening.
Good evening. Thank you. Thank you.
It seems that your 300 synergies is pretty good number. Looking for fiscal fiscal 2021 or 22.
So what I would say to that is, you know, we are ahead of the accretion target today. Right. Just in some cases, we have pulled some of the synergies in. It has gone better in terms of integration. But we haven't revised the final number.
The other major change that happened is this business environment recession that we're going through that we had not built into the forecast. Nobody had anticipated it back then. It will depend on the shape of the recovery. If the recovery is fast, like, it has happened in some prior cycles, then we get back on that schedule. If the recovery is a lot slower and it's kind of l shape recovery.
It stays in doldrums for a year. Then, then the schedule for achieving that may have to be adjusted. But I don't think we are uncomfortable with the number, total accretion.
So it really means that you get $8 non GAAP earnings in fiscal 21 or 22, or you could.
Well, you're putting words in my mouth, but, that was our forecast then. And, again, depending on the shape of the recovery, that is still our target.
Okay. And your long term model targets stayed the same as you made in March of 2018?
Correct. I think, state them again for everybody.
So it is a 63% gross margin 22.5 percent operating expenses and a 40.5 percent operating margin on a non GAAP basis.
Yes, thank you.
And Do I need to be concerned that autos represent 17% of your mix?
Autos has been a very good business, and you shouldn't be concerned. We have just a tremendous funnel of the design wins in automotive for future and all that, significant entry into various electric vehicles around the world and autonomous vehicles around the world. So there is really no reason to be concerned. The issue in automotive market have been 2. One is, Europe implemented a new emission standard for their diesel vehicle starting September 1.
And all the agencies had a 1 year notice. They knew a year ahead of time that, the new emission standard will go into effect on 1, 2018. September 1, 2018 came and there was no capacity. People kind of just felt sleep on the switch. So there were millions of cars, taking away airport parking lots that can't be on the road because they're on transmission standard.
So that created a significant dislocation in the European car market. It's working through it. We'll take more time. To work through all that. So that was one issue.
And the second issue was the slowdown in China. China is now the largest automotive market. Larger than U. S. And larger than Europe.
And China is going through its own issues of slowdown and stock market crash and some of the people's wealth has been acted. So the China automotive market, all that will come back.
And Gil, if I can add one more point. The consumption of electronics going into cars continues to go up year after year after year. So and in many years, that consumption of electronics going up offsets any reduction in production as well. And so that's been the long term trend and remains so.
I thank you very much.
Thank you, Gil. Nice to hear you on the call. Thank you.
We'll take our next question from Kevin Cassidy with Stifel.
Thanks for taking my question. Hi, hi, Steve. Maybe just on the 32 bit micro, traction that you're seeing. Can you say what end markets it is? Maybe your discussion around automotive, maybe that plays into it, but can you say which end markets you're gaining the traction?
We're broadly represented the 32 bit micro total market, the standard products are broadly represented in all the end markets. It's a ubiquitous product. I can't pick any one of them that's early the one that's towing there. But we've been coming off of, being lower in the rankings. We're rapidly coming up the rankings.
And as we do that, it has to come from all the different segments that we play in.
Okay. Great. And maybe, is there such a thing as an upgrade from the your eight 16 bit customers going to 32. Is that helping your traction?
No, not at all. I think, the 8 and 16 bits are continue to do well. And again, when you see the, the annual results for 2018, you'll see that all three segments as it was in prior years are doing well. The 32 bit, we have, more capabilities that have come both organically as well as through the acquisitions. It's allowing us to play in a number of incremental markets that perhaps we couldn't get to a few years ago.
And so I think the point of providing some color was there was a sense that perhaps, you know, 32 bit was still very small for us and we were just playing in 16s, a 32 bed at over $1,200,000,000 annualized based on the last two quarters is a pretty significant portion of a $3,000,000,000 plus annualized microcontroller market for us.
We'll go next to Chris Rolland with Susquehanna.
Hey, Steve. So regardless of the SEC's opinion, this analyst support see that the standard should be sell through for what it's worth. But in terms of a question, now that we're a few quarters into microsemi, what has been the biggest positive surprise for you in terms of products, and traction and demand for those products positively? Since you guys closed?
So, I would say that you know, we we confirm usually a lot of positives after we close the acquisition. We don't usually find new positives. Because the management's always, you know, that's those are the positives they bring out and they're selling the company. So they're really not hidden positives. We usually find some new negatives that we may not have known or may not have fully understood or or may not have been fully explained, as you have seen.
We but on the positive side, we don't get surprises, but we get confirmation. And here, as I said, we got a very good confirmation. The products are very good. Customer sockets are very sticky. In discrete military products, in FPGA sockets and a lot of the analog sockets and timing business and data center businesses.
There's a very good businesses, a good sticky circuit, very complex products as well as very simple discrete products. So it has a range of products and, very, very good engineering teams and very, very good work done. And I think we have continuously said that we feel very good about it. Business fits very well with Microchip. We have truly enhanced the ASPs and gross margins by a methodology of discontinuing the some of the discounts and all that.
We brought the inventories to the right levels, internal inventory was still working through. As we reramp the factories, I think that will have some more positive effect. So all that is very good. I think we feel good about where we are.
Great. And then on some of the PMCS products, whether it's optical or storage, given kind of the well known storage slowdown that we've seen out there more broadly. And then some guys talking about a data center slowdown or hyperscale digestion out there Have you seen any of this at all? And have you seen that play into either optical or storage for you guys?
I think built into our guidance for this quarter, as I mentioned earlier, does reflect that there is some weakness those two segments in communications and data center. It's not different from what others have been talking about as well. And, we are seeing that in the microsemi products. Play into those segments.
Thanks. But I think, I don't think anybody questions the strength of data center communication market as a good market longer term. Any segment is going to go inventory digestion and cycles. The question we were dealing with was, is Microsemi a good business? Is it the right acquisition?
A short term cycle coming in and having some hyperscale digestion for a quarter or 2 will not really factor into our decision. I think this a very good business long term. Thanks
guys.
Our next question will come from Rajvindra Gill with Needham and Company.
Yes, thanks for taking my questions. And forgive me if this question was asked because I'm joining late, but I was wondering if you could if you can make a distinction between, any potential trade settlement or trade agreement versus the actual deceleration that's happening in the Chinese economy. So meaning, if there is some sort of trade settlement what impact would that have in the business environment or is it just maybe taking one risk off the table, but the reality is that the economy is slowing down dramatically and the trade agreement would really more have a sentiment improvement, but nothing really changing in terms of actual business. Wondering if you could order maybe if you could just elaborate on that.
So, Rajiv, I think our assessment is that trade is the problem why Chinese economy is weakening so much. China has been, the production center for the world. And, you know, as these trades came in, Chinese goods became more expensive and threaten to go more expensive, with $200,000,000,000 of Chinese goods getting 25% tariff. That's a $50,000,000,000 tax. So companies have moved production out of China to the extent they could to the extent the product was running in 2 different factories and 1 was outside.
But there is just not enough capacity outside of China to take all that. Outside, but there is there are lots of them in works. With the tariffs, Chinese stock market has taken a major hit, And, Chinese consumers use the stock market as a cash machine to run their businesses. And by cars and buy stuff. So I think, you cannot take the trade issue away from the Chinese economy.
As the trade issue is settled, know, that is the boost that the Chinese economy will need. And then the people who have to think about, you know, do do they stop taking factories outside of China, or would the trade talks settled? All that efforts stop. I can't know what would happen there. Is there a future risk?
If there is complete removal of trade barriers, then I think nobody's going to do the work to move the factories outside. If, if the settlement happens where there's significant barrier on both sides, then all that will continue.
That's helpful. And along those same lines, do you think there will be some sort of fiscal stimulus in addition to the if there's a trade agreement, but a fiscal stimulus coming out of the Chinese government?
I thought it already was There's some small ones that
have been done, but we don't have any inside knowledge of it.
Post New Year? Post Chinese New Year?
I think there was one small one done, but I would think, yeah, if there is a settlement on trade post Chinese New Year, Whenever Chinese economy has been weak, that's what they have done, stimulus for various things, that's largely predictable. And I don't know. I don't have a line to the premiere, but I think that's probably what would happen.
We'll take our next question from Janet Gramkerson with Quadra Capital.
Yeah. I was still there as a shareholder, Steve. Very happy. Just a question about the China again, Have you could you comment on business with ZTE in the quarter? Did you see a recovery there?
And, do you have any exposure specifically to Huawei?
So ZTE, had no restrictions in the quarter, and our business was normal. I think we said in the prior quarter, there was some demand destruction where during the time ZTE couldn't build a product. They lost some designs and competitor picked it up and in certain cases, we got designed with a competitor also. In certain cases, we did not, but GT business is kind of normal. The Huawei business is normal.
There is a lot of talk about U. S. Indictments and the CFO has been detained in in Canada. There has been no impact of any of that on the Huawei business yet.
Thanks very much. Appreciate it.
You're welcome.
Our next question will come from Craig Ellis with B. Riley F
Thanks for taking the question. Steve, I wanted to go back to the issue of integration with Microsemi, but approach it more qualitatively than quantitatively understanding that you're not changing any targets at this point. So as we look at calendar 2019, can you just touch on what the key integration milestones are, objectives are, top 2 or 3, for sales items in channel management. And then the follow-up, I'll just hit it right now because it's similar. If we looked lower on the income statement at manufacturing and operating expenses, what would be some of the key issues you'd want to tackle this year in those areas as well?
Well, we're moving forward on a very, very wide beachfront. So pick 1 when we bought Microsemi, Microsemi compiled their results on 21 different ERP systems. Business unit by business unit and then they're compiled, it's sort of like a conglomerate. We, the companies we have bought have brought them all into our enterprise system and ran a single enterprise system for years years. With Microsemi, we have said, We're going to go down to 2 systems.
You know, I would love to go down to 1, but the work was just too much. So, we were 22, 1 of us in 21 of Microsemi from 22 will go down to 2. And we're making progress. We took one business in into our system on November 1, We took 3 on February 1. We have another 3 or so plan for May 1.
And then there'll be a cadence of these, go live every quarter. In another 12 to 18 months, we've reconsolidate. So that's a huge project with lots of synergy and accretion coming from that. The business units in terms of the marketing and design and pipelines and integration with our technologies and factories and all that is largely some done, some ongoing. Most of microsemi parts are not going to come into our factories, like PMC Sierra parts, they run-in foundries and FPGA parts and onion foundries, and they're not going to come in inside, but certain products of other business units may come in.
And that's an ongoing process. As far as sales is concerned, so sales all work for a common sales leader. So that's already done. The biggest job in sales is cross training and cross pollinating. So a microchip salesperson feel very confident selling Microsemi products and in a total system solution gets all those designed in and vice versa.
Microsemi person feels very confident with Microchip, with $4,000,000,000 company on one side, $2,000,000,000 company on the other side, and that takes some time. And that's progressing And how we kind of make it work is really a, is a team where you call on the expert from the Microchip side or the Microsemi side, to make the joint call. So you start to get, total system solution effect. And that we're already getting Now the reviews we see from various businesses, in the microsemi reviews, we see microchip parts designed in in the future boards and on the microchip reviews, we see the microsemi parts designed in. So that is starting to happen.
But a lot more needs to happen.
That's helpful. And on that last point, Steve, is that something that will bear fruit from a revenue standpoint this year? Or does that just put you in a position where you've got the design win and then you work through what can often be a 12 to 18 month gestation period before that design would go to revenue?
It's the latter. The designs take about 9 months to 2 years to go to production depending on how complex it is. You could have a very simple, some discrete parts sets or something are designed in, that could be faster. But there are complicated parts, which could be longer. So it really, yes.
There's a gestation period after you get the design in. You should see some, revenue coming out of TSS in 2020. And then it accelerates from there.
That concludes today's question and answer session. I'd like to turn the conference back to Mr. Steve Sanghi for any additional or closing remarks.
Well, we want to thank everyone for joining this call today. And, we'll be seeing some of you between now and the next conference call on the road, there are various conferences we'll be going to. So thank you.
This concludes today's call. Thank you for your participation. You may now disconnect.