Good day, everyone. Welcome to this Microchip Technologies Second Quarter And Fiscal Year 2019 Financial Results Conference. As a reminder, today's conference is being recorded. At this time, for opening remarks and introductions, I'd like to turn things over Mr. Eric Bajorn Holt.
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 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 Sangey, Microchip's Chairman and CEO and Ganesh Moorthy, Microchip's President and COO. I will comment on our second quarter fiscal year 2019 financial performance and Steve and 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 to respond to specific investor and analyst questions. I want to remind you that we are including information in our press release and 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 GAAP and non GAAP results. I wanna remind investors that during the quarter ended June 30, 2018, we adopted a new GAAP revenue recognition standard, which 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 distributors to an end customer. We are not able to provide guidance on a GAAP basis as we are not able to predict whether inventory at our distributors will increase or decrease in relation to end market demand and this is not how we manage net inventory at our distributors increase or decrease by a significant amount in a single quarter. Our non GAAP revenue was based on end market demand in which we measure the revenue base on when the product is sold by our distributors to an end customer.
We will continue to manage our business in the end market demand. Therefore, along with the GAAP results based on sell in, we will also report our non GAAP results based on sell through revenue recognition. I will now go through some of the using revenue based on end market demand and expenses prior to the effects of our acquisition activities and share based compensation Non GAAP net sales in the September quarter were $1,513,000,000, just above the midpoint of our guidance and up 24.4 percent sequentially from net sales of $1,210,000,000 in the immediately preceding quarter. We have posted a summary of our revenue by product line and geography on our website for your reference. On a non GAAP basis, gross margins were 61.7%, operating expenses were 23.4 percent of sales and operating income was a record $579,300,000 and 38.3 percent of sales.
Non GAAP net income was a record $454,600,000, Non GAAP earnings per diluted share was On a GAAP basis, net sales significant reduction in the Microsemi distribution channel during the quarter, resulting in Microsemi distributor months of inventory being down to 2.6 months. We believe that the current levels that distributors are holding the amount of inventory needed to support end market demand and that the inventory levels are in GAAP gross margins were 48.1 percent and include the impact of $3,900,000 of share based compensation, $184,400,000 or inventory levels. Total operating expenses were $586,600,000 and include acquisition intangible amortization of 100 $69,900,000, special charges of $18,200,000, $6,600,000 of acquisition related and other costs and share based compensation of $37,500,000. The GAAP net income was $96,300,000 or $0.38 per diluted share, and includes one time tax benefits of $115,600,000 related to a variety of matters, including tax reserve releases due to audit settlements and statute of limitations expiring, tax reform and transition tax refinement, and intercompany restructuring of intellectual property. The non GAAP cash tax rate was 3.5% in the September quarter, and we expect a similar rate for all of fiscal 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 tax associated with restructuring 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 credits and interest deductions that will keep our cash tax payments low. The transition tax for the combined Microchip Microsemi group is expected to be about $3.64 transition tax payments on the Investor Relations page of our website. For GAAP purposes, we had a significant tax benefit in the quarter for the variety of reasons I discussed earlier. Moving on to the balance sheet, our inventory balance at September 30, 2018 was $836,700,000, including $120,100,000 of inventory markup from Microsemi required for GAAP purchase accounting.
Excluding the inventory markup, we had 117 days of inventory at the end of the September quarter, which was down 2 days from the prior quarter levels. Inventory at our distributors in the September quarter were 37 days compared to 40 days at the end of June. As indicated earlier, we believe that our distributors are holding an appropriate level of inventory to The cash flow from operating activities was a record $487,600,000 in the September quarter As of September 30, the consolidated cash and total investment position was $464,200,000. We paid down the September quarter and the net debt on the balance sheet reduced by 315,500,000. At September 30, Our debt outstanding includes $3,100,000,000 of borrowings under our line of credit, $2,733,000,000 of term loan B, $2,000,000,000 in high grade bonds and $4,481,000,000 excluding our very long dated convertible debt that matures in 2037 and is more equity like in nature was 4.9 at September 30, 2018.
Our leverage is higher than we originally projected primarily due to lower EBITDA from the Microsemi business, driven by needing to correct in the quarter. As indicated earlier, we believe the distribution inventory correction for Microsemi is essentially complete. We are committed to using substantially all of our excess cash generation beyond our dividend payment to reduce our debt levels and we expect our debt levels to reduce significantly over the next several years. Our net leverage metrics are based on 12 month trailing EBITDA which will continue to provide some headwinds due to the significant distribution inventory reductions, which caused our shipment activity to be significantly less than end market demand for the past two quarters, well as our guidance for the December 2018 quarter. Capital expenditures were $72,000,000 in the September 2018 quarter, We expect about $50,000,000 in capital spending in the December quarter and overall capital expenditures for fiscal year 2019 to be about 2.30 and technologies and to bring in house more of the assembly and test operations that are currently outsourced.
Will bring some gross margin improvement depreciation expense in the September quarter was $47,200,000. I will now turn it over to Ganesh to give his comments on the performance of the business in the September quarter and provide an update on
Ganesh?
Thank you, Eric, and good afternoon, everyone. As I review our product line performance, please bear in mind that the September quarter has a full quarter of contribution from Microsemi, while the June quarter only had a month of contribution from Microsemi. This, along with the fact that Microsemi revenue only maps into 4 of the 6 product line reporting categories we have, will in some cases distort the quarter over quarter comparisons of revenue by product line. Taking a closer look at microcontrollers, our microcontroller business was sequentially up 12.6% as compared to the June quarter. This benefited from a full quarter of Microsemi contribution in September, as compared to a partial quarter for June.
Our September quarter microcontroller revenue annualizes at almost 3 $300,000,000 putting us within striking distance in the next few years of the 2 industry players who were ahead of us in 2017 microcontroller rankings. Our microcontroller portfolio continues to expand with several new product introductions, Our roadmaps remain strong and our design in funnel is robust. We see all these as positive indicators for future growth. We believe we Now moving to analog, our analog business was sequentially up 33.6% as compared to the June quarter. This too benefited from a full quarter of Microsemi contribution in September as compared to a partial quarter for June.
Our September quarter analog revenue annualizes at over $1,750,000,000, firmly in the top 10 of analog semiconductor players. With Microchip 2.0 and our total system solutions approach, we expect to continue to grow and gain further analog market share. Next up is our FPGA business, which came to Microchip through the Microsemi acquisition, Our FPGA revenue hit an all time record, even after going back through the Microsemi and Actel history. Our low power mid range Polar Fire family continues to garner strong market acceptance. With revenue more than doubling sequentially as compared to the end market consumption in the full June quarter.
Despite being a new product category for Microchip, We're optimistic about the prospects for the FPGA product line based on the highly defensible markets and applications they're designed into. As well as the intense These requirements are very similar to Microchip's microcontroller business requirements, and therefore, we expect the FPGA product line will very nicely leverage our capabilities. Moving next to our licensing business. This business was sequentially up 40.3% as compared to the June quarter, we achieved an all time record for our royalty revenue. Additionally, our results also benefited from the sale of a patent license for a specific set of patents that can be used in a non competitive fields of play.
We did anticipate this patent license to close in the September quarter and included it in our guidance. We continue to retain indefinite rights for these patents for the fields of play that are of interest to us. Even without the Patent Licens sale, the September quarter licensing business revenue was sequentially up from June. Let me share some background as to our thinking in regards to patent licensing. We have inherited a substantial patent portfolio from the companies we acquired over the last 10 years.
Several quarters ago, based on licensing requests we were receiving, our licensing business unit embarked on a strategy to monetize certain patents which have value to players non competitive fields of play. In all cases, we retain rights to use these patents in our products as well. The first results from this monetizing effort is what we saw in the September quarter results. There is a second such patent license sale for a specific set of patents which is in that the revenue contribution in the future from Our memory business was sequentially down 3.8% in the September quarter as compared to the June quarter. And finally, our MMO, which stands for multi market and other business, was up 90.7% sequentially, as we had a full quarter of Microsemi contribution in the September quarter as compared to just a month in the June quarter.
On a combined company basis, which has a full quarter of Microchip and Microsemi, our second quarter fiscal 2019, non GAAP end market demand revenue of $1,510,000,000 was split across the 6 product lines we report as follows. Microcontrollers were 54.2 percent, analog was 29%, FPGA was 6%, memory was 3.1% licensing was 2.5% and MMO is 5.2%. We expect this will be the approximate forward going revenue percentages by product line and that quarter to quarter changes from here onwards will be relatively small. Now an update on the Microsemi integration progress. The business unit integration continues to progress well.
We are restructuring underperforming businesses, while implementing the strengths and best practices from both companies to drive improvements across the board. The key Microsemi business unit leaders we retained continue to run their businesses and are adapting to the Microchip culture and business expectations. New product development and design win momentum are continuing to happen as planned. The sales integration is also progressing well. We have converted the Microsemi sales team to a Microchip style non commissioned sales approach.
Teams from classic Microchip and Microsemi are working collaboratively as one team to drive new opportunities and pursue product cross selling opportunities. Our internal reference designs are increasingly taking advantage of our combined Total System Solutions approach. A comprehensive analysis of our new channels and channel partners from the Microsemi acquisition was completed and we're making the adjustments required for an effective combined company approach. The operations integration work is an enormously complex undertaking as little to no integration of prior Microsemi acquisitions had taken place. Because of the size of The 1st phase for 1 of the business units went live on November 1st successfully.
Further phases have been planned with a quarterly cadence of go live events for many quarters. We expect the overall operational integration will take about 2 more years to complete. From a factory standpoint, the initial plans for insourcing, some of what Microsemi was outsourcing have been completed, and prioritize actions to execute these plans have commenced. In the G and A functions, we eliminated some more of the support organizational redundancies and more will happen after we get further along with our business system and operational integration plans. Let 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 second quarter of 2019. I will then provide update on our progress at Micro semi, I will then provide guidance for the fiscal third quarter of 2019. Our September quarter financial results were good. Our consolidated non GAAP net sales came in just above the midpoint of our guidance that we issued on August 9, 2018.
Our consolidated non GAAP gross margin was strong at 61.7% of sales Microchip classic non GAAP operating margin was an all time record. Consolidated non GAAP operating profit including Microsemi was 38.3 percent of sales and near the high end of our guidance. Our consolidated non GAAP EPS was an all time record at $1.81 and near the high end of our guidance. There was a strong EPS contribution from both classic Microchip and Microsemi. The accretion from Microsemi exceeded our original guidance of $0.15 for the September quarter.
This was based on non GAAP and is representative of real market demand. On non GAAP basis, this was also our 112th, consecutive profitable quarter. Now let me provide you some update on the progress we have made with the Microsemi integration. First, distribution inventory. We had told you last quarter that we will complete a distribution inventory reduction in two quarters.
September December. I am pleased to report that with a lot of work by the combined teams of Microchip and Microsemi, and in cooperation with the distributors, we almost completed the inventory reduction in 1 quarter. The distribution inventory at the end of September was 2.62 months, down from about 4 months prior to the closing of the acquisition. This level of inventory, we believe is the level distributors need to support in market demand and is in line with the level maintained by distributors for Microchip Classic business. This was accomplished without any negative impact on distribution sales out.
The non GAAP net sales from microsemi based on direct shipments and distribution sales out was an all time record. 2nd is termination of deals. Since closing the Microsemi acquisition on May 29, 2018, we terminated deals discounts and subsidies that were used prior to the acquisition in connection with sales into distribution and contract manufacturers. For example, we canceled the Arrow supply assurance program concerning sales into the channel of end of life product. At acquisition close, there was approximately $47,000,000 of inventory in distribution under this Arrow supply assurance program.
We won't take any inventory back, but we will not ship any more into distribution under that program. We also canceled the interest subsidy that was offered to some distributors to compensate them based on the inventory they held. We also under which there was a discount offered to contract manufacturers to take additional inventory. Cancellation of this program has had no negative impact on contract manufacturer's willingness to purchase the product they need. Finally, there were a number of OEM customers that were transferred to distribution and then the inventory shipped into distribution.
This resulted in lower margin for Microsemi. As of today, we have transferred many of those customers that account for about $110,000,000 of annualized So overall, we are pleased that we were able to reduce the microsemi distribution inventory very rapidly. There was one business unit called the high reliability Discrete Products business unit, where the inventory at the end of June was very high at 8.6 At the end of September, we had brought it down to 6.7 months. We are continuing to reduce the inventory for this business unit further. The shipments are now quite linear in the 4 quarters prior to being acquired by Microchip About 57% of Microsemi's quarterly sell in revenue was shipped in the last month of the quarter.
In the September 2018 quarter, only 31% of sell in revenue for Microsemi products were shipped in the 3rd month. Now next is Microsemi internal inventory. It is obvious that as we reduce the distribution inventory, the inventory that Microsemi would grow substantially unless we took corrective actions in the factories and subcontractors by cutting production targets. And that is what we did. Fortunately, a very large amount of microsemi business was done from wafer foundries and assembly and test subcontractors.
We aggressively cut wafer starts at the foundries and loadings at assembly test subcontractors. Microsemi had several small fabs and assembly locations owned by Microsemi We cut loadings in these factories quite substantially. Some of them as much as 50%. We let go temporary workers in many of these facilities and implemented temporary plant shutdowns to control inventory. Microsemi did not produce a high percentage of their products inside.
So the gross margin impact was fairly small. We maintained over 61% overall gross margin for Microsemi We believe that the under loadings of the factories got somewhat counterbalanced by the discontinuance of all the discounts. But as I have said before, there is also going to be a bit noisy for a couple of quarters. At the end of September, the overall inventory internal inventory at Microchip, including Microsemi, was 117 days, down 2 days from 119 days in the end of June quarter. So we did a great job in controlling internal inventories.
Now this may or this may seem all too easy after the fact, but there was a tremendous focus and amount of work that went into reducing the distribution inventory and at the same time ensuring that our internal inventory does not balloon up. We have multiple joint teams from Microchip and Microsemi, some focused on distribution inventory reduction others focused on controlling internal factory production and others managing reduction of foundry wafer starts and assembly and test loadings. So while addressing the inventory has provided some headwind on the distribution sell in driven GAAP revenue, including sales to contract manufacturers, the non GAAP revenue for distribution, which is based on sell through has not been affected. I am pleased that Microsemi Business achieved record non GAAP net sales based on end market demand. The second issue we highlighted last quarter was extravagance.
In this area, we have been moving aggressively to implement Microchip's frugal Penn's culture. We have shut down the executive floor at the Microsemi Headquarters building, canceled the private jet account, terminated or sold many of the sports Skyboxes, canceled golf and auto racing sponsorships and substantially pruned many memberships. As we reduced inventory and spending, Microsemi business has continued to do well. This was a narrative from the beginning that Microsemi has very good engineering teams and has very good products. The customer sockets are sticky and there are 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 and the likes of Microchip. Here, we are starting with excellent products, excellent gross margins, and excellent engineering teams. With the distributor and contract manufacturing inventory reduced and with Microchip's operating expense approach. We are optimistic about achieving our long term targets for accretion from Microsemi. So far, we are ahead of our original targets.
I also want to provide you one more figure. In the September quarter, we paid $501,000,000 of our debt. This was accomplished by squeezing all the cash We could not have done it without the new tax law. Despite the large, debt pay down in the September quarter, The debt leverage has not moved, though, primarily because the EBITDA has dropped, driven by lower GAAP revenue of Microsemi and also some softness in the Microchip Classic business. I also want to provide you update on our classic Microchip business.
All of the issues that I highlighted last quarter that was built into our guidance essentially came true. I had described 4 concerns. First, long lead times for some of the passive components, this issue did affect some sales as we expected. Since the customers could not complete the whole kit. Number 2, tariffs.
While we were one of the first to highlight the risk of tariffs and trade war, this issue caught investor and analyst attention during the quarter for the whole industry. We saw significant impact on our business during the quarter due to customer concerns about tariffs, and we saw significant weakening of our bookings. We believe that tariff and related customer concerns will continue to be an issue. Number 3, ZTE, We saw some impact for not being fully able to ship to ZTE for both Microchip and Microsemi despite the release from the Justice Department, there has been some demand destruction at ZTE. And number 4, Bitcoins, Bitcoin business has essentially evaporated.
It was about 1% of our business supplying microcontrollers and power management products for the power supplies as well as Ethernet controllers. Now I will provide you guidance for the December quarter. The guidance we provided for the September quarter, 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 the December quarter we see weak market conditions for automotive and industrial, our 2 largest markets. Automotive business is negatively impacted by emission test bottlenecks in Europe as well as weakness in China, the industrial business is negatively impacted by tariffs On the other hand, communication, data center And Aerospace And Defense Businesses are seeing strength.
With all this commentary, we expect our total non GAAP net sales to be down 5 to 10% sequentially. We expect our non GAAP gross margin to be between 61% 61.5% of sales. We expect non GAAP operating expense to be between 24.9 percent 25.4 percent of sales. And we expect a non GAAP operating profit percentage to be between 35.6 percent 36.6 percent of sales. And we expect non GAAP earnings per share to Given all the complications of accounting for the acquisitions including amortization of intangibles, restructuring charges, inventory write up on acquisitions and changes in distribution inventory, Microchip will continue to provide guidance and track its results on non GAAP basis, we believe that non GAAP results provide more meaningful comparison to prior quarters.
And we request that the analysts continue to report the non GAAP estimates to first call. With this, operator, will you please poll for questions?
Certainly. Strength. We'll hear first today from Christopher Rolland with Susquehanna.
Hey guys, great quarter in light of some of the headwinds that we're having here. And a great update on Microsemi as well. I'll elaborate a little bit more on some of the end markets there. You had a little bit more detail than others did perhaps on know, maybe talk about industrial as well? And then, and then some bright points, maybe within data center coms, maybe that's your optical business that you might be pointing to.
Any more details there would be great.
Well, if you look at the auto business, we highlighted 2 areas. 1 is there was a new emission standard implemented in Europe effective September 1. There was a 1 year notice on it almost from September 1 the prior year. However, testing agencies couldn't build up the capacity. To test all the car production.
So there was a significant bottleneck of cars waiting to be tested. Which brought the European car production down. And the whole China economy has been weak. Due to various reasons, some incentives were taken away. The concerns about tariffs in Chinese production all sorts of other reasons, China automotive market has been weak.
In the industrial area, The concerns are mainly tariffs. So, both driven by Chinese and the products coming to U. S, which have a 10% duty today, going to 25% in January. So a lot of people concerned about whether they will be competitive or not in selling products in U. S.
And, and because of weak Chinese economy, industrial really weak in China too. The three markets which are doing stronger are data center communication, and defense and aerospace. If I take them in the reverse order, defense and aerospace, I think after years of drawing down defense spending, the defense in aerospace spending has been on the way up. And we are very broadly designed in into essentially every single weaponry system, every single aircraft, helicopters and others. So that part of the business is doing well.
The data center business, I think, you we have seen some other companies with higher exposure to data center, data center, cloud, hyperscalers and all that. That part of the business has been stronger. So that business did well last quarter and is stronger relative to the automotive and industrial and other businesses. And third is the communication. I think we also see the communication business doing well.
And you guys have talked about this potential weakness that we're seeing from most guys out there in the market a little bit earlier. Some, however, haven't guided for much weakness at all. Do you think that perhaps they're going to see it a little bit later and you might be working through this process a little bit earlier? And then are there any signs of stabilization in late October or early November?
Well, we're not going to talk about what other companies have said or what may happen to other industry players, I think you should ask them. Regarding Microchip, we first saw some impact in June quarter. And what we were seeing in June based on that, we had a fairly conservative guidance for the September quarter. And most people didn't talk about it till the results for the September quarter. So we were 4 months earlier before we saw it.
And that's not that's not first time. Numerous times in the past, we have seen the impact of industry events about 3, 4 months ahead of the others see it. And, we feed early and we always end early. If we talk about the industry 4 months earlier, nobody tends to believe it because nobody else is talking about it and you're not seeing it. And therefore, we start cupping about the industry.
We just talked about some factors that were affecting our business. So it turned out we were correct again, and everybody else saw it later. And now on the other side, we always come out earlier, but whenever we tell you that, that won't get believed either because others are not seeing it yet. So we're not really ready to talk about the other end of the cycle yet.
Great. Thanks so much, Steve. Appreciate that.
Welcome.
We'll hear next from Harsh Kumar with Piper Jaffray.
For the MSCC update, congrats on preserving UPS in a tough market. Maybe one for Eric. Eric, I think you had cited a goal of 0.7 turns of de levering I believe for this fiscal year. Can you maybe talk about if that gets impacted at all, with this environment? And currently based on what you're seeing?
And also, maybe one for Steve and I want to ask a follow-up after this. Microchip was usually up in March. I think mostly MSCC was just all over the place. Maybe could you help us think about how we can think about modeling March just from your initial read on what you've seen in the business?
Sure. So I'll take the deleveraging one first and then pass it back to Steve. But we made really good progress in terms of paying down debt as both Steve and I mentioned in our prepared remarks. We took down $500,000,000 of total debt and on a net basis, $315,500,000. So did a really good job there of using all the cash that we could to pay down debt.
We will continue to use substantially all of our excess cash generations after dividends to reduce our debt levels and we expect our net leverage to line dramatically over the next several years. Now with the correction of the Microsemi distribution inventory having a significant impact on our EBITDA, in the June September 2018 quarters. And then combining that with our guidance for the December 2018 quarter, Our trailing 12 month EBITDA will have significant headwinds over the next year, and our net debt to EBITDA will not trend down as fast as we had indicated back. In August. But this is a very good cash flow business.
Like I said, we'll continue to pay down debt, but in the current quarter, we probably expect that debt pay down to be somewhere in the $160,000,000 range. It's a broad range. It'd be $150,000,000 to $200,000,000, but we'll have to see how things here over the next few quarters to give you a longer term forecast.
Got it.
So I'll pick up the second question you had, which was regarding the March quarter. So I remind investors that, when we bought Atmel, it was not a small acquisition either, Atmel was about 40% to half of our business. After we integrated Atmel, we didn't understand Atmel's seasonality for a while. Because companies on their own, their prior seasonality was based on sell in. However, they worked with the distributors.
The whole end market mix was different. And after we had Atmel for entire year or more than a year, we fully understood the impact of atmel seasonality on our business to be able to guide properly. Same is the situation now with Microsemi. We don't fully understand Microsemi seasonality. We haven't had a March quarter where the Microsemi in it.
And we do not consider the March quarter on a Microsemi's clock to be a meaningful indicator for us regarding seasonality because that business was managed with a sell in driven mentality with a significantly high distribution inventory Our guidance will be based on real market demand. So, and the end markets for Microsemi are quite different. Stronger in defense, stronger in data centers, stronger in communication and, almost no automotive, very little automotive and all that. So I'm not ready to talk about the March quarter in terms of guidance, until we have some more experience on our belt. In understanding their seasonality as well as being able to gauge the impact of the current correction when it is ending and how its impact would be in the March quarter.
We'll hear now from Craig Ellis with B. Riley.
I'll start with a clarification. With respect to the strong performance on the Microsemi inventory cleanup in the quarter, Did that have a particular impact on any of the product segment revenues that you reported or was the impact spread about equally among MCUs analog and other businesses.
So it really did not have an impact on the sales out activity that Ganesh talked about, breaking out by product lines. So it was really just more of correcting the inventory sitting in distribution. So I don't think there was really any end market impact from the actions that we took.
We basically, we haven't broken out the sell in data by product line. We only have broken out the sell out data by product line, and that did not change based on lowering the sell in cleaning up the inventory.
Yes. So I mean, we have the sell in data in our public filings in our 10 Q. But that doesn't really give you an indication of where the distribution inventory drain was by product line.
Got it. And then the follow-up, there were a couple of references to accretion. And I just wanted to clarify What was the exact amount of Microsemi earnings accretion in the quarter? And Steve, are you retaining all the prior synergies and accretion targets, the $300,000,000 in synergies as well as the $0.75 plus in year 1 in the the $8 to, I believe, fiscal 2020 earnings?
Yes. We're not breaking out the exact numbers of Microsemi accretion, which we're kind of managing it as one company, but we gave you an anecdote that the accretion in the September quarter was higher than the $0.15 for the September quarter we had originally guided. And we feel very confident that going out of the 1st year, the accretion will be higher than the $0.75 that we guided. And we remain committed to a longer term accretion of or earnings per share of $8 that we guided before. There is a short term impact based on this business cycle environment whatever 1, 2, 3 quarters at last, it doesn't really have a long term impact over the 3, 4 years.
Because usually the bounce back gets you back to where you were.
From SunTrust, we'll hear from William Stein.
Great. Thanks for taking my questions. First really more of a housekeeping 1, the share count was a little lower than expected in the quarter and in the outlook Is that just owing to share price and the treasury method accounting for, for average shares in the quarter or is there something else going on there?
No, that's exactly what it is. We post a schedule on our Investor Relations page under supplemental information that walks through what the share count approximately would be based on various prices. As you know, we have several convertible debt instruments outstanding and the share dilution from those has gone down with the stock price falling.
That helps you. And the other is, to address the GAAP to non GAAP revenue adjustment I think it was $81,000,000 in the quarter. You noted that the channel inventory for Microsemi now approximates the sort of heritage microchip business channel inventory. So it sounds like maybe there's a little bit more work to do, but it's mostly done. And so while I understand that, Disty inventory is going to fluctuate somewhat quarter to quarter after this $81,000,000 delta that we saw in the quarter you just posted going forward, should we expect this number to sort of fluctuate around 0 or average around 0 over time?
Is it the right way to think about it?
Well, I'll take a stab at answering that and then Steve or Ganesh can chime in. So, you know, we're really pleased with the progress that we made in getting the microsemi just the inventory down to 2.62 months, which is right in line with where Microchip has been historically. We really are not able to project what distributors are going to do. Some of that is going to be based on environment. It's going to be based on working capital needs.
It's going to be based lead times. There's so many things that factor into it. We have 120 or so distributors that we work with worldwide. We don't manage our business in a way where we get that type of visibility from them and really are driving for end market demand forecast versus sell in. One surprise me in an environment like this, distributors are going to be very tight with their working capital.
But again, for us be able to provide any sort of forecast of what it's going to do is quite difficult and we don't feel we have capability to do that. Steve, do you want to add anything?
Well, what I would add is, we do not put any effort into managing our business. To put the inventory into distribution. We put our entire effort into creating market demand, which pulls the inventory out of the distribution and then allow the asset managers at the distribution to buy the product they need to serve the end market demand. So as the quarter is approaching, the quarter end is approaching, we don't look at sales out is this and the sell in is this. And we've got to go make another $10,000,000 a deal.
So sell in is lower than the sell out. Or to hold back product because it's going to go upward or lower. We don't manage both those numbers. We only manage one number, which is sales out. And like I told you last quarter, the standard has changed.
GAAP standard is sell in. I told you that before. We disagree with it, but we have to report a gap, sell in number, which we do, and we'll continue to do it. But all our measurements, all our bonus programs, what board manages us is to a market demand driven number that we report as a non GAAP revenue. And sell in would be whatever distributors want based on their own asset management, their cash flow needs, lead times, 100 of things go into what they do with that inventory.
And we don't manage that.
Understood and appreciated. Thank you.
Thank you.
We'll hear now from Craig Hettenbach with Morgan Stanley.
Yes, thank you. Steve, understanding you don't want to talk about the March quarter and seasonality yet, just for the core business, your commentary about cautious into December. What type of signals are you looking for in terms of distribution or customers in terms of how far along we are for the correction here? Well,
we interact with a large number of customers and distributors over the course of this quarter. And based on that collective engagement with 100, if not thousands of customers, in all three geographies, U. S, Europe, Asia, we will have an assessment by the time we announced the December quarter results, which will be in early February. If there is a meaningful information that develops for that, and gives us enough data points that we can kind of make a call, then we'll use the opportunity at one of the conferences to make comments on it. But fresh coming from the elections yesterday with 1% of the precincts reporting, we cannot make the call on the election.
Understood. And appreciate the color on the end markets where you're seeing strength and weakness any thoughts on consumer appliances? Because that's the market that we've seen some potential slowing in China as well. Do you have any thoughts there?
So that part of the business, appliance, consumer part of the business is weak also. I kind of put it in industrial. People who make air conditioners and appliances and that kind of industrial kind of business. You may call it consumer. But yes, that is weak also.
From Stifel, we'll hear from Kevin Cassidy.
Thanks for taking my question. With reference to China, have you seen any change in behavior on new designs where maybe because of the tariff and the trade war, if there's preference for non U. S. Microcontrollers as an example rather than microchip.
We haven't really seen a lot of impact in reality. There is a lot of talk about it. But it's not changing the funnel size in any way, partially because very large portion of Microchip business is proprietary. And such functionality with such low power or such features or performance for that price really is not available. In any local kind of Chinese parks, which are really fairly low end.
So I don't think we have seen any meaningful difference in the funnel size or design activity, there's a lot of talk about it.
Yes. And maybe I didn't Dan the question directly, but the tariff impact on our products directly is very, very small, right. It's the products that our customers are building with our products where the tariff applies. So I think it's probably too early for us to see any real impact on the design side, Kevin?
If they were to use a Chinese microcontroller or analog part, to build an end product, appliance or washer or dryer or whatever, that will have duty also coming in here. So not designing a microchip product does not evade the duty coming into U. S. And that is a bigger impact.
Right. It's just more whether there's an anti U. S. View in the design point of view. So even if it's say an SD micro something from Europe rather than a U.
S. Space. So that's what I was trying to get
at. I think your question is the right one. And we hear that, but like I said, fortunately, we're not easy to design out.
Okay, great. Thank you.
We'll hear next from John Pitzer with Credit Suisse.
Yes, guys. Thanks for letting me ask the questions. Congratulations on the good results. So Steve, relative to the industrial weakness you're calling out tariffs, I know this is probably possible question to answer, but I'm going to ask your opinion anyhow. To what extent do you think customers are reacting to the 10% tariff that's already been levied?
And to what extent do you think that they're actually trying to be anticipatory to the raise to 25% come the beginning of the year. And I'm just trying to get a sense as to whether or not you think there's another shoe to drop or not? And then my second question, you did a great job kind of talking about the distribution inventory at Microsemi. I'm kind of curious about direct customer inventory. What did you see as the quarter unfolded?
Was there any meaningful adjustments you needed to make there? Are those behind you? And to the extent they might be behind you, could there be a potential tailwind, which I think you referred to on the last conference call once this inventory depletion was done?
So let me take the first one first, which is a tariff question. So what's happening is, as the percentage tariff and the products which are have tariffs on keeps moving. It is kind of creating waves in customer sentiment originally back in June, July timeframe, when there were some tariffs ready to go on in August, some people will try to get ahead of it, build the product, So they bring it to U. S. And avoid that tariff.
Others will hold back production. They want to draw down their inventory because they don't really know whether they'll be able to pass the tariff to the customers, or they would like to eat that entire tariff. So it kind of creates a waste both ways. And that was for the 10% tariff. And through the quarter of September, customers were essentially, cutting down production, drawing down their inventory because they felt that there will be uncompetitive passing on the tariff to U.
S. Customers who had a choice to buy the product made in Taiwan, made in Singapore, made in Vietnam, made in Mexico or wherever. And now very recently, we're hearing the talk that the expectation many of the customers had was heading towards the elections, the whole thing was going to get settled. You may recall at the UN Trump was talking so bad about Canada that Canada wasn't cooperating and all that. And there may be an agreement with Mexico only 1 week later, they signed an agreement and announced the agreement with Canada.
So the thought was similarly a few days before the election, there may be a settlement with China. And so kind of people were holding back. Well, that didn't happen. And now the feeling is, I don't think the settlement is close. So now some of the customers are thinking tariffs are going to go to 25% And we should pull in and build some of the stuff and bring it to U.
S. At 10% tariff rather than bringing to 25%. So you could see that the waves moving all over the place. And 50,000 customers we might have in China are not all aligned. It's very noisy.
It's very hard to make decisions. And we are lead times are short and we're responding to every customer. And the website as we see it. So I don't know if that answers your first question.
No, that's helpful. And then just on the direct customer inventory situation at Microsemi?
So on the direct customer, the The inventory we saw on the direct customer side was with contract manufacturers because contract manufacturers It's considered OEM business. It's a direct business. It's not through distribution. There was really not much inventory in the direct to direct customers that we saw. And we wouldn't know it either.
I mean, you don't know every customer's inventory, but the where the deals were made, where the discounts were given were to the contract manufacturers under a program called It was called the program, production incentive program. So we canceled that program. As we cancel that program, contract manufacturers only started taking what they need for their needs and they do down their inventory.
Perfect. Thank
time. We'll hear next from Chris Danely with Citi.
Hey, thanks guys. Steve, I know you're not going to comment on March seasonality. If hypothetically speaking, if Marsh revenue was down, would you be able to keep OpEx flat to down?
Well, we, we definitely, will have the March OpEx down, not even flat to down will be down, because we're still continuing to, reduce microsemi expenses as we do integration. And if March quarter is down, as you're supposing, no, bonuses would be lower. So bonus accrual will be lower. So I would say in that situation, March expensive will not be flat, they will be down.
Okay, great. And then for my next question, any sort of comparisons on this correction versus previous corrections? Are you seeing anything in common or is this completely new?
Well, I think that's more of your department than mine, but you know
I'm just as clueless as you
guys are.
2015, you know, we saw this impact, I believe, in August, September time frame. And, we made a call, I believe, in late September timeframe that we see, China slowing down. It was driven by China and nobody else was seeing it. And by And then when the numbers came out, numbers were cut and they were cut again and everybody was down as much and most trucks went down lower than they had gone down that day when we had the call. So everybody was about 4 months behind.
Same thing is happening this time. I think we saw the impact 3 to 4 months behind everybody else. So that is common. But what's driving it today versus what was driving it back then I think the reasons are a little bit different. Tariffs, maybe lead time to come in shorter.
Some are same. Some are different. Tariffs is a new phenomena.
Got it. Okay. Thanks guys.
We'll hear now from Vivek Arya of Bank of America Merrill Lynch.
Thanks for taking my question. Steve, for the first one, can you give us some more real time sense on production plans? Are you still looking to reduce them? Further versus seasonality or do you think they have kind of stabilized on these levels?
Well, so if you look at Chris Daneley's question, you have to make an assumption on March. We cut back production quite a bit with that, the internal inventory is in good control. We are internal inventory went down by a couple of days. So if the business is stable from here, if this quarter marks the bottom, then factories start building back slowly. If there is a further downside, which was an assumption Chris was making, I don't know if it was making that assumption, then you have to adjust to that reality.
I see. And then on the OpEx side, if my math is right, so you had $354,000,000 non GAAP OpEx in September I think December, you are guiding to $352,000,000. So kind of a flattish. Why are we not seeing more cost synergies and or does it just mean we'll see them later on?
Well, we took a lot of costs out early. I think if you were to combine the Microchip and Microsemi models from back in March or even a year ago, you're going to see that significant expenses has been taken out and that doesn't mean that there's still not more to come. But, I think we're actively managing that. You know, our OpEx came in significantly lower than our guidance for the quarter that we just completed. And we're managing based on the environment that's presented to us.
And I think we're doing a good job of that.
Got it. And just one quick housekeeping. I think Eric you said tax rate under 5%. I believe in the past it was between 3 to 4. So just for modeling, a purpose should be more like 3.5 or 4.5 for the next 1 or 2 years?
Thank you.
Well, when we gave a 3% to 4% before, that was kind of the short term. And we've got now questions coming in in terms of what's it going to be over few years. And it's not a perfect science to forecast this, but under 5% or 5% or less is where we're at. Today. It's not saying it can't be 3.5, but that's a pretty tight, pretty tight range.
I think you're modeling 100 plus subsidiaries around the world and varying tax rates in various countries and interest payments and deductions. All these taxes and it's kind of average of all that. It's not a perfect sense. It can change based on mix.
Got it.
Thank you.
Moving on to Mark Delaney with Goldman Sachs.
Yes, good afternoon. Thanks for taking the questions. The first question is hoping you could help us better understand some of the trade offs that you've made with Microsemi's business, now that you've had it under your wing for a longer period of time. It sounds like there's been several efforts taken to improve gross margins and I think that business had run-in the low 60s, on a stand alone basis, with all the changes that some of the product pruning and if anything is along those lines, do you think it gets to above that $63,000,000 range that you're guiding for on a combined basis or just towards the higher end once utilization rates normalize. And related to that, maybe you can help us think about, has there been any share shifts or the size of, product pruning that you may have done given some of these changes that you're making to the business model?
I think, Mark, one mistake most people make in looking at microsemi's gross margin is that they did a acquisition of a company called Vectron, which closed in late November, early December time frame, it had gross margins in the mid-30s and was a $100,000,000 revenue. And so its impact was really never seen by investors in a non GAAP basis. December quarter was fairly short just 1 month. And then, March quarter, we announced a deal on March 1. So March quarter was really never fully announced based on a non GAAP.
Call. But you
don't have a conference call. So you wouldn't really know the non GAAP margin, taking away all these charges and everything else that acquisitions do. So microsemi gross margin wasn't 63%, driven by all those acquisitions, margin was below 60%. And we have already improved some and will continue to improve the gross margin. But looking for that gross margin to go over 63 would be, would be quite a stretch right now.
Yes. So we, as you said, have margin improvement programs that are in place and we still have confidence in the combined long term model of 63 sense. And this last quarter, we were at 61.7. So it's not like we're light years away from that. But
And we
got to get the factories to full production again. Because of the inventory correction as you ship less to distribution, all that inventory stays in house unless you production. So we did. And we, we take the under absorption in the current quarter. We don't put it into don't capitalize it into the inventory.
So as the production starts going back, you will have some accretive effect on gross margin.
That's helpful. And then for the second part of that question, obviously, there's a different focus on the types of businesses, micro we'll be participating with there. But, you just help us think about the scope of revenue that you may not participate in anymore either because you're focusing on narrow set of product lines, any share shifts that we should be contemplating, things along those lines so we can think about the right revenue run rate for that business once we adjust for some of these inventory dynamics that have gone on the last couple of quarters?
So we said that before, we are going to keep and we like all the businesses. The combined microsemi oil business is together, P and L is very good. There are product lines which are lower gross margin. There are product lines which are higher gross margin than average. Their product lines that grow less than average.
Their product lines are growing more than average. Microchip Classic is no different. Our gross margins are lower in certain microchip businesses, but mix and match overall gross margin is excellent. And that is the case with microsemi every business is accretive and we're not going to offload a business just because it's lower gross margin than the average. If it's accretive and growing and adding and providing additional attach, is a part of the total system solution.
If all the other things are working, then it's a good Microchip product.
And every business unit leader that we have is tested and not just growing the revenue but improving gross margin and operating margins over time. And with in the Microchip system, we work together to make that happen.
Thank you.
We'll move next to Kristin Cyaka with Nomura.
Good evening. Thanks for taking my question and congrats on the great execution of Microsemi. I just want to up on the, the OpEx question from before, it looks like the OpEx from this quarter came in a little bit lower than expected. And are wondering if that was just due to better than expected execution on synergies or was there something else going on in the quarter there that we should be thinking about?
There was nothing else going on, although we would say that Since we saw the effect of this downturn coming much earlier than anybody else, we hunkered down earlier. We canceled majority of the open recs. We cut back on capital. We canceled some orders that we had on capital to the extent we were able to cancel them. And as we slip them out, we, we hunkered down and we kind of bedding down the hatches.
Ask our employees to treat the spending as if it's their own money and do that on a global basis and it has very, very good results. I think Steve's right. We just got out ahead of this quicker.
Okay, great. That's helpful. And then just moving to the inventory correction from Microsemi and how you completed that about a quarter earlier, then you stated on the prior call for the most for the most part. What exactly caused, that faster, that correction to happen happen faster than expected. Was there something in particular that, Microchip did or was it just better end demand or what was kind of driving that for us.
Let me take that. So I think especially when you buy new business, you have a lot to learn for that business. You're getting to know the people that are concerned with employees regarding what Microchip could do with various businesses. Let me get this in various analysts, right, about various businesses that we will sell. We should sell And I always ask you, please don't do that because you create problem for us.
The employees of that business read those reports and they get concerned that their is maybe sold, not get focused on. And we have said that we're going to keep all the businesses, but every time you look at some analysts will make this speculation, why data center doesn't business doesn't fit with microchip or opto businesses isn't fit with microchip or something else is in fit with Microchip. All that does is creates concern for our customers and creates concern for our employees. So what I'm seeing is, we're working very hard on all these items, the lending the businesses, keeping the customers at PE is talking to the employees, learning the inventory. And when such a larger challenge comes up like the inventory, then it just takes an enormous amount of energy forming the teams and focusing the teams to go clean up the inventory.
It also depends on how in mix that inventory was. If that inventory was highly out of mix, then you have to continue to ship additional product for which there is demand. And if there is lot of slow moving inventory that we call sludge, then that will take much longer time. And in certain business units, the inventory was in good mix in certain other business units. Inventory was not as good of MX.
So basically huge amount of work, combined teams, working together, creating a goal for everybody to clean up this inventory faster than the two quarters we guided to. And I think that's that's where we are and also working and getting cooperation from the distributors.
Excellent. Thank you. A lot
of grant work. There's not much magic there. It's just a lot of hard work.
Yes. And as Steve mentioned in his prepared remarks, there's still business unit or 2 that's inventory higher than we'd like it to be and it'll come down over time. And there may be a business unit or 2 that's inventory is too low and these things kind of balance each other out. We think at 2.6 months, we're in a very good position today.
And in this business unit number 1, the inventory was very high over 8.6 months. Clearly there was a lot of excess inventory. And, when you build that much inventory, then inventory also tends to age and gets out of mix, where it was shipped such a high amount of inventory and customer demand shifts. So a lot of the inventories then becomes very slow moving and takes time to correct.
But I guess I'll give kudos to all the business units that were involved, the sales and distribution organization, our distributors, the planning folks that's just it was a very large team and everybody did a good job of executing.
There was also $110,000,000 of product that we shifted back from distribution to direct and customer by customer and distributor by distributor, whichever the payer was a distributor shipping to customer, you had to go work that relationship and convince a customer and commence a distributor, distributors are going to lose that business to direct customer. We'll ship it directly, make sure distributor cleans out their inventory the new business and microchip shifts, and creating accounts for those customers, receivables, learning where the product has to be shipped, some places. Sometimes it goes into hubs of distributors. Sometimes there are multiple locations. All that challenging task by the shipping teams and marketing teams and sales teams it's just purely a guess when we first talked to you regarding how long would it take?
I'd rather tell you two quarters and get it done in 1 quarter, then tell you 1 quarter and takes 2 quarters.
From Raymond James, we'll go to Chris Caso.
Yes, thank you. Thanks for taking the question. Just a question with regard to customer inventory levels. And I'd say this probably more pertains to the microchip class business, how much of the slowdown that you're seeing now do you attribute to some of the demand function issues that you talked about as opposed to just customers holding too much inventory. And typically when we've seen these slowdowns in the past, it's of the 2, do you think about it any differently this time around?
Well, when customer buys less product, you are unable to differentiate whether that is just purely an inventory correction or, his demand is slower. It always tends to be a combination. If you're building 100,000 widgets a week, then you have certain amount of inventory at your loading dock in your factory floor, some raw material, some in work in process, your certain amount of inventory. If your demand drops because of your tariff concerns, let's say you only want to build a 90,000 widgets, then the entire inventory in your structure divided by 90 is going to become more weeks of inventory than at 100. And then when you draw it down, You could call it inventory correction, you can call it because of lower demand.
I don't know how you separate it.
Right. Understood. As a follow-up, if you could talk about the linearity of your order rate as you proceeded through the quarter and into October. And I assume that the order rates have slowed down since we last spoke in August. But, have they sort of stepped down to a certain level and then stabilize that level given the uncertainty about tariffs and such you spoke about or, did they continue to worsen on a month on month basis?
The, the order rates slowed down and stayed pretty constant at the low level. And have recently, bounced back, partially because, you know, lead times are fairly short. So the guy who placed the orders for December January, they don't need to place orders for next June, but they do need to place the order for the next quarter. So the order rate, as you said, slowed down, but has recently bounced back up.
In the month of October?
In the month of October, yes.
We'll hear next from Vijay Rakesh with Mizuho.
Hi, guys. Just wondering on your deleverage have you changed, are you accelerating that? What's, how are you looking at that?
So, I tried to answer that in an earlier question. But essentially our deleveraging going to be at a slower pace than what we had originally guided to the Street. We've got headwinds very low EBITDA in both June September due to distribution inventory reduction. We were we're having a down quarter this year at the midpoint of We're going to be down 7.5%. And that just has an impact and is going to stay with us now for 12 months because debt calculations or EBITDA calculations are all 12 month trailing.
So we the cash flow from the business is going to be high. But if you look at our accounts receivable balance, it's down $120,000,000 quarter on quarter and that translates to cash. So It's going to take us some time, but all of our cash, really all the significant cash in excess of what we need to run the business and pay dividends is going to be used to pay down debt. And with that, we will reduce the debt balance, but the EBITDA is going to be something that sticks with us for the next year.
Got it. And just a follow-up here. Getting past some of the near term tariff issues, the lack of visibility into the March quarter and first half, let's say, Any thoughts, one of the pending concerns on microcontrollers has been, especially as you look at automotive, where does content go? And just wondering, just wanted to get your thoughts on how you look at that? Thanks.
Denise, you want to take that?
Ganesh had the run. It gets a flight.
So I think we are not concerned about the long term prospects of microcontroller, analog, or any of our businesses. Our fundamental premise of being able to sell total system solution into a customer socket whether it's automotive, whether it's industrial, with microcontroller, analog, connectivity products, Wi Fi, ethernet, Bluetooth LoRa. And now with lots of microsemi products, including discrete products, fets and diodes and RF and other products. I think, I think there is fundamentally no concern about long term microchip and the design win funnel and all that are very, very healthy. I think we're just talking about this impact, some from the tariffs and some from the slowdown in the business, you could go back, there was an earlier question, how it is different or same as the 2015 cycle.
I mean, at 2015 cycle, some of the assumptions were like, this thing is over. The industry just goes away and all these things don't get designed in. And you can see how the business bounced back and we had record quarters and record years and outstanding market share gains and everything else. So there's no long term concern here. It's a short term.
Got it. Thanks.
We'll hear next from Harlan Sur with JP Morgan.
Good afternoon. Thanks for taking my question. Maybe just touching on some of the pockets of strength in the business. In Aerospace And Defense, it's obviously very sticky, very high profitability segment. It sounds like near term it's kind of doing well.
In order for you guys to sort of take advantage of this very profitable area, how much effort is required to get your MCU and analog products No Arrow RadHard qualified. Is there a lot of work to be done here or is the core microchip team already engaged in cross selling?
So there is a, there's a lot of work underway There was a small Aerospace And Defense business that we have acquired as part of the Atmel acquisition which was headquartered in France. And they did business largely with French Aerospace Companies and didn't have any market share in U. S. And after acquiring them in the last year and a half or so, we've been putting efforts, we expanded their charter to take microchip standard microcontroller analog and memory products and make them rad hard, recharacterize them to the needs of military and aerospace with broad temperature engines and all that. So all that work has been underway for the last 2 years or so in, militarizing our products.
Microsemi brings even just a much, much higher level of expertise in that area and about 10x to 15x larger business than Atmel had in Aerospace And Defense. So in our integration, we have combined the Atmelge Aerospace And Defense business together with the MicroSpace Aerospace And Defense business as 1 business unit. And that business unit is accelerating taking Microchip products to market in that segment. So that effort is about a year old and, and is really getting significant boosts right now. But we're not, we're not shipping core Microchip products and military for revenue today.
Any Microchip products going into Aerospace And Defense Sector are still standard commercial products that are bought from distributors and just kind of use standard commercial product in some non sensitive applications, aerospace and defense is allowed to use standard commercial products. The military products, radhard products is an effort underway, but it's not making revenue today.
Got it. Thanks for the insights there. And then in the FPGA segment, you guys drove record revenues. Obviously, the Microsemi team built a strong no aero leadership franchise there. And I think Ganesh talked about some of the new opportunities with the mid range, Polar your family, which is more for kind of like multi market applications, but it sounds like overall the business is doing well.
Can you guys just give us a sense on how strongly the FPGA business is going on a year over year basis?
So I don't have a year over year comparison. Somewhat it won't be valid because it will be a sell in by putting a high channel inventory versus a sell through that we are measuring. So that's why we said based on sell through basis, the numbers were a record, it was all time record. And I don't have a year over year comparison since we haven't had the business for a year. The business is doing very well.
It's doing very well in defense and aerospace. It's doing very well in the multi market. It has a very good design in funnel. The next generation architecture, which is Gen5, is just going into market and just introducing at the sample level. And there's a significant demand pull on that.
So I think we're very optimistic about that business.
We'll go next to Jefferies, Mark Lipacis.
Hi, thanks for taking my question. Just one Steve, a number of the contract manufacturers with the global footprint have talked about some of their customers already shifting manufacturing out side of China and accelerated quote activity with our customers to do as much. I was wondering if you were noticing that any evidence anecdose on that front and to the extent that you think that might be causing some near term disruption? That's all I had. Thank you.
You're very correct. We're seeing that too. So two things are happening. 1, if there are 2 sources of production one in China and one outside of China, then some attempt is being made to take the Chinese production and sell it to Europe and Asia and take the non Chinese production and ship it to U. S.
This way you can optimize and not pay any duties. Two challenges in that. Number 1, it's a lot of men will work and most people aren't set up to really differentiate the product where it should go, but manually and then writing some automation it's really being done. But it's not perfect because in many cases, the U. S.
Demand is not exactly and Europe and Asia demand isn't equal to Chinese production. So there are still problems. So to solve that problem, You are correct that many customers are moving Chinese production to outside of China, but they are rapidly running into capacity issues. Where the outside factories are full, there was a little bit space and they are now full, there is lot more to be transferred from China, but there's no place to put it till they really expand capacity, build more square footage and all that, and that's a slow process. So yes, we're seeing that.
Very helpful. Thank you.
And at this time, I'd like to turn things back to Steve Sanghy for any closing remarks.
Well, we want to thank all of our customers and analysts for your patience and for your understanding. I think This has been tough for 4 months here. But I think, I think we have done a lot of good work in cleaning up the Microsemi inventory. And at the same time, it's really the first acquisition, who's timing was such that the wind is not on our back. We did number of other acquisitions and the timing was great.
Here, along with the Microsemi inventory challenges, we're also facing this downturn in the business. And so we're dealing with the dual challenges, but I think we posted pretty good quarter. And despite sequentially down guidance, I think we're managing the inventory very well. The internal inventory is in very good shape. Overall gross margin, operating margins are still very, very good.
And we look forward to really getting through these issues and getting back to our long term $8 earnings target. So thank you very much.
And that does conclude today's conference. Again, thank you all for joining us.