Good day everyone. Welcome to this Microchip Technology first quarter and fiscal year 2019 financial results conference call. As a reminder, today's call is being recorded. At this time, I'd like to turn the call over to Microchip's Chief Financial Officer, Mr. Eric Bjornholt. Please go ahead, sir.
Thank you. Good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press releases of today, as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. In attendance with me today are Steve Sanghi, Microchip's Chairman and CEO, and Ganesh Moorthy, Microchip's President and COO. I will comment on our first quarter fiscal year 2019 financial performance. Steve and Ganesh will 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.
We will 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 want to remind investors that during the quarter ending June 30th, 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, as this is not how we manage our business. As evidence of this uncertainty in recent years, we have seen net inventory at our distributors increase or decrease by a significant amount in a single quarter. Our non-GAAP revenue is based on true end market demand, in which we measure the revenue based on when the product is sold by our distributors to an end customer. 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 the amount of revenue earned from fulfilling end market demand.
Along with 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 operating results, including net sales, gross margin, and operating expenses. I will be referring to these results on a non-GAAP basis 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 June quarter were $1.217 billion, above the midpoint of our guidance and up 21.4% sequentially from net sales of $1.002 billion 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 a record 62.2%, operating expenses were 23.3% of sales, and operating income was a record $473.5 million and 38.9% of sales.
Non-GAAP net income was a record $405.8 million. Non-GAAP earnings per share was a record $1.61, which was $0.13 above the midpoint of our guidance of $1.48. On a GAAP basis, net sales in the June quarter were $1.213 billion. GAAP gross margins were 52.9% and include the impact of $3.6 million of share-based compensation, $107.7 million of acquisition restructuring and acquired inventory valuation costs, and $3.4 million impact from changes in distributor inventory levels. Total operating expenses were $509.7 million and include acquisition intangible amortization of $133.7 million, special charges of $40.1 million, which includes $15.9 million of share-based compensation, $26.9 million of acquisition-related and other costs, and share-based compensation of $25.8 million. The GAAP net income was $35.7 million, or $0.14 per diluted share. The non-GAAP cash tax rate was 3.5% in the June quarter.
We expect our non-GAAP tax rate for fiscal 2019 and the next several years to be between 3% and 4%, exclusive of the transition tax and any potential tax associated with restructuring the Microsemi operations into the Microchip global structure. We have many tax attributes and net operating losses, tax 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 $364 million, was recorded last fiscal year, and will be paid over eight years. The first transition tax payment was made in July 2018 in the amount of $35 million. We expect payments of about $28 million in fiscal years 2020 through 2023, $54 million in fiscal year 2024, $72 million in fiscal 2025, and $91 million in fiscal year 2026.
Microchip's GAAP tax rate in the June quarter was 5.2% and was impacted by the various GAAP purchase accounting adjustments from the Microsemi acquisition and prior acquisitions as well as one-time discrete benefits related to changes in U.S. and foreign tax laws. Moving on to the balance sheet. Our inventory balance at June 30th, 2018 was $1.105 billion, including $359.7 million of inventory markup from Microsemi required for GAAP purchase accounting. Excluding the inventory markup, we had 119 days of inventory at the end of the June quarter. Our targeted inventory levels are between 115 and 120 days. Inventory at our distributors in the June quarter were at 40 days compared to 36 days at the end of March. The historical Microchip distributor inventory was actually down by about a day in the June quarter, but the consolidated increase is driven by the high inventory in the Microsemi distribution channel.
We expect the Microsemi distribution inventory to reduce through the end of calendar year 2018. The cash flow from operating activities was $302.4 million in the June quarter. As of June 30th, the consolidated cash and total investment position was $649.7 million. At June 30th, our debt outstanding includes $3.3 billion of borrowings under our line of credit, $3 billion of Term Loan B, $2 billion of high-grade bonds, and $4.5 billion of convertible debt. Our net debt to EBITDA, excluding our very long-dated convertible debt that matures in 2037 and is more equity-like in nature, was 5.0 at June 30th, 2018. Our leverage is higher than we originally projected, primarily due to lower EBITDA from the Microsemi business, driven by needing to correct distribution inventory levels through lower shipment activity.
We are fully committed to using 100% of our excess cash generation beyond our dividend payments to reduce our debt levels. We expect our net leverage to decline dramatically over the next several years. Capital expenditures were $89.4 million in the June 2018 quarter. We expect about $70 million in capital spending in the September quarter, and overall capital expenditures for fiscal year 2019 to be about $220 million-$250 million. We continue to add capital to support the growth of our production capabilities for our fast-growing 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 significant gross margin improvements to our business, particularly for the Atmel and Microsemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the June quarter was $38 million.
I will now turn it over to Ganesh to give his comments on the performance of the business in the June quarter and provide an update on some of the Microsemi integration activities. Ganesh?
Thank you, Eric. Good afternoon, everyone. Before we get started with the product line discussion, I thought it may be helpful to summarize what we said at our May 31st conference call in regards to our revenue reporting. Classic Microchip, which is Microchip excluding Microsemi, used to report five product lines; microcontrollers, analog, memory, licensing, and finally, multimarket and other, which we used to call MMO. In fiscal year 2018, our revenue of $3.98 billion was split across the five product lines as follows: microcontrollers at 65.8%, analog at 23.9%, memory at 5%, licensing at 2.6%, and MMO at 2.6%. With the addition of Microsemi, we will add a sixth product line category called FPGA. Microsemi's revenue reporting will be split across four of the six product line categories in microcontrollers, analog, FPGA, and MMO.
Microsemi has no memory or licensing product lines. Hence, the contribution to these categories will be zero. Directionally, on a combined basis, we expect our analog revenue percentage to tick up while our microcontroller revenue percentage will tick down. That is exactly what the final results for FQ1 have shown, with a partial quarter of Microsemi results included in our overall results. Let's get to the product line performance. On a combined company basis, we performed a little better than we expected in the June quarter, with sequential revenue growth of 21.4% as compared to the March quarter. Microchip, excluding Microsemi, achieved a new record for revenue. The Microchip 2.0 transformation continues to make good progress, especially in terms of new design opportunities as we enable our clients' innovation with the very best smart, connected, and secure solutions.
Taking a closer look at microcontrollers, our microcontroller business, excluding Microsemi, set a new record in the June quarter. Microcontroller revenue, excluding Microsemi, also outgrew classic Microchip overall. Both 8-bit microcontrollers and 32-bit microcontrollers for classic Microchip set new records. On a combined basis, including Microsemi, our microcontroller business was sequentially up 10.8% as compared to the March quarter. Our microcontroller portfolio and roadmap has never been stronger. We are seeing continued growth in our design-in funnel, which we expect will drive future growth as these designs progress into production over time. We believe we have the new product momentum and customer engagement to continue to gain even more share in 2018 as we further build the best performing microcontroller franchise in the industry. Moving to our analog business. Our analog revenue, excluding Microsemi, set a new record in the June quarter.
Analog revenue, excluding Microsemi, also outgrew classic Microchip overall. On a combined basis, our analog business was sequentially up 35% as compared to the March quarter. Moving next to our licensing business. This business was sequentially up 0.2% as compared to the March quarter. Up 5.8% as compared to the year ago quarter. Our memory business was sequentially down 1.8% in the June quarter as compared to the March quarter. Finally, our MMO business, for Microchip excluding Microsemi, was down sequentially. However, it was up 63% sequentially when including Microsemi. On a combined company basis, which has a full quarter of Microchip and a partial quarter of Microsemi, our FQ1 2019 revenue of $1.2 billion was split across the six product lines we report as follows: microcontrollers at 59.9%, analog at 27%, FPGA at 3.4%, memory at 4%, licensing at 2.2%, and MMO at 3.5%.
We expect the tick down in microcontroller revenue percentage and tick up in analog revenue percentage will be further accentuated when we announce our FQ2 results in November, as we will have a full quarter of Microsemi revenue included in the results. An update on the Microsemi integration and our progress since our May 31st conference call. We made dramatic changes to the top-level leadership structure in the first few weeks after the close. Essentially, all of the top leadership are no longer with Microchip. The reasons for this will be more evident after Steve provides you some color in his section. As we have done in other large acquisitions, we have used our leadership depth and strong pipeline to insert Microchip executive leaders in the top positions to run the Microsemi enterprise. The business unit restructuring is progressing well.
We have retained several of the key Microsemi business unit leaders to continue to run their businesses while selectively combining some of the smaller businesses, where Microchip had similar product lines into the Microchip business unit structure. This eliminates duplicate infrastructure and creates synergy in the process. We have also restructured some of the less profitable businesses and adjusted their going forward investment levels to be consistent with what is affordable, and we have some more to go. The sales integration has commenced. We have converted the sales team to a Microchip style non-commission sales team and ended all incentives to discount product for quarter end revenue maximization. Teams from classic Microchip and Microsemi have started to identify and pursue product cross-selling opportunities, and have also identified reference designs that can take advantage of our combined total solutions approach.
Several of the sales office space consolidations have already taken place and many more are in the works. The normal analysis of effectiveness of channels, as well as of each channel partner, is underway. One decision we have already made, which was announced last week, is the refranchising of Avnet for Microsemi products, thus adding more channel bandwidth to sell Microsemi's products. The operations integration work has started but is an enormously complex undertaking, as little to no integration of prior Microsemi acquisitions had taken place. For example, Microsemi has 21 ERP installations that we need to converge in our business system and operational integration plans. We expect to have the plan worked out by the end of this month and start working towards specific business system and operational integration goals at that time.
Given the complexity we are seeing, we expect the operational integration will be a two to three-year project. We're also performing a detailed analysis of what outsourced operations can be insourced, as well as evaluating the efficiency and cost effectiveness of Microsemi's internal factories. Lastly, the normal task of working with the supplier base to find the best cost from either company and applying it to the other is happening as we speak. In the G&A areas, we have eliminated some of the support organizational cost redundancies. 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 first quarter of 2019. I will then provide commentary on our first two months at Microsemi. I will then provide guidance for the fiscal second quarter of 2019. Our June quarter financial results were good. Our consolidated net sales came in above the midpoint of our revised guidance that we issued on May 31, 2018, after the closing of the Microsemi transaction. In discussion with our board of directors, the board wants us to manage as a combined business from day one, not break out the individual components of Microchip and Microsemi, and proceed to integrate the businesses together at a rapid pace. The board does not want to engage in the old controversy of organic versus inorganic growth and wants to measure us on the overall results achieved.
What we are driving towards is to produce an increasing non-GAAP earnings per share from the combined company. This worked well when we acquired Atmel, and it should work well here. Therefore, we will not provide a breakdown of the two businesses other than some useful nuggets of information along the way. I will refer to Microchip business without Microsemi as classic Microchip. When we include Microsemi, we will call it consolidated. Our classic Microchip's non-GAAP revenue, non-GAAP gross margin, and non-GAAP operating margins were all new records last quarter. Our overall consolidated non-GAAP revenue, non-GAAP gross margin, and non-GAAP EPS were also new records. Non-GAAP EPS exceeded the high end of our guidance, and non-GAAP earnings per share was $1.61, $0.13 better than the midpoint of our guidance.
$0.05 of this EPS beat came from higher operating profits, and the balance $0.08 of the EPS beat came from a much lower tax rate. Our tax rate guidance was intentionally conservative in the wake of new tax laws and significant uncertainty of the tax rate of the combined company after acquisition of Microsemi. We consider the tax planning for the combined company to be a part of our planned synergy and had intentionally modeled for it in our synergies plannings. On non-GAAP basis, this was also our 111th consecutive profitable quarter. Our inventories at classic Microchip at the end of June 2018 were 119 days, which is right at our target of 115-120 days. The total inventory, including Microsemi, is cluttered by purchase accounting adjustments, where inventory is written up to market value and hence the total inventory indicator is not meaningful.
We have made enormous progress on the manufacturing side by bringing capacity online and decreasing lead times. Our lead times are now near normal, with the majority of our products having lead times of between 4-8 weeks. Scattered issues with certain products continue to cause longer lead times on those products. Let us shift gears. I will give you our observation from our first two months at Microsemi. This has been the time when we are able to get access to all the company's information that we were not able to get before. This is the time when we discover some of the weaknesses as we have found in other acquisitions like Atmel and Micrel. This is typically the low point in the acquisition. Things usually rapidly improve from here as we go to work to fix things and integrate.
In the case of Microsemi, we found that Microsemi management was extremely aggressive in shipping inventory into the distribution channel. Microsemi's distributors had about 4 months of inventory, whereas Microchip's distributors carry about two and a half months of inventory. While we have seen some excess shipments of inventory into the distribution channel in other acquisitions, we have never seen as much excess as we found in the case of Microsemi. Microsemi also over-shipped into the contract manufacturers by making deals and offering discounts. This excessive distribution in contract manufacturer's inventory will provide some headwind for revenue for the next couple of quarters. Our trailing EBITDA and the next two quarters of cash generation will also be impacted by needing to correct this inventory for Microsemi products.
While excessive shipments into distribution and contract manufacturers has been the main issue at Microsemi, we also found a culture of excessive extravagance and high spending. The company had millions of dollars of sponsorships in several luxury suites in sports stadiums, luxury private plane travel, and generous sponsorships for many conferences, stadiums, and other venues that are wastage of shareholders' money. We are undoing commitments to all such spending. What are we doing to clean up excess inventory and other spending? We did not make any deals with the distribution contract manufacturers or end customers in the month of June to ship excess inventory. As a result, we shipped close to $100 million less in the month of June than Microsemi ex management would have shipped. That was nearly half the inventory correction accomplished in a single month.
We expect to achieve the balance of the distribution inventory correction in the next two quarters and nearly complete the correction by the end of this calendar year. Based on high inventory and distribution as well as inside Microsemi, we have substantially cut back on the manufacturing build plan in internal factories as well as foundries and assembly test subcontractors. The vast majority of Microsemi business is subcontracted, we will see a dollar-for-dollar cash saving, which will offset some of the negative cash impact of inventory correction. While this may seem disappointing, we have seen such challenges before as the problems of the acquired company become more visible post-close. We remain optimistic about the medium and longer-term prospects from the Microsemi acquisition and are not changing our longer-term thesis. We have high confidence in the $300 million of synergies that we previously communicated. Microsemi has very good engineering teams.
We are still very bullish on the Microsemi products, the stickiness of the customer sockets, and the end market opportunities for the combined company. Our strategy for the better part of this decade has been to buy underperforming assets and turn them into world-class performers in the likes of Microchip. Here, we are starting with excellent products and excellent gross margins, we will correct the aggressive distribution in contract manufacturing shipments and high expense culture as we have done before, for example, at Atmel. Let us go into the non-GAAP guidance for the September quarter. In addition to the headwinds I described on Microsemi, there are several small factors that are starting to impact the business. Standalone, none of them will be material, all of them together are causing us to provide a cautious guidance for fiscal second quarter of 2019. I would describe four reasons.
Number one, the lead times in the market for some of the passive components continue to be long. We are seeing pushouts by several customers because they cannot complete the whole kit and hence do not need our devices. Number two, all the talk about tariffs and trade war is making our customers nervous. While it is hard to put your finger on it is hurting business confidence, which makes people pull back on investments, expansion, and capital spending. A very small portion of products are made in China, even a smaller portion are imported back in U.S. We are not worried about duties on our products imported into U.S., we are concerned about our customers' products imported into U.S. This is based on original July 6 tariff implementation. We are still analyzing the impact of expected August 23 tariff implementation.
Here was a quote from one of our sources, one of our customers. "U.S. imposed 25% tariffs on some Chinese goods on July 6. U.S. issued a list of thousands of Chinese goods for the new tariffs. It makes manufacturers conservative in building product due to uncertainty of market demand." unquote. Third point, we are seeing the impact of not being fully able to ship to ZTE. While the Justice Department is now allowing shipments to ZTE is still organizing and figuring out what their real demand is now, and if they can assemble the entire bill of materials with long lead times on passive components. Despite the release from the Justice Department, there has been some demand destruction at ZTE. Number four, Microchip is a supplier to Bitcoin mining industry by supplying microcontrollers and power management products for the power supplies as well as Ethernet controllers.
Bitcoin values have crashed. It has lowered the demand for new shipments to the Bitcoin industry quite substantially. With all this commentary, we expect total non-GAAP net revenue in the September quarter to be between $1.474 billion-$1.55 billion. Our best estimate for overall non-GAAP gross margin is between 61.3% and 61.9% of sales, a range wider than normal as we integrate and understand Microsemi, as well as deal with the excess inventory in the channel and resultant reduction in the internal factory builds. We expect non-GAAP operating expenses to be between 23.6% and 24.2% of sales.
We expect non-GAAP operating profit to be between 37.1% and 38.2% of sales, and we expect a non-GAAP earnings per share to be between $1.65 and $1.83 per share. This includes more than the $0.15 of attrition from Microsemi that we had originally guided to. You can see that despite a significant headwind on Microsemi's revenue and cautious guidance, our non-GAAP EPS guidance at the midpoint is well above prior consensus analyst estimates. This reflects our rapid pruning of some underperforming product lines, raising some prices on mature products, and significant restructuring already at Microsemi. Our guidance also represents some excellent tax planning, resulting in a lower effective cash tax rate. Our synergy assumptions included this tax planning for the combined company.
We do expect our financial results to be a bit noisy for a couple of quarters as we correct distribution and subcontractor inventories and as we adjust the internal manufacturing based on inventory correction. Our synergy assumptions for FY 2019 and our long-term synergy assumption of $300 million and our FY 2021 non-GAAP EPS target of $8 per share have not changed. The target for non-GAAP EPS of $8 per share in FY 2021 may in fact seem conservative in light of the progress we have made in integration and a much lower effective cash tax rate. We expect to exceed the $0.75 accretion guidance that we had provided as the annualized run rate accretion for the first year after close.
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. 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. If you'd like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Due to time constraints, we ask that you limit yourself to one question per person. Again, that's star one to ask a question. We'll take our first question from Harsh Kumar with Piper Jaffray. Go ahead, sir.
Yeah. Hey, thanks, Steve. Seems like you guys are going through the normal things when you acquire a company. Steve, I had a quick question for you and a follow-up. You mentioned a lot of things that are coming into play, Bitcoin, some other stuff, trade wars. I'm curious, does your guidance on the top line take into account, obviously, the Microsemi inventory clearing, but is there also a slowdown in your organic business, or is it mostly all Microsemi that's being played out in your revenue guide?
We're not breaking it out, but it's a combination. The Bitcoin exposure was on the Microchip side. ZTE exposure were mostly on the Microsemi side. If there is any kind of demand slowdown because of tariffs, if the customers would be nervous to draw down their inventories because they do not know what the tariffs would be to bring the product into U.S., then that would really affect both sides, Microchip as well as Microsemi. It's really a combination of it, but the fair amount of correction really is on the Microsemi side.
Got it, Steve. For my follow-up, your margins in the September guide are slightly lower than your margins and what you reported in the June. I am assuming that that is predominantly a function of you guys taking down the Microsemi inventory quite hard down in the channel. Then you said you cleared 50% in one month. Do you expect the rest to be cleared evenly, or you are going to come down pretty hard in September again and then sort of ease off with very little left in December?
Several questions. Let's take the margin first. Microsemi margins are lower than Microchip's classic margins. Many investors and analysts may have forgotten that Microsemi acquired a company called Vectron back in September, and that company only had little over 30% gross margin. That brought the gross margins low, but during all this time, they had been sort of in the acquisition. Microsemi never reported their March quarter, where their margins were impacted by Vectron, and prior quarter was some sort of ratio.
Just to clarify, that acquisition was in the November, December timeframe of 2017, not September.
Okay, stand corrected.
Yeah.
That makes my point actually better.
Yeah.
Since it was in the November, December timeframe, the first full quarter of the lower Vectron margin would represent itself in the March quarter, and March quarter was never reported by Microsemi in a way because they were already in acquisition. We are seeing lower gross margins of Microsemi. Last quarter was only one month, and this quarter we have the entire quarter. Therefore, it has a larger impact of the lower gross margins. This quarter, we will also see the impact of substantial reduction of the build rates in the internal factories of Microsemi. That was the answer on the gross margin side. The other part of your question was?
Distribution correction over
Distribution correction. Roughly the $100 million less that we shipped was a combination of shipments, lower shipments through distribution to contract manufacturers and also to direct customers, because they were essentially equal opportunity in making deals with everybody and shipping excess product into every channel. Out of the $100 million, a good portion, more than half of that, was a correction in distribution. We will see another distribution correction in the September quarter and the December quarter, and right now we're expecting that that will complete the majority of the correction. The largest piece got done last month, in the month of June, and then the September and December will be two roughly equal pieces. If anything is left after that, it's kind of a tail. A very, very small portion here and there, which will not be meaningful.
Understood. Thanks, Steve, and guys, best of luck.
Thank you.
Thank you, next we'll hear from John Pitzer with Credit Suisse.
Good afternoon, Steve. Thanks for letting me ask the question. Steve, I just want to go back to yours and the board's decision not to kind of break out Microsemi. I think that makes a lot of sense looking several quarters out, especially because you're so confident in the revenue synergies of this transaction that you included it in the initial synergy targets. As you kind of think about the June and September quarter, if you could just help me understand the rationale of not telling us what Microsemi was, and to the extent that you're not, can you help us get some comfort level about how the classic Microchip business is performing relative to peers?
In the absence of kind of not being able to do that math, I think it's pretty easy for some of us to perhaps wrongfully conclude that maybe the core Microchip business just isn't holding up as well as some of your peers in this environment.
Well, John, I'm not surprised to get that question from you. Really rightly, day one, we took our guy who runs the networking business, and he took over the Ethernet business, and all those products are combined, and we're getting a single forecast from that division. Similarly, is the case with our analog products, power management products, and others. I think if you go back to the Atmel scenario, if we had managed the business to look at Atmel's 8-bit MCUs and Microchip's 8-bit MCUs and Atmel's 32-bit MCUs and Microchip's and E2PROM products and automotive and others, we probably wouldn't have gotten as good results in Atmel as we were able to get because we went at it as it's really one business, ship the lowest cost product at the highest ASP, wherever you have the best specs and best product, and that's really what we're doing here.
We just don't want to spend, and board doesn't want to spend any of company's energy to do it any other way. I think Microchip business was fine, and Microsemi business was fine. One month can't tell the story because the business was very non-linear. Even though you're looking at overall, we achieved the numbers and slightly better than the guidance, both pieces were in the range, so this is really not a problem. Reporting it is just like a slippery slope then. Honestly, John, what you guys would like is really there are two clean spreadsheets, one and the other, and everything adds up, and two plus two is equal to 4.00000. The world is too complex on our side.
We got too many moving parts, and things are moving too fast, and this whole inventory correction got shoved on us from Microsemi that we were not aware of. There was so much inventory, and board doesn't want to put the energy on what doesn't add value in us really driving the business.
That's helpful, Steve. You kind of updated us or reiterated a lot of the accretion targets around Microsemi. I'm just kind of curious, given that there are some concerns about the leverage on the balance sheet relative to this deal. Can you just give us an update on how we should think about leverage going forward and how aggressively you're thinking about taking that leverage down? Thank you.
Certainly. Eric can point that out to the leverage. Yeah.
Okay. As I mentioned in my prepared remarks, our leverage on a net basis, excluding our very long-dated convertible, was 5.0 at the end of June. We had originally guided that we'd have about a turn reduction per year. Because of the distribution and inventory correction that we need to make, we think that in that first year, we're going to be somewhere in the 0.75 range in terms of reduction and then get back to the 1 turn per year. It's a little bit slower pace, and absolutely, we are focused on de-leveraging the balance sheet and using 100% of our excess cash generation beyond the dividend to pay down debt. It's a focus area of ours. We know that we have a lot of leverage at this point in time, we're committed to bring it down.
That reduction from 1 turn to 0.7 turns is largely because a shortage of the next two quarters. When you look at on the LTM basis a year from now, the September quarter and December quarter are going through substantial inventory correction. That is a shortage of the EBITDA.
Right.
After that, we get back to one turn.
Helpful, guys. Thanks for the details on this.
Welcome.
Our next question will come from William Stein with SunTrust.
Great. Thank you for taking my questions. I have two. First, I know in the past you've evaluated potential divestitures. I wonder, in this case, if you think that evaluation continues. Is it more or less likely than in the past? You highlight this lower margin Vectron business. Is there anything that you might want to divest? Then I have a follow-up, please.
Well, I think we always evaluate a lot of things when we buy a company. As you have seen in our prior acquisition, we have really divested very little. There was a tiny, small piece out of the Atmel. There was nothing out of Standard Microsystems, there was nothing out of Micrel, nothing out of Supertex. We look at divestiture more driven by it doesn't fit at all, rather than it isn't performing well or it's lower margin, because we fix margins, we fix pricing, increase pricing, we adjust the model mix of the products. We move the product into different set of customers, industrial or automotive and others, where the margins may be higher. We have done that in many, many acquisitions, and we'll do similar things here.
The acquired company focus or their reach may be in a certain set of customers, and we expand that and improve margin. So far we have not found anything we're going to divest, but it's only been a couple of months, and that's not where we are focused on divesting. We're focused on improving.
Thanks. As a follow-up, I just want to make sure I understand the discussion point around Microsemi having stuffed not only the distribution channel, but other sort of channels, including sounds like direct customers as well. When we marry that up with Microchip's approach to rev rec, which is sell-through, the reduction in inventory in the channel, that doesn't actually reduce your non-GAAP revenue. That maybe perhaps a shortfall in your outlook on the revenue side is more driven by the reductions in inventory, perhaps at contract manufacturing and other direct customers, not what's going to distribution. Is that the right way to think about it?
Well, good question. Very good question. That would be the case, if everything was pure. Everything was not pure. Ex-management had also taken, every quarter, they would take some direct customers and move them to distribution, by giving distribution some discount so they could make a margin on it. In doing so, they would take the next couple of quarters of product for that customer and stuff them into distribution. Therefore, you get to recognize higher sell-in revenue because to the end customer, you'll only ship 1x, to the distributor, you can give them 1.5x or 2x. They will do some of that every quarter. There was overall more than couple of $100 million of direct accounts had been moved to distribution over the last year or so.
You can't totally put your finger on it, but a lot of that seemed to coincide when it was sort of decided when the company would be sold. There is some timeline you can triangulate to, but it's not something I can really prove.
Thanks very much.
There is inventory sitting in distribution for the direct customers, and those direct customers, we are converting them back to direct customers, but they wouldn't be buying anything for a little while till the distribution has cleared out their inventory, shipping it to the direct customers.
Got it. Thank you.
Does that make sense to you?
Yeah. It does help clarify. Thank you.
Thank you. Next from Raymond James, we'll hear from Chris Caso.
Yes, hi. Thank you. Just as a follow-on to the other question, I guess, as we look forward, I guess from what I'm hearing you're saying is the quarterly revenue that we were seeing for Microsemi, at least for the past couple of quarters, was inflated, if we looked at it on a pure sell-through consumption basis. Is there any way you can give us any help with where the correct run rate should be? I guess suffice to say, it's lower than what we were seeing reported over the last few quarters.
You're correct. The revenue they reported. I want to be very clear that there was no fraud involved because the ASC 606 allows you to recognize revenue shipped to distribution at sell-in.
Did the prior revenue recognition standard of ASC 605.
Ordinarily, a management team in managing their business will ship it to distribution roughly what distribution ships out, and have the distribution inventory grow only by the amount distribution is shipping higher amount, in terms of business growing. That's not really what happened here. Hiding under the revenue recognition that sell-in is a revenue recognition, there were a large number of deals made with the distribution. When the inventory got higher and higher, they even offered interest subsidy to the distributor to carry inventory beyond a certain number of months, because distributor wouldn't want to carry this money tied up, and they will offer interest subsidy. Basically, shipping to distribution was made an art form almost. Yes, the revenue was higher than the real end market demand. At this point in time, we're not totally prepared to give you that number.
I think it's not extremely large. It's in a few % range, but we need to clear out this inventory over the next one or two quarters and ourself be comfortable with what the run rate is. As we clean out this inventory over the next couple of quarters, there will be a larger revenue increase as we head towards the full board shipment, because inventory correction is over. There'll be some accentuation out in time of the growth rate, and I think we'll provide you some guidance over time, but not today.
Okay, that's helpful. If my follow-up, I could pivot on to the Microchip organic business and understood what you said about those four issues which were impacting revenue as we go into the September quarter. Can you talk to the sustainability of those headwinds? Is this what you'd consider to be a short-term issue? Maybe you could speak to the health of, outside of these four issues that you talked about, the health of the remaining business, and then what you're seeing in terms of order rates, any change in the fundamentals of the business, I suppose.
Core Microchip business does not really have any fundamental problem. I think there isn't anything we're trying to correct there. I think our issues are on the Microsemi side. If you take those four points, the lead times on passives, you have heard from many other companies, the whole industry is kind of being impacted. We do not know why passive lead times are that long. It's not like businesses have grown 30%, 40% where passives can't be provided, but there must have been significant reduction in passive capacity of some kind. That's not long-lasting. I think as the industry corrects and passive lead times come down, that issue will go away.
The tariffs and trade war is beyond our scope of being able to control it or fathom it. We don't know any more than anybody else does, what the effect of that would be. The ZTE situation, Microchip had a fairly small business with ZTE. The overall business, Microsemi had larger business, but it's not huge. For the combined company, I can't give you exact number, but let's say it's the order of 1%. Standalone, that wouldn't be meaningful, that wouldn't be all that large. You don't highlight 1% kind of customers. If there's a significant demand destruction and one goes to half, then half percent change on a sequential basis can be meaningful. The Bitcoin is similar. Bitcoin was on the core Microchip side. It's not like it's a huge business like it may be at some other companies like Nvidia or something.
For us, it was like a 1% type business, but it's down 70% or more. Standalone, it's not really very much. With all these moving parts, you can make up with growth in other segments. When you combine many of these factors together and with all the headwinds from Microsemi, we cannot make up for these small components when you add these four together. I don't know if that helps.
Yeah, it helps. Thank you.
Next we'll go to Craig Hettenbach with Morgan Stanley.
Yes, thank you. Steve, just going back to the topic of tariffs and the business confidence, are you seeing any change in terms of order activity that your customers have been placing?
Yeah, we are seeing it in order activity. More than that, I think we are seeing it in distribution sell-through in China to those customers. A fair amount of business in China is done through distribution just because, logistics and all that. We do business both direct and distribution. We're seeing it in both channels. The distribution does business with lots and lots of small customers who build stuff, hardware that ships back into U.S. We have always told you, our business consists of long tail, thousands and thousands of probably 70,000, 80,000 small customers, which can adjust their build rates in real time. They're very nimble, and when they think they don't really know whether they can pass on this cost to end customer in U.S., whether they're competitive with a 25% duty, will this product have a duty or not have a duty?
It makes them pull back on their builds. We're seeing that impact in sales out from distribution in China.
Got it. Appreciate the call there. Then on Microsemi, once you get through the inventory correction and adjustments over the next couple quarters, are there any parts of the business that you'd call out that you see as attractive from a growth perspective or have a better outlook once you get past these issues?
Well, we like lots of different businesses. They have very good FPGA business. They have very good business in the data center. They have very good business in analog, discretes, aerospace and defense. Then there are certain businesses maybe not as great. I mentioned one, that electronics business they bought. We don't know why they bought that. That was a low-margin business, and Microchip would not have bought it. Yeah, there are a number of good businesses. What attracted us to Microsemi in the first place really hasn't changed. We had not imagined this seven months of inventory correction and crisis that we had to go through. Fundamentally, we're saying fiscal year 2021 guidance that we gave you on $8 per share is now conservative. This year, we said by the end of this fiscal year, we'll be producing $0.75 of accretion.
We think that is conservative.
Okay, thanks.
Next we have Kevin Cassidy with Stifel.
Thanks for taking my question. On the CapEx guidance, it seems the second half of the year, the CapEx comes down quite a bit to maybe 2.5% of revenue or so. Is that going to be the run rate going forward, or is it just a temporary adjustment?
I would say longer term, Kevin, probably a good estimate to use is 4% of revenue. We need to continue to evaluate the Microsemi business and see with the investments there. Obviously, we'll be looking to see if there's ways that we can improve the margin on their products by making investments like we've done in other acquisitions and investing in assembly and tests and bringing activities in-house. I think that's kind of the swing factor there. We were more heavily weighted in the front end of fiscal 2019 from a CapEx perspective.
That heavily weighted, those products you were targeting certain long lead times, as all your lead times, you feel like you've got the equipment in place to correct that?
Our lead times are in very good condition at this point in time. I think Steve mentioned that the majority of our products have lead times of four to eight weeks, and there's always some exceptions to that, and we're making the proper investments to correct all of our lead times to the right level.
Okay, great. Thank you.
Our next question comes from Chris Danely with Citi. Chris, go ahead.
There, can you hear me?
Yes, Chris, go ahead.
Oh, sorry. Wrong mute button. Fat fingers. Danely here. Just a couple of clarifications. Steve, it sounds like the headwinds from Microchip and Microsemi are going to last a couple of quarters. I guess conceptually, how big of an impact should we be thinking about into the December and March quarters would it be? What gives you confidence that revenue should bottom in the March quarter? Do you think that at least the slowdown you're seeing on the, I guess, the classic Microchip business, would you expect this to hit others in the space?
Well, to last question, I don't have any comment. For others, ask the others. We don't comment on the industry, we comment only on ourselves. In terms of the inventory correction, we can somewhat control because we're working with distribution, contract manufacturers, and end customers, moving the end customers back from distribution to direct, which were erroneously transferred to distribution and should not have been. That we know completes sometime in the calendar fourth quarter. To distribution, we are monitoring very carefully, shipping less product to them. With the distribution, they didn't want all this inventory. In the month of June, we simply didn't offer them any discounts, and then they didn't take the inventory. You don't have to do much. You just run the business, say, "Distribution, buy what you need," and it will get corrected by the end of the year.
You don't have to do much in that case, because inventory was jammed through incentives and discounts, and to smaller distributors, even threatening. You don't do any of that, inventory would correct. We have high confidence that the inventory corrects. That's not an issue. The impact of tariffs, nobody can call. We don't really know what happens in the trade war area. The passive components issue, I think should go away because capacity is being added. I think that should go away. ZTE is temporary. ZTE will get its act together and figure out what the real demand is, what demand they have lost to their competitors. The Bitcoin is anybody's guess. It's not a huge portion of our business over a long period of time. For $1.5 billion roughly per quarter, 1%, we're talking about $15 million a quarter.
It's really not a huge portion of the business, and we don't know whether Bitcoin comes back to its old glory or not. I think the main issue is the inventory correction one. That gets corrected in six months, and then tariff one is not clear.
Thanks. I guess, one last quick one before I leave. Were these guys worse than Atmel in terms of the shenanigans they were pulling out there? You guys corralled the Atmel stuff pretty handily. Is this a similar situation, or is it worse?
Well, I'm not willing to accuse anything. I just think accounting standard is wrong. We have been saying it from the beginning, and we wrote even a position paper on it when the accounting standard was changed for a sell-in. All you need is a willing distributor or a set of distributors who are willing to take increasing amount of inventory, which will ship out eventually someday. There are products in distribution from Microsemi that will take two years to clear. It's not a huge amount, like we're saying, majority of it will clear by the end of the year, but there are certain products, every quarter, they will take certain products, older products, and slate them as end of life. Then they will build three, four years of inventory and give it to distributor and recognize it for revenue in the current quarter.
Next quarter, do it some more products. Standard allows it, since it's non-returnable by the distributor, you give them at a deep discount, and you give them interest subsidy, so the distributor is willing to carry it, they will eventually ship it. The standard allows you to recognize it for revenue. They didn't do anything illegal. The issue is, they represented to us, to their own analysts before, to their customers, or to the investors and everybody else, that there was a run rate. Legally, there was a run rate because they could continue to do this for I don't know how long, till someday, it bursts. That's not how we do it. We have never stuffed a channel in our life.
We have always recognized revenue on sell-through, even though now GAAP standard says you have to account for sell-in, we're giving you that GAAP number, but we give no GAAP guidance. We manage our business on sell-through. All our incentives are based on sell-through. I just say, that's really what happened. They did what they were allowed to do.
Okay. Thanks a lot for all the clarifications, Steve.
Our next question will come from Krysten Sciacca with Nomura Instinet.
Good afternoon. Thanks for squeezing me in here. Just a different take on the revenues for the second half of this fiscal year. On prior calls, you've noted that December and March typically tend to be the softer quarter seasonally, with December being the weakest. Given the inventory issues that you are having with Microsemi, are you expecting any changes to the seasonality, or do you expect this to still be the case?
We expect that still to be the case, but what you start to see is really, certain products' inventory corrects. It all doesn't all correct in one day. Certain products have high inventory, certain products have low inventory, and every month, certain products' inventory corrects. Their run rate returns back to normal. You got lots of moving parts, where you should see an ordinary kind of December weak quarter to the extent certain products' inventory has corrected, those see an uplift. I think driven by all those, we should just see a normal low single digit down kind of December quarter. I think that's usually what we see.
I think in all our acquisitions in the past as well, the blend of seasonality will adjust, and it'll take some time before all that settles out. I don't think a historical seasonality would be an accurate predictor of future seasonality when there are acquisitions with different seasonalities and different blending taking place.
Understood. Thanks for the detail. On a more positive note, can you just maybe detail what was behind some of the strong growth in analog and your microcontroller segments for classic Microchip this quarter?
If you're asking for segments of growth, we don't break out any of the segments. Those businesses have been in a long-term growth mode. We have shared with you what we've been doing with Microchip 2.0, with the total system solutions. You have to note, though, that some of the growth this quarter that we're showing sequentially is a combined company growth, reflects some of the addition of Microsemi in those numbers. We haven't broken out the classic Microchip microcontrollers and analog, other than to give you some comfort that they both hit records. They both grew more than classic Microchip as an average, so that you can see the underlying strength in those businesses.
I would say, some of the questions are overly focused on just the shortfall in revenue guidance. Nobody has mentioned that the earning guidance is $0.07 better than consensus. I think our consensus was $1.67, $1.68. At the midpoint, we're guiding $1.74. We're doing very well, actually. We're increasing our assessment of the overall earnings for the year and going out of the year, the accretion we can get. I think, look at the glass also half full. We, at the end of the day, deliver non-GAAP earnings per share, increasing amount. That is our goal. That's where all our incentives are built on. That's what the board manages us by. Even the EBITDA doesn't give you the credit for a lower tax rate. If the earnings per share are better for a given share count, that's creating higher amount of total profit after tax.
We feel pretty good about where we are and how we executed the quarter, how we are carrying out the integration. The issues and challenges we see in inventory correction, they're straightforward. They are fixable. It's not like we need to devise a tool or do some invention. These are just a normal blocking and tackling to correct this. Otherwise, earnings per share are great.
Great. Thank you.
Welcome.
Our next question will come from Harlan Sur from J.P. Morgan.
Good afternoon, and thanks for taking my question. I understand product line rationalization is kind of taking a second priority to some of the more structural changes you're making in terms of business process improvements at Microsemi. If I look at Microsemi's data center storage and OTN optical product lines, these are very different products, right? Leading-edge silicon, leading-edge packaging, big complex chip designs, very different versus Microchip's focus on classic embedded microcontroller, analog, memory, and all the other complementary building blocks around this. Help me understand how the storage and the OTN optical stuff kind of fits into the Microchip 2.0 model.
They are standalone businesses, you're right. They do have more leading-edge process technologies and design technologies and packaging in many cases that they use. That's no different from when we went to SMSC, five years ago, six years ago in the acquisition. It brought a new degree of complexity. We adapt to it. It fits within the overall portfolio. We find the strengths that the acquired entity has and bring it into the rest of Microchip. We find the strength that Microchip has and take it back to the acquired businesses. On a blended basis, if we don't get out of our box, our growth opportunities are limited. Of course, new product lines will bring new complexity, but they also bring lots of opportunity to use the strengths of both companies, and that's the way we look at it and how we go forward.
In these two businesses in specific, there's also a substantial amount of Microchip classic content available to us to take into those markets where they have significant strength, customer presence, and visibility into what else is needed. In fact, some of the reference designs I talked about, where the joint sales teams have looked at, that's coming from the joint teams looking and saying, "Wow, here's things Microchip didn't know could be done," added to things that Microsemi does extremely well in certain applications and certain customers.
I tell you guys after every acquisition that don't underestimate, don't undersell Microchip management's ability to transform the company to take on the challenges that the new acquisition presents. In Standard Microsystems, the complaint was they're vertical, you're horizontal. Look at how well that thing has worked out. In the case of Atmel, they're ARM, and you have MIPS and all that. Look at how well that thing has worked out. Don't underestimate Microchip's ability and the management team and a huge pipeline we have built internally, that we prepare for this to take on the new challenges and expand our business. We're about the eighth-largest U.S. semiconductor market cap in a consolidating industry. You can't just be sitting in your box and want everything to come with a nice bow tie on the microcontroller.
We have to get into other businesses and grow our business in a consolidating industry.
It reinforces Steve's point earlier that as we move forward, we focus on the combined company opportunities rather than trying to box it and saying, "Well, let's make the old one look good or the new one look good." It's really the combined company opportunity to provide the richest forward-looking opportunities.
A number of our business units are planning to leapfrog the lithography at the foundries by skip one generation and leapfrog because that leapfrog technology has already been used by Microsemi in some of the same business units that you're mentioning with library available, with experience available, with ESD structures and chip designs and all that kind of stuff available. It will accelerate our roadmap and leapfrog the technology to be able to reuse some of that stuff at Microchip. I think that's kind of how we look at it. A ship is very safe in the harbor, but that's not why ships are made for. We can't sit in a box and just look for everything to be a neat little microcontroller. We have to branch out and be able to expand our business, and we have done successfully that in the last decade.
Yep, absolutely. Thanks for the great insights.
Thank you.
Next from Darphil, we have Gil Alexandre. Please go ahead, sir.
Hello, Gil.
Thanks for taking my question. I get back to tariffs. Is there a willingness to compromise, and how is it affecting your automotive business?
Well, is there a willingness to compromise? Compromise by who? That compromise has to be between the Chinese and U.S. authorities, that's way above my pay grade. In terms of how's our automotive business, I don't think automotive business has yet been affected by tariffs.
No, I think some of the uncertainties are there. Cars are built in the U.S. and shipped to other parts of the world. Cars are built in Europe and shipped into the U.S. Some of the discussions have created uncertainty. We'll see how it all plays out. I think Steve's right.
So far, automobiles are not included in the tariffs.
They're not.
Steel and all that are, but the built automobiles are not included. It's still negotiation. When they had an edict on July 6th and then August 23rd, set of products that have tariffs, washers and dryers, and those things are included, cars are not. Cars are not dutiable right now. Some of the car components are like steel. This thing is still raw. Thank you for your question again.
I thank you, and good luck.
Yes. Thank you.
Our next question comes from-
Anybody else, operators?
Yes. Our next question comes from Christopher Rolland with Susquehanna International Group.
Hey, guys. I think it's nice to see you guys get out in front of this in the true Microchip way. I think it's appreciated by guys who've known your track record. Steve, as we try to judge the snapback in revenue, once you work through this inventory, can you give us some perspective of perhaps how long this overshipment issue was going on for? Was it just the last few quarters when they knew that they were in negotiations, or was this accumulated over a couple of years?
Well, there are a lot of moving parts, and you can't put a complete finger on it because there is some EOL mechanism with which they put the distribution inventory. Normal amount of inventory was very high. There was a huge nonlinearity. A lot of stuff was shipped in the third month. There was also this direct-to-distribution conversion. There were a lot of these programs interlayered. I'm not accusing anything, but I'm just saying that the timing, roughly, it all started about a year or so ago, which is more like when the conversations about the acquisition began. I couldn't prove that. I think it's very rough.
Yeah. Sounds pretty common in a lot of these deals. Lastly, on Microsemi's product pricing, after the Atmel deal, you saw a lot of kind of pricing imbalances. I can't remember, maybe they were selling some below gross profit, if I remember right, or priced it below gross profit. Are you seeing anything like that here? Just any other tidbits on where you get more synergies.
I think on that thing, I will give kudos to the sales and marketing team. The prices are not below market or anything like that, but when they got an excellent price for a customer, then they inserted a distributor and kept the customer price the same, and then they discounted to the distributor, gave an interest subsidy to carry the inventory. After a good price negotiated with the customer, they asked the customer to take much more inventory than the customer wanted and offered them a discount. I think the pricing by marketing was done well, but then later on, in the overzealous attempt to really recognize higher revenue, they kind of did the wrong thing on the top of that. This one is easier to correct. It's much harder to raise prices on the customer.
It's much easier simply not to offer the discount and say, "Just buy what you need, customer. I don't want you to buy a lot of product that you don't need." We think this one is easier for us to correct that way.
The high starting gross margins are a good indicator of how that was far better discipline than other acquisitions we've done. Hopefully there's some upside from the discounting being rolled off that we'll see in the coming quarters.
Yeah.
Yep. Good point. Thanks, guys.
Thank you. Next, we'll hear from Craig Ellis with B. Riley FBR.
Thanks for taking the question, Steve and team, thanks for all the color on where you see things shaking out at this point of the integration. Steve, I wanted to follow up on a comment that you made in the Q&A regarding the deal's accretion in the current quarter. I think you said your synergies are tracking above the prior expectation for $0.15 of accretion. If I've heard that correctly, the question is, does that mean that while retaining longer-term accretion target $0.75 run rate first full year, $8 a couple of years out, that you're realizing your synergies earlier, but you still have the same expectation? Or do you think you're tracking above prior expectations? To the extent that's the case, can you identify where you think that is?
A little bit of both. I said that we believe that the accretion run rate at the end of the first year will be higher than $0.75. We didn't numerically say what the number is, because there is still, like I said, the numbers are going to be noisy here for the next couple of quarters because there's just a lot of moving parts. As we get out by June next year, we see a number higher than $0.75, which will represent really a little bit of pull-in based on our prior plan. In terms of $8 for fiscal year 2021, we see that as conservative also. Internally, we're modeling a number higher than $8. That is the incremental accretion. I think some of that difference is coming from tax rate, lower tax rate also.
That's helpful. Previously the company, and on this call, the company had identified the $300 million in synergies targets. When do you think you'll be able to provide some color on how that breaks out between revenue synergies, COGS synergies, and other synergies?
Really, never. We're just going to deliver it, not going to break it out.
Okay. Given that quick response, can I take a swing at another one? There's been a lot of discussion on what you found with distribution, and I've heard you talk a lot about levels and what happened with shipments, but the question is really an operational one. What have you found with respect to the appropriateness of the consignment versus demand generation distribution, geographic representation, and the degree to which you think you've got a good distribution fit for the business that exists there? How long does it take to right-size any of the operational changes that are needed with distribution?
Sure. As we have interfaced with a lot of the distributors, some of them, by the way, a fair number of them are common with Microchip. Their largest distributor was Arrow Electronics, and our largest distributor is Arrow Electronics. Similarly, there are some other common distributors in Asia and Japan and Europe and others. The large amount of interaction with the distributors was, how much inventory they would take. It basically began around the middle of the quarter, and large amount of, I would say, tension with the distributor was largely, how much inventory would you take? As we have spoken with the distributors feel refreshed in saying that you're not going to force me to take inventory I never wanted.
You will, in fact, let me drain down my inventory, and so we can have a conversation about demand creation, reference design, how can we together build the business? Let's go call on common customers. Let's highlight and beef up the website and put reference designs and solutions on it. How do we take advantage of total system solution, Microchip and Microsemi common products going into the same platform? On and on. Conversations with distributors have turned into positive interaction regarding growing the business. Before that, and this is distributors are telling us, the ex-management of Microsemi is gone. Distributors are telling us that this tension about such a large amount of inventory jamming took all the oxygen out of the room. It just consumed the entire energy and interaction with the distributors.
It's actually liberated time within the company as well because the business units and others that were all part of that discussion process.
When do you start to see a positive benefit from this new conversation that's occurring?
You will start to see it as this inventory bleeds out. By the end of this calendar year, you'll start to see the impact starting the March quarter or so. If you're talking about getting brand-new designs in production, that usually takes 12 to 18 months. You'll start to see impact on the funnel, impact on joint opportunities probably as early as late this quarter.
Thanks for the insight, Steve.
Yeah. Thank you.
Thank you. Our next question will come from Rajvindra Gill with Needham & Company.
Yes. Thank you.
Hello, Raj.
Hi, how are you? Just switching to earnings, as you noted. Eric, what is the deleveraging campaign? Is that changing at all, given the situation? As part of the $8 per share in fiscal year 2021, how much of that is related to a lower interest reduction related to deleveraging? Just wondering if you could talk about that, in the grand scheme of earnings, being the end to be all of everything.
The deleveraging approach is essentially all cash generation above and beyond the dividend is going to go to pay down debt. We aren't going to do anything unnatural. We're not going to push inventory into the distribution channel to generate cash and things like that.
We're not going to cut the dividend.
We're going to run the business, going to get our synergies as quickly as we can, with that, generate cash to pay it down. We are definitely a little bit behind schedule to start, and we've got a little bit of a headwind in front of us. Long-term cash generation and operating profit generation from these businesses combined is very high. No real change in that long-term outlook. Hopefully that answers your question. Then, obviously as we pay down debt, there's interest expense reduction that's built into our forecast, but we aren't going to give any real details in terms of how that lays out quarter by quarter at this time.
One of his question was really, what portion of incremental to possibly $8 is tax related. Raji, what I would say is that, in the past when R&D tax credit used to go away every year and then used to come back later in the year. Most companies will have a much lower tax rate in the fourth quarter, and then they'll true up and have a much lower tax rate and sometime make up the earnings missed with that tax rate and all that, and analysts and investors will discount the additional earnings per share coming by the tax rate. This is not that kind. This is a real tax rate, current quarter. There is nothing we're taking from the past or future. This is actual good old tax planning, which for next several years will have a very low tax rate.
You should look at that as, it's no better or worse than earnings per share produced from higher gross margin or higher revenue or lower expenses or anything else.
No, that's true. At the end of the day, that's what it is. Last question, Steve, I know it might be difficult to understand the tariff, but in late 2014, you saw a slowdown in China industrial, you saw a slowdown in China housing. You're one of the first ones to note that, we did see a slowdown in China in 2015. I'm just wondering if, is that a scenario that could repeat itself or just any general thoughts on that? Thanks.
Raji, I resigned from that job back in 2014. I would let those thoughts be yours rather than mine. I'll just talk about our business. I get no benefit from that. I let you guys decode that.
Okay, got it. Thank you.
Our next question will come from Mark Lipacis with Jefferies.
Thanks for taking my question. Just one for Eric. Eric, in the trailing previous four quarters, free cash flow tracked pretty close to the non-GAAP net income. This quarter, there's a little bit more of a gap, and I think that's typical when you start an integration process. I was wondering if you could give us a sense of when does the free cash flow start to track back to the net income? If you could give us any help on that, I'd appreciate it. Thank you.
I think we had a big correction in June, as we've kind of talked about. I think it continues through the end of the calendar year to have a little bit pressure on that because of the continued reduction that we expect in distribution inventory. After that, I think it should return to a more normalized basis.
Fair enough. Thank you.
Welcome.
As that was our final question, gentlemen, I'll turn the call back over to you for final comments.
Well, we want to thank everyone for attending this call. We'll see some of you on the road at conferences, which I think begin again late August and September.
Yeah.
Thank you very much.
That concludes today's conference call. We thank you for joining.