Good day everyone, and welcome to this Microsemi acquisition 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 Executive Officer, Mr. Steve Sanghi. Please go ahead, sir.
Thank you very much. Good afternoon, everyone. Before I begin this call, I wish to remind you that during this call, we'll be making some projections and forward-looking statements regarding the future financial performance of Microchip. These always involve predictions, and the actual results may vary materially. I refer you to Microchip's filings with the SEC and also the press release of today for some important risk factors about our business. With that, as you know, Microchip completed its acquisition of Microsemi on May 29, 2018, with over 99.5% of the shareholders who voted approving the transaction. Today, we would like to do three things in this conference call.
First, our CFO, Eric Bjornholt, will provide you the details of how this transaction was funded, the effective interest rate for the funding of this transaction, and the total interest we expect to show in the P&L for the June quarter and for the full quarter of September. Secondly, Ganesh Moorthy, our Chief Operating Officer and President, will provide you some information on how we will be reporting revenue for Microsemi. As you might know, Microsemi reported their revenue by end markets and not by product lines. Microchip reports its revenue by product line and not by end markets. We occasionally update our end market mix, but because of the very horizontal nature of our business and 115,000-plus customers, majority of whom buy product from distribution, our end market mix is approximate and has judgments applied to it.
In combining with Microsemi, we will report our consolidated revenue by product lines. Ganesh will explain how Microsemi's revenue will port over to Microchip's product lines. Third, I will provide you guidance for non-GAAP revenue addition from Microsemi from May 29 to June 30, and the impact on our non-GAAP earnings per share. Let me pass it on to Eric Bjornholt. Eric?
Thank you, Steve, and good afternoon, everyone. Microchip paid $10.3 billion to complete the purchase of Microsemi. The equity purchase value was $8.1 billion. We retired Microsemi's debt for $2 billion and incurred transaction-related expenses of about $0.2 billion. We used about $1.9 billion of cash from the combined company's balance sheet, $3.4 billion from our revolving line of credit, $3 billion from a new Term Loan B, and finally, $2 billion from a new investment-grade bond. The current interest rate on the revolver and the Term Loan B is about 3.97%, and the average interest rate on the investment-grade bonds is 4.13%. The combined effective interest rate on $8.4 billion of borrowing is just over 4%. Our line of credit and Term Loan B are floating rate instruments, while the investment-grade bonds are fixed rate instruments.
We expect the adjusted other expense on our income statement will increase by about $34.8 million from what we had provided in our May 8th earnings conference call due to the impact from the additional interest expense and the loss in interest income from the transaction closing on May 29th through the end of the quarter. The total adjusted other expense on a non-GAAP basis is expected to be between $49.6 million and $51.6 million for the June quarter. For the full quarter of September 2018, we expect the total non-GAAP other expense on the P&L to be between $113 million and $116 million, and we have assumed a 25 basis point increase in our floating rate debt cost impacting the September quarter.
As we have said before, we will take the entire net cash generation from our business after paying for CapEx, dividends, and taxes, and use it to rapidly delever the balance sheet. Our net leverage at the end of the June 2018 quarter is expected to be 4.7 times, excluding the 2037 convertible bonds on the balance sheet that are very long dated in nature and more equity-like. We expect to reduce this leverage by about one turn per year on a go-forward basis. Our revolving line of credit and Term Loan B are pre-payable debt, and we will begin to pay them as we generate cash in the future. With that, I will now pass it to Ganesh to give his comments. Ganesh?
Thank you, Eric, and good afternoon, everyone. In regards to revenue reporting, Microchip currently reports five product lines. They are microcontrollers, analog, memory, licensing, and finally, multi-market and other that we call MMO. In fiscal year 2018, our revenue of $3.98 billion was split across the five product lines as follows. Microcontrollers were 65.8% of our revenue, analog was 23.9% of our revenue, memory was 5% of our revenue, licensing was 2.6% of our revenue, and MMO was 2.6% of our revenue. With the addition of Microsemi, we will add a sixth product line category called FPGA
We expect Microsemi's revenue reporting to be split across four product lines, microcontrollers, analog, FPGA, and MMO, ticking up a little bit from where it's at today, while the microcontroller revenue percentage will tick down a little bit. We will provide you with more details at our fiscal Q1 earnings conference call in August. With that, let me pass it to Steve. Steve?
Thank you, Ganesh. As you know, we have really only had a couple of days with Microsemi. We have assessed the non-GAAP revenue that Microsemi expected to ship in the quarter under our clock. I also want to remind you that Microsemi reported its quarter under sell-in revenue recognition method. Microchip in the past has reported revenue on sell-through revenue recognition method. Just starting this quarter, we will begin to report our GAAP revenue based on sell-in, as it is required by the new accounting standard ASC 606. As we told you during our May 8th conference call, we will continue to run our business, provide guidance, and track and compare our results based on sell-through revenue recognition method. At Microsemi, distribution sell-through revenue information is available, and it is a true measure of market demand.
Microchip will combine Microsemi's revenue with its own based on sell-through revenue recognition method, and we will call it our non-GAAP revenue. For the June quarter, we expect Microsemi to add approximately $160 million-$180 million to our non-GAAP revenue. As we told you, the Microsemi deal will be accretive to our non-GAAP EPS right from the beginning. We expect Microsemi to add about $0.02-$0.06 to our non-GAAP EPS for the June quarter. We will provide full guidance for September quarter in our August earnings call, but for the modeling purposes, we're providing the guidance that Microsemi will add $0.75 of non-GAAP EPS accretion annualized run rate in the first year after close. For September quarter, we expect Microsemi to add about $0.15 non-GAAP EPS. We have begun the integration of Microsemi into Microchip's business.
We will provide more details about our integration plans in the August conference call as we flush out the details under our own clock and verify and double-check our assumptions. With that, operator, will you please poll for questions?
Ladies and gentlemen, if you'd like to ask a question at this time, please press *1 on your telephone keypad. If you're on a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. We ask that you please limit yourself to one question. You may press *1 to enter the queue again to ask more questions. Once again, that's *1 for questions at this time. Our first question will come from Craig Ellis from B. Riley.
Yeah. Thanks for taking the question, and congratulations on getting the deal closed in the timeframe that you had originally projected, guys. Steve, I wanted to follow up with a clarification on the first quarter's guidance. One, in the $0.02-$0.06 of earnings, are there any synergies included in that earnings guidance? You had a comment on $0.75 of EPS in the first full year after the close, and then you said something in addition to that. I think you said $0.15 in the first full year, which would be basically the midpoint of your initial guidance, and why wouldn't it be higher than that, given that you're starting at $0.04 per quarter at the midpoint? Thank you.
The $0.15 was not for the full year. $0.15 was for the September quarter.
Okay.
Just the September quarter. Yeah, that's for one quarter. $0.75 was after one year. The other part of your question was whether $0.02-$0.06 included any synergies.
Any synergies.
It's really the first month. You can't change much and have really a whole lot of effect in the first month.
Thanks, Steve.
That's really almost native what we get from Microsemi because they were a profitable company.
Thank you.
There is a tiny bit. We terminated some people, mostly executives that are no longer here. There's a small amount, but it's not meaningful.
Our next question will come from Harsh Kumar with Piper Sandler.
Yeah. Hey, guys. Congratulations again. Again, pretty big deal closing it on time in this environment. Steve, I wanted to ask you, most of the time when companies buy another company, there's a lot of leakage of revenues in the target. With MSCC, there was hardly any leakage, and your guidance for the June quarter seems to suggest that exactly what MSCC was doing previous to the acquisition, you're capturing most of that. Is there anything special about the situation that is causing it relative to the other deals in the history?
Well, we haven't had enough time to really explore that, look at business unit by business unit and really answer the question. Looking at from a high level, I believe there has not been any leakage because of two reasons. One, a very large portion of the product line is proprietary, and this is the argument we make at Microchip also, that very large portion of Microchip's business is proprietary other than a small amount from memory business that may not be. When there's a proprietary business and you're designed in, you're really not competing at the buyer's desk because no other part can be substituted. A good portion of their business, like storage controllers, FPGAs, a lot of timing products, lots of the other Ethernet devices, they're really all proprietary.
There is some business which could be commodity-like in the discrete area, I think that's the number 1 reason. Second reason, maybe because there's not an abundant supply of semiconductors in the marketplace. The environment is still quite good, and there are plenty of challenges for the customers to be acquiring parts. In that timeframe, I think it stops the leakage. I would say those two would be the reasons.
Fair enough. Thanks, Steve. I'll get back in line.
Thanks.
Ladies and gentlemen, once again, that's star one if you'd like to ask a question today. Our next question comes from Chris Caso with Raymond James.
Yes, thank you, congratulations getting the deal done. Just wanted to go through some of the assumptions, I assume the $1.75 accretion target over the longer term is still the right number to use. Now that you're a little farther down the line, can you give us a little more color on what are the elements which drive that $1.75? Just in general terms, this is a bit of a different acquisition than what you've done in the past. What sort of improvements are you looking to make, that you'd expect to make, versus what Microsemi was doing on their own?
I think with two days at it, we're still not able to break out the synergies further. It's a combination of revenue and cost synergies. I want to point out that the track record of Microchip achieving synergies which are higher than what we initially projected in our public acquisition announcement has been really pretty good. The combined companies will be working on refining this estimate in the coming months. Looking at it broadly, from the cost front, there are a lot of public company costs that go away right away, like the board-related costs and a lot of the SEC costs and filing fees and 8-Ks and 10-Ks and annual reports and audit fees and legal fees and others. Some may increase Microchip's audit fees further, but it's not equal to Microchip plus Microsemi. There is a significant benefit in it.
We will be moving all of Microsemi products over to Microchip's enterprise system, really there'll be long-term only one enterprise system. Microsemi itself had multiple enterprise systems. You could say as many as 21. There are three main ones, but there are many versions of it. As they acquired other companies, they pretty much left them running on their own enterprise system. There is a large amount of staff really dealing with all these different enterprise systems. As we move them to Microchip, there'll be significant synergy coming out of that. On the sales and marketing side, you obviously have, I know we'll be slowly looking at all the sales offices, combining them into a common footprint. There is a lot of duplication in country-level VPs and managers and geographical vice presidents and others, there'll be synergy coming out of there.
We'll be looking at the distribution network of both companies. There are common distributors, and there are those that are not common. We'll be figuring out what to keep, what to not keep, and who else to franchise. There's always synergy comes out of that. Microsemi also was really managing their business with sell-in revenue recognition, where Microchip manages with sell-through revenue recognition. Just like we have seen with other companies, Atmel and Micrel, in 2 days, we have found that out in Microsemi, where there are a lot of quarter-end deals, essentially, to put product into distribution. There are discounts given to make that happen because they want to show you a sell-in revenue. Microchip is stopping that starting this quarter because we don't care what the sell-in revenue is. We only care what the sell-through revenue is.
I think we'll be getting a gross margin and ASP lift coming from there. Environment is pretty good. Microsemi was guiding for 6%-8% revenue growth year-over-year. I don't think many people in the street believe that, but there is growth as we're looking at the business. Following our TSS concept, they were doing something similar, not calling it TSS, though. With all these companies they have acquired, they were winning larger and larger number of chips on the board. There is some growth coming. You look at all that. Then the R&D. We always find synergies on R&D where 2 companies can commonly develop process technologies, key circuits, cost of qualification of technology, managing the foundries, managing the back end.
Finally, on the COG side, just like we found in Atmel, where we can take some of the packages, assembly and test from outside to inside, there will be substantial benefit, and you have seen how much we have improved the gross margin of Atmel. We are seeing similar opportunities in Microsemi. Even on the top of very high gross margin they have, we're still seeing significant potential. Now, there's a lot to do with all that. We're still in the process of improving Atmel by bringing things inside, and this brings just an additional amount of workload. It all has to be prioritized. It just takes a period of time. That's why we have given it 3 years to accomplish. All those would be the reasons where the synergies will be coming from.
Well, thank you. You've answered a lot of questions in that actually. As a follow-up, just in terms of customer base, Microchip's obviously got a lot of customers, but Microsemi brings you into some different end markets. What's the customer overlap between Microsemi and Microchip? I guess to the extent that you'd be bringing new customers on, how do you handle that? I guess, are there cross-selling opportunities as some of those new customers come under the tent?
We do business at Microchip with about every customer in the world. I'm not sure anybody brings us totally new customers. What happens is, we do business in different applications or different business units sometime than Atmel was or Microsemi was or Standard Microsystems was. With each company, within the same customers, you break into additional products, you break into additional business units of the customers in different sites. I think that's where the incremental customers come from. If you are doing business at a very large multinational company, and we're doing business in one division, and Microsemi is doing business in other division, you could say that we have common customer, but it's usually not a common customer. There's no reference from one to the other. It's just totally different. Different design team, different buying team, different manufacturing flow.
It does give us the opportunity to be able to sell some of our products into Microsemi customers or those divisions where Microsemi is selling, and it gives us also the opportunity to take some of the Microsemi's discrete products, especially, they make diodes and transistors and FETs and analog devices and voltage and DC-to-DC and all these general-purpose parts that almost go into any systems going around our microcontrollers. With our 115,000-plus customers, it gives us substantial more opportunity to take our total system solution concept and sell these devices around our sockets.
Very helpful. Thank you.
You're welcome.
Next, we'll take a question from Craig Hettenbach with Morgan Stanley.
Thank you. A question for Eric. Just as you think through the integration, any implications on an intermediate to longer term on CapEx of the combined entities and free cash flow dynamics?
Yeah. We are not at a point where we want to give an updated CapEx forecast for fiscal 2019 today. Microsemi's business historically has not been as capital-intensive as Microchip's, because they outsource a much larger proportion of their overall manufacturing activities in the 85%-90% range of what they outsource. As part of our plans, as Steve mentioned, we'll be evaluating what could make sense to bring in-house, and we'll be evaluating that and building up that capital plan shortly. I think overall, from a percentage of revenue perspective, it's probably a little bit less capital-intensive than Microchip's business. That's the first piece of your question. What was the second piece, Craig?
Just kind of tied to that, just the free cash flow dynamics as they come on board.
Microsemi was generating a lot of cash on their own. The combined companies are going to be generating a significant amount of cash, and as synergies come on and both companies grow, that's just going to continue to grow. We indicated publicly now that we think that we can delever at about one turn per year, which is important, because we know we've taken on quite a bit of debt from this transaction. The combined cash flow is very healthy, and really all of the excess free cash flow is going to be going to pay down debt very rapidly.
Got it. Thanks for that, Eric. Maybe just a follow-up for Steve. As I think through how Microsemi reported from an end market perspective, be it data center, aerospace, defense, and communications, any of those markets kind of stand out to you as most strategic in terms of where you see opportunities?
Ganesh, you want to take that?
Yeah. I think as we told you when we announced the acquisition, the three major market segments, defense and aerospace, communication, and data center, are positions where Microsemi has strong positions in.
We absolutely expect that in all of them, we're going to find more Microchip attach opportunities. In that sense, they're strategic to Microsemi standalone, but they'll be strategic for Microchip combined with Microsemi as well. We need to get into some more detail in terms of what exactly and what product lines. Already our teams are identifying opportunities that they had not seen before that can be led through the leadership that Microsemi has. It's both ways. We also have Microsemi products that we believe in the markets where Microchip is strong, we'll also find more attach opportunities, and those are also being starting to get identified.
Got it. Thank you.
Our next question will come from William Stein with SunTrust.
Great. Thank you for taking my question. I was hoping you might discuss the portfolio strategy from here a little bit. Clearly, it would seem incremental acquisitions are going to be a far forward-looking idea. Microsemi has been acquisitive in their own right, and in that process, they had often divested or shut down pieces of businesses as they acquired other companies. I wondered if Microchip's considered any part of that portfolio from Microsemi, either something that they're not interested in pursuing or that you would see an opportunity to divest to focus the portfolio.
We have not identified and have no plans to divest any of the acquired assets from Microsemi at this point.
Thanks. One more, if I can. I'm wondering if you can address sort of the cross-selling opportunity. It seems to me that's always also very long-term sort of process, both in getting sort of cross-designed solutions, but generating revenue even longer term. There's always an earlier opportunity, I would expect, in sort of cross-references on data sheets, and I'm hoping you can give us an idea as to how big an opportunity that might be and how near in. Are there any relatively earlier opportunities for cross-selling in that manner? Thank you.
Well, we don't have any information numerically. Just not long enough to really put any numerical numbers on it. In my earlier answer to the question, I don't know if you were listening to that one, I think I mentioned various areas in where there could be opportunity, where we sell into a customer in one division but not the other division, and Microsemi sells into another division. It gives both companies, Microchip and Microsemi, opportunity to really sell also into other division attached parts. When you begin with a design in, it always takes two years to get revenue. Six months to get going and start designing the part in, and then another year and a half before customer buys volume.
Our apps engineers will immediately open up all of our diagrams, customer diagrams or designs, and identify Microsemi parts where we could provide solution now where we didn't have it before, and we'll ask Microsemi apps engineers to do the same thing, to essentially look at all the block diagrams of their customer designs and identify opportunities where our chip could go in, where they didn't have a chip that could go in. We will try to, through our distribution, through our TSS approach, try to sell what we can short term. I think there could be some opportunity in the discrete area. There could be some opportunity in the RF area. There could be some opportunity in some other business units, but the design-in parts will take a couple of years.
There certainly is some short-term opportunity that we can start to harvest in about six months from now.
Thanks, Steve, congrats on closing the deal early.
Thank you.
Our next question will come from Kevin Cassidy with Stifel.
Thanks for taking my question and congratulations also. On the non-GAAP sell-through model for Microsemi, what would their revenue have been if it was still in the sell-in model?
What would the Microchip revenue be or Microsemi revenue be? I don't understand the question.
Microsemi one. Yeah, what would be the difference from the way they were reporting it as sell-in and the way you're adding on the sell-through? What's the difference between GAAP and non-GAAP revenue with Microsemi?
Well-
Steve, maybe I can take that.
Go ahead.
The bottom line is, on a sell-in basis, the quarters tend to be a little bit more back-end weighted than on a sell-through basis. Sell-through, yes, all the distributors are trying to meet their own quarterly numbers. On a sell-in basis, sometimes the customers or distributors are waiting to make a deal at the end of the quarter. That tends to be more back-end weighted, and that's just not how we run our business. We focus on true end market demand. I don't have a specific number for you that I could provide on a sell-in basis. The bottom line is we will report sell-in for GAAP accounting purposes, and that will be impacted in the first couple of quarters by all the purchase price accounting adjustments. It's kind of hard for investors to get a feel for that anyway.
If, Steve, you want to add anything to that, go ahead.
No, I think that's really it. There are just too many moving parts to mark up all the inventory for purchase accounting and make all those adjustments. GAAP really would not really make any sense at all. The non-GAAP is really all you can look at. I think if we keep running the business the way Microsemi would have run in June, then in the next 15 days, we'll be making all these deals to put the product in distribution, which they used to call it packages. All these packages come from all these distributors, discounted product that you can sell before the end of the quarter. If we do all that, then the GAAP revenue based on sell-in would be higher than sell-through. Sell-through tends to be a little more linear and sell-in is very back-end loaded. We're not going to be doing that.
We're not going to be trying to push parts into distribution. It lands wherever it lands. We don't really care about what the GAAP revenue would be. Based on the way we do it, I think the GAAP and non-GAAP will be about the same, because there would be just no incentive to put any more parts into distribution than is required. My feeling would be, it would be in the similar range as we have guided $160-$180, even if you look at it by GAAP, give or take some.
Yeah. That would be GAAP before any of the purchase accounting adjustments.
Yeah.
Right. Okay, great. It looked like it was very linear the way you're adding on to your revenue for one month out of the quarter. Just looks like it'll be aligned more with-
Yeah
your quarters, fairly linear through the quarter.
Yeah, I think, honestly, just largely ignore the month of June. I mean, the deal could have closed at the end of June. We closed early, then we have to really take all these purchase accounting calculations in the month of June. Really just look at the full September quarter. That would represent the true revenue for the whole quarter, the gross margin, the operating expenses. Otherwise, if you look at just one month, there's a lot of offset. There are things that are paid early, there are things that are late, things are with revenue and OpEx. When you take one month out of the quarter, it doesn't make as much sense. Companies tend to not run by month. They run by quarters.
Okay. Thank you.
Yeah.
That concludes our question and answer session for today. I'd like to turn the conference back over to Mr. Sanghi for any additional or closing remarks.
Well, we want to thank all the investors for joining us today. We're really pleased and proud to have closed this acquisition in record time comparing to really what many of the other deals are going through. Thanks, we'll talk to you at some of the conferences we'll go to in this month, the month of June. Otherwise, we'll talk to you in our next earnings call, which will be sometime in early August. Thanks.
That does conclude our conference for today. Thank you for your participation.