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 Sangee. 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 in the will results may vary materially. So 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. So with that, as you know, Microchip completed 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 Bjornhold, 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 and L for the June quarter and for the full quarter of September. Secondly, Ganesh Muthi, 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 report its revenue by product line and not by end markets. We occasionally update our end market make 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 judgment applied to it. In combining with Microsemi, we will report our consolidated revenue by product lines, Ganesh would explain how Microsemi's revenue will port over to Microchip's product lines. 3rd, 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.
So let me pass it on to Eric Beonhold, Eric.
Thank you, Steve and good afternoon, everyone. Microchip paid $10,300,000,000 to complete the purchase of Microsemi. The equity purchase value was $8,100,000,000, where retired Microsemi's debt for $2,000,000,000 and incurred transaction related expenses of about $200,000,000. We used about $1,900,000,000 of cash from the combined company's balance sheet. From a revolving line of credit, $3,000,000,000 from a new term loan B and finally $2,000,000,000 from a new investment grade bond.
The current interest rate on the revolver and the term loan B is about 3.97 percent and the average interest rate on the investment grade bonds is on $8,400,000 of borrowing is just over 4%. Our line of credit and term loan B are floating rate instruments while the investment grade bones or fixed rate instruments, we expect the adjusted other expense on our income statement will increase by about $34,800,000 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 $49,600,000 51 point $6,000,000 for the June quarter. For the full quarter of September 2018, we expect the total non GAAP other expense on the P and L to be between $113,000,000 $116,000,000. And we have assumed a 25 basis point increase and 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 de lever the balance sheet. Our net leverage at the end of the June 2018 quarter is expected to be 4.7 times, excluding the 20.37 convertible bonds on the balance sheet that are very long dated in nature and more rapidly like. We expect to reduce this leverage by about one term 3 year 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 5 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 $3,980,000,000 was split across the 5 product lines as follows. Microcontrollers 65.8 percent of our revenue.
Analog was 23.9 percent 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 6th product line category called FPGA, We expect Microsemi's revenue reporting to be split across 4 product lines, microcontrollers, analog, FPGA and MMO. It will take 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?
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. So for the June quarter, we expect Microsemi to add approximately $160,000,000 to $180,000,000 to our non GAAP revenue As we told you, the Microsemi deal will be accretive to a non GAAP EPS right from the beginning We expect Microsemi to add about $0.02 to $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 1st 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?
And our first question will come from Craig Ellis from B. Riley.
Yes, thanks for taking the question and congratulations on getting the deal closed in the time frame that you had originally projected guys. Steve, I wanted to follow-up with a clarification. Clarification on the first quarter's guidance, 1, in the $0.02 to $0.06 of earnings, are there any synergies included in that earnings guidance. And then you had a comment on, $0.75 of EPS in the 1st full year after the close. And then you said something in addition to that, I think you said $0.15 in the 1st full year, which would be the basically the midpoint of your initial guidance and why wouldn't it be higher than that given that you're starting $4 per quarter at the midpoint?
Thank you.
So,
the $0.15 was not for the full year. $0.15 was for the September quarter. Just for September quarter. Yes, so that's for 1 quarter. And $0.75 was after full year after 1 year.
And the other part of your question was whether $0.02 to $0.06 included any synergies. I mean, it's really the 1st month. I mean, you can't change much and have really a whole lot of effect in the 1st month. 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 Jaffray.
Hey guys, congratulations again. And again, pretty big deal closing in 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, but 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 year by business it and really answer the question. But 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 business, is proprietary other than a small amount of memory business that may not be. So 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.
So 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, but it's really, I think that's the number one reason. Second reason, maybe because there's not an abundant supply of semiconductors in the place. Environment is still quite good and there are plenty of challenges for the customers to be acquiring parts. So in that timeframe, I think it stops the leakage.
So I would say those 2 will be the reasons.
Fair enough. Thanks, Steve. I'll get back in line.
Thanks.
Our next question comes from Chris Cassell with Raymond James.
Yes, thank you. And congratulations getting the deal done. Just wanted to go through some of the assumptions, and I assume the $1.75 accretion target over the longer term is still the right number to use. Now 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.
And then, I mean, 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?
So I think with 2 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. But 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.
Then, we will be moving all of Microsemi products over to Microchip's enterprise system and 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 3 main ones, but there are many versions of it. So as they acquired acquisition, as they acquired other companies, they pretty much left them running on their own enterprise system. So 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's a lot of duplication and country level, VPs and managers and geographical vice presidents and others. So there'll be synergy coming out of there. We'll be looking at distribution network of both companies. There are common distributors and there are those that are not common.
And 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. You know, Microsemi also was really managing the business with sell in revenue recognition where Microchip Managers would sell through revenue recognition, just like we have seen with other companies, Atmel and Micrell, we 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. And 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. So I think we'll be, we'll be getting a gross margin on ESP lift coming from there. There is some natural growth environment. It's pretty good. Microsemi was guiding for to 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. So there is some growth coming. So if you look at all that, And then the R and D, we're finding we always find synergies R and D where 2 companies can commonly develop process technologies, key circuits, cost of qualification of technology, managing the foundries, managing the backend, And finally, on the, on the COGS side, just like we found in Atmel where we can take some of the packages assembly and tests 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 up 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.
So just takes a period of time. That's why we have given it 3 years to accomplish, but 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 and microchips obviously got a lot of customers, but microsemi brings you into some different end markets. What's the customer overlap between Microsemi and Microchip And I guess to the extent that you'd be bringing new customers on, how do you handle that? And I guess, are there cross selling opportunities as some of those new customers come under tent?
So there are, we do business at Microchip with about every customer in the world. I'm not sure anybody brings us totally new customers, but what happens is We do business in different applications or different business units sometime than atmelvaz or my semi was or micro standard microsystem was. So with each company within the same customers, you break into additional products, you break into additional business units of the customers and different sites. So I think that's where the incremental customers come from. And if you are doing business at a very large multinational company and we're doing business in 1 division and my is doing business in other division.
You could say that we have common customer, but it's usually not a common customer. It's just there's no reference from one to the other. It's just totally different. Different design team, different buying team, different manufacturing flow. So 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 microsemis, discrete products, especially now they make diodes and transistors and fats. And analog devices and voltage and DC to DC and all these general purpose parts that almost go into any terms going around our microcontrollers. So 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?
Yes, so we are not at a point where we want to give an updated CapEx forecast for fiscal 19 today. Microsemi's business historically has not been as capital intensive as microchips because they outsource a much larger proportion of their overall manufacturing activities in the 85% to 90% range of what they outsource. So as part of our plans, as Steve mentioned, we'll be evaluating what could make sense to, to bring in house. And we'll be evaluating that and building up that capital plan shortly. But I think overall, from a revenue percentage of revenue perspective, it's probably a little bit capital intensive than Microchip's business.
So that's the first piece of your question. What was the second piece, Craig?
I just had to that, just the free cash flow dynamics as they come on board?
So, I mean, Microsemi was generating a lot of cash on their own, you know, 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. So We indicated, publicly now that we think that we can de lever at about one term per year, which is important because we know we've taken on quite a bit of debt from this transaction that the buying 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, if I think you, 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? Most strategic in terms of where you see opportunities?
Yes, I think as we, told you when we announced the acquisition, the 3 major market segments, defense and aerospace, communication and data center are positions where microsemi has strong positions in. And, we absolutely fact that in all of them, we're going to find more microchip attach opportunities. And, in that sense, they're strategic to my semi standalone, but they'll be strategic for Microchip combined with Microsemi as well. And, we need to get into some more detail in terms of what exactly and what product lines. But already, our teams are identifying opportunities that they have not seen before.
That can be led through the leadership that Microsemi has. And it's both ways. We also have Microsemi products that we believe in the markets when Microchip is strong, we'll also find more attached 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, but Microsemi has been acquisitive in their own right. And in that process, they had often divested or shutdown pieces of businesses as they acquired other companies.
I wondered if microchips 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, 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, 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 how near in are there any either relatively earlier opportunities for cross selling in that manner?
Well, we don't have any information numerically, just not long enough to really put any numerical numbers on it. But in my earlier answer to the question, I don't know if you're listening to that one, I think I mentioned various areas in where there could be opportunity, at the where we sell into a customer in one division, but not the other division. And microsemi sells into another division. So it gives both companies microchip and microsemi opportunity to really sell also into other division and test the parts. When you begin with a design in, it always takes 2 years to get revenue.
6 months to get going and start designing the park in and then another year and a half before customer buys volume, But 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 the customer designs and identify opportunities where our chip could go in, where they didn't have a chip that could go in. And then, 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, 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. But there suddenly is some short term opportunity that we can start to harvest in about 6 months from now.
Thanks, Steve, and 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 cell in model?
What would the Microchip revenue be or Microsemi revenue be?
Yes, what would be
the difference if from the way they were reporting it is sell in and the way you're adding on the sell through? What's the difference between GAAP and non GAAP revenue with microsemi?
Steve, maybe I can take that. So, you know, the the the bottom line is on a sell in basis, the, 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 early numbers that are on a selling basis, you know, sometimes the, the customers or distributors are awaiting to make a deal at the end of the quarter. So there tends to be more back end weighted, and, you know, 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 cell in basis.
But, bottom line is we will report selling for GAAP accounting purposes, and that will be impacted in the 1st couple of quarters by all the purchase price accounting assessment. So it's kinda hard for the for investors to get a feel for that anyway. And if if Steve, you wanna add anything to that, go ahead.
No, I think that's really it. There's too many moving parts to mark up all the inventory for purchase accounting and make all those adjustments. So 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 and 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 selling would be higher than sell through, because sell through tends to be a little more linear and sell in is very back end loaded. But 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.
So based on the way we do it, I think the GAAP and non GAAP will be about the same because it would be just no incentive to put any more parts into distribution than is required. So my feeling would be it would be a similar range as we have guided $160,000,000 to $180,000,000, even if you look at it by gap, give or take some.
Yes. And that would be GAAP before any of the purchase accounting adjustments.
Yes.
Okay, great. That's what I it looked like it was very linear the way you're adding on to your revenue for just 1 quarter for 1 month out of the quarter. And just Looks like it'll be aligned more with your quarters, fairly linear through the quarter.
Yes, I think, honestly, just largely ignore the month of June. I mean, the deal could have closed at the end of June, close early. And 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 1 month, there's a lot of offset. There are things that are paid early.
There are things that are late. Things are with the revenue and OpEx. And when you take 1 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.
And that concludes our question and answer session for today. And I'd like to turn conference back over to Mr. Sange 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 a record time comparing to really what many of the other deals are going through. So thanks and We'll talk to you at some of the conferences we'll go to in this month, a month of June. And 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.