Good day, everyone, and welcome to the Microchip's Fourth Quarter Fiscal 2019 Financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Eric Bjornholt, Chief Financial Officer. Please go ahead, sir..

Good morning, everybody. 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 last evening 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 fourth quarter and full fiscal year 2019 financial performance. And Steve and Ganesh will then give their comments on the results, discuss the current business environment as well as our guidance, provide an update on our integration activities associated with the Microsemi acquisition.

We will then be available to respond to specific investor and analyst questions. 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 30, 2018, we adopted the 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 for revenue on such transactions were deferred until the product was sold by our distributors to an end-customer.

We continue to track and measure our performance internally based on direct revenue plus distribution sell-through activity and we'll provide a metric for this called end-market demand in our earnings release each quarter.

Therefore, along with our GAAP and non-GAAP results based on distribution sell-in, we will also provide investors with our end-market demand based on distribution sell-out, but will not provide a P&L on end-market demand. End-market demand in the March 2019 quarter was $1.34 billion, which was $10.4 million above our GAAP revenue.

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, which is based on expenses prior to the effects of our acquisition activities, share-based compensation and certain other adjustments.

Our fiscal 2019 non-GAAP results are calculated as the sum of the non-GAAP sell-through based information we disclosed previously for each of the first three quarters of fiscal 2019, plus the non-GAAP sell-in based information disclosed today for the fourth quarter of fiscal 2019.

Net sales in the March quarter were $1.33 billion, which was above the midpoint of our guidance and down 3.3% sequentially. We have posted a summary of our GAAP net sales and the end-market demand by product line and geography on our website for your reference.

On a non-GAAP basis, gross margins were 62.2% and well above the midpoint of our guidance, which was 61.5%. Operating expenses were at the low-end of our guidance range at 25.8% of sales. And operating income was $484.1 million and 36.4% of sales. Non-GAAP net income was $370.4 million.

Non-GAAP earnings per diluted share was $1.48, which was over $0.08 above the midpoint of our guidance of $1.395. For fiscal 2019, on a non-GAAP basis, net sales were a record $5.476 billion and up 37.6% year-over-year. Gross margins were a record 62.1%, operating expenses were 24.3% of sales and operating income was 37.7% of sales.

Net income was a record $1.636 billion and non-GAAP EPS was a record $6.55 per diluted share. Please note that for fiscal year 2019, our non-GAAP results are based on our publically reported non-GAAP results, which Q1 through Q3 as mentioned before were based on sell-through revenue recognition in the distribution channel.

And Q4 was based on sell-in revenue recognition in the distribution channel. Fiscal year 2020 non-GAAP results will be based on sell-in revenue recognition, in line with our GAAP revenue reporting and the revenue recognition standard adopted during first quarter of fiscal 2019.

On a GAAP basis, gross margins were 61.7% and include the impact of $4 million of share based compensation and $1.8 million of acquired inventory valuation cost.

Total operating expenses were $535.9 million and include acquisition intangible amortization of $176.9 million, special income of $23.3 million, $4.4 million of acquisition related and other costs, and share based compensation of $35.1 million.

The GAAP net income was $174.7 million or $0.70 per diluted share and includes an income tax benefit of $23.5 million.

The GAAP tax benefit in the quarter related to a variety of matters, including tax reserve releases due to statute of limitations expiring, tax reform refinements and tax benefits associated with restructuring the Microsemi operations into the Microchip global structure.

On a GAAP basis for fiscal 2019, net sales were a record $5.35 billion and up 34.4% year-over-year. Gross margins were 54.8%. Operating expenses were 41.4% of sales and operating income was 13.4% of sales. Net income was $355.9 million and EPS was $1.42 per diluted share.

The non-GAAP cash tax rate was 1.4% in the March quarter and 3% for fiscal year 2019. For cash planning purposes, we were able to defer the payment of some of our fiscal 2019 taxes into fiscal 2020. And this is one of the reasons our FY 2019 tax rate was lower than originally projected.

We expect our non-GAAP tax rate for fiscal 2020 to be between 5% and 6%, exclusive of the transition tax, any potential tax associated with restructuring the Microsemi operations into the Microchip global structure and any tax audit settlements related to taxes accrued in prior fiscal years.

We have many tax attributes and net operating losses and tax credits, as well as U.S. interest deductions that we believe will keep our tax cash payments low. The future cash tax payments associated with the transition tax is expected to be about $246 million and will be paid over the next 7 years.

We have posted a schedule of our projected transition tax payments on the Investor Relations page of our website. Moving on to the balance sheet, you will notice that Microchip's accounts receivable balance is up significantly from the prior quarter.

We have made an accounting presentation change to reclassify the distributor price adjustments that reduce the amount of cash we ultimately receive from our distributors from a reduction in the AR balance to an increase in accrued liabilities.

Remember, that we generally sell to our distributors at a price that is higher than the ultimate sales price and then that price is reduced by a distributor price adjustment when the ultimate sale occurs to the distributors' customers. Excluding this reclassification, our accounts receivable balance was up about $5 million in the quarter.

Our inventory balance at March 31, 2019 was $711.7 million. All the inventory markup for Microsemi required for GAAP purchase accounting has now been sold through and is no longer reflected in the ending inventory balance. We had a 128-days of inventory at the end of the March quarter, up 5 days from the prior quarter's level.

Inventory at our distributors in the March quarter were up 35 days compared to 36 days at the end of December. We believe that barring any negative developments in the U.S./China trade front, our distributors are holding a reasonable level of inventory to support end-market demand.

The cash flow from operating activities was $403.4 million in the March quarter. As of March 31, the consolidated cash and total investment position was $430.9 million. We paid down $277.5 million of total debt in the March quarter. And the net debt on the balance sheet reduced by $272.3 million.

At March 31, our debt outstanding includes $3.267 billion of borrowings under our line of credit, $1.912 billion of term loan B, $2 billion on high grade bonds and $4.481 billion of convertible debt. Our EBITDA in the March quarter was $544.4 million, and our trailing 12 months EBITDA was $2.212 billion.

Our net debt-to-EBITDA, excluding our very long-dated convertible debt that matures in 2037 and is more equity-like in nature, was 4.8 at March 31, 2019.

Our net leverage metrics are based on a 12-month trailing EBITDA, which will continue to provide some headwinds due to the distribution inventory reductions that were made in the June and September quarter for Microsemi, which caused our shipment activity to be significantly less than the end-market demand during these periods.

The weaker economic environment also has negatively impacted our EBITDA in the December 2018 and March 2019 quarters. We are committed to using substantially all of our excess cash generation beyond our dividend payments to reduce our debt levels and we expect our debt levels to reduce significantly over the next several years.

Our dividend payment in the March quarter was $86.7 million. Capital expenditures were $40.1 million in the March 2019 quarter and $228.9 million in the fiscal year 2019. We expect about $35 million in capital spending in the June quarter and overall capital expenditures for fiscal year 2020 to be between $130 million and $150 million.

We continue to add capital to support the growth of our production capabilities for our new products and technologies and to bring in-house more of the assembly and test operations that are currently outsourced.

These capital investments will bring some gross margin improvement to our business, particularly for the outsourced to Atmel and Microsemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the March quarter was $48.4 million.

I will now turn it over to Ganesh to give us comments on the performance of the business in the March quarter and provide an update on some of the Microsemi integration activities.

Ganesh?.

Thank you, Eric, and good morning, everyone. Before I get started, I'd like to clarify that the product line comparisons I will be sharing with you today are based on end-market demand, which is how Microchip measures this performance internally. Let's start by taking a closer look at microcontrollers.

Our microcontroller business was sequentially down 4.6% compared to the December quarter, reflecting the broad macro weakness in the markets we serve. Microcontrollers, however, were up 8.6% from the year-ago quarter. On a fiscal year basis, fiscal year 2019 microcontroller revenue was a record at over $3 billion and grew 15% over fiscal year 2018.

Microcontrollers represented 53.3% of our end-market demand in the March quarter.

During the quarter, we continue to introduce a steady stream of innovative new microcontrollers, ranging from the industry's first Arm-based microcontroller with space-qualified versions that have scalable levels of radiation performance; new dual- and single-core dsPIC33C Digital Signal Controllers with built-in functional safety; the industry's smallest IEEE 802.15.4-compliant module that combines an ultra-low-power microcontroller with a sub-gigahertz radio.

And last but not least, we unveiled our unified 32-bit microcontroller software framework called Harmony, extending support for Atmel-originated SAM microcontrollers in Microchip's development tool environment.

We now support our MIPS-based microcontrollers as well as our Arm-based microcontrollers on a single development environment of MPLAB and Harmony. Last month, Gartner released their microcontroller market share report for calendar year 2018. We're pleased to report that Microchip retained the number one position for 8-bit microcontroller.

Once again, we gain market share as we grew faster than the 8-bit microcontroller market overall. And in fact, we are now 73% larger than the number two player.

In the 16-bit microcontroller market, we remained in the number five position and continue to gain significant market share, as we grew faster than all our top competitors and at about 5x the growth of the 16-bit microcontroller market.

In the 32-bit microcontroller market, we remained in the number six position and gain significant market share, as we grew almost at 2x the growth rate of the 32-bit market - microcontroller market. We were also the fastest growing franchise among the top six players, who make up over 80% of the 32-bit microcontroller market.

These results are despite, Gartner rolling up our 32-bit microcontroller revenue to be 30% lower than the over $1 billion revenues that we informed you of in our last conference call. Had Gartner used our actual calendar year 2018, 32-bit microcontroller revenue, we would have moved up to the number four ranking.

Additionally, our 32-bit microcontroller revenue in fiscal year 2019 was over $1.1 billion demonstrating continued momentum. For microcontrollers overall, we remained in the number three position and grew faster than the two players ahead of us.

The Gartner reported revenue is considerably lower than our publically reported revenue for calendar year 2018. Using our publically reported revenue, we would be approximately 13% and approximately 18% away from the top two players ahead of us. As we continue our relentless march toward the number one spot.

Our microcontroller portfolio and roadmap has never been stronger. We believe we have the new product momentum and the customer engagement to continue to gain even more share in 2019, as we further build the best performing microcontroller franchise in the industry. Now moving to analog.

Our analog business was sequentially down 5.8% compared to the December quarter, reflecting the same broad macro weakness our microcontroller business experienced. Analog, however, was up 60.2% from the year-ago quarter.

On a fiscal year basis, fiscal year 2019 analog revenue was a record at well over $1.5 billion, and grew 64.6% over fiscal year 2018. Analog represented 29% of our end-market demand in the March quarter.

During the quarter, we continue to introduce a steady stream of innovative analog products, including a new analog to digital converter family that enables high speed, high resolution analog to digital conversions in harsh environments.

Our FPGA business was sequentially down 5% as compared to the December quarter, reflecting the same broad macro weakness. However, design wins in our new low-power mid-range PolarFire family continue to grow strongly. And we are optimistic about this product family adding another leg of growth for the future.

During the quarter, we introduced the PolarFire FPGA imaging and video solution that supports resolution as high as 4K in the small, low-power form factors necessary for a wide variety of imaging and video applications. We also released our Libero SoC design tool, which offers a unified suite.

FPGA represented 7% of end-market demand in the March quarter. Moving next to our licensing business. This business was sequentially down 42.3% as compared to the December quarter. The production activity of our licensing customers has been cut significantly in response to industry conditions.

Also as we mentioned in our February conference call, we did not expect nor have any meaningful patent licensing revenues in the March quarter, while we did in the December quarter.

Our patent licensing strategy is to monetize portions of the substantial patent portfolio, we inherited through our acquisition by licensing select patents to players in non-competitive fields of use, while retaining the rights to these patents in our products as well.

Investor should expect that the revenue contribution from patent licensing in the future will be lumpy from quarter-to-quarter. Our memory business was sequentially up 3.8% in the March quarter as compared to the December quarter. And finally, our multimarket and other business was up 3.5% sequentially as compared to the December quarter.

A quick update about our Microsemi integration, as we come up on the one year anniversary after the close. Business units, sales, operations and support groups are all making good progress. Our thanks go to the combined company employees, who are working hand-in-hand to achieve accelerated synergy results.

Overall, we are ahead of our synergy targets and expect continued synergy gains for many quarters to come. Business systems and operations integration is taking the longest time to complete, as we're conducting this complex transition in phases.

The first and second phases were completed on November 1 and February 1, respectively for a combined total of four business units. The third phase went live on May 1 and involved four more business units.

With that, we are about one-third of the way through the business systems and operations integration, and more phase releases are planned every quarter. We expect the overall business and operational integration will take about another 12 to 15 more months to complete.

Finally, prior to our acquisition, Microsemi had announced the closing of the small 4-inch fab Bend, Oregon. The last wafers came out of this fab at the end of the March quarter and we ceased production on schedule. Additionally, we were able to find a buyer for the fab and closed the sale last week. The sale price was not material to Microchip.

Let me now pass it to Steve for some comments about our business and our guidance going forward.

Steve?.

Thank you, Ganesh, and good morning, everyone. Today, I would like to first reflect on the results of the fiscal fourth quarter of 2019. I will then provide guidance for the fiscal first quarter of 2020. Our March quarter GAAP and non-GAAP net sales based on sell-in revenue recognition came in just a tad above the midpoint of our guidance.

The business in the quarter proceeded as we had expected. Our end-market demand measured by sell-through was about $10 million higher than the sell-in revenue. But unfortunately, we cannot call sell-through based market demand as revenue anymore based on the new revenue recognition standard.

The end-market demand were stronger than sell-in revenue, which is consistent with our thesis that the channel is continuing to manage their working capital conservatively by reducing inventory due to uncertainty. Our consolidated non-GAAP gross margin at 62.2% exceeded the high-end of our guidance.

Our consolidated non-GAAP operating margin of 36.4% was also above the high-end of our guidance. These gross and operating margin percentages are the highest results we have ever posted at the bottom of a cycle. Our consolidated non-GAAP earnings per share exceeded the midpoint of our guidance by over $0.08 per share.

On non-GAAP basis, this was also our 114th consecutive profitable quarter. I want to thank all employees of Microchip including employees from all of our acquisitions for their contribution. One other area I wanted to point out is our debt payments. In the March quarter, we paid down $277.5 million of our debt.

Our total debt payment since the end of June 2018 has been $1.156 billion. With expected $250 million payment in the June quarter, we expect to have paid down about $1.4 billion of our debt since the closing of the Microsemi transaction on May 29, 2018, which we feel is excellent progress.

In addition, with Federal Reserve Board expected to be on hold for any further interest rate increases, we're optimistic that the peak of our debt-to-EBITDA leverage is behind us and we should see meaningful reduction in leverage in the next one year starting this June quarter. Now, I will provide you guidance for the June quarter.

The guidance we provided for the September quarter of last year, which reflected our caution on business conditions, turned out in retrospect to be spot on and was a harbinger for broader industry weakness through the last several quarters.

In our last quarter earnings call, we said that barring any negative development on the trade front, we see the March 2019 quarter to mark the bottom of this cycle for Microchip. Secondly, we said that last quarter we did not know the shape of the recovery, whether it is V, U or L shaped. And it would depend somewhat on the outcome of the trade talks.

Towards that end, we did not get a settlement on the trade front. In fact, in recent days, the rhetoric has turned more negative with 25% duties on $200 billion of Chinese goods expected to go into effect this Friday. Therefore, the uncertainty related to U.S. China trade relations continues.

Given this continued uncertainty, we see weaker than seasonal business conditions for Microchip.

We continue to operate our business prudently for long-term shareholder value and we believe that the end-market demand will continue to be stronger than the GAAP sell-in revenue in the June quarter, and the channel and customer inventory will continue to decrease.

Given this color about business conditions, we expect net sales for our products to be about flat sequentially plus or minus 5% in the June 2019 quarter. We want to correct some of the analysts' and investors perception about what is the seasonal growth for us in the June quarter.

If you take our past year's revenue as it reported and average them for a calculation of the June quarter seasonality, you will get a very wrong result, it is because several of our acquisitions closed in April. Supertex acquisition closed on April 1, 2014. Atmel acquisition closed on April 3, 2016. And Microsemi acquisition closed on May 29, 2018.

If we make the calculation based on moving the acquired company sales in the first quarter then based on the last seven years at average net sales in the June quarter were up about 3% sequentially. Therefore, our current flattish guidance at the midpoint for June quarter is below historical seasonality for classic Microchip.

We expect our non-GAAP gross margin to be between 61.8% and 62.2% of sales, we expect the non-GAAP operating expenses to be between 25.3% and 26.3% of sales. We expect the non-GAAP operating profit percentage to be between 35.5% and 36.9% of sales. We expect our non-GAAP earnings per share to be between $1.26 per share to $1.49 per share.

Now the next question is what happens after the June quarter. The hints coming out of Washington regarding the status of U.S. China trade talks continue to oscillate between positive and negative.

While there is no guarantee that talks will end successfully with the settlement, we believe that any finality of such talks will remove some of the uncertainty and will have positive effect on the business.

China has already taken a number of stimulus measures to boost business including a cut in the VAT from 16% to 13%, cutting the personal income tax rate and cutting reserve requirements of the banks thus increasing the money supply.

We have seen some strength in our China business from the bottom in the March quarter and expect more strength to pick-up in the second half of calendar 2019. The automotive business continues to be weak around the world, because of car production down in U.S., Europe and China.

We expect that our automotive business, bottomed in March quarter, too, and should start to recover from the low base and strengthen into the second half of calendar 2019.

Considering all of the above factors, we are renewing our belief that barring any negative developments on the trade front, we will expect the business recovery to pick-up in the second half of calendar 2019.

Given all the complications of accounting for acquisitions, including amortization of intangibles, restructuring charges and inventory write-up on acquisitions, Microchip will continue to provide guidance and track its results on non-GAAP basis, except for net sales, which will be on a GAAP basis.

We believe that non-GAAP results provide more meaningful comparison to prior quarters and we request that the analysts continue to report the non-GAAP estimates to first call.

With this, operator, will you please poll for questions?.

Of course, thank you. [Operator Instructions] Okay. We will now take our first question from John Pitzer from Crédit Suisse. Please go ahead. Your line is open..

Yeah, good morning, guys. Thanks for letting me ask the questions. Steve, my first question, very helpful to - help us understand how you're viewing seasonality into the June quarter, but just given all the acquisition, and I think a couple of quarters ago you talked about still trying to understand the seasonality of all the new businesses together.

I'm wondering if you could just level set everyone on the call and help us understand how you think about seasonality in September, December, in March as well as June?.

John, we're not able to give forward-looking seasonality for multiple quarters yet. We haven't had enough experience on the Microsemi front. Some of the last year's performance was affected by the inventory reduction we undertook in distribution. So we haven't had number of normal quarters.

Then we got hit by all these U.S./China trade issues for the last couple of quarters that we have been fighting and are now looking for the recovery. So the historic seasonality for June quarter I mentioned was to remove the acquired company's first quarter revenue and then average the last 7 years.

We certainly can do that for the September and December quarter, and provide that information to the investors, but that would be backward-looking seasonality. We are not yet able to give you information on the forward-looking seasonality..

That's helpful. And then just as my follow-up, on the CapEx guidance for the new fiscal year, it's down fairly meaningfully year-over-year.

To what extent is that just a reflection of the weak business environment? Or is this just really some of the CapEx projects you had in place to help integrate the acquisitions are mostly behind you? And how do we think about kind of the run-rate of CapEx, whether as a percent of sales or an absolute dollar number from kind of what you're projecting for the current fiscal year?.

Okay. This is Eric. I can take that question. So as indicated, we're projecting somewhere between $130 million and $150 million in CapEx for fiscal 2020. That's down from about $230 million in fiscal 2019.

Fiscal 2019 we have some kind of onetime events associated with some building projects that we talked about at the last few conference calls that was in the $60 million to $70 million range. And we have put capacity in place in the first half of last fiscal year, expecting the environment to be stronger. So I think we're pretty well positioned.

And then we also have a full year of Microsemi, couple of months in fiscal 2020 compared to fiscal 2019. So all that combined, I think our CapEx projection is reasonable range for the current year.

I think over the course of time, we'll be in that 3% to 4% of sales and there will be peaks and valleys to that just based on the environment that we're facing at that time..

Thanks, guys..

Thank you. We will now take our next question from Chris Danely from Citi. Please go ahead. Your line is open..

Hey, thanks, guys. So, Steve, your tone seems a little more pessimistic than it did three months ago.

So has anything changed? Is this just because we're looking at another $200 billion? Has anything changed in your business over the last week or the last, I guess, three months since you're last on the call to make you little more pessimistic on how things are going?.

Well, what changed is really the tone on the U.S./China trade front, going from lot of positive signals coming from various officials, including Secretary Mnuchin and all that over the last couple of months.

And then, turning into a tweet by President Trump on Sunday that the 25% tariffs on $200 billion of Chinese goods are going into effect this Friday, resulting into cancellation of the visit by Vice Premier of China first and then later on he put back the visit and he is now arriving on Thursday.

So the rhetoric has turned meaningfully negative here and causing significant uncertainty. Now, there hasn't been a lot of time since that news to gauge the reaction of our distributors and customers. And as you know, we have very broad distribution and thousands and thousands of customers. And in couple of days you cannot really gauge all that.

So, yes, our tone has turned distinctly negative due to those developments..

Sure.

I guess, if this wasn't going on, maybe last week or the week before, what would your guide just be and what have you heard from customers kind of as the quarter has progressed on the their tone of business?.

I think that's kind of would I, should I, could I, we don't know. But certainly, our guidance would have been much more narrower in the range versus a wide range. And the guidance would have been more positive on the midpoint than the one we have provided now..

Okay. Thanks, Steve..

Chris, I would add also, the trade resolution has also been delayed. So not only the most recent news from the weekend, when we were speaking to everybody back in February, there was a much earlier date for resolution. So that continues to push out and create uncertainty as well..

During our conference call last quarter, which I think was on February 9 or something, the trade resolution was supposed to happen prior to March 1. So it was relatively imminent. Then it was delayed to May 1 and then it didn't happen on May 1. And then the events turned negative. So there has been a substantial delay and change on that front..

Okay. Thanks..

Thank you. We will now take our next question from Harlan Sur from JPMorgan. Please go ahead..

Morning. Thank you for taking my question. Last year Analyst Day which was held in early March of last year, you guys were able to accurately call out the trends for the June quarter and even provide June quarter sequential growth outlook.

And I think a big part of the analysis back then was the rate of backlog built for the June quarter post Chinese New Year, so which in a normalized environment kind of flattens out during CNY and then rises post Chinese New Year. So, I guess, the question is what seems like you didn't see this type of recovery in the backlog this year.

So maybe if you could just provide us with some color here on the backlog trends, post-CNY this year? And what are the current backlog trends telling you about the September quarter?.

So I think the environment is of significant uncertainty, because of U.S./China trade talks this year than it was last year, there was no such uncertainty.

The only uncertainty we were dealing with last year was investor's perception about the letters we had written a year before, which many investors felt that pulls demand up and there will be a correction. And I think we showed through the charts that there was no such effect of the letters we write.

Those letters are simply to inform our customers' broad base of 120,000 plus customers, the environment we were dealing with. And through backlog in turns and various metrics we show to the investors that our business was in good shape and we were not really seeing any challenges.

The environment today with uncertainty with the two largest markets we have, which are the U.S. and China, together they make close to 50% of our business, if not more, is of significant more uncertainty. And simply looking at the backlog in turns and all that in the middle of the quarter cannot make up for large amount of customer sentiment.

So having said all that, our backlog on April 1 started lower than our backlog was on January 1, because last quarter bookings were weak. So our backlog started lower.

However, the bookings quarter to date in this quarter for the month of April and few days in May has been stronger than the bookings we got at the - during the same time last quarter from January 1 to February timeframe. So the bookings are stronger. And the turns coming from those bookings are stronger, because the lead-times are short.

But with significant change in the sentiment, driven by just the events of last few days, it's very difficult to project what the distributor and customer sentiment would be in the balance of the quarter.

Just imagine if you were a supplier and you didn't know whether you will be able to pass on a 25% tariff increase to your customers, whether your customer will then choose to buy that product from Korea, Taiwan or somewhere else and that's from the Chinese supplier.

In that environment, you would take actions to protect your business by not having large amount of inventory only building to form orders and negotiating with your customers, what kind of price increase you can pass on.

Those are all uncertainties of thousands and thousands of customers have been dealing with for quite a while impacting our business..

I think, one of the thing I would add to what Steve said is, comparing the sentiment at March 1 last year when we did our Analyst Day to today, the other significant change over that time period is lead times have contracted significantly.

And so that gives customers flexibility to place very short-term orders on us and to be responsive, which wasn't necessarily the case over a year ago back in March..

Great. Thanks for the insights there. My follow-up question is strong showing on the market share front in MCUs for 2018. On 32-bit, you guys do your business almost 900 basis points, faster than in the overall market.

And I don't think, Microsemi had any 32-bit MCUs, so pretty much all organic, you've got your MIPS architecture, you've got your ARM family. You guys could just help us understand the drivers of the strong outperformance. I assume maybe part of it is helping your customers move up stack.

But what are some of the other dynamics driving the strong market share performance?.

So it is not completely correct, that Microsemi had no 32-bit microcontroller. They did have a class of what we call specialized microcontrollers, which are 32-bit microcontrollers. But in general, the classic Microchip 32-bit products of both architectures, MIPS and ARM, have been doing extremely well.

As you know, we acquired the ARM microcontrollers through the Atmel acquisition, so that is given us the ability to serve a broader set of customers, a broader set of applications.

And so that combination of both what classic Microchip could do with the 32-bit microcontrollers we have, that a more general purpose, plus some of the specialized microcontrollers that come through Microsemi, all contributed to the last 12 months or the calendar year 2018 growth numbers that you see..

Great. Thank you..

Thank you. We will now take our next question from Rajvindra Gill from Needham & Company. Please go ahead. Your line is open..

Yes. Thank you for taking my question. Yes, just to follow-up on the China trade issue, I'm trying to get a sense in terms of how the issues with trade, how it translates into actual orders on the ground.

A lot of the companies in the coverage, that you saw kind of an abrupt cut in orders from their customers in China starting in December different from kind of past cycles and then have been starting to see some rebound, and given kind of your guidance in June reflecting kind of weaker seasonal trends even though the comment from Trump came out on Sunday.

I'm just trying to reconcile your guidance and the short nature of the change in sentiment, because this only happened last week, and the actual impact that you're seeing on the ground to give you - to give way to give the guidance in the first place..

Hi, Rajiv. It's very, very difficult to accurately assess the impact of the substantial negative turn on the developments of trade talks. That's why we have a fairly broad guidance not being accurately able to model the impact.

These are not the issues where there is a - historic record of what happens, and then these kind of things haven't happened in history, so only in the last couple of quarters. And I think, we predicted the downturn better than anybody in the industry, we were the first one to predict that.

And many of the earnings report, this season came before the Trump's tweet on Sunday citing the talks have turned negative. So having that knowledge that these talks have returned negative, in our announcement last night in our earnings, we have to put the possibility of negative customer behavior.

One thing I have described before to analysts and investors in various calls and meetings. The world economy largely runs on people building to forecast. Every manufacturer builds large amount of their products on forecast form electronic stores to grocery stores to furniture stores.

You go to a store and grocery store is full of grocery and you put it in the bags and you go home. If the manufacturers did not put the grocery store inventory, you would go there and just place your order and come back in two days to pick it up.

So in an uncertain environment, when the - when our customers, I'm not able to figure out the demand for the products, because they do not know, whether they will be able to pass it 25% tariff to their end customers.

In their environment, they stop a building to a forecast, and they largely want to build to hard orders, where they can negotiate the price increase. And that is happening with our industrial customers, with our consumer customers, housing appliance customers. You have heard where prices for washers and dryers and others have gone up 20%.

So in that environment, the ecosystems squeezes down the inventory from end customer inventory to loading docks to intermediate hubs to stores to everywhere else. And that creates a negative impact on our ability to supply chips, which then eventually going to products.

And you have seen that phenomena experienced by every other semiconductor manufacturer whose revenue has fallen in the last six, nine months, where back in August, nobody was confirming that there's a problem, when we said there was a problem.

Does that make sense, Rajiv?.

Hello?.

Yes..

Yeah. I think that makes sense. It's a moving target, I just read that now, that Trump said, the Chinese Vice Premier is coming to the U.S. to quote make a deal. So I guess, it's a constant change. But I appreciate. Thank you..

Thank you. We will now take our next question from Vivek Arya from Bank of America Merrill Lynch. Please go ahead..

Thanks for taking my question. Steve, I know, we're trying to get the best sense for June, and I understand and appreciate that it's a moving target. So the conservatism is justified. My first question is that in just in terms of what you have actually seen so far in terms of bookings from your customers in China or U.S. or Europe.

Is it fair to say that any of these concerns about trade have not yet reflected in those bookings so far? But have you seen any trend, I realize that we are just within a week of all these political development.

But so far, is it fair to say that you've not really seen any negative development in bookings from any geography or end-market or anything along those lines?.

So Vivek, you have to first decide from what timeframe you're comparing. If you're simply comparing it to what we talked last Friday, yes, we have not seen an impact in the last two days, because it's just too hard to gauge. But if your timeframe is February 9, our last call, then we have seen the impact.

At that time, the trade settlement was supposed to happen prior to March 1 then it got delayed to May 1, and we didn't - then we didn't see it on May 1 either.

So all the time, we have seen the impact on bookings and customers' ability to want to build the appropriate amount of inventory for the business from the endpoint inventories to loading docks to hubs to everything else.

If your reference point is our last earnings call, yes, the business is weaker than what it could have been, if there was a settlement on March 1..

Got it. I asked that Steve, just because I think your March numbers were actually fine, and I think, what you mentioned was that so far in June. The bookings have also been fine. But let me leave that aside for a second.

On Microsemi, could you remind us how much earnings accretion you finally saw now that fiscal 2019 is over? And how much earnings accretion, we should be thinking about from a fiscal 2020 perspective? Thank you..

Okay. So we have not broken out in the current quarter, what - the quarter we're just reporting what the Microsemi contribution was. We are definitely ahead of schedule. We had mentioned last quarter that we had achieved kind of one-year target of run rate of 75% accretion. We were above that as the end of December.

And that things are continuing to progress, we're taking cost out of the system. Ganesh gave commentary in terms of how we're doing on business units and sales and support groups from an integration perspective, so making good progress. We still feel good about our long-term synergy numbers and are working towards that.

But we haven't broken out and aren't breaking out at this point in time, that specific accretion that we've achieved so far..

Thank you..

Thank you. We will now take our next question from William Stein from SunTrust. Please go ahead. Your line is now open..

Great. Thanks for taking my questions. I have two. First, the company posted some better-than-expected results on the gross margin line. Can you help us understand whether that's attributed more to mix or cost savings from Microsemi or anything else? And then I have a follow-up, please..

Okay. So I'll take that. So we exceeded the midpoint of our non-GAAP gross margin guidance by about 70 basis points. The very strong gross margins were driven by a variety of reasons, including favorable product mix and ongoing cost reduction. So it always is a mix of things.

There's a lot of moving parts, margin, but we're making good progress on integration and the product mix was favorable in the quarter also to help us with that. And even at the midpoint of our guidance on the current quarter at 62%, we're only really 1% away from our long-term target of 63%. So I think things have really held up well in this downturn.

Yes, our inventory situation is a little bit higher than our target, but with short lead times and customers and distributors been in the pattern of decreasing their inventory levels. It gives us the visibility to respond very proactively to their needs..

I would reemphasize one point that I made in my prepared remarks that as we go through various cycles, you can look at in the last 20 years. This would be the highest growth in operating margin nearly at the bottom of the cycle. In the past, you will see this kind of growth in operating margin usually on the top of the cycle.

So this is how much we have improved creating higher highs and higher lows. So as we go further in the next couple of years, complete this integration, have better loading in the factories with the demand coming back. It's really a good feeling to think about where the growth in operating margins could go..

I appreciate those comments. One follow-up, if I can. Turning to the Microsemi acquisition, less about the integration, but more about the inventory, I understand from the prepared remarks that you've worked through all of the Microsemi inventory that was on your balance sheet.

I was hoping you could comment on inventory, not only in the channel, but in any other places like at customers to the degree you can see it. Is that work down to more normal levels where this is less of a deterrent to grow going forward? Or is there still some inventory in channel or at customers to work down? Thank you..

Yeah. So I think, we've done a good job of working through the issues that we've identified early on in the acquisition. The Microsemi distribution inventory, take you back to the September quarter.

It was reduced to about 2.6 months over the course of the first four months of holding the assets, and the shipment activity into this distribution was impacted dramatically by that. But that has stayed very constant, that 2.6 months has stayed the same and the December quarter and the March quarter. So we think, we've got a good balance there.

There can be a business unit or two that adds a little bit of elevated inventory, and just taking some time to leave that down? But overall, I think, we are in good position. And the other things, that we had talked about was contracts, manufacturing inventory; and things like that. And I think all those have been corrected at this point in time.

Steve or Ganesh might have some additional comments..

The only comment I'll make is, I think, in terms of end customers, we really don't get inventory reports. So we don't think there's a big overhang there. But we don't have much visibility into it. Our own inventory internally, we're continuing to work down.

So this is our production areas and we have been running lower than what the sell-through as in terms of what we're building, and that is slowly coming back into levels that should be, but it's not completely where it needs to be..

Thank you..

And we did take a under capacity utilization charge in the quarter overall for various factories of a little over $7 million in the last quarter..

And as the demand comes back, and when that $7 million charge goes away, that $7 million ends up in the gross margin..

Yeah. Excellent..

Thank you. We will now take our next question from Craig Ellis from B. Riley FBR, Inc. Please go ahead. Your line is open..

Yeah. Thanks for taking the question. I'll start with clarification on two operating items. First, debt reduction came in much better than expected at least on my front, and the outlook suggests that the improvement that the company saw versus expectations is structural.

So I wanted to get some clarification on that, and further on the comments that Ganesh had in his prepared remarks, where he outlined three milestones that have been achieved with business integration.

The clarification there is, is the financial benefit fairly linear with the milestones achieved, so that we're about one-third of the way through the financial benefit? Or is it front-end loaded or back-end loaded?.

So Craig, just to clarify, you had started off with - it's an OpEx question, right?.

The first one is debt reduction. And the $277 million, I thought that was above the expectation of the company.

What's the cause of the positive variance?.

Okay. All right. So we continue to really manage our working capital requirements quite tightly, and had a good execution there, and just managing our overall cash balances worldwide. So we've outperformed on debt pay down, no doubt about that, over the last couple of quarters and made good progress.

I've mentioned that our debt-to-EBITDA is still 4.8 and we expect as we progress in the second half of 2019. And the EBITDA improves, and we're going to continue to be using all of our excess cash generation to pay down debt that we will see some significant improvements in our debt-to-EBITDA.

So I think, it's the working capital management, we talked about CapEx a little bit earlier, also CapEx being down significantly in fiscal 2020 as a projected number compared to fiscal 2019 will also help on the cash flow and we should expect to see debt come down significantly over the course of the next 12 months..

To your second question on the business and operations integration. It's on a longer-term basis, it's more linear, but quarter-to-quarter, we're going to see more or less effects depending on are we able to retire some of the prior ERP systems completely or not. And so it's not entirely linear looking at the quarter-to-quarter..

Thank you. And then the follow-up is for Steve. Steve, you given us a very clear picture of the dynamic that you're seeing now and the way recent political developments are impacting, you're thinking. What I wanted to do is, is reconcile that with comments that I thought, I heard you say that there could be a pickup in the back half of the year.

Is that potential pickup more predicated on a favorable set of developments that could happen on the macro front? Or is it closer proximity to typical enterprise and consumer bills that would take place in the back half of the year or something else? Thank you..

I think there are two possibilities on the trade front, actually three. One, the worse would be that trade talks break and there is 25% duty, not only on the $200 billion of goods, but another $325 billion of goods that are threatened. That will be the worst-case scenario.

But the other possibilities are there is some very good settlement, where whatever the issues are between the two countries on IP theft and forced transfers of technology, and all those things, there is a system put in place to monitor all these and issues are resolved and tariffs come down. That would be the best-case scenario.

And the other one is that there is some sort of finality, but it's not as good as U.S. wants.

As long as there is a finality on the settlement, where the people know what the rules are, then the manufacturers can adjust to those rules and can negotiate with their customers to pass the additional cost, whether it's 5%, 10% duty cost, as long as there is a finality, I think will be positive for the business.

Of course, it will be extremely positive if there is a settlement and duties go away, and there is a very good environment. But even if it is not the ultimate best, but there is some sort of finality, I think they would be better than the uncertainty we're dealing with..

That's very helpful. Thanks, gentlemen..

Thank you. We will now take our next question from Harsh Kumar from Piper Jaffray. Please go ahead. Your line is open..

Yeah, hey, guys. First of all, we appreciate your position, trying to guide in all this seesaw trade chatter and running the company prudently for the long-term. Steve, now, you're taking share for quite a bit of time in what is a mature 8-bit market.

What do you think are some of the things that Microchip specifically is doing that is helping you take share in that market?.

Well, I don't really want to tell my competitors how I'm taking shares.

I would simply say that if somebody doesn't develop any more 8-bits parts and adds no innovation to them, simply because that by a thesis that 8-bit market is not growing and put all their energy in the 32-bit, then they will continuously become more and more uncompetitive in the 8-bit and will continue to gain share, which is really what's happening.

There are many more things we're doing, but we are continuously able to show 8-bit customers how they can keep on utilizing our newer and newer 8-bit microcontrollers and continue to add innovation and not having to go to 16 or 32-bit microcontrollers. And therefore, we've taken a lot of share..

Fair enough, Steve, thanks for that color. And then, I wanted to ask about - you cited some bookings data and some order data, all of it seems to be improving, the back-half commentary is improving.

Would it be fair for me to assume that, that you basically haircut it what you might - let's say, you were doing earnings last week, you might have had a completely different commentary, completely different set guide.

You simply haircut it that based on the developments this week, is that a fair assumption?.

Yes, that's a fair assumption..

Okay. Thank you..

Thank you. [Operator Instructions] We'll now move on to our next question from Kevin Cassidy from Stifel. Please go ahead. Your line is open..

Okay. Thank you for taking my question. Steve, you mentioned the automotive market. You thought that that had hit a bottom and is coming back.

Can you give a little more details around that? And, also just maybe what your content increases might be for this year?.

So I think the way to think about it is not that it is rebounding into this quarter. I think we said it's hitting bottom and it is heading to where as we look into the second half, things are getting better. The content increases, a constant effort that we drive.

We have shown you some of the slides in investor forums where we have 60, 70, 80 different components. And that continues to take place. And various carmakers may not be for the same design in every carmaker. But it is a part of how we drive the market. It is a part how the market is evolving.

There is more and more electronics that is going into safety, into convenience, into some of these new electric and electrification and ADAS, those types of trends. And we have our fair share in all of those areas.

And I think the last piece is the European WLTP regulational change, I think the last remnants of that will cleared into the - by the end of this quarter. It has taken longer to clear. But believe that all that clears as we go through the end of this quarter. So those are all the different factors going into some of the color that Steve provided..

Okay, maybe just as a follow-up, that China VAT tax, have you seen a more positive bookings from the Chinese automotive companies?.

We haven't really broken down to Chinese automotive specifically. I think if you look at China overall, we are seeing stronger bookings. And there should be a part of that reflected in most of the other areas, markets that are in China..

The lower VAT went into effect I think on April 1, so just like in U.S., when tax law changes or sales tax changes in a city or a state or some of those rule change or interest rate changes. I mean, it takes a while to affect the economy.

And I don't know if that's enough time for us to measure that a Chinese customer changed their orders based on the VAT. I think that takes longer term to take hold in the economy. We're going to get orders from Chinese customers based on them having orders from their customers to build modules, build cars or whatever.

And that's not likely to change in four weeks of VAT changing..

Okay. Thank you..

Thank you. We will now take our next question from Mark Delaney from Goldman Sachs..

Yes, good morning. Thanks for taking the questions. First question was on operating expenses, which was pointed out, came in at the low-end or just below guidance.

Can you help us better understand to what extent those structural cost takeouts that helped the better performance on cost or more timing or other temporal factors?.

All right, so, I mean, we've done what I consider to be a very good job in managing OpEx over the last several quarters. We've essentially beat significantly on OpEx on both September and December and came in at the low-end of guidance here in the current quarter. So we're managing the operations very tightly, given the environment that we're facing.

And as the environment improves in second half, if it improves, we will have investments to make in the business that will have those dollars go up. So we're holding OpEx flat at the midpoint of guidance in the current quarter.

And that's pretty tight controlled, and again, would expect that OpEx will increase over time as we need to invest in the business to drive the long-term health at 40% plus operating margin goals that we have..

Okay. It's helpful. And there's a lot of discussion on the call about the distribution business. So I was hoping maybe to pivot a little bit and better understand some of the trends in the direct business that came over from Microsemi acquisition. I believe servers and storage were markets that were served on an OEM direct basis.

Help us understand how bookings and market share is trending in those areas and I think cross-selling the full portfolio was part of the strategy. How successful has that been? Thank you..

So there is weakness in some of those markets as you have seen reported by other players as well. I don't think there is anything particular about bookings that would give us any insight there. In terms of the cross-selling, those customers have given us access for other solutions that classic Microchip had.

And we're having good progress in discussions on how those can be incorporated into next generation designs using Microchip classic solutions that surround some of the storage and other networking solutions that Microsemi brought. So the customer access has been extremely useful to take solutions that are necessary in the market.

But we did not have as good customer access as Microchip standalone..

Okay. Thank you. We will now move on to our next question. It comes from Christopher Rolland from Susquehanna International Group..

Susquehanna. Yeah, one for Eric and then - and one for Steve. I guess, Eric, the $7 million in underutilization, is there a level of company utilizations which you deem underutilized? And then also, if you could talk about where utilizations are now and your inventory levels and if you have plans to bring them down. Thanks..

Okay. So really the underutilization is looked at on a factory-by-factory basis, based on kind of the historical norm. So there isn't kind of a one-size-fits-all for that.

And we've got our three large fabs, three large assembly and tests that Microchip classic has had historically, and then a bunch of smaller factories that have come through the Microsemi acquisition. So it's kind of a case-by-case scenario that we look at that. And we don't break out a specific capacity utilization percentage.

We just haven't done that historically. But we've got lots of capacity in place, and so we're well poised to be able to respond to growth as it comes in the future with pretty low CapEx. So that's a good thing.

The piece of your question was what?.

Was internal inventories, and do you have guys have a plan to work that down? And how do you feel about that level?.

Okay. So inventory was up 5 days in the quarter to 128. We've kind of had a target of 115 to 120 that we talked about. And so, inventory is on the higher end.

But I think it is prudent for us to hold that level of inventory, given the fact that the distribution inventory has come down and customers are managing their own inventory quite conservatively, we believe, again, we don't give real-time reports from them.

So it allows us to report quickly in this uncertain environment, where customers are needing to respond quickly when they get demand, because they're not building to forecast as Steve kind of described before. So longer term, our goal would be to get the inventory down to 120 days or less. But that's not the environment that we're facing right now..

A little extra inventory at this part of the cycle also prevents CapEx expenses on the other side of the cycle. So these are products with very long life. There is a little to no obsolescence risk. And it does help from an overall cycle standpoint to have some inventory investment that can then defray CapEx spending on the other side of the cycle..

I would say also that our inventory is a lot lower than some of the large other analog players' inventory I have heard about. So while our target is 115 to 120, you would expect that this part of the cycle, when you're at the near bottom of the cycle, the inventory to be higher than the high-end of that.

And yet I think I'm - when I compare it our inventory is lower than a lot of other players..

Yeah, many have 150ish..

Yeah..

Yeah, that is fair. And then, Steve, for you, if a trade deal was reached, would you still view kind of the return of business as a potential bonanza or are you more tempered here? So is there something that makes you more tempered? Just as these negotiations, it seems like, even if we think something is finalized, but they may not be..

I think having seen the yo-yo sentiment on the trade talks, I would rather wait for the talks to conclude, then analyze what that finality is, whether it ends up at 10% duty or something higher than that or goes all the way to 0%, and have a chance to understand our customers' and distributors' reaction through our sales people and talking to some directly to really make an informed opinion rather than just throw something out..

Yeah, that's fair. Thanks, guys..

Thank you. We will now take our next question from Craig Hettenbach from Morgan Stanley. Please go ahead. Your line is open..

Thanks. I understand all the focus on China in terms of what's happening from a macro. But was hoping, Steve, you can talk about trends that you're seeing in Europe and the United States as well..

Well, trends in U.S. and Europe are really not that great either. Lot of our U.S. customers are impacted because of the same trade issues. Industrial customers build a lot of their products in China and are having to pay the tariff cost, which are currently 10% going to 25%. So our industrial business in U.S. is impacted.

Our consumer business, which is in the consumer appliance area, is impacted. The automotive business is impacted not because of tariffs, but I think the automotive in general. Automotive production is down in all three geographies..

But China is weak too. And China was a big export for European automotive..

Yes, so go ahead, comment on Europe. I was going to go there..

So I think Europe is seeing some of those headwinds that are - none of these are confined to just one geography. There is interconnection between how global economy is played. And so, for example, on the European carmakers, especially the luxury car makers, they've had significant declines, because the China market has been very weak for them.

And that ripples through into some of the lower, in recent times, lower GDPs coming through some of the European economies. And many of them like Germany are highly export oriented and affected by any impact in other regions of the world.

And so, there is a continuous uncertainty and weakness that expands beyond just China and the U.S., but in part driven by what's happening in these economies..

Got it. And just a follow-up question on the commentary of inventory, the expectation that you think it will be drawn down again in the June quarter.

Do you think that the customers or distributors will be reaching kind of limits of how far they will take it down? Or if things remained uncertain directionally, you think it would still go lower in terms of their inventory management?.

I think distributors will assess what the sales-out is and if the sales out is decreasing because of whatever, then they will continue to draw down inventory. If they expect that sales out is increasing then they would start to build inventories to serve that sales-out. So it's not that the inventory is changing that much in months of inventory.

It's mostly multiple of really what their expectation of sales-out is. And many of the Chinese distributors, their sales out has been much lower in December and March quarters, lot of it driven by trade issues, because their end-customers couldn't sell the product given the duties..

Got it. I appreciate your color..

Thank you. As there are no further questions at this time, I would like to hand the call back over to you, Mr. Sanghi, for any additional or closing remarks..

Well, we want to thank you. There was a very large participation on this call compared to what we have had in the last several quarters. We've got lots of very, very good questions from investors and analysts. And thank you for giving us a chance to explain our views on U.S./China trade, where the things are, how the business is.

And we'll see some of you as we get on the road to various conferences this quarter. Thank you very much..

This will conclude today's conference. Thank you all for your participation. You may now disconnect..