Microchip Technology Inc (MCHP) — Q3 2019 Earnings Call Transcript

Thank you and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward-looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press release as of today as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. In attendance with me today are Steve Sanghi, Microchip's Chairman and CEO; and Ganesh Moorthy, Microchip's President and COO. I will comment on our third quarter fiscal year 2019 financial performance, and Steve and Ganesh will then give their comments on the results, discuss the current business environment as well as our guidance and provide an update on our integration activities associated with the Microsemi acquisition. We will then be available to respond to specific investor and analyst questions. I want to remind you that we are including information in our press release in 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 a new GAAP revenue recognition standard, which requires revenue to be recognized at the time products are sold to distributors versus our historical revenue recognition policy where revenue on such transactions was deferred until the product was sold by our distributors to an end customer. We recently went through a comment letter process with the SEC regarding our non-GAAP reporting. As a result of this process, we will now be referring to what we used to call non-GAAP revenue as a metric called end-market demand and we'll provide this metric in our earnings release each quarter. End-market demand is the net dollar amount of our products, licensing revenue, and other services delivered to our direct customers to non-distributors and buyer distributors to their customers. We are able to calculate end-market demand by our distributors based on information that our distributors provide to us about their product shipments to their customers and inventory holdings. The value of end-market demand from our distributors is calculated as the net transaction value of these shipments. We will continue to manage our business and distributor relationships based on creating and fulfilling end-market demand. All of Microchip's bonus programs will continue to work based on end-market demand. 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 based on end-market demand. So even though we are changing our guidance practice going forward, for transition purposes, today, we will provide a review of our Q3 results compared to our non-GAAP guidance provided on November 7, 2018, using our historical non-GAAP nomenclature. Our guidance going forward will reflect the outcome of the SEC comment letter process, which Steve will also comment on during his remarks about our guidance for the March 2019 quarter. I will now go through some of the operating results, including net sales, gross margin, and operating expenses. I will be referring to these results on a non-GAAP basis using the end-market demand metric as expenses and expenses prior to the effects of our acquisition activities and share-based compensation. End-market demand in the December quarter was $1.416 billion, above the midpoint of our guidance, which was $1.4 billion, and down 6.4% sequentially from end-market demand of $1.513 billion in the immediately preceding quarter. We have posted a summary of our end-market demand and GAAP net sales by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were a record 62.2%, operating expenses were 24.8% of end-market demand, and operating income was $530 million and 37.4% of end-market demand. Non-GAAP net income was $405.6 million, and non-GAAP earnings per diluted share was $1.66 and was $0.095 above the midpoint of our guidance of $1.565. On a GAAP basis, net sales in the December quarter were $1.375 billion, GAAP gross margins were 56.7% and include the impact of $3.4 million of share-based compensation, $74.3 million of acquired inventory valuation cost, and $23.8 million impact from the differences in GAAP revenue and end-market demand. All operating expenses were $584.9 million and include acquisition and intangible amortization of $193.7 million, special income of $1.3 million, $5.4 million of acquisition-related and other costs and share-based compensation of $36 million. The GAAP net income was $49.2 million or $0.20 per diluted share and includes one-time tax expense of $0.4 million related to a variety of matters, including tax reserve releases due to audit settlements, statute limitations expiring, tax reform, and transition tax refinement and fiscal 2018 tax provision to tax return adjustments. The non-GAAP cash tax rate was 3.5% in the December quarter and we expect a similar rate for all of fiscal year 2019. We expect our non-GAAP cash tax rate for fiscal '20 and fiscal '21 to be 5% or less, exclusive of the transition tax, any potential tax associated with the restructuring of 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 cash tax payments low. The cash tax payments associated with the transition tax for the combined Microchip-Microsemi group are expected to be about $293 million and will be paid over eight years. We have posted a schedule of our projected transition tax payments on the Investor Relations page of our website. For GAAP purposes, we had a significant tax benefit in the current quarter for a variety of reasons discussed earlier. Moving on to the balance sheet. Our inventory balance at December 31, 2018 was $702.5 million. All of the inventory markup from Microsemi required for GAAP post-accounting has now been sold through and is no longer reflected in the ending inventory balance. We had 123 days of inventory at the end of December quarter, up six days from the prior quarter's levels. Inventory at our distributors in the December quarter was 36 days compared to 37 days at the end of September. We believe that our distributors are holding an appropriate level of inventory to support end-market demand. The cash flow from operating activities was $481.5 million in the December quarter. As of December 31, the consolidated cash and total investment position was $436.2 million. We paid down $377.5 million of total debt in the December quarter and the net debt on the balance sheet reduced by $349.4 million. At December 31, our debt outstanding includes $2.743 billion of borrowings under our line of credit, $2.713 billion of term loan B, $2 billion on high-grade bonds, and $4.481 billion of convertible debt. Our net debt-to-EBITDA, excluding our very long-dated convertible debt that matures in 2037 and is more equity-like in nature, was 4.8 at December 31. Our net leverage metrics are based on a 12-month trailing EBITDA which will continue to provide some headwinds due to significant distribution inventory reductions that were made in the June and September quarter for Microsemi, which caused our shipment activity to be significantly less than end-market demand during these periods. The weak economic environment also negatively impacted our EBITDA in the December 2018 quarter and will continue to do so in the March 2019 quarter. 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 December quarter was $86.3 million. Capital expenditures were $27.4 million in the December quarter. We expect about $45 million in capital spending in the March quarter and overall capital expenditures for fiscal year 2019 to be about $235 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 December quarter was $47 million. I will now turn it over to Ganesh to give us comments on the performance of the business in the December quarter and provide an update on some of the Microsemi integration activities.

Thank you, Eric, and good afternoon, everyone. Before I get started, I'd like to clarify that the product line comparisons I would be sharing with you are based on an end-market demand metric, which is how Microchip measures this performance internally. Let's start by taking a closer look at microcontrollers. Our microcontroller business was sequentially down 8.7% compared to the September quarter, reflecting a broad macro weakness in the markets we serve. Microcontrollers, however, were up 13.2% from the year-ago quarter. Microcontrollers represented 52.9% of our revenue in the December quarter. During the quarter, we continued to introduce a steady stream of innovative new microcontrollers, ranging from the industry's lowest power LoRa System-in-Package family; the single-chip maXTouch touchscreen controllers for screens up to 20 inches in size; to Intelligent Network Interface Controller technology, the industry's most efficient automotive infotainment networking solution that supports all data types, including audio, video, control and Ethernet over a single cable. In my prepared remark last quarter, I mentioned that our microcontroller business was annualizing at over $3 billion in end-market revenue. Through our subsequent investor meetings, there seemed to be the perception that our 32-bit microcontroller business was not very big. To address this perception gap, we'd like to share with you that over the last two quarters, our 32-bit microcontroller business is annualizing at over $1.2 billion in end-market revenue. The 2018 microcontroller rankings from Gartner are normally available in April and, as we have seen in prior years' results, we expect to see significant market share gains again. We will report on these results during our next conference call. Now moving to analog. Our analog business was sequentially down 6.2% compared to the September quarter, reflecting the same broad macro weakness our microcontroller business experienced. Analog, however, was up 77.9% from the year-ago quarter. Analog represented 29.1% of our revenue in the December quarter. And during the quarter, we continued to introduce a steady stream of innovative analog products as well, including the industry's smallest multi-output MEMS clock generator, the industry's smallest five-channel temperature sensor, and the most robust silicon carbide diodes and MOSFETs in the industry. Our FPGA revenue hit another all-time record even after going back to the Microsemi and Actel history with 8.7% sequential growth compared to the September quarter. Our low-power, midrange PolarFire family continues to garner strong market acceptance, while the prior generations continue to demonstrate consistent growth even in the current market environment. We also unveiled the industry's first RISC-V system on a chip FPGA architecture, combining the industry's lowest power midrange PolarFire FPGA family with a complete microprocessor subsystem based on the open, royalty-free RISC-V instruction set architecture. FPGA represented 7% of our revenue in the December quarter. Next, moving to our licensing business. This business is sequentially up 7.9% as compared to the September quarter. Our results reflect the sale of another type of license for a specific set of patents that can be used in noncompetitive fields of use. We anticipate that this patent license will close in the December quarter and include it in our guidance. We continue to retain indefinite rights to these patents for the field of use that are of interest to us. Our patent licensing strategy is to monetize portions of the substantial patent portfolio we inherited through our acquisitions by licensing select patents to players in noncompetitive fields of use. In all cases, we retain rights to use these patents in our products as well. We had meaningful patent license transactions in September and December quarters. Investors should expect that the revenue contribution in the future from this effort will be lumpy from quarter to quarter. We do not expect meaningful contribution from the patent licensing in the March quarter. Our memory business was sequentially down 15% in the December quarter as compared to the September quarter. And finally, our multimarket and other business was down 3% sequentially compared to the September quarter. A quick update about the Microsemi integration. Business units, sales, operations, and support groups are all making rapid progress. Our thanks and kudos go out to the combined company employees who are working hand-in-hand to achieve the accelerated synergy results. Overall, we are ahead of our synergy targets and expect continued synergy gains for many quarters to come. What will take us the longest is the business systems and operations integration, which is being done in phases. The first phase is where one of the business units went live on November 1, 2018. The second phase just went live on February 1 and involved three more business units, and more phase releases are planned with a steady cadence. We expect the overall business and operational integration will take about 15 to 18 more months to complete. Let me now pass it to Steve for some comments about our business and our guidance going forward.

Thank you, Ganesh, and good afternoon, everyone. Today, I would like to first reflect on the results of the fiscal third quarter of 2019. I will then provide update on our progress at Microsemi. I will then provide guidance for fiscal fourth quarter of 2019. Our December quarter non-GAAP financial results based on end-market demand exceeded our guidance for net sales, gross margin percentage, operating profit, operating margin percentage, and earnings per share. Our consolidated non-GAAP gross margin reached an all-time record at 62.2% of net sales and exceeded the midpoint of our guidance by about 100 basis points. Our consolidated non-GAAP operating margins were strong at 37.4% of sales and exceeded the midpoint of guidance by about 130 basis points. Our consolidated non-GAAP EPS exceeded the midpoint of our guidance by $0.095 per share. We are pleased with the financial results despite a very unfavorable business environment with tariffs, slowdown in China, the European automotive issues, higher interest rates, and under absorption charges from some of our factories. Let me also touch on the performance of Microsemi. Microsemi's non-GAAP operating profit reached a record. We are systematically improving Microsemi's financial performance and realizing significant synergies. At the time of our announcement of the Microsemi acquisition, we had guided to $0.75 accretion run rate after the first year. After nearly seven months, we are well ahead of the $0.75 run rate for accretion from Microsemi. On a non-GAAP basis, this was also our 113th consecutive profitable quarter. I want to thank all employees of Microchip, including employees from our acquisitions, for their contribution. Now, let me provide you some further update on the progress we have made with the Microsemi integration. First, distribution inventory. After reducing the inventory and distribution channel in the September quarter, Microsemi distribution inventory remained stable at 2.6 months in the December quarter. We believe that at the current levels, distribution is holding the amount of inventory it needs to support the end-market demand. In last quarter's earnings conference call, we discussed moving several Microsemi customers back to being serviced directly that Microsemi had transferred to distribution. We completed this transition during the December quarter. Microsemi internal inventory. Microsemi's internal inventories are still high as we continue to maintain lower loadings in Microsemi's internal factories as well as subcontractors until the inventory comes in line. As we said from the beginning, Microsemi has very good engineering teams and very good products. The customers' pockets are sticky and we continue to believe there are very good end-market opportunities for the combined company. Our strategy for the better part of this decade has been to buy businesses and turn them into world-class performers in the likes of Microchip. Here, we started with excellent products, excellent gross margins, and excellent engineering teams. With distributor and contract manufacturing inventories reduced and with Microchip's operating expense approach, we are optimistic about achieving our long-term targets for attrition from Microsemi. So far, we are ahead of our original target. Now, regarding guidance going forward. Beginning with this March quarter, as Eric mentioned, we are changing the information included in our financial guidance in response to comments and discussions with the staff of the Securities and Exchange Commission. After the GAAP standard change to sell-in revenue recognition, we continued to provide guidance and track our results based on sell-through revenue recognition and refer to the sell-through revenue as non-GAAP net sales. After the adoption of ASC 606, the feedback we received from investors and sell-side analysts had been very positive on a continuing use of sell-through revenue recognition in our reporting of non-GAAP net sales. We continue to strongly believe that managing our business on a sell-through basis is the appropriate way to run Microchip. Therefore, we would have preferred to continue to use our end-market demand as our non-GAAP sales. However, after receiving an SEC comment letter and discussing with the SEC, we have decided to provide net sales and sales guidance based on sell-in revenue recognition under the new GAAP standard. We will continue to provide non-GAAP guidance for gross margin percentage, operating expense percentage, operating profit percentage, and earnings per share, but we will use sell-in days GAAP revenue for these calculations. When we report our results, we will also provide information on end-market demand so that investors can understand the consumption of our product in the marketplace, but we will not use the end-market demand for calculation of the non-GAAP P&L. Now, I will provide you guidance for the March quarter. The guidance we provided for the September and December quarters, which reflected our caution on business conditions, turned out in retrospect to be spot on and was a harbinger for broader industry weakness. We continue to be cautious about the outlook for the March quarter. We see a very uncertain business environment with tariffs, slowdown in China, European automotive issues, higher interest rates potentially causing U.S. GDP to slow down, any lingering effect of U.S. government shutdown, and potential for further U.S. government shutdown. With all this commentary, we expect our total GAAP net sales based on sell-in revenue recognition for the March quarter to be up 2% to down 9% sequentially. We expect our non-GAAP gross margin to be between 61.2% and 61.8% of sales. We expect non-GAAP operating expenses to be between 25.8% and 26.5% of sales. We expect non-GAAP operating profit percentage to be between 34.7% and 36% of sales. We expect our non-GAAP earnings per share to be between $1.26 per share to $1.53 per share. Again, all these ranges for non-GAAP gross margin percentage, operating expense percentage, operating profit percentage, and earnings per share are based on GAAP revenue and sell-in revenue recognition. We also want to give the investors and analysts a sense of how we see the Microchip business past the March quarter. As you know, there's a substantial pending date of March 1, 2019 when, if there is no settlement between U.S. and China, a 25% tariff would kick in for about $200 billion of Chinese goods shipped into the U.S. We think that the two governments will make some progress, but it is likely that the data from March 1, 2019 will be extended further out. Barring any material negative development on the trade front, we see the March 2019 quarter to mark the bottom of the cycle for Microchip. We cannot yet say what the shape of the recovery would be, whether the recovery be V-shaped, U-shaped, or L-shaped. That will depend somewhat on the outcome of the trade talks. What we do see is a bottom forming and believe that the March quarter will mark the bottom for this cycle for Microchip. Given all the complications of accounting for our acquisitions, including amortization of intangibles, restructuring charges, and the inventory write-up on acquisitions, Microchip will continue to provide guidance and track its results on a non-GAAP basis, except for net sales, which will be on GAAP basis. We believe that non-GAAP results provide a more meaningful comparison to prior quarters and we request that the analysts continue to report the non-GAAP estimates to first call.

I appreciate the color around kind of tariffs and how you're thinking about things kind of post-March. Just any signals that you're looking at in terms of calling the bottom here, whether it's kind of run rate of business, inventory distribution, or customers? Just how you're seeing kind of the business overall kind of beyond the March quarter?

Well, we look at a variety of factors, including bookings and billings activity, discussion with our direct and distribution customers, distribution sell-through activity, customer cancellations, customer pull-ins, delivery push-outs and pull-ins. With over 120,000 customers that we service in a vast range of end markets and applications, we really believe that we get a very broad perspective of what is happening in our business. Today, these indicators are telling us that the environment is still very uncertain driven by a variety of factors, including the trade situation. However, we don't see things getting worse at this point unless something more negative occurs on the trade front. Based on the vast amount of data that we get, we're releasing a framework for the formation of a bottom for this cycle in the March quarter.

Got it. And then just as a follow-up, can you talk about, so far this quarter to date, kind of January to February, what type of linearity you're seeing and how the business has been?

So business is tracking well to the guidance we are providing. We have seen the bookings stabilize and even increase somewhat very recently, but I would say it's a very short duration indicator and it's really not enough for a long enough time to be really making calls based on that.

Steve, I was hoping, first, if you could give us a sense, as you think about the March quarter, if you think sell-through will be above or below or similar to the sell-in revenue that you're giving guidance for?

Yes. So we do not really have a good process for forecasting what the change in distribution inventory is going to be. That's not how we used to run our business historically. You know that, and that's why we've given the sell-through information or end-market demand consumption historically. We really feel, as we said kind of in our prepared remarks, that distribution inventory is in a good position to support what end-market consumption is.

That's helpful. And then my follow-up question on the completed quarter, revenue and gross margins were above your guidance. Can you just give us a better sense of what enabled the company to exceed its guidance on those financial metrics?

Well, do you want to take that, Eric?

Sure. Revenue was slightly over 1% better than we expected, which reflects the various influences we encountered during the quarter. It was positive to exceed the midpoint of our guidance. On the gross margin front, we experienced a favorable product mix this quarter and have continued to prioritize cost reductions in our manufacturing processes. Additionally, we implemented significant changes regarding discounts previously offered for sales of the Microsemi business to distributors or contract manufacturers, and we're now seeing the positive impact on our gross margin.

Maybe just stick to the gross margin side. Your guidance is, on a Q-over-Q, that's a pretty big delta, but yet your margins are coming in much stronger than what I would have modeled it. Could you just help us understand the dynamics there in the guided two quarters, especially in light of your inventory came down as well? And I'm expecting you're not building inventory in the quarter. And then I have a quick follow-up.

Is your question that the gross margins are coming down, but the operating margins are not as much?

No. My question is gross margin is coming in stronger than what I would have modeled given your shortfall in the revenues versus what the street was expecting.

Well, I think the same reason why the gross margins were strong this quarter. We are getting an uplift from a lot of the discounts that were given to the distribution channel and contract manufacturers and others. And a lot of the business of that was moved to distribution from the Microsemi business, we have completed that conversion back to direct and, therefore, you take out the distribution margin hit. So all that is having a positive effect on ASPs and our margins. We are continuing to reduce costs in all of our factories. There is still a lot of Atmel products, which were outside. Every quarter, more and more of it is coming in. There is also some Microsemi product we're starting to bring in. Some of the expenses have been taken out from the manufacturing overhead in synergies. So we have a lot of moving parts and the product mix is very healthy.

So Steve, can you give us some color by end market, whether it's industrial or autos or consumer or communications, where you are perhaps seeing better or worse trends than what the midpoint of your March outlook would suggest?

Yes. Rather than going segment-by-segment, I think we have previously indicated that the automotive, industrial, and consumer home appliance markets were weaker in the last quarter. Especially as we look at this in the guidance for this quarter, we're seeing the addition to that, the data center market, the communication markets have also started to have some softening that goes with it. So at this point in time, I can't pick any one of them to say this is the main reason why the strength is coming or the weakness is coming. I think we're seeing a broad-based weakness and even some which were stronger last quarter are less strong at this point in time. Defense and aerospace have continued to be strong. It could have some impact this quarter from the government shutdown and what impacts that may have, but that's all built into our guidance at this point.

Aerospace and defense operate independently of typical market trends seen in industrial or consumer sectors, making it a unique business. We experienced some effects from the government shutdown, which delayed the processing of certain export licenses and the release of some programs. However, we anticipate resolving these issues within the quarter, minimizing any significant impact as we move forward. There is also the effect of budget flushes that occur in September and December, as large customers with government budgets need to utilize their funds or risk losing them. Consequently, the March quarter shows a sequential decline in this segment due to the budget flush.

Got it. And for my follow-up, Steve, if we, let's say, do have a trade resolution in the next few weeks, do you think there is a potential for an inventory refill? Or do you think the industry is shipping to consumption right now, so we should not be modeling any better than seasonal quarters going forward?

I don't know about how everybody else is doing, so I will just speak for Microchip rather than the industry. A settlement of trade would be a bonanza. Our customers and distributors are so cautious. There is low visibility. They're building bare bones what they need for the backlog from their customers. Nobody wants to get stuck with anything depending on what happens. If the trade talks are settled prior to March 1, this would be a big bonanza.

Yes. Vivek, just to add to that, as you can tell from our last two quarters of actual results where our end-market demand was higher than what the sell-in revenue was, there's definitely a bleed-down of the distribution inventory and we don't think that the end customer is probably any different, although we don't get real data points on that.

Yes. So we are not shipping to consumption as you said. We're shipping well below consumption.

I guess, Eric, you said in your prepared comments, you made the comment that the guide for the March quarter on the revenue is wider than normal. Can you help me understand, to what extent is that just a reflection of how uncertain this environment is and to what extent is that just a reflection of having now to guide just sort of a sell-in revenue? And as we think about future quarters, is this now the right range of guidance around the midpoint you're going to give us, or is this just wider because of uncertainty?

I think it’s a mix of both factors. We haven’t historically provided guidance based on sell-ins, so this is a new approach for Microchip. We also don’t have a reliable way to predict changes in distribution inventory during a specific period. That said, the environment remains quite uncertain, making it difficult for me to specify what percentage each factor contributes. Overall, this leads to a broader range of guidance.

Yes, I believe that over time, we will be able to provide more refined guidance. Our distribution network is extensive, consisting of over 100 distributors globally, unlike many semiconductor companies that rely on just a few large distributors. In the past, we’ve worked with significant global distributors, catalog houses, and we have around 80 to 100 distributors specifically in China. This broad distribution means it’s challenging to predict exact purchases. Our focus is on what distributors actually sell out rather than what they buy, and our systems are designed to manage that. We expect to improve our guidance quickly, likely within quarters rather than years, and as the market becomes more stable, we will also be able to narrow our guidance further.

Yes, and I think another contributing factor is that the lead times are very, very short today, right? So backlog visibility is not great.

That's helpful. Then maybe for my follow-up, guys. I just wanted to go back to the gross margin. A couple of other questions were asked around that. I'm just kind of curious, given that, Steve, you mentioned you're undershipping demand today. In conjunction with sort of the slowdown at the industry level, you were also working through some excesses that the Microsemi business had when you bought it. I'm just kind of curious, how should we be thinking about utilization now? Have you done all the utilization adjustments you needed to? And I guess, more importantly, as business comes back and you benefit from increasing utilization and some of the more in-sourcing activities you're doing, how do we think about kind of that long-term target gross margin? Because relative to that 63% you've talked about, you're not too far away in what's a really rather lackluster business environment. Is 63% the right margin to think about, or could it be higher?

Good question, as always. Just to keep that question on the back of your mind, and I think as we get further, as we establish 63%, then we will assess further. Right now, especially Microsemi factories are significantly underloaded because we first corrected the distribution inventory, and then the internal inventories were much higher. The internal inventories from Microsemi that we inherited are a lot higher than really the level of inventory at Microchip. So we have a number of factories running at 50% capacity; a number of them are running something higher than that. So overall utilization is very low. I mentioned last quarter that only about 10% to 20%, specifically 15%, of Microsemi's business is produced in our internal factories, while the rest comes from foundries. We have proactively reduced starts and assembly and test loads at subcontractors to quickly decrease these numbers. Our internal factories are currently operating below capacity. When business volume increases, we can expect some improvement in utilization from these internal factories, but since they represent only 15% of Microsemi's business and about 5% of Microchip's total business, we need to proceed with caution.

I have a question for Steve and one for Eric. Steve, I wanted to follow up on your comment about recognizing the bottom back in March. Several other large companies have mentioned similar sentiments, typically in relation to either a stabilization in their backlog or specific metrics they are monitoring. I'm also recalling Ganesh's response to a question where he mentioned that conditions are still worsening in some markets. So, do you have any concrete data regarding your backlog or orders that you can refer to? Additionally, do you believe the China industry has reached a point of saturation, leading us to ship according to actual demand or potentially undershooting, which may explain your more optimistic outlook? I have a follow-up question for Eric.

Well, I would say some of the data center and other businesses you're talking about, they're also down somewhat seasonally, and they're weaker seasonally because March quarter is weaker compared to September and December quarters in which year-end shipments happen. But I think the question you're really asking is, what gives us the confidence that the March market will mark the bottom is that the current backlog for June quarter is about flat with the backlog we had for the March quarter on November 5, okay? So that may look flat. But then you have to look at after November 5, we had a bunch of holidays, Thanksgiving, Christmas, and then Chinese New Year in the March quarter. There are no major holidays for June quarter. So starting with the flat backlog and going into the stronger quarters without the holidays, that's why we say barring any significantly negative developments on the trade negotiations with China, we believe that June quarter will strengthen or we're confident that it should not be sequentially down again. But the second point I would say, Harsh, is, and I don't mean this for all the analysts and for all the investors, there are lots of them that have followed us for a long time and believe the calls we make, but there are a lot of the others who don't. We have made numerous calls in the last 15 years or so for the business environment to turn negative and then turn positive. When we first make a negative call, first it is not believed, it's even ridiculed a few times. Then 3 to 4 months later, what we say gets confirmed and everybody goes down. Then comes the recovery part of the call, it is not believed either. As we go on the road over and over and over we get the question, what gives you the confidence, and we answer it. That is not believed either. So to my recollection, we have not been wrong in 15-plus years in calling the downturn, and we have not been wrong in the same time frame calling the upturn. That's what gives us the confidence. Like you saying your business, past performance is no guarantee of the future results. So we don't guarantee anything. So of course, our confidence is subject to some number of risks, but I think that's the narrative I'd like to explain.

No, that's very helpful actually. And then question for Eric was, how much free cash flow do you expect by your calculation to be available for debt payment in March? And if that's the base level number, and we expect business to get kind of better so we can get an idea of what you're kind of going to be able to do hopefully going forward if nothing macro changes?

Sure. We expect somewhere between $175 million and $200 million of debt pay down in the current quarter. The last two quarters were significantly higher than that. I would say that we obviously are coming off where accounts receivable is down quarter-over-quarter. We had some very good help from some of our customers and some of our vendors in terms of payment terms and negotiating that, and really making significant progress compared to what our guidance was in the December quarter, but we don't really have those levers to pull in the current quarter. So I don't think I'd use that $175 million to $200 million as kind of an ongoing run rate. We do expect that it will get significantly better from this point forward, but we'll continue to focus really all of our excess cash generation outside of the dividend on paying down debt.

Steve, I’d like to take a different approach to the cycle and recovery question. I recognize that you’ve often identified these turns early and accurately. I’m curious about the confidence you’re expressing regarding trade, especially with the March 1 deadline looming. It seems you’re hinting at a constructive resolution for demand after the March quarter, and I’d like to understand why you feel assured about this. I have a follow-up question as well.

I'm not sure if that's exactly what I meant. What I'm saying is that, unless there are major negative developments in trade, that's a key point to consider. Additionally, I believe that with a month left until March 1, progress is being made by the governments, and there are positive signals emerging from the White House. You might remember how negatively things were perceived regarding Canada during one of the conferences, but then a week later, everything turned out well. Trump has used this strategy before, and the negative signals about China suggest that progress seems to be happening. However, there's still a lot of work to be done. I expect some positive announcements, but actual resolutions may take longer. The timeline for these settlements is being extended, and the current environment we're observing remains. Our guidance reflects this ongoing environment, and if it stays the same, the June quarter looks to be better than the March quarter. Correct. I think there was one small one done. But I would think, yes, if there is a settlement in trade post-Chinese New Year, whenever Chinese economy has been weak, that's what they have done, stimulus for various things. That's largely predictable. And I don't know, I don't have a line to the Premier, but I think that's really what would happen.

I have a question about China again. Can you comment on the business with ZTE in the quarter? Did you see any recovery there? Also, do you have any exposure specifically to Huawei?

So ZTE had no restrictions in the quarter and our business was normal. I think we said in the prior quarter there was some demand distraction where during the time, ZTE couldn't build a product. They lost some designs and competitors picked it up. And in certain cases, we got design with a competitor also; in certain cases, we did not. But ZTE business is kind of normal. The Huawei business is normal. There is a lot of talk about the U.S. indictment and their CFO has been detained in Canada. There has been no impact of any of that on the Huawei business yet.

Steve, I wanted to go back to the issue of integration with Microsemi but approach it more qualitatively than quantitatively understanding that you're not changing any target at this point. So as we look at calendar 2019, can you just touch on what the key integration milestones are, objectives are, top 2 or 3, for sales items and channel management? And then the follow-up, I'll just hit it right now because it's similar. If we looked lower on the income statement at manufacturing and operating expenses, what would be some of the key issues you'd want to tackle this year in those areas as well?

We're making significant progress on integrating our acquisitions. When we acquired Microsemi, they were using 21 different ERP systems for their various business units, which were then compiled in a somewhat conglomerate fashion. In contrast, all the companies we have acquired have been incorporated into our unified enterprise system for many years. With Microsemi, our goal is to reduce the number of systems from 22 to two. Although ideally, I would prefer to go down to just one system, the effort required is substantial. We already transitioned one business into our system on November 1, followed by three more on February 1, and we have plans for approximately three more by May 1. There will be a regular schedule for these go-live events every quarter. We expect to achieve full consolidation within the next 12 to 18 months, which represents a major project with significant potential for synergy and benefits. The business units in terms of the marketing and design and pipelines and integration with our technologies and factories and all that is largely some done, some ongoing. Most of Microsemi parts are not going to come into our factories. Like PMC-Sierra parts, they run in foundries, and FPGA parts run in foundries, and they are going to come in inside. But certain products of other business units may come in, and that's an ongoing process. As far as sales is concerned, sales all work for a common sales leader. So that's already done. The biggest job in sales is cross-training and cross-pollinating. So a Microchip salesperson feels very confident selling Microsemi products, and in a total system solution gets all those designed in. And vice versa, a Microsemi person feels very confident with Microchip. With $4 billion company on one side, $2 billion company on the other side, that takes some time. And that's progressing. And how we kind of make it work is really a team where you call on the expert from the Microchip side or the Microsemi side to make the joint call so you start to get your total system solution effect. And that we're already getting. The reviews we see from various businesses in the Microsemi reviews, we see Microchip parts designed in, in the future boards and on the Microchip reviews, we see the Microsemi parts designed in. So that is starting to happen. But a lot more needs to happen. It's the latter. The designs take about 9 months to 2 years to go to production depending on how complex it is. You could have very simple, some discrete parts, et cetera, something that are designed in. There could be faster, but there are complicated parts which could be longer. So it's really, yes, there's a gestation period after you get the design in. You should see some revenue coming out of TSS in 2020, and then it accelerates from there.

Well, we want to thank everyone for joining this call today. And we'll be seeing some of you between now and the next conference call. On the road, there are various conferences we'll be going to. So thank you.