Microchip Technology Inc (MCHP) — Q1 2020 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 releases of today as well as our recent filings with the SEC that identify important risk factors that may impact Microchip's business and results of operations. In attendance with me today are Steve Sanghi, Microchip's Chairman and CEO; and Ganesh Moorthy, Microchip's President and COO. I will comment on our first quarter fiscal year 2020 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 ongoing 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 our GAAP and non-GAAP results. We have also posted a summary of our outstanding debt and leverage metrics on our website and I understand that those schedules aren’t showing up right away but we should have that issue corrected very shortly here for all of you. I want to remind listeners that during the June quarter of 2018, we adopted the new GAAP revenue recognition standard which requires revenue to be recognized at the time products are sold to the distributors versus our historical revenue recognition policy where revenue on such transactions was deferred until the product was sold by our distributor to an end customer. As discussed in previous earnings conference calls, we continue to track and measure our performance internally based on direct revenue plus distribution sell-through activity and each quarter we'll provide a metric for this called end-market demand in our earnings release. 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. End-market demand in the June 2019 quarter was $1.35 billion which was up 0.7% sequentially from the March 2019 quarter. End-market demand was about $27 million more than our GAAP revenue in the June 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 which is based on expenses prior to the effects of our acquisition activities, share-based compensation and certain other adjustments as described in our press release. Net sales in the June quarter were $1.323 billion which was down 0.5% sequentially and slightly below the midpoint of our guidance of $1.33 billion. I remind you that our guidance for the quarter was made prior to the ban on shipments to Huawei which has historically been between a 1% and 2% revenue customer for us. We have posted a summary of our GAAP net sales and end-market demand by product line and geography on our website for your reference. On a non-GAAP basis, gross margins were 62%, operating expenses were 25.8% of sales and operating income was 36.2% of sales. Non-GAAP net income was $357.6 million, non-GAAP earnings per diluted share was $1.41 which was $0.035 above the mid-point of our guidance of $1.375. On a GAAP basis, gross margins were 61.6% and include the impact of $4.9 million of share-based compensation, total operating expenses were $643.6 million and include acquisition intangible amortization of $248.5 million, special charges of $8.1 million, $9.6 million of acquisition-related and other costs and share-based compensation of $35.8 million. The GAAP net income was $50.7 million or $0.20 per diluted share. Our June quarter GAAP tax benefit included $12.6 million of discrete income tax benefits primarily related to tax reserve release due to a statute of limitation expiring. The non-GAAP cash tax rate was 5.5% in the June quarter. We expect our non-GAAP cash 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 will that we believe will keep our cash tax payments low. The future cash tax payments associated with the transition tax is expected to be about $246 million and will be paid over seven years with $10 million of that being paid this quarter. We have posted a schedule of our projected transition tax payments on the Investor Relations page of our website. Our inventory balance at June 30, 2019 was $733.1 million. We had 132 days of inventory at the end of June, up four days from the prior quarter's level. Inventory at our distributors in the June quarter were at 32 days compared to 35 days at the end of March. We believe that barring any negative developments on the U.S., China trade front, our distributors are holding a reasonable albeit lower than normal level of inventory to support end-market demand. The cash flow from operating activities was $380.6 million in the June quarter. As of June 30, the consolidated cash and total investment position was $437.1 million, we paid down $257.5 million of total debt in the June quarter and the net debt on the balance sheet was reduced by $263.7 million. Our EBITDA in the June quarter was $537.1 million and our trailing 12-month 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 4.65 at June 30, 2019. 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 June quarter was $87.1 million, capital expenditures were $23.9 million in the June quarter, we expect about $30 million in capital spending in the September quarter and overall capital expenditures for fiscal 2020 to be between $110 million and $130 million. We continue to add capital to support the growth of our production capabilities of our new products and technologies and to bring in-house more of the assembly and test operations that are currently outsourced. We expect these capital investments will bring some gross margin improvement to our business particularly for the outsourced Actel and Microsemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the June quarter was $46.2 million. I will now turn it over to Ganesh to give his comments on the performance of the business in the June quarter and provide an update on some of our ongoing 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 will be sharing with you today are based on end-market demand which is how Microchip measures its performance internally. Also with the start of a new fiscal year and a full year of Microsemi results under our belt, we are making an adjustment to our product line reporting for our conference calls. We will continue to provide product line reporting for microcontrollers, analog, and FPGA which make up almost 90% of our revenue. We will report licensing, memory, and MMO or multi-market and other as a fourth category called LMO which stands for licensing, memory, and other which is about 10% of our revenue. Let's start by taking a closer look at microcontrollers. Our Microcontroller business was sequentially up 1.8% compared to the March quarter reflecting some strength in what otherwise continues to be broad macro weakness in the markets we serve. During the quarter, we shipped our 25 billionth microcontroller, a milestone in our rich heritage as a microcontroller solutions provider. We also continue to introduce a steady stream of innovative new microcontrollers including several new touchscreen microcontrollers with industry-leading noise immunity with screen sizes of 9 to 20 inches. The industry's first commercially available Enhanced Serial Peripheral Interface known as eSPI to low pin count known as LPC bridge product for industrial computers, the addition of a single port solution to our USB smart hub family targeted at entry-level automotive applications. And last but not least we unveiled our META-DX1 family of Ethernet devices, the industry's first terabit scale Ethernet device that enables high-density 400 Gigabit Ethernet and flexible rate Ethernet connectivity. Microcontrollers represented 53.8% of our end-market demand in the June quarter. Now moving to analog, our analog business was sequentially down 0.7% compared to the March quarter reflecting the broad macro weakness, Microchip and others in the industry are experiencing. During the quarter, we continue to introduce a steady stream of innovative analog products including the production release of our 700-volt silicon carbide MOSFETs as well as our 700 Volt and 1200-volt silicon carbide Schottky barrier diodes. High precision 16-bit and 24-bit analog to digital converters and IEEE 802.3 compliant Power Over Ethernet switch and the industry's first clock buffers that meet PCIe Generation 4 and Generation 5 specifications. Analog represented 28.5% of our end-market demand in the June quarter. Our FPGA end-market demand reached an all-time record even after going back through the Microsemi and Actel history with a 7% sequential growth compared to the March quarter coming in at almost $101 million, the FPGA business does have some lumpiness because of our significant exposure to space, aviation, and defense markets where procurement timing can be a function of programs and their shifting priorities schedules and budgets. Design wins on our new low-power mid-range PolarFire family continue to grow strongly and we remain optimistic about this product family adding another leg of growth for the future. FPGA represented 7.5% of our end-market demand in the June quarter. Our licensing, memory, and other product lines which we refer to as LMO were sequentially down 4.9% in the June quarter as compared to the March quarter reflecting the broad macro weakness that Microchip and others in the industry are experiencing. Collectively, LMO represented 10.2% of our end-market demand, a quick update about the ongoing Microsemi integration, business units and sales have substantially completed their integration activity. We are pleased with the synergies we have achieved since we closed the transaction despite the weaker macro environment over the last four quarters. As we said before, Business Systems and Operations Integration will take the longest time to complete as we execute this transition in phases, we expect the overall business and operational integration to take about another 12 months to complete and we expect continued synergy gains for many quarters to come. Finally, a short update about the Huawei situation from our perspective. We estimate that our exposure to Huawei to be approximately 1% to 2% of our end-market demand. Our revenue with Huawei is a combination of what we ship to them directly as well as what we ship indirectly to their subcontractors and in some cases through distributors. We stopped all shipments of Huawei when the Department of Commerce issued that Export Administration Regulation or EAR in May. About a month after that based on further analysis of the EAR, we began allowing shipments of Huawei for several products that were permissible to ship under the EAR. However, the benefit for the June quarter was limited as Huawei in many cases did not want the product since they could not complete their bill of materials. There remains continued uncertainty as to whether Huawei will want all that we can ship this quarter as they may or may not be able to complete their bill materials. 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 first quarter of 2020. I will then provide guidance for the fiscal second quarter of 2020. Before I analyze our June quarter results, I want to remind everyone that our guidance for June quarter was provided before the ban on shipments to Huawei was announced. The midpoint of our guidance was flat sequentially, Huawei is approximately 1% to 2% of our revenue and about half the quarter was impacted. Our June quarter GAAP net sales based on selling revenue recognition was down half a percent sequentially and without the Huawei ban, it would have been slightly positive. Our end-market demand based on sell-through was 0.7% up sequentially and would have been higher without the Huawei ban. The end-market demand was 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. As we stated on our February conference call, our view that the March quarter would mark the bottom for this cycle based on end-market demand is proving to be correct. This statement is also proving to be correct for GAAP revenue after excluding the impact of the Huawei ban. So given very difficult and uncertain market conditions, we are pleased with the net sales results that we have delivered. Our consolidated non-GAAP gross margin at 62% was right at the midpoint of our guidance. Our consolidated non-GAAP operating margin of 36.2% also was at the mid-point of our guidance. The integration of Microsemi continues to proceed very nicely since the closing of the acquisition, we are continuing to see strong synergies and improvement in gross and operating margins for Microsemi products. Our consolidated non-GAAP EPS was $1.41 and exceeded the midpoint of our guidance by $0.035 per share. On a non-GAAP basis, this was also our 115th consecutive profitable quarter, a tribute to the employees of Microchip including employees from all of our acquisitions for their contribution to our success. In the June quarter, we paid down $257.5 million of our debt. Our total debt payment since the end of June 2018 has been $1.414 billion. The pace of debt payments has been strong despite the weak and uncertain business conditions that we have experienced with some of the inventory correction quarters rolling off from four-quarter rolling calculations, we’re optimistic that the peak of our debt-to-EBITDA leverage is behind us and we should see meaningful continuing reductions in leverage in future periods. Now I will provide you guidance for the September quarter. While the uncertainty begins with U.S. China trade friction, the uncertainty has become global. Europe was the weakest geography for us during the June quarter. Our customers and distributors are blaming the weak business conditions in Europe to the effect of very weak exports to China as well as uncertainty due to Brexit. The largest economy in Europe, Germany is near recessionary levels with auto production down significantly. Our China business was actually up recovering from the Chinese New Year with more shipping days as we expected. While there is this continued uncertainty in Europe as well as the U.S., China trade relations given the multi-quarter inventory correction we have seen at the distributors and customers, we expect net sales for our products in the September quarter to be between flat to up 4% sequentially. We expect our non-GAAP gross margin to be between 61.8% and 62.2% of sales, we expect non-GAAP operating expenses to be between 25.3% and 26.3% of sales. We expect non-GAAP operating profit percentage to be between 35.5% and 36.9% of sales and we expect our non-GAAP earnings per share to be between $1.37 per share to a $1.49 per share. Given all the complications of accounting for acquisitions including amortization of intangibles, restructuring charges and an inventory write-up on acquisitions, Microchip will continue to provide guidance and track its reserves on non-GAAP basis except for net sales which will be on a GAAP basis. We believe that non-GAAP results provide for more meaningful comparison to prior quarters and we request that the analysts continue to report their non-GAAP estimates to first call. With this operator, will you please poll for questions.

Great, thank you. Steve, thanks for the color by geography. As you look into the September quarter, do you expect similar trends in terms of the recent stabilization in China, Europe weakened and any thoughts on just North America, how that's holding up into September?

So I think it should be reasonably similar. The September quarter is usually a good quarter in Asia and that should continue Asia and China but Europe should continue to be the weakest geography and America is sort of normal.

Thank you for taking my question. Steve, over the last few quarters, we have observed that your distributors have been reducing inventory. In the past two quarters, this has decreased from 36 days to 35, and now to 32 days. Do you think this is about as low as it will go, and can you provide some historical context regarding the lowest inventory levels for distributors outside of the financial crisis?

Okay. So this is Eric Bjornholt. So if you look at the last 10 years, our distribution inventory days have ranged between 27 and 47. You have 32 days that's the lowest that we've definitely seen in several years. And we don't really think that it's going to go much lower than this. So I think it's probably relatively stable here. But our distributors are definitely managing their working capital requirements given the uncertainty of the environment and last quarter we had made similar commentary that we didn't think it would go much lower and it went down by about three days. But we think this is likely to bottom. But it could fluctuate by a day or two in either direction. That's definitely possible.

Thank you.

Hey guys, quick question Steve. Seems like you sound a little bit more bullish than you have in the past three or four calls. I'm curious if you can share specifics. You talked a little bit but specifics of maybe what you're seeing within China that that might give you some optimism or why you might have been up, any color in product segments and you think we can go back to normal growth from here including seasonality or we're going to kind of chug along the bottom a little bit?

It's always a familiar story in every cycle. We often recognize the cycles before most and notice their conclusion earlier as well, which leads to skepticism from both ends of the cycle. We began experiencing a downturn around July or August of last year, and we've been in that phase for a year, working to reduce inventory across distribution channels, with major OEM customers, and internally. After several quarters of inventory correction, we're seeing our backlog has increased compared to the previous quarter, indicating some returning strength. That's my perspective, especially when you consider others in the industry are still dealing with their inventory corrections, either because they entered it later or maintained strong shipments based on sell-in revenue recognition, which we avoided. Additionally, there remains significant uncertainty regarding U.S.-China trade relations and the upcoming Brexit deadline in three months, and I can't predict what will happen in those situations.

Appreciate it, Steve. Thank you.

Hi guys. This is Jamison calling in for Ambrish. So I was hoping you guys could talk about some of your receivables and notes that they're up about 6% quarter-on-quarter on a dollar basis and five days sequentially. And I understand that there was some classification, reclassification in your receivables last quarter. But can you talk about what is at play here or is it just a timing thing. And do you expect them to come down in the upcoming quarters? Thank you.

Okay. That's a good question. So there's no reclassification that's occurring this quarter. That was something that we did as part of our year-end process in March. So this is really just based on the shipment linearity in the quarter one quarter to the next that drove that to be a little bit higher and we would expect that to really kind of correct itself over time and kind of be more in line with what the revenue curve is going to be in the future. So hopefully that answers your question but there's nothing unusual going on in receivables, there's no receivables are in good shape and won't have any significant bad debts or anything like that. So all that should come to cash year over time.

Okay. Thanks. And then my follow-up is regarding CapEx looks like your 2020 guidance is reducing towards $120 million which I believe is around give or take a 2% capital intensity and lower than the last several years. So I was wondering what is driving these reductions. Just lower demand and do you expect CapEx to stay around these levels in the near-term or tick back up towards the more historical 4% to 5% in the future?

Okay. So we were in last fiscal year, fiscal 2019 we were putting capital in place at least early in the year for an expansion environment which didn't come to fruition. So we're very well positioned from a CapEx perspective of what's in place. We've reduced the CapEx in the current year by about $20 million from when we last talked to the Street and just managing the business appropriately in that environment. So we tend to go through peaks and valleys in CapEx but I'd say over time you should expect CapEx to be in the range of 3% to 4% of sales.

Okay, great. Thank you very much.

Welcome.

Thanks guys. Eric I had couple questions for you on the gross margin and OpEx, I believe you are guiding for the June quarter for underutilization impact gross margin by 70 basis points. Was that the case and were you sort of discounting in your September quarter outlook and then with respect to the OpEx, non-GAAP OpEx, you're I think guiding for a $10 million sequential increase based on the midpoint of the guidance. That's the first increase in five quarters. I'm just wondering what's behind that?

Okay. So we'll take it one at a time. So on the gross margin side, we did have underutilization charge again this quarter, it was pretty much in line with what it was in the previous quarter it was $7.3 million, I think that's up 200K quarter-on-quarter. We're running our factories kind of at an attrition level in most cases at this point in time, so production has been coming down or inventory is higher than kind of our normal operating levels of 115 to 120. And at this point in the cycle that is not unusual but overtime we do want to bring that inventory balance down. So that's really hit on gross margin. On OpEx, you're right we are guiding to an increase and we've managed operating expenses very tightly really since the September 2018 quarter and have really kind of beaten our guidance on OpEx in September, December and March quite significantly and came in kind of at the target in the current quarter and running the business conservatively but there are investments that we feel we need to continue to make in this business to drive the ongoing health of our business and future growth opportunities. So we view that change is relatively small in the current quarter as a percentage of revenue, it is targeted to be flat at the midpoint of guidance at 25.8%.

Okay, thanks guys.

Great. Thanks for taking my question and congrats on the good results considering such a tough demand environment. I'm hoping you can quantify the dollar savings or the synergies that are remaining with regard to the Microsemi acquisition and your anticipated timing on achieving those? Thank you.

So I think we can order that generically because really not at this point in time breaking results out. We had guided at the end of first year of our synergy to be at the radar for $0.75 per share on an annualized basis. We can tell you that we’re ahead of it, after one year we have really exceeded those targets. And then the longer-term three years synergy targets that we had identified were $1.75 which were and you can pick the second year numbers somewhere in between $0.75 and $1.75 and the $1.75 number was consisting of three items although we didn't provide a breakdown of those three items, one was the OpEx synergy, second one was COGS synergy with bringing stuff inside and improving gross margin. And the third one was the benefit coming from sales, incremental sales growth and all that. There was actually a fourth item which was tax although we originally did not mention tax. So as we look at it about a year and a quarter after, we are head of synergy targets on the expenses, we’re ahead of our synergy targets on the COGS side and we are ahead of our synergy targets on the tax side. So three out of four are ahead and one we are behind which is that revenue largely driven by the environment that we face. So that's kind of where we are.

Thank you.

Yes. Thank you. Good evening. I guess a question on some of the ongoing trade tensions and specifically some of the new tariffs are going to come into place. I know Steve you've been watching this closely with respect to your business. And I guess with this next round, do you expect any activity from the channel kind of pull forward, push outs as a result of that or going on long enough now that maybe there's some exhaustion in the channel and it's having a less of an effect. Appreciate your perspective.

I think first thing I would say is that this is a second quarter in a row where there has been a significant tweak between the time we prepared our guidance and prepared our notes for the time, we delivered our guidance and delivered our notes and quarter-ago, I said the same thing in the conference call that based on that tweak we had to nudge the middle of our guidance down. We had to do exact same thing this time where we had to nudge the middle of our guidance slightly down because of the tweak and the extra tariffs to go into effect on September 1 whether that would happen or not. I think this is a whole lot of uncertainty. Nobody really knows what would happen or what not. In terms of the tariffs that Microchip pays, the effect of this additional $300 million is virtually nothing. There could be a small amount of our development tools or something, we're talking thousands of dollars not millions of dollars. So that is not effect. The effect really is how will Chinese customers behave in terms of buying our products to parts which are being exported back to China. Will the customers prefer to buy it from somewhere outside of China. And if they choose a brand outside of China, does that have also other parts of designed in or it’s not. And I think it’s always some in some, in some cases we will gain business because of the outside brand outside of China has more of products and sometimes we lose because the given brand outside of China has more of the parts from Japan or Europe or somewhere. This is very, very hard to figure out especially when you're dealing with 120,000 plus customers. So hopefully we have navigated this well in the last one year. I think when you write the history of this last one year, I'm not sure how you would conclude that we were not correct. And hopefully we have navigated it correctly and have guided you correctly and all that wisdom, we have tried to put it in our guidance. That's the best I can say.

Thank you.

Hey, good afternoon. Thanks for taking my question. Lots of recent consolidation maybe if you want to call it land grab for wireless connectivity assets especially Wi-Fi maybe you guys can just remind us on Microchip’s connectivity portfolio I believe it's pretty comprehensive. I know you guys have Bluetooth, Zigbee, Lora I believe you guys also have Wi-Fi capability but if you could just clarify that and if you can maybe qualitatively sort of quantify the attach rates of your connectivity solutions with your microcontroller platforms and opportunities that do require this type of connectivity capability?

Okay, so you're right. We do have a pretty broad portfolio of Wi-Fi and Bluetooth and other solutions. So just about all the major requirements that are standards based and even many that are proprietary based wireless solutions, we have in our portfolio. They have come through organic work and they've come through several of the acquisitions that we have done over time. So we don't have a particular glaring issue with a particular wireless requirement that we're not able to meet in the marketplace today. It doesn't mean we don't have new products, new innovations coming. Those are a normal part of doing the business itself. As far as attach rates go, we don't track as closely what is the attach rate of wireless, we think of systems, our customer systems needing to have smart connected and secure capabilities in them and we provide the building blocks of many different types of smart capabilities with our microcontrollers, processors, analog and other products many different connectivity options not just wireless, wireless and wired and we have a very leading portfolio of Wired analog of wired connectivity solutions as well. And then finally security itself. So that's how we go to market. Looking at how do we enable smart connected and secure solutions but we don't have to have a close tracking of how many of them have connected and off those that are connected how many of those are wireless and if they're wireless, what exactly is the standard that goes behind them. But we're very happy with the portfolio we have and are able to prosecute the markets and the businesses we want to be able to go after.

Yes, great. Thank you.

Hi this is Josh Buchalter on behalf of Matt. Thanks for taking my question and congrats on the results in a tough environment with gross margins hanging in pretty nicely, I was hoping if you could provide an update on the overall pricing environment you've seen through this down cycle. It seems like things have hung in there pretty well all things considered and it would be helpful to hear your view particularly how it compares to prior down cycles? Thank you.

So I think when we talk about pricing, I would say that the pricing has held up in this environment better than really it has held up in any business cycle before Microchip pricing in general held up in the prior business cycle also because so many of our products are proprietary but as you talk about this particular business cycle, I would say 95% of what we make today across various different business units is proprietary where you cannot take our part out and plug somebody else's part in. So therefore we really have never competed for pricing at the buyer's desk. We often compete with pricing at the designer's desk which is usually two years ahead of time and whatever quotation you're making at the designer's desk, you have the time to achieve and do cross reduction or achieve the results you need to achieve when the part goes into production. Now especially in this cycle, I think it could be somewhat driven by the consolidation industry has seen, somewhat driven by the players who have been taken out where the weaker player in price management and some of them we ourselves took them out. I think a result of all that is that the pricing has held up or our record all-time high record gross margins, I believe were 62.23% that we made two or three quarters ago and the quarter we just announced that gross margins were 62.2%, that's 23 basis points below the record and we're sitting at the bottom of the cycle. So I think that's good news as the cycle improves and as our factories get further full and as we complete the rest of the Microsemi integration and as we bring more of this stuff from outside to inside, the remaining stuff from Actel and some from Microsemi, it's really interesting to think about where this whole business model goes.

Very helpful, thank you.

Thank you.

Thanks for taking the question and like many others congratulations on the good execution guys. Steve I wanted to follow up on your remarks regarding an earlier synergies question. You mentioned that that the difficult macro environment has made it tough to realize revenue synergies which is understandable. But the question is this do you still think there is the same degree of revenue synergies that's possible from the combination. Or is there something about what's happened over the last year that would cause you to lower your view of longer-term synergies potential with revenues? Thank you.

Yes, the opportunity for revenue synergies a theme and some of the earliest piece of revenue synergy where we have gotten our parts around Microsemi sockets and their part around Microchip socket is kind of already beginning to happen but the starting point is lower. The whole industry has lost significant amount from the top line as a starting point. So even though we may be adding a little bit of the revenue synergy already, the total revenue is still below where we started and that's the more difficult part but the longer-term as the industry recovers from the cycle there is the funnel is very healthy. The indicator we track internally which is the number of Microchip products per customer design, extremely proprietary indicator is continuing to increase and as the baseline business goes up, I think this should be working pretty well. So no we have not lowered the long-term target at all.

That's helpful, thank you. And then if I could ask a follow-up to Eric. Eric I recall when the Microsemi transaction was announced that there was an element of the debt burden that was variable rate. Can you confirm how much that is at present and given the decline in interest rates that we've seen especially over the last three to four years. When would that be expected to benefit the interest burden that exists on that debt?

Okay. Sure. So we have two pieces of variable rate debt in the portfolio. We've got a revolving line of credit and then a term loan B, the revolving line of credit had a balance of $3.197 billion at the end of June and the term loan was $1.724 billion. So roughly $4.9 billion of floating rate debt and we are seeing the Fed cutting interest rates that we are getting a benefit of that today. And that's been reflected in our guidance for the other expense that we've guided to the Street. That is the debt that we are paying down those still, we are paying down the variable rate debt and that come down, we should see the benefit in the overall operating results. Does that address your question?

Yes, it does. Thanks guys.

Yes, good afternoon guys. Steve, thanks. Let me ask the question. Steve, I think one of the challenges that all the M&A you guys have done over the last several years has been both for the industry analysts and I think internally for you guys is to getting a better understanding of how seasonality is in your business? I'm kind of curious if you can give us some insights when you look at the September guide you just gave a flat-up for how did you peg that against sort of “normal seasonality” And I guess more importantly as you look into the December quarter, are you guys any closer to helping us understand what normal seasonality might look like in December?

So I think John very, very good question. We always try to figure out the same pain. However seasonality is very hard to measure. Number one with all the acquisitions that keep changing the seasonality because different acquired businesses work differently but also in the current environment with trade tensions and general economic conditions, the variability on the business caused by the U.S., China trade friction and general economic conditions is much larger than any impact of seasonality. So we can't really compare this to any kind of seasonality. Seasonality is also driven by kind of how somebody was measuring the revenue. Historically, we measure the business based on sell-through revenue recognition and now based on the GAAP standard, we're having to report the numbers based on sell-in and sell-in and sell-through work differently. We have much more cycles learning on a sell-through revenue recognition on seasonality than we have on sell-in. So I think with changing revenue recognition totally different seasonality for Microsemi business with defense and aerospace and FPGA in discrete parts and uncertainty of China, U.S., Brexit and general economic conditions. I think this one remains a very, very good question with no real answer today.

That’s helpful, Steve. If I could sneak one in. You did a very good job quantifying the impact of Huawei in the June quarter. I'm just kind of curious and I apologize if I missed this. What's embedded in the September guide. Is it a similar dollar magnitude or would it be more given that you're taking a view of the entire quarter instead of just half the quarter?

It's not that easy to answer, it’s not only a function of what is it that we're allowed to ship but what is it that Huawei is able to use. And that is changing day by day as they get inputs from their various suppliers of what they can and cannot ship as well. So what we have built in is less than what a full board would be for a quarter. But it's a conservative estimate that we have put in with our best judgment of what we think Huawei is likely to take. And that changes day to day as we go along.

Helpful, thanks guys.

Hey guys, thanks for the question. Any early feedback so far from your silicon carbide products. And then also do you guys have any plans or have you thought about expanding into other compounds semi's out there or perhaps even vertically integrating like guys like wanted to do and then Eric just one for you, the IT security remediation that you guys referenced in non-GAAP expenses, just any details on that? Thanks.

So with respect to our silicon carbide products and the customer reaction has been extremely positive. I think that is driven by one, we are a known provider into some of the markets that care most about silicon carbide automotive in particular. But second what differentiates our silicon carbide solutions is the robustness of the product line and that robustness is measured in different ways that we've been able to demonstrate through test results. And in this area where there's very high voltages that are involved in the applications that need silicon carbide robustness is highly valued in what we've done. So the discussions with customers are going well, there's high interest in the product line. It's early days as we are launching and then starting to go into design activities with them. With respect to any other compounds that we might be looking at. There's really nothing exotic at this point to talk about and we need to really harvest the places where we have investments and make sure they go into production and in time there may be other things we would do but nothing to report on at the moment.

Okay. And then on the security matter, I mean we kind of fully disclosed this in our 10-K which was filed in late May that we had a security incident that we are in the process of remediating and it did cause a weakness in our internal controls. So we are working hard on remediating that issue and that that's really what those costs are associated that we are excluding from the non-GAAP results.

Thanks guys.

Steve I had a longer-term question, do you think because of the U.S., China trade conflict there is the possibility of market share shifting onto non-U.S. microcontroller companies, I understand there's obviously nothing near-term but do you think that becomes a risk factor longer term?

That suddenly becomes a risk factor, if Chinese were to think that designing parts from suppliers outside the U.S. is safe for although they have similarly strange relationships with Japan. I'm not sure they like those people either. The other thing is you have to look at the complexity of the products, so commodity products probably would be more subject to risk than many of our advanced products in their datacenter business, communication business, FPGA, 32-bit microcontrollers, networking products, USB, Ethernet, automotive and others where some of the commodity products will be more vulnerable. So but I think what is happening right now is that we’re seeing a large number of customers starting to move their production outside of China, they’re going to Malaysia, they're going to Thailand, they’re going to Vietnam, they're going wherever some may come to Mexico. So I think we're likely to pick up share in that part of the business that moves outside of China because in the local competition kind of disappears, they largely sell in China and many times passing out a very high quality and they may be okay for the local Chinese market but naturally okay internationally. So there could be some longer-term impact from that but I think it's largely going to be a wash. Every decade or so another country appears that seems to threaten the world back in the 1980s and Japan was going to take everything and U.S. semiconductor industry was going to die in the 1990s, it was Korea then, then it was Japan, Taiwan and now seems to be China. I think this industry is still pretty innovative and it will survive in the world.

If I could sneak in a quick follow-up on gross margins. If I add back the underutilization charges, you're getting close to your longer-term 63% target. Is that the upper limit, is there something in the portfolio that kind of limits you to those kind of gross margins or do you think there is a potential to do better over time? Thank you.

Well we haven't hit it yet, once we hit it then we'll take a look at it. But yes as I mentioned earlier that the gross margins we have today are I think 600 basis points or so better than in the bottom of the last cycle. So there is a significant accretion usually from the bottom of the cycle to the top of the cycle. So there's a significant opportunity here. Not willing to talk about another target yet but I think your question is a good one.

Thanks Steve.

Great. Thanks for squeezing me in congrats guys on a tough environment execution there. Hey Ganesh maybe this is one for you. For the FPGA business, how much of that is coming from aerospace, defense and aviation?

So we don't break it out by segments but suffice to say based on whatever data has been provided previously through Microsemi or Actel, it is a significant portion of the business that's where many of the differentiation of the FPGA product line was built around low power around security, around robustness, reliability et cetera which are highly valued there. But it is a pretty significant amount that is also in non-aerospace and defense business and it's growing in those areas quite a bit more as well. So as time goes on, we will retain the strength we have in defense and aerospace but we will also gain in many new areas. As you might see in the most recent announcement we made of a smart and better vision solution using the PolarFire FPGA solution.

Okay. And then as a follow-up Ganesh, is there on the non-aerospace FPGA business, is there a 5G angle to that business over the next several years?

There is and it's being worked on. It's I would call an emerging opportunity for where it's not the same places as some of the high-performance players are playing in today but yes as 5G rolls out, there are going to be opportunities and it's on how intelligence is embedded into the edge and less into where it is in the core. And again some of the smart embedded vision solutions that type of opportunity will show up on the 5G side as well. But it's more on the edge side not in the core network.

Great. Thanks again.

Yes, thanks and congrats as well in a precarious environment good results. And forgive me if this question was already answered but I wanted to get a sense some of the other players in the space noted the inventory correction in the China automotive market is coming to a completion and that that particular segment which had been affected pretty significantly less than the first two quarters is starting to perhaps recover. Same thing with China Industrial and again if you answered this before forgive me but just wondering if there is any thoughts there in terms of China auto and China Industrial as we go into the second half?

So I think automotive in China continues to have pretty significant year-over-year declines. I think what we may have seen and maybe the data you saw was in the month of June, there were stronger sales that took place in part that was driven because there was emissions change that was happening on July 1 and cars that were sold before the end of June qualified under the old requirements and then the new requirements went into being. So I don't believe that fundamentally the China automotive market has strengthened in any recent timeframe. It will obviously has more probability to bottom and go up given how far it's come down but I wouldn't say there's anything in the short term that has shown up in China automotive.

Let me add to it, Raj you begin with talking about inventory correction in the China automotive. I don't know if that is the case. I don’t think we have seen an inventory issue in China automotive that inventory needed to be blown out. We have seen a reduction in demand driven by just duties and problems in China economy therefore lot of the luxury car manufacturers are building much, much less. So we have seen demand disruption. I don't really think there was at least from a Microchip standpoint, there was not a high inventory in China automotive.

Go ahead.

With respect to your question on industrial, I think industrial weakness is not limited to just China alone. I think industrial in Europe, in the Americas, in China across the board has seen weakness. I think you've seen that in some of our competitors releases as well. Some of it has been initiated from the trade and tariffs and impact from about a year ago. But industrial remains a weak segment.