Good day, everyone, and welcome to the Microchip's Third 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 call over to Microchip's Chief Financial Officer, Mr. Eric Bjornholt. Please go ahead, sir.

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 were 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…

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 continue 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…

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 the 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 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 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…

[Operator Instructions]. We'll go now to Craig Hettenbach with Morgan Stanley.

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. Whether 120,000 plus 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.

We'll go next to Mark Delaney with Goldman Sachs.

Steve, I was hoping, first, if you could give us about 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 are -- 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. So I think at this point in time, we've given a pretty broad range of guidance for the quarter of plus 2 to down 9, so that's probably the broadest range of guidance you've seen from Microchip in a long time and some of that is the unpredictability of what the sell-in versus sell-through is going to be.

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 for what enabled the company to exceed its guidance on those financial metrics?

Well, do you want to take that, Eric?

Sure. So, I mean, revenue was roughly 1% -- a little more than 1% better than our guidance was. And I think that's just kind of the puts and takes that we saw in the quarter, but it was good that we came in above the midpoint. And then on the gross margin side, we had a very favorable product mix in the quarter. We continue to really focus on cost reductions of our manufacturing areas. You know that we made quite a bit of changes in terms of any discounts that were previously given for the Microsemi portion of the business, on sales to distributors or contract manufacturers, and we're really seeing the benefit reflect itself in the gross margin today.

We'll now take a question from Ambrish Srivastava from Bank of Montreal.

Maybe just take 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 a 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 are -- 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 cost in all of our factories. There is still a lot of Atmel products, which was 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.

Okay. Good. And then my quick follow-up, Steve, usually things don't turn around that quickly. And it's a small piece of your business. FPGA, if my memory serves me correct, it was kind of in the $320 million, $325 million run rate annual, and you posted $100 million quarter. What's going on? Is there, hopefully not a last time buy, but some design wins that are ramping?

Yes. There are no last time buys in FPGA that are driving that revenue. There has been feed zone for many quarters on some of the new products, the fourth and fifth generation of the FPGA products. There's some of the FPGA, which is exposed to markets like defense and aerospace, they have some quarter-ending budget that needs to be spent. But it's a stable, solid business and we see many, many good characteristics for how that can be continued to be built on. Quarter-to-quarter, we may have small changes, but our overall, if you look at annualized revenue, it's on a nice good growth path for us.

We'll take our next question from Vivek Arya with Bank of America.

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?

Ganesh?

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 has 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.

I think aerospace and defense is a market in its own. It's in its own space and it doesn't really follow the usual -- what happens in industrial, consumer and other. It's a very different business. We did see some impact from the government shutdown where we couldn't get certain export licenses processed and some programs were not released, but we kind of expect it to square up in the quarter and that really help any significant impact going out of the quarter. There is some impact of a budget flush and there's a lot of budget flush in September and December quarters where all these large customers, they have government budgets and they need to spend it. Otherwise, they use it or lose it. And so March quarter is sequentially down in that segment because of 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.

We'll take our next question from John Pitzer with Credit Suisse.

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 believe it is the combination of both, right? I mean, we haven't given guidance historically based on sell-ins. So this is new to Microchip and we don't feel that we have a good way to understand if distribution inventory is going to increase or decrease in a period. So that is a factor, but obviously the environment is very uncertain. So I can't parse it out in terms of what percentage is each, but I -- this is just a pretty broad range of guidance...

Yes. So I think -- I would just say, maybe sticking my neck out a little bit, that over time, I think we will learn to have the guidance narrower. We have a very broad distribution. We do business with over 100 distributors around the world, which is not the case with many other semiconductor players that do business with largely 3 or 4 large distributors. We, as you know in the past, we have large distributors, which we call global distributors, we have catalog houses and we have nearly 80 to 100 distributors in China alone. So our distribution network is very, very broad. And to really figure out what everybody is going to buy, those are not the profits that we worked on in the past. We don't really care what distributor buys. We care about what distributor sells out and our processes take care of that. So we will get better at it very rapidly. We're not saying years. We're saying quarters. We'll get better at it and guidance will narrow. And the other impact is the uncertain environment. Once the environment gets more certain, I think we'll narrow it also.

Yes, and I think another contributor 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. But, I made this point last quarter, I think only about 10% to 20% of -- 15% of Microsemi business is done in the internal factories, that comes from the foundries. So from foundries, we have aggressively cut the starts and assembly and test loading to really bring that down rapidly at subcontractors. Internal, we have carried and the factories are running below capacity. And when the business comes back, we get some improvement from utilization from the internal factories but there were only 15% of Microsemi business, they're only probably 5% of our business, total, Microchip. So just be careful.

We'll take our next question from Harsh Kumar with Piper Jaffray.

One for Steve and one for Eric. Steve, I wanted to ask about your comment about marking the bottom in March, a couple of other broad companies have said the same thing. But they are usually talking about either some sort of stabilization in the backlog or some kind of metric that they are watch and monitoring. I'm also -- when you make that statement, I'm also hearing sort of, Ganesh, in response to a question said, things are still getting worse in some of the markets. So I'm curious if you have any kind of tangible data in terms of either backlog or orders or something else you could point to. And do you think the China industry is sort of flushed at this point in time and that's we're basically shipping to true demand or maybe undershipping and that's the reason why you feel better about it? And then I've got a follow-up for Eric.

Well, I would say some of the data center and other business 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 question?

Yes, yes.

Okay. So I think I would say we really can't present you enough data to convince you and we're not going to try. What we can tell you is that our 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 a $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 focus really all of our excess cash generation outside of the dividend on paying down debt.

We'll go to William Stein with SunTrust for our next question.

Steve, I'd like to maybe take a different approach to the sort of cycle and recovery question. Acknowledging that you've tended to call these turns early and correct, I just want to understand what's giving you the confidence -- from the perspective of trade, we have this March 1 deadline hanging over us, and it sounds like you're providing us with some, not guidance, but some sense of demand post-March quarter that implies this gets resolved constructively. And I'm just wondering why you feel confident to do that? And then I have a follow-up, please.

I don't know if that's what I'm saying. Actually, I'm saying very clearly that barring any significant negative developments from the trade front, that was the caveat in what I said. And what I also said was that I think with a month to go to March 1, I think the governments are making progress, there are positive signals coming out of the White House. You recall how negatively signals were coming out regarding Canada during one of the conferences, I think. And then all of a sudden, a week later it all came out good. So it's -- Trump had used that strategy in a way and then not those negative signals coming about China. So I think the progress must be good, but it's a lot of work to get done. And I'm simply saying, it's most likely that there's some positive announcement but the actual settlement gets pushed out further. The settlement gets pushed out further, the environment we're seeing remains. Our guidance assumes a fairly current environment continuing. And if that current environment continues, then June quarter is still better than March quarter.

Okay. One other question on the Microsemi integration. I know that -- I recall they acquired Vectron, a lower-margin business right before you acquired the whole company, and that was a -- they had never reported a quarter with that asset. And there were some other things in their portfolio that might not have met Microchip's, I don't know, view of a great business to be in. I'm wondering if you've made any portfolio adjustments, if you've closed any of their businesses so that we can think about maybe a different margin profile or growth profile when demand normalizes and all the inventory adjustments are made?

We have not. We have not sold any of the businesses, we have not closed any other of the Vectron factories. We're running the business. You are correct that the business is at a lower gross margin. We're using our usual techniques. We are trying to improve the gross margins. We asked the management, they also -- Microsemi had to cut some expenses, and we have cut some. So the contribution to EBITDA is actually much higher than really what it was originally. But the gross margin, if you only focus on that, then the gross margins are lower. We have other businesses at Microchip where the gross margins are lower than our corporate margin. We have also many businesses that are higher, in the 70s and 80s. So at the end of the day, it's a mix.

If your question goes beyond Vectron. In the last two conference calls, we've also mentioned as part of our integration effort, we have reviewed every single business. And while there are many, many excellent businesses, there were some that needed improvement. And we have made adjustments in terms of level of investment we're making in those businesses to be better overall result for us as well. So -- but that's all largely behind us. At this point, as Steve mentioned, on Vectron and all the other businesses, we're working on improving what we inherited and making significant progress towards that.

And when the factories come back to full production, as we take out these excess inventories, Vectron business will see substantial cost reduction through higher utilization in that factories, their numbers are going to start looking much better.

We'll now take a question from Chris Caso with Raymond James.

Just wanted to ask a question about revenue geographically. And I guess that we probably anticipate some of the weakness that you've seen in Asia that you talked about before. It look liked from the results that you saw a downtick in Europe also. Can you talk about that? And if there's anything specific geographically you're anticipating as you go into the March quarter?

I can take that. So I mean, the in all geographies, we're down. We posted this on our website. So it's available for everybody to see and will be in our 10-Q filing. But all geographies were down. It is not unusual at all for the Americas and Europe to be down in the December quarter just because of all the holidays. And typically, we see strength from Asia in that time period prior to leading in the Chinese New Year in the current quarter. But I think all geographies were weak. This weakness was not just the China issue, it's just kind of spread across the globe. And in terms of forecast for the next quarter or the current quarter that we're in, we don't really break out the forecast by product line or geography.

But I think directionally, March quarter, usually, our European business is strong, our China business is weak because of Chinese New Year, even in a normal time, we're also dealing with trade here, and the U.S. business is kind of normal. So I think directionally, it can have that.

Okay. And just as a follow-up, the follow-up question's on revenue of linearity through the quarter and kind of expectations for March as well. And you mentioned last quarter that you saw a slight uptick, I guess, in the first month of the quarter. I presume that downtick towards the end of the quarter. And then how do typically see linearity as you go through the March quarter again taking in consideration the Chinese New Year holiday in the middle?

Well, so I think the uptick we talked about in bookings in November call basically did not hold. I think you've heard from everybody that December was fairly weak. That's always the problem in making decisions based on very short-term data. And I said that earlier that our bookings have normalized very -- lately, we have even seen some strength. But don't take it to the bank yet, I'm not taking it to the bank. We have made the call today, at the midpoint down about 3.5% sequentially from GAAP-to-GAAP revenue. This does not include any dramatic improvement of bookings or improvement of trade or anything like that. I think it just assumes that the market stays in the doldrum.

Our next question comes from Harlan Sur with JPMorgan.

In terms of executing on the March quarter guide and maybe providing the team with a bit more confidence on the June quarter kind of qualitative outlook, historically, how much hinges upon the replenishment rates post-Chinese New Year? And when do typically get these signals? Is it two weeks, three weeks after Chinese New Year?

So March quarter sometimes lands up very much depending on where that Chinese New Year falls based on the lunar calendar. Earlier the Chinese New Year, the better than March quarter usually lands up being because Chinese customers can go slow before that and they come back and then they see all charged up and ramp up their factories. So Chinese New Year is happening this week, which we will consider kind of early because it can be late February, it can even be fairly late. But it has been even earlier sometime in late January. But this is really early to mid. So this is good sign, and we will see what happens after Chinese New Year.

Okay. No, I appreciate the insights there. I know you guys are waiting for the Gartner data, but just looking at the recent SIA data, the MCU segment was down about 4% sequentially in Q4 versus your MCBU business, which was down about 9% sequentially. I know you guys look at this data as well. Any reason for the big delta? Is it sell-in versus sell-through so not a fair comparison?

I think in any given quarter, you're going to find that the data is more noisy. It's easier to look at these on a four quarter rolling basis, and that's what we expect when we'll see the 2018 data. So there is no doubt in our mind we're gaining market share. But quarter-to-quarter, the numbers can be more noisy.

Our next question will come from Gil Alexandre with Darphil.

From all that say, it seems that your 300 synergies is pretty good number looking for fiscal '21 or '22.

So what I would say to that is we are ahead of the accretion target today. Just in some cases, we have pulled some of the synergies in, it had gone better in term of integration but we haven't revised the final number. The other major change that happened is that business environment recession that we're going through that we have not built into the forecast, nobody had anticipated it back then. It will depend on the shape of the recovery. If the recovery is fast like it has happened in some prior cycles, then we get back on that schedule. If the recovery is a lot slower and it's kind of the L-shaped recovery, it stays in doldrums for a year, then the schedule for achieving that may have to be adjusted. But I don't think we are uncomfortable with the number, total accretion.

So it really means that you get $8 non-GAAP earnings in fiscal '21 or '22, or you could?

Well, you're putting words in my mouth. But that was our forecast then. And again, depending on the shape of the recovery, that is still our target.

Okay. And your long-term model targets stays the same as you made in March of 2018?

Correct. I think state them again for everybody?

So it is 63% gross margin, 22.5% operating expenses and 40.5% operating margin on a non-GAAP basis.

Yes, thank you.

And do I need to be concerned that autos represent 17% of your mix?

Autos has been a very good business and you shouldn't be concerned. We have just a tremendous funnel of the design wins in automotive for future and all that, significant entry into various electric vehicles around the world and autonomous vehicles around the world. So there's really no reason to be concerned. The issue in automotive market have been two. One is, Europe implemented a new emission standard for their diesel vehicle starting September 1. And all the agencies had a one year notice, they knew a year ahead of time, that the new emission standard was going to effect on September 1, 2018. September 1, 2018, came and there was no capacity. People kind of just felt sleep on the switch. So there were millions of cars taking away airport parking lots that can't be on the road because they don't pass emission standard. So that created a significant dislocation in the European car market, it's working through it, will take more time to work through all that. So that was one issue. And the second issue was the slowdown in China. China is now the largest automotive market, larger than U.S. and larger than Europe. And China is going through its own issues of slowdown and stock market crash and some of the people's wealth has been affected. So the China automotive market, all that will come back.

And Gil, if I can add one more point. The consumption of electronics going into cars continues to go up year after year after year. So -- and in many years, that consumption of electronics going up offsets any reduction in production as well. And so that's been the long-term trend and remain so.

We'll take our next question from Kevin Cassidy with Stifel.

Maybe just on the 32-bit micro traction that you're seeing. Can you just say what end markets it is? Maybe -- your discussion around automotive, maybe that plays into it. But can you say which end markets you're gaining the traction?

We're broadly represented in the 32-bit microcontroller market. The standard products are broadly represented in all the end markets, it's a ubiquitous product. I can't pick any one of them that's necessarily the one that's going there. But we've been coming off of a -- a being lower in the rankings. We're rapidly coming up the rankings. And as we do that, it has to come from all the different segments that we play in.

Okay, great. Maybe is there such a thing as an upgrade from the -- your 8 and 16-bit customers going to 32? Is that helping your traction?

No, not at all. I think, the 8 and 16 bits are continuing to do well. And again, when you see the annual results for 2018, you'll see that all three segments as it was in prior years are doing well. The 32-bit, we have more capabilities that have come both organically as well as through the acquisitions. It's allowing us to play in a number of incremental markets that perhaps we couldn't get to a few years ago. And so I think the point of providing some color was there was a sense of perhaps 32-bit was still very small for us and we were just playing in 8 and 16s. Now 32-bit, at over $1.2 billion annualized based on the last two quarters, is a pretty significant portion of a $3 billion-plus annualized microcontroller market for us.

We'll go next to Chris Rolland with Susquehanna.

Steve, so regardless of the SEC's opinion, this analyst supports you that the standard should be sell-through, for what it's worth. But in terms of a question, now that we're a few quarters into Microsemi, what has been the biggest positive surprise for you in terms of products and traction and demand for those products positively since you guys close?

So I would say that we confirm usually a lot of positives after we close the acquisition. We don't usually find new positives because the management's always, those are the positive that's been out, and they're selling their company, so they're really not hidden positives. We usually find some new negatives that we may not have known or may not have fully understood or may not have been fully explained as you have seen. But on the positive side, we don't get surprises but we get confirmation. And here, as I said, we got a very good confirmation, the products are very good, customer sockets are very sticky in discrete military products, in FPGA sockets, in a lot of the analog sockets, in timing business and data center businesses. They're very good businesses, they're good sticky sockets, very complex products as well as very simple discrete product. So it has a range of products and very, very good engineering teams, very, very good work done. And I think we have continuously said that we feel very good about it. Business fits very well with Microchip. We have truly enhanced the ASPs and gross margins by a methodology of discontinuing the -- some of the discounts and all that. We brought the inventories to the right levels. Internal inventory, we're still working through. As we revamp the factories, I think they will have some more positive effect. So all that is very good. I think we feel good about where we are.

Great. And then on some of the PMCS products, whether it's optical or storage, given kind of the well-known storage slowdown trends that we've seen out there more broadly, and then some guys talking about a data center slowdown or hyperscale digestion out there, have you seen any of this at all? And have you seen that play into either optical or storage for you guys?

I think, built into our guidance for this quarter, as I mentioned earlier, it does reflect that there is some weakness in those two segments in communications and data center. It's not different from what others have been talking about as well. And we are seeing that in the Microsemi products that play into those segments.

But I think I don't think anybody questions the strength of data center or communication market as a good market longer term. Any segment is going to go through inventory digestion and cycles. The question we were dealing with was, is Microsemi a good business? Is it the right direct acquisition? Is short-term cycle coming in? And having some hyperscale digestion for a quarter or two will not really factor into our decision. I think this will be a very good business long term.

Our next question will come from Rajvindra Gill with Needham and Company.

Forgive me if this question was asked because I'm joining late, but I was wondering if you can make a distinction between any potential trade settlement or trade agreement versus the actual deceleration that's happening in the Chinese economy. So meaning, if there is some sort of trade settlement, what impact would that have in the business environment? Or is it just maybe taking one risk off the table but the reality is that the economy is slowing down dramatically and the trade agreement would really more have a sentiment improvement but nothing really changing in terms of actual business? Just wondering if you could -- or if you -- maybe if you could just elaborate on that.

So Raji, I think our assessment is that trade is the problem why Chinese economy is weakening so much. China has been the production center for the world. And as these trades came in, Chinese goods became more expensive and threaten to go more expensive, with $200 billion of Chinese goods getting 25% tariff, that's a $50 billion tax. So companies have moved production out of China to the extent they could, to the extend the product was running in two different factories and one was outside. But there is just not enough capacity outside of China to take all that outside. But there are lots of them in works. With the tariffs, Chinese stock market has taken a major hit. And Chinese consumers use the stock market as the cash machine to run their businesses and buy cars and buy stocks. So I think you cannot take the trade issue away from the Chinese economy. As the trade issue is settled, that is the boost that the Chinese economy will need. And then the people will have to think about do they stop taking factories outside of China or would the trade talk settle, all that effort stops. I can't know what would happen there. Is there a future risk? If there is complete removal of trade barriers, then I think nobody's want to do the work to move the factories outside. If the settlement happens where there's significant barrier on both sides, then all that will continue.

That's helpful. And along those same lines, do you think there will be some sort of fiscal stimulus in addition to the -- if there's a trade agreement but a fiscal stimulus coming out of the Chinese government?

I thought there already was one.

There are some small ones that have been done. But we don't have any inside knowledge of them.

Post New Year? Post-Chinese New Year?

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.

We'll take our next Janet Ramkissoon from Quadra Capital.

Just a question about China again. Have you -- could you comment on the business with ZTE in the quarter? Did you see a recovery there? And 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 competitor 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.

Our next question will come from Craig Ellis with B. Riley FBR.

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 moving forward on a very, very wide beachfront, so pick one. When we bought Microsemi, Microsemi compiled their results on 21 different ERP systems, business unit by business unit, and then they are compiled, somewhat like a conglomerate. We -- the companies we have bought, we have brought them all into our enterprise system and ran a single enterprise system for years and years. With Microsemi, we have said, we're going to go down to two systems. I would love to go down to one, but the work was just too much. So we were 22, one of us and 21 of Microsemi. From 22, we'll go down to two. And we're making progress. We took one business in into our system on November 1. We took three on February 1. We have another 3-or-so planned for May 1. And then there'll be a cadence of these go-live every quarter. In another 12 to 18 months, we will consolidate. So that's a huge project with lots of synergy and accretion coming from that. 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 feel 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 other side, that takes some time. And that's progressing. And how we kind of make it work is really a -- is 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.

That's helpful. And on the last point, Steve, is that something that will bear fruit from a revenue standpoint this year? Or does that just put you in a position where you've got the design win and then you work through what can often be a 12 to 18 month gestation period before that design would go to revenue?

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 a 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.

That concludes today's question-and-answer session. I'd like to turn the conference back to Mr. Steve Sanghi for any additional or closing remarks.

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.

This concludes today's call. Thank you for your participation. You may now disconnect.