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Cypress Semiconductor Corp  (NASDAQ:CY)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to Cypress Semiconductor Third Quarter 2018 Earnings Release Conference Call. Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. Colin Born, Vice President of Corporate Development and Investor Relations. Sir, you may begin.

Colin Born -- Vice President of Corporate Development and Investor Relations

Good afternoon, and thank you for joining our Q3 2018 earnings conference call. With me today are Hassane El-Khoury, CEO; Thad Trent, CFO; and Mike Balow, Executive Vice President of Worldwide Sales and Applications. Hassane will make some introductory remarks and Thad will provide a financial overview, and then we will take your questions.

All information discussed in our earnings release and on this call is based on preliminary unaudited results and we encourage you to review our 10-Q, once it is filed. During the call, management will make statements about our fourth quarter guidance, our long-term financial model, and other future matters that should be considered forward-looking. Actual results might differ materially from the results anticipated in our forward-looking statements. Please refer to our earnings release, the risk factors in our most recent 10-K filed with the SEC, and our other SEC filings for a more detailed discussion of risks and uncertainties that could cause these differences. All forward-looking statements are based on the information available to us as of today, and individuals are cautioned not to place undue reliance on our forward-looking statements. In addition, we undertake no obligation to update these statements.

Please note, the financial measures to be discussed by management today are non-GAAP measures, unless they are specifically identified as GAAP measures. Reconciliations of non-GAAP measures to their most comparable GAAP measures and certain limitations of non-GAAP financial measures are included in our earnings release and our investor presentation deck, both of which are dated today and available on our website at investors.cypress.com.

I will now turn the call over to Hassane.

Hassane El-Khoury -- President, CEO & Director

Thank you, Colin, and thanks to everyone for joining us today. Third quarter was a record quarter for Cypress across many metrics, including revenue, operating income and cash flow. We continue to execute our gross margin initiatives reaching the 47% mark in Q3, a 770 basis point improvement since the beginning of 2017, when we first embarked on the repositioning of our business, the focus on the fast growing automotive, industrial and consumer IoT markets, while exiting the more commodity pieces of our business.

Over this period, we have also worked aggressively to optimize our supply chain and overall cost structure to ensure we are well prepared to continue executing our strategy with a goal of maintaining greater than 20% operating margins through industry cycles or changes in the macro environment. Thanks to our team and our customers. The Cypress business is clearly stronger today than when I took over as CEO in 2016.

This improved posture is particularly relevant as we believe we are seeing some signals of changes to the demand environment as tariffs and macro concerns are causing disruptions for some of our customers across our key markets. While we closely monitor and actively prepare for potential market changes, we also continue driving the strategic evolution (inaudible) by our Cypress 3.0 strategy. Another important step was outlined today with announcement that we have entered into an agreement with SK hynix system ic to create an SoC NAND flash joint venture. This transaction will help Cypress focus more on the automotive, industrial and IOT markets where our embedded solutions are most differentiated. With approximately half of our NAND revenue coming from consumer applications, we believe SK hynix system ic is the right partner to focus on driving the growth and investment required in this business to more dynamic market cycles. We are already seeing signs of NAND supply recovery, which would add margin pressure on this business. While this transaction will negatively impact our near-term EPS, it will be accretive to Cypress' revenue growth, gross margin and cash flow in the long run.

Our remaining storage portfolio of NOR and RAM solution will continue to be focused on differentiation and more predictable markets that fit our long-term target model at 50% gross margin. In fact, post transaction over 90% of our memory product division revenue will come from automotive, industrial and enterprise markets. With ADAS industry 4.0 and 4.5 and 5G as a respective growth drivers in each of these markets. This transformative transaction converts a two year wafer purchase agreement into a five-year cash flow, while along Cypress to participate in the success of the JV, Thad will provide additional details on the financial structure and implications of the NAND joint venture. We have also posted supplemental detail outlining the strategic rationale and financial impact to our Investor Relations website. Although, we do see some slowing down in the demand environment, specifically in Asia-Pacific due to the disruptions, the tariffs have caused. We continue to be extremely well positioned for the next wave of growth from IoT application. Devices are getting smarter and more connected. The Cypress 3.0 strategy we laid out two years ago is starting to pay-off as our investments in IoT focused microcontrollers and connectivity are now coming to market and translating into strong design activity with our customers. Cypress' new design wins were up 23% year-over-year in Q3, driven by the outstanding performance of our microcontroller and connectivity portfolio where design wins were up 42% year-over-year and 12% sequentially.

Specifically, Cypress's PSoC MCU has been the driving force behind our steady share gains and the worldwide microcontroller market. Moving forward, we expect the success to accelerate as more and more customers are designing IoT applications with our latest innovations in the PSoC MCU family including our PSoC 6, the world's lowest power and more secure 32-bit microcontroller now available with integrated Bluetooth wireless connectivity. In fact, when it comes to IoT connectivity, there is simply no better problem solving partner then Cypress. We give our customers the power to develop with highly differentiated WiFi/Bluetooth combo solutions for wireless connectivity or with industry's most flexible and highly integrated USB-C solutions for wire data transfer and power delivery.

The strength of this future IoT pipeline and strong design activity underscores the strategic progress our team is driving and gives us confidence as we position the company to went through all market cycles including the mentioned possibility of a softer macro environment. Moving back to the business activity for the quarter, our automotive business increased 13% year-over-year, and is on track to grow 13% in the full-year 2018, compared to 2017 exceeding our long-term target of 8% to 12%. This growth is being delivered across our entire portfolio of Automotive MCU, wireless connectivity and fail-safe storage solutions.

After 10 years of investing in automotive, we have earned the trust of our customers. They know they can rely on Cypress to provide a compelling line-up of high value embedded products together with the DNA, the demand for zero defect quality, supply assurance and overall execution. Our compute, connect and store solutions are essential building blocks as developers create the new experiences, passengers will expect when safe, autonomous driving allow them to focus more on infotainment, productivity and comfort. As a result of the autonomous driving mega trend, Cypress is poised for a sustained period of growth in our automotive business and our addressable content per vehicle. We see it happening in new designs to date or 2021 cars that are rapidly adding features across major subsystem, areas including ADAS, infotainment, DENSO clusters and body electronics.

And today's designs Cypress microcontroller connectivity and storage products have a constant opportunity of at least $125 per vehicle. Looking at ADAS, customers are specifically requiring that their systems build up with Cypress flash, because it is the fastest and most reliable on the industry. When the cars of the future start a dozen or more sophisticated computers were boot up immediately and reliably using Cypress NOR flash. Another key area of Cypress content growth will be an infotainment and connectivity, while Bluetooth has become standard in new vehicles, the addition of WiFi is now increasing from our estimate of 25% attach rate today to over 50% by 2021.

WiFi in the car is rapidly being deployed for multiple use cases, such as display sharing, streaming from mobile devices, Apple CarPlay, Android Auto, MirrorLink, Internet Access, and over the air firmware updates to name a few. Many of these use cases need to be executed in parallel at high speed driving demand for Cypress' robust and reliable real simultaneous dual-band solutions. Each of these subsystems also requires additional compute and fail-safe storage opening cross-selling content opportunities for Cypress, and other content growth drivers is Cypress's portfolio of products or instrument cluster platforms and body electronics.

We are the number one in digital cluster MCUs today and we'll continue to grow our share through our new Traveo MCU design wins shipping in 2019. A great example is the recently announced launch of GM's Global B cluster platform with five Cypress products inside, a Traveo MCU, one PSoCs, two NOR flash chips and a PMIC. This award winning cluster will be used in a wide variety of GM models made by Cadillac, Chevy and GMC to name a few. On the industrial and consumer IoT side of our business. We had multiple records in Q3, including another all-time high in wireless IoT revenues, which were up 14% sequentially. Our popular WiFi/Bluetooth combo chips continue to track above 50% of total wire revenues, while our 11ac solution reached a new high of 38% of wireless revenue. We also had a record quarter for MCUs, where revenue was up 12% sequentially. The success was not due to any single product customer or market segment. In fact, our success and industrial and consumer IoT application has been very broad spanning multiple industries and sub-sectors such as factory automation, medical devices and aerospace, in addition to our strong position in the connected consumer segment for smart home, audio and wearable applications.

Adding to the 2018 holidays, Cypress has once again designed into many of the hottest products of the year with wearable's expected to be among the top gift of the season. Having evolved beyond simple Sports' Tracker, now the healthcare service and insurance providers are using them to monitor biometric, dispense medication and even make actuarial decisions. Cypress' wireless MCUs are the low PowerSmarts inside a number of these popular wearable devices, such as Fitbit Charge 3, Huawei TalkBand 5 and multiple garment, smart watches and fitness bands. Fitbit is the first of many customers to leverage the PSoC 6 unique dual-core ability to act as both a secure host MCU and a Bluetooth low energy solution savings space, power and cost.

In addition, Cypress continues to lead the charge in proliferating USB-C's mission of being the single wired solution to replace all cable needed for mobile devices and other consumer electronics. During the third quarter, Cypress's cumulative USB shipments reached 2 billion units. One major smartphone customer recently introduced and started shipping three new smartphones with USB-C connectivity. Third-party teardowns have already validated that Cypress solutions are inside all three of them. Cypress' USB-C is now in production in 490 customer platforms, up from 316, this time last year. These platforms span across a wide variety of PCs, docking station, cable, chargers, TVs, media players and much more. In our storage business, we've seen some pricing erosion in the market, primarily across our NAND business, which has the most consumer exposure. While our NOR competitors have seen softness in their end markets with commodity NOR, our NOR business has remained stable growing 4% sequentially and 50% year-over-year due to our focus on higher densities where we offer more differentiation and command higher market share.

We have set all along, we have shifted our business to high density differentiated storage solutions, which are not as impacted by market dynamics as the low density commodity memories and focused on markets like automotive where we hold over 65% share and is not subject to meaningful pricing adjustments. In our RAM business where we are number one in most sub-segments. We continue to price rationally determine by the value of our products and not in reaction to commodity competition.

In closing, we continue to execute on our strategy, enable developers to connect, compute and store with our innovative solutions for automotive, consumer and industrial applications. We have expanded our gross margin and derisks our manufacturing by qualifying more product, in fact 25, which will remain above 80% utilized through this end market softness. We will manage OpEx to prioritize our strategic investments as we have done through the second half of 2018 with R&D investments, focused on MCU and connectivity proprietary products. In this market environment, when some of our peers hold back, we will double down on demand creation and keep our funnel growth momentum going. All other spend will be managed tightly. Let me just point out that although we are seeing softness in Q4, reflecting caution in our outlook at the midpoint of our Q4 revenue guidance, Cypress will still deliver 7% annual growth over 2017, which is still in line with our long-term plans with a greater than 20% operating income, also inline with our model highlighting our robust financials and our focus on execution. We remain committed to executing our Cypress 3.0 strategy.

I'll now turn it over to Thad to talk more about our numbers.

Thad Trent -- Executive VP of Finance & Administration and CFO

Thanks, Hassane. Q3 was another solid quarter of execution for Cypress, as we report record revenue continue to expand gross margins, operating margins and cash flow. Q3 revenue was $673 million, representing an 11.3% year-over-year and 7.8% sequentially, reflecting better than normal seasonality of up 3% to 4%. As expected, we saw growth across all major product lines, including microcontrollers, wireless IoT, wired connectivity, NOR and RAM products. We are also reporting record automotive revenue, an increase of 13% year-over-year as we continue to gain content in the car of the future.

Q3 non-GAAP EPS was $0.40, increasing 48% over Q3 of 2017 and four times faster than revenue growth demonstrating the leverage in our model once again. While these are excellent results, there are headwinds facing the business related to tariffs in global trade tensions going forward. While these headwinds may continue for some time, we remain optimistic about the opportunity to increase shareholder value over the long-term by continuing to execute our (technical difficulty) business over the last years to (technical difficulty) Cypress in high growth markets with differentiated solutions. Then we announced another step in this journey as we entered a joint venture with SK hynix systems ic to exit the highly commoditized and volatile NAND business.

I'll give you more details on this transaction after walking through the current demand environment, additional details on the quarter, and then I'll give you a guidance for the fourth quarter. First, for the demand environment, while our business delivered to our expectations during the quarter with consistent sell-through at our distribution partners, we started to see softness as the quarter progressed in the form of slowing order patterns across all product lines. Through the first four weeks of Q4, we continue to see a reduced order replenishment rates as customers assess the uncertainties in the market, particularly from Asia-Pac. As we noted last quarter, the direct impact of the China tariff is minimal. After the implementation of the third tariff lift approximately 2% of our revenue is subject to a tariff. We continue to evaluate our supply chain to minimize its impact, while also monitoring broader impact the tariffs will have on the overall semi market.

Our average lead times remain stable in the 13 to 15 week range except for NAND. NAND is no longer on allocation and lead times have dropped to 10 weeks as supply has come online in the market. Our NOR products remain on allocation as customers on long-term agreements, particularly in automotive and datacom infrastructure continue to show healthy demand for our storage products. Our distribution channel, which accounted for 73% of our revenue in Q3 remained stable within the quarter with inventory levels flat quarter-on-quarter at 7.7 weeks and in line with our targeted 6 to 8 week range. For Q4, we see our Asia-Pac distributors remaining cautious and are slowing order replenishment orders in a wait and see approach to the market uncertainties. We are of course monitoring our channel carefully for signs of weakness in inventory build.

Turning to the divisions. MCD revenue was $413.4 million, up 11% over Q3 2017, and up 12% sequentially from Q2 as expected with growth in our microcontrollers, as well as both wireless and wired connectivity. We saw a record revenue levels in microcontrollers and wireless IoT increasing sequentially 9% and 14% respectively. Our USB-C revenue continues to ramp in four years after introduction, we have cumulatively shipped approximately four times more units than any other generation of USB at the same point in time.

Moving to MPD. MPD revenue was $259.6 million, up 12% over Q3 2017, and up 2% sequentially from Q2. We saw mid-single digit sequential growth in NOR and RAM, while NAND decreased due to pricing pressures as supply comes back online across the industry. Conversely, we saw no meaningful price declines in NOR as we continue to focus on the high-end, high-density, non-commoditized portions of the flash market solidified by the long-term agreements we put in place over the last 24 months.

That brings me to gross margins. We continue to execute well on our gross margin expansion plans. Our Q3 gross margin came in at 47%, an increase of 400 basis points from Q3, 2017 and up 70 basis points sequentially, driven by further reductions in our manufacturing cost structure. Gross margins improved in both divisions sequentially and utilization was up 25, remain constant with Q2 at 83%, and is expected to remain at this level in Q4 even with lower revenue. As a reminder, 85% is fully utilized, and we believe we can maintain these levels through a downturn as we manufacture roughly 35% of our products in-house.

I want to give you some additional numbers for your models. Our Q3 operating expenses were $150 million or 22% of revenue, this was flat with Q2, as we actively controlled spending as we saw the market softening. Q3 operating income was at record levels increasing 45% over Q3 '17 to $166 million or 25% of revenue. Our OIE was $10.6 million, $10.7 million, which reflects reduced interest expense due to lower debt levels and approximately 80% of our debt is now fixed rate with our converts in interest rate swaps we have implemented.

Our non-GAAP tax expense in Q3 was $2.8 million. Our diluted share count was 377.3 million shares, and that includes 3.2 million shares for the in-the-money portion of the convertible notes. Please note that we've added a new convert dilution reference table to our IR website to assist you with calculating the share impacted various stock prices. So this all resulted in net income of $153 million or $0.40 per share at the high end of our guidance range.

Turning to the balance sheet. Cash and short-term investments totaled $205 million, and we had $540 million undrawn on our revolver. Accounts receivable was $405 million resulting in DSO of 55 days. Cash from operations was $187 million, which is up 30% over Q3 of 2017. Net inventory increase slightly sequentially to $289 million with increases in both MCD and MPD. Our days of inventory were down from Q2 at 74 days. Our Q3 adjusted EBITDA was $183 million or 27% of revenue. Total debt was $937 million as we paid down $26 million in Q3. Our debt-to-EBITDA leverage is now at 1.5 times on an LTM basis.

CapEx was $16 million and depreciation was also $16 million for the quarter. We repurchased $10 million in share -- $10 million shares during Q3 and have $190 million remaining on the $450 million authorized buyback. Our long-term model is to return 50% of free cash flow to shareholders through the dividend and buybacks. And the dividend yield was 3% (ph) at the end of the quarter and continues to be one of the highest in the industry.

Turning to guidance for the second quarter. Taking into account the market uncertainties and slower ordering patterns. We are expecting Q4 revenue of $585 million to $615 million. Although we entered the quarter over 90% booked, the book-to-bill declined from 1.04 in Q2 to 0.8 in Q3 with both divisions below one. We are seeing more of those seasonal weakness, primarily in the consumer and industrial end markets and primarily in Asia-Pac. Our outlook for automotive continues to be stable and it's not significantly tied to auto unit, since we continue to win new contract. Our Q4 gross margin is expected to be in the range of 47% to 48% with the incremental improvement coming from additional cost improvements and the ramping of new products, as we track to our model. As always, gross margins will vary with product and customer mix. We expect Q4 operating expenses between $145 million and $147 million for the quarter. Net OIE will be approximately $11 million. Tax expense will be approximately $4 million. CapEx is estimated to be $13 million, and depreciation of approximately $17 million. We anticipate the fully diluted share count to be 379 million shares, as a result, earnings per share is expected to be in the range of $0.31 to $0.35 for the quarter. At the midpoint of our guidance, Cypress would grow 2018 revenue 7% over 2017, and EPS 51% over 2017, which is inline with our long-term projections even in a soft market.

So finally, let me give you more details on the NAND joint venture. We have posted a slide deck on our IR website detailing the transaction, but I'll walk you through a few of the key components here. First, our rationale for this transaction is to continue to execute our Cypress 3.0 strategy focusing on differentiated solutions for the automotive, industrial and IoT end markets. By exiting the NAND business we reduced our exposure to a commoditized product line that has traditionally been highly volatile with low gross margin. Approximately 50% of this NAND revenue is in consumer markets where we are seeing significant pricing volatility. By entering a joint venture with SK hynix systems ic, we are converting a two-year take or pay wafer purchase agreement into a five-year JV that will generate much greater cash to Cypress through ongoing dividend. Additionally, this arrangement provides our customers a long-term roadmap with a supplier best position to lead in this volatile market. After closing, the NAND business will be excluded from Cypress' non-GAAP results and accounted for under the equity method in our GAAP results. This eliminate future negative gross margin pressure as we expect NAND gross margins to rapidly decline to the 20% to 30% range over the next two years. At the same time, this will improve cash flow to Cypress by extending approximately $80 million of cash flow over the next two years to greater than $150 million over five years.

Now I'd like to provide some data points on this field to help you adjust your model. The JV will be a subsidiary of SK hynix systems ic with Cypress owning 40% of the entity. The transaction is expected to close in Q1 of 2019 subject to regulatory approval. The NAND flash revenue was $186 million over the last 12 months. Cypress will transfer approximately $3 million in annualized operating expenses to the JV, including 15 employees. Since earnings of the JV will be accounted for under the equity method in our GAAP results, we expect a reduction to our 2019 non-GAAP EPS of $0.08 to $0.10 assuming the transaction closes at the end of Q1. However, this will be offset by the cash flow from the JVs dividends, which is expected to be $150 million or approximately $0.08 per share per year in cash flow over five years.

In summary, we believe this transaction will be accretive to both our overall revenue growth rate and our gross margins in the long-term as we execute toward our 50% gross margin target, while generating incremental cash and strengthen our balance sheet, which is positive for shareholders. To wrap things up. We remain disciplined as we navigate through the current market headwinds, and we are optimistic on our long-term outlook as we continue to execute our Cypress 3.0 strategy.

With that, I'll turn the call back over to the operator to begin Q&A.

Questions and Answers:

Operator

Thank you, sir. (Operator Instructions) Our first question comes from Rajvindra Gill from Needham & Company. You may go ahead, sir.

Rajvindra Gill -- Needham & Company -- Analyst

Yes. Thanks. I was just wondering if you could kind of elaborate further on the impact to 2019 non-GAAP earnings, you mentioned $0.8 to $0.10. Can you also talk about the $186 million of NAND flash revenue that you did last 12 months, is that transfer out or could you talk a little bit about the impact on the revenue, how we should model that in 2019?

Thad Trent -- Executive VP of Finance & Administration and CFO

Yes. Rajvi, this is Thad. So you can think about the NAND business being completely removed out of the non-GAAP P&L, so you have revenue decline by the -- by that amount and you'll have EPS come out, you'll have about $3 million of OpEx come out as well. So it's -- completely from the non-GAAP and you'll see the earnings come through on the GAAP P&L through the equity method accounting.

Rajvindra Gill -- Needham & Company -- Analyst

So there is no non-GAAP EPS impact?

Thad Trent -- Executive VP of Finance & Administration and CFO

There is not.

Rajvindra Gill -- Needham & Company -- Analyst

Okay. Got it. And then in terms of the demand signal that you saw kind of soften, which has been consistent with some other semiconductor companies, you said it's going to across the different product lines. Can you maybe give us a little bit more detail in terms of order cancellations, any specific feedback from your customers. Any kind of view in terms of how they're going to build inventory in the future in light of these tariffs?

Hassane El-Khoury -- President, CEO & Director

Sure. I mean, I think Thad, just try to do very well, right this time, where he said, a lot of the customers are in wait and see, so through Q3, the POS was normal, cancellation even today, there is no any cancellation other than what we see in any normal quarter even through 2017, and the first half of '18. So there are no signals of out of line cancellations or outlier cancellations, POS was normal, what we are seeing the softness -- reflected is in the replenishment and specifically in APAC. Demand, if you look at our funnel, as far as R&D activity, as far as new designing activity, as far as our sampling of new products that has not changed, we've shown a stellar growth in the funnel. So I would describe as the wait and see. And uncertainty in all this is how long, and that you'll have to ask somebody else or how long, but that's where we're seeing it, and that's talking to our customers, they haven't changed their behavior as far as designing in, they haven't changed deployment of new systems that they will send to the market. Everything is just in a wait and see environment and that's where we've been very cautious. We started being cautious on the OpEx walking into the second half of '18, that's why we've maintained a pretty strong financial result even through the Q3 and Q4. Thad, did I miss anything?

Thad Trent -- Executive VP of Finance & Administration and CFO

No. I would just kind of expand that, generally we saw -- we're seeing softness kind of across the board, but where you seeing the most significant softness is in Asia-Pac, and it's primarily in consumer and industrial end markets.

Operator

Thank you. Our next question comes from Harsh Kumar with Piper Jaffray.

Harsh Kumar -- Piper Jaffray -- Analyst

Hi, guys. Just wanted to follow-up on the question before. So you mentioned industrial and consumer has been weak. Is there one that's weaker than the other?

Thad Trent -- Executive VP of Finance & Administration and CFO

Yes. Well, you're seeing softness in consumer, probably deeper than you are an industrial, now part of that is Q3 is naturally a high point for us as well. But if you think about normal seasonality, we're seeing more there than normal, but closely followed by industrial.

Harsh Kumar -- Piper Jaffray -- Analyst

And your gross margins will be flat to up again, despite lower revenues, can you tell us what's going on there?

Thad Trent -- Executive VP of Finance & Administration and CFO

Yes. Well, as I said in my prepared remarks. This is Thad. Our utilization still stays up in that 83% plus area, so you don't have any compression on that side of things. We've been doing a good job of continuing to take cost out of our manufacturing cycles and out of our own products, and you get a little bit more of that. So if you look at the midpoint of our guide, you're up another 50 basis points and it's just more of the same of what we've been working on for really the last two years, and we'll continue to execute on that plan going forward.

Operator

Thank you. Suji Desilva from Roth Capital. You may go ahead, sir.

Suji Desilva -- Roth Capital -- Analyst

Hi, Hassane. Thad, I just wanted to follow-up on the question just asked about utilization. I would presume that some products being made in Austin, I understand, 65% of them made outside, but when you have to throttle back the production of some products given the current weakness, are you really in a position where you can flex and keep often running pretty full even with the broad weakness you're seeing?

Hassane El-Khoury -- President, CEO & Director

Hi Suji, it's Hassane. The answer is yes -- 35% has been on site over the last two years, as we qualified Fab 25, obviously we have a lot of our products, especially in the high runners, high volume qualified in two, sometimes in three different sites. So as volume changes we will just pull more into Fab 25 from the outside, and that will keep the Fab full, and it's a very versatile Fab now after two years of working on it, where we have NOR, we have USB-C, actually runs in there. We have the legacy microcontrollers, both automotive and industrial and consumer microcontrollers from the Fujitsu days (ph) that can run in there. So you can see it's across the board, so regardless of the softness we are seeing, today, we'll just pull more of these products in and most of them are also qualified at customers, so that gives us the flexibility, and it's not a one-year away, we've actually been preparing, Thad and I both talked about how we derisk our model, we derisk our model by making sure under any fluctuation or even mix that Fab is always full above the 80%, and you see it stay at the 83% utilization with different revenue levels, so that gives us that confidence and outlook shows me the same.

Suji Desilva -- Roth Capital -- Analyst

Okay. Appreciate the color -- that's different from it's been the -- how it's been in the past, that's good to hear. And then on the automotive side, I know this is a tough question given the current environment, but maybe automotive is less in -- across the areas of the current macro Asia-Pac weakness, I'm curious if this above trend year-over-year growth you're seeing 13% versus 8% to 12%, whether that's sustainable, whether there were factors in the last few quarters that caused above trend growth or whether the pipeline gives you confidence that perhaps you could be at the high-end or above that with the ramping in content gains you have, any color there would be helpful?

Hassane El-Khoury -- President, CEO & Director

Sure. I mean, if you think about, it' is not, it's not the one, the business has been growing and has been growing consistently over the last few years. If I recall last year was a 15% growth, I've outlined the 8% to 12%, so it's not out of the ordinary for us to deliver the 13%, given all the content growth that I've talked about. So we're still on the upper end of the 8% to 12% (technical difficulty) 12%, and what happened here is kind of I highlighted a little bit in my prepared remarks, you have RSPV (ph) that's turning on and that's more content that was not in prior generations, that is now a new generation, I talked about the GM Global B, which historically, I'm talking years ago we would win only the microcontroller, now we'd won five sockets per vehicle. So you can look at the design win ratios that we are getting versus units, is now at a much higher level. So the unit can fluctuate, but our content is really what's adding to the growth, it's not just because of one model or another model, more content per unit. The units are -- could be flat or slightly up based on a lot of the earnings that the OEMs have been saying, even with that content is growing, because we have more content per car than we historically have had.

Operator

Thank you. Our next question is from Blayne Curtis with Barclays. You may go ahead, sir.

Thomas James O'Malley -- Barclays Bank PLC -- Analyst

Hey guys. This is Tom O'Malley on for Blayne Curtis. I just wanted to ask about the new shape of the memory business, obviously with the consumer portion coming out next year, and you guys are more aligned to the auto segment. Can you guys kind of try to frame for us what the new growth profile we'll look for that business?

Hassane El-Khoury -- President, CEO & Director

We -- yes, I mean, if you look at it, we're looking at as being about flat with the remaining for the memory business and the exposure at the end market, about 94%, once you take NAND out. MPD would be 94% exposed from a revenue side, exposed to stable markets like auto, industrial and enterprise with a 4.5 and 5G, so that gives us over 90%, which is very comfortable for me to look at with predictable and normal price environment than the commodity that fluctuate with supply and demand, so that gives us a much more stability, much more predictability. And obviously, the margin where we would like to see helping the company, get to our model of 50%.

Thomas James O'Malley -- Barclays Bank PLC -- Analyst

Thanks. That's helpful. And just on the segments into December, Thad, you gave some color there, but can you kind of walk through where you see the most outperformance versus where you see some of the underperformance just for December?

Thad Trent -- Executive VP of Finance & Administration and CFO

Well, I think I gave you the significant downside, right, which is the industrial and consumer, where we're seeing the most pressure. As I said in my prepared remarks, automotive is looking more stable, but clearly across the board we're seeing softness and we'll continue to monitor that, but the downside is really in the consumer and industrial.

Operator

Thank you. Our next question comes from Vivek Arya from Bank of America. You may go ahead, sir.

Adam Gonzalez -- Bank of America -- Analyst

Hi. This is Adam Gonzalez, on for Vivek. Thanks for taking my question. When you say the weakness is primarily concentrated in Asia and the consumer industrial markets, would you be able to quantify percentage wise what your exposure is there?

Thad Trent -- Executive VP of Finance & Administration and CFO

So, it's tough to quantify as things are moving, right. We're monitoring the sell-through on our distributors, and that's really where you see the endpoint consumption. If you think about both of those, they're down double digits in the teens, sequentially.

Adam Gonzalez -- Bank of America -- Analyst

Got it. And then if we did compare what your expectations are, at least at this point for this downturn versus prior downturns. Do you see this is being kind of a one, two quarter phenomenon or can it last longer than that, or it's just too early to tell? Thanks.

Hassane El-Khoury -- President, CEO & Director

Yes. We -- it's too early to tell, and it'd be imprudent from any of us, I think to put a timeline on it, what we can do and we are doing is monitoring the situation closely, and obviously running our business you have the best possible outlook, you've seen us and just in our quarter for the second half of '18, where we saw this coming, we managed our business, we kept our investment in the areas that sustain our growth with the momentum. We find OpEx where we can. We delivered on the gross margin. We delivered on the revenue, and we delivered on the earnings to keep the 20% operating margin consistent. So that's what we can do as far as predicting, I think I'll leave that somebody with a different title.

Operator

Thank you. Our next question comes from Ruben Roy with MKM Partners. Sir, you may go ahead.

Ruben Roy -- MKM Partners -- Analyst

Thanks. My first question is for Thad, just was hoping that you could maybe expand a little bit on the discussion around NOR, and you would said that the price environment there has been holding up, you're happy about the LTAs that you had in place. I'm wondering if you could talk about how often those LTAs are renegotiated and what those negotiations are like, I would imagine that, and what you said with the high density nature of the NOR going into those markets, maybe still not as price-sensitive as some of the commodity markets, but any clarity on how often you renegotiate those and how those negotiations would go would be helpful? Thanks.

Hassane El-Khoury -- President, CEO & Director

Sure. This is Hassane. I'll take that one. So we're already negotiating some of them, because if you recall, when we talked about the LTAs last year, we said it depends on the end markets, some of them are multiple years, three years or so for automotive. Some of them are 9 to 12 months, some of them are 18 months in the case of industrial, so the range really depends on how much visibility the customer has from their business in order for them to give us an LTA, so having said that, some of them are being negotiated today, we don't see any price erosion out of the normal price decline that you might see in a normal cycle, normal business, and this is usually negotiated with additional market share or a cross-selling opportunity. So nothing out of the ordinary that is related to what I would call supply and demand commodity pricing. I mentioned in my prepared remarks, we don't price our NOR or we don't price our products in general based on competitive pressure. While we price them is on, based on the value that they provide and our end customers design. So with that, the LTAs are going pretty well. We've delivered to what we committed to our customers, our customers were very satisfied that they were able to get what they need to ramp their end products. And both our customers are coming to the table, and now we are in the process of talking about what they need through 2019, and what densities they need in order for us to establish that LTA. We already signed a few of them, so I'm not saying we are fresh and we are early on in the conversation, some customers already signed the LTA extending through the 2019, and the rests are in talks, but it's a normal way we do the business, nothing changed because of the commodity low density NOR environment.

Ruben Roy -- MKM Partners -- Analyst

Great. Thanks a lot for that, Hassane, that's helpful. Just a quick follow-up, you had in your prepared remarks talked about you threw out some design win or design activity stats, and I'm just wondering in light of sort of the slowdown out there, it sounded like, that has been really slowing down on that side, but relative to or if you can give us a perspective of how those stats lineup with maybe this time last year, have they been accelerating, so are the same or any clarity on sort of that design activity you're seeing would be helpful?

Hassane El-Khoury -- President, CEO & Director

Yes. So, if I look at it, it's been -- it's accelerating. It's up from where it was last year, which is why also in my closing remarks, I said we're doubling down on our demand creation momentum, because we see it, and when all the dust settles, that's what's going to keep the company growing ahead of the semiconductor industry, but to give you -- it's being led by IoT and wired connectivity, and if I look at the last year wired connectivity more than doubled, as far as design activity and IoT is over 35%, so very healthy growth in MCD, very healthy growth in the areas that we have been talking about as the growth drivers for the company. And that gives me all the optimism I talked about in my prepared remarks to keep and stay the course for Cypress 3.0, as when the dust settles with all that chaos that's going on, that's what's going to be keeping us apart.

Operator

Thank you. Our next question comes from William Stein with SunTrust. You may go ahead.

William Stein -- SunTrust -- Analyst

Great. Thanks for taking my questions. Congrats on the good performance, especially on margins. I want to start with the order patterns, the slowdown that you're seeing now, you mentioned tariffs, is that known to be -- known to you based on customer feedback to be related to tariffs or are there other issues here that are affecting the pace of orders. And then also I'm hoping you can talk about the rate of change. Are we seeing the sort of slowdown in replenishments grow as we go into early Q4 or did the pace of business slow and then stabilize. What does that shape look like? Thank you.

Hassane El-Khoury -- President, CEO & Director

Sure. So, on the first question, is if the tariff and can you pinpoint on the tariff, specifically are there anything else. I mean, if you think about what was the talk in town of the reasons for it, it was shortage of MLCC, it was tariff (inaudible). We don't see that, we don't see the MLCC as far as our customers are getting what they need. We have majority automotive and industrial in any allocation environment, those are the customers that get the allocation for any product that is on allocation. So that wasn't the case, we validated that, I personally and Mike went to customers and went through that cycle before we even walked into the Q3 and the Q4, so that I'll put aside that's not really a driver and might be in certain pockets, but that's not a driver, it is the uncertainty that we are seeing that is slowing down the replenishment of order, and like I said, POS was healthy, replenishment was below linearity where we need to be. The second part of the question is from the data, and I can only tell you the data that I have, it's not a projection of where it'd be, if I look at a rate, the rate slowed down, but I'm not going to say is it going to stay flat or go up or go down, I can give you a prediction, I can tell you where it is today. And where we are today at this time of the quarter, it is flattening. So label it whatever you want to label it, I look at it everyday, and based on that I make decisions to run the company, but that's kind of the real-time data that I'm sharing with you.

William Stein -- SunTrust -- Analyst

Great. Thank you.

Operator

Thank you. Our next question comes from Karl Ackerman with Cowen and Company. You may go ahead.

Karl Ackerman -- Cowen and Company -- Analyst

Hey, good afternoon, gentlemen. I had two questions. I guess I wanted to ask about your longer-term gross margin outlook, I know your margin expectations would exit the year at 48%, and your guide suggest that, but what is your comfort level around being able to drive margin leverage outside of memory. And as a follow-up, while there's much trepidation on the trajectory of flash ASPs, I was curious is 15% (ph) margins in your memory business now back on the table, just given the fact that you've now -- you will now be able to kind of strip out SoC NAND in 2019?

Hassane El-Khoury -- President, CEO & Director

Sure. This is Hassane. So I'll answer the first one. So obviously our model is 50% gross margin, we've always said, we'll exit this year, but it's not, we're not going to stop where we will exit the year. We have a trajectory and our trajectory will get us to 50 and above, but our model is 50% gross margin. How do we get there, it's the last two years of investments that we've had and we've made has been focused on products, specifically proprietary products, the NAND more than 50% margin. So if you want to get to 50% margin when you have a portion that is memory business that is not going to get to 50, and I'll cover that the NOR specifically, and the rest of the company has to be above 50, and that has been our focus. Our new products are delivering that in the areas that we want above the 50, and the products, the innovative products that we are doing, we see that in the funnel, and some of the trajectory that we've had in '18 actually was contributed a little bit from the new products that are just starting to turn to revenue, not meaningful revenue yet, so they're not moving us to the 50 now, but as those products become a higher percent of our overall company over the next couple of years, when you think about auto RAMs and so on, then you're going to start seeing the whole company get to the 50, and the trajectory will keep us going above that. For NOR specifically, I don't see NOR as an overall, because it's a very wide comment to make being above the 50, I see the NOR being in the mid 40s to high 40s. So, but the number will start with a four and that will be defined by a lot of the NOR that we are getting into automotive, we may release for a new NOR, which was covered obviously by our partner arm also, which has a smart microcontroller in it, so it's not your grandfather's memory anymore, it is differentiated, it commands a higher margin and as that product turns into revenue the mix of NOR will start getting in the high 40s with everything else. So that's the color I'll give you, our goal and our model remains 50, and our goal is to drive above that, and all our actions are driving to that, I don't know Thad, if you want to add some color.

Thad Trent -- Executive VP of Finance & Administration and CFO

Yes, Karl, I'd like to add one more thing on the memory gross margins. Keep in mind today about 30% of the memory is RAM in specialty memory, and that has gross margins that are above the corporate average. So don't think about that whole bucket as being just flash and NOR.

Karl Ackerman -- Cowen and Company -- Analyst

Perfect. If I may, I would love to circle back on the earlier question on your automotive business, obviously, automotive has been a focal point for investors and a large European microcontroller provider talked about its automotive business should face headwinds in December on softness from Chinese OEMs, but if I recall correctly, your automotive business in China is much smaller and really with your Traveo design wins really kicking into full gear in 2019, I mean, do you think your automotive business could grow high-single digits next year. How should we think about that? Thank you.

Hassane El-Khoury -- President, CEO & Director

Yes. So, I mean, it's hard to give a projection, it's going to depend really on what the market is doing in the next few quarters, and I'll label that as I have to wait till the dust settles, but I can't comment on design wins, which is the prior comment, because that I have visibility that's credible and that's predictable for us. And what the market does the market will do, and we'll find that out toward -- as we get into 2019. But from that aspect, you're absolutely right, we are winning platforms, we're winning similar platforms like the one we talked about -- with the global view with cross-selling in the China market, and I'm talking about the domestic China market, not the transplant China market where Europeans are building out in China, but we have a very big focus both on the ground and from corporate about proliferating our footprint and our design activity in China, I've talked about it in the past, as you know, it's been a work in progress for the last two years, we are starting to see the fruit today is in design win, as they go into production, at what level they go into production, it will be growth, I just can't call the rate of growth yet, because China automotive is a very touchy point at this point in time for me to call it.

Operator

Thank you. Craig Hettenbach from Morgan Stanley. You may go ahead.

Craig Hettenbach -- Morgan Stanley -- Analyst

Yes. Thank you. Thad, solid job on the OpEx management, especially in the context of the revenue revision. So, can you talk about some of the leverage you have to pull in the model, and then how you might be managing kind of R&D versus SG&A?

Thad Trent -- Executive VP of Finance & Administration and CFO

Yes. I think Hassane nailed it in his prepared remarks, right, he said we're going to continue invest for the future. We're not going to cut off the future growth of the company, and we're going to manage OpEx very tightly. So we're going to be very strategic in where we invest, and we're going to run very lean in other areas, you've seen us do this in the past and we can do it again. If you look forward into Q4, the midpoint of our guidance for OpEx was down. Now, there's a reason for that, part of that is some of the variable expenses, commissions, bonuses, things like that, that step down, but it's also just our relentless focus on driving efficiencies inside the company and getting every -- getting a return on every dollar of OpEx we spend. So, the short answer here is we'll continue to invest for growth, and we're going to be very strategic in how we manage that OpEx going forward.

Craig Hettenbach -- Morgan Stanley -- Analyst

Great. Thanks for that. And just a follow-up for Hassane, in the context of IoT, which has been a great business. Some of the broad-based slowdown you're seeing now in consumer and concerns around tariffs, any feel for that in terms of on a near-term basis, the impact that it might have?

Hassane El-Khoury -- President, CEO & Director

Yes, I think Thad was mentioned, the consumer drop in Q4, slightly above seasonality that we see. So that's, I guess the short-term, but if I take it and look at forward looking in 2019, which is where a lot of the investments that we are making today will pay-off is in 2019, not really in Q4, that funnel is growing -- like I said above 35% from this time last year, so that's growth, and it's growing still in support of our strategic initiative. So, short-term, yes, the consumer, we're seeing that pressure in the fourth quarter, but the design win is still solid and still upward.

Operator

Thank you. At this time, we are showing no further questions. It will be my pleasure to turn the conference back over to Mr. Hassane El-Khoury for any closing comments.

Hassane El-Khoury -- President, CEO & Director

All right. Thank you all for joining us today. Again, we are pleased with another quarter of record financial performance as we positioned Cypress for long-term revenue and earnings growth. During Q4, we exhibit electronica in Munich, and then we will be presenting at the Credit Suisse Technology Conference in Phoenix. Global Mizuho Investor Conference in New York, and the Barclays Capital Global Technology Media and Telecom Conference in San Francisco. We look forward to seeing many of you on the road. Good night.

Operator

Thank you. This concludes today's conference call. You may go ahead and disconnect at this time.

Duration: 57 minutes

Call participants:

Colin Born -- Vice President of Corporate Development and Investor Relations

Hassane El-Khoury -- President, CEO & Director

Thad Trent -- Executive VP of Finance & Administration and CFO

Rajvindra Gill -- Needham & Company -- Analyst

Harsh Kumar -- Piper Jaffray -- Analyst

Suji Desilva -- Roth Capital -- Analyst

Thomas James O'Malley -- Barclays Bank PLC -- Analyst

Adam Gonzalez -- Bank of America -- Analyst

Ruben Roy -- MKM Partners -- Analyst

William Stein -- SunTrust -- Analyst

Karl Ackerman -- Cowen and Company -- Analyst

Craig Hettenbach -- Morgan Stanley -- Analyst

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