Cypress Semiconductor Corp (CY) Q1 2019 Earnings Call Transcript

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Cypress Semiconductor Corp (NASDAQ: CY)Q1 2019 Earnings CallApril 25, 2019, 4:30 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to Cypress Semiconductor First Quarter 2019 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 -- VP of Corporate Development & IR

Thanks, Michelle. Good afternoon, and thank you for joining our Q1 2019 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. Hassan will make some introductory remarks, 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-K once it is filed.

During the call, management will make statements about our second 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 filed 10-K 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're 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 everyone for joining us today. Welcome to our first quarter 2019 conference call. The first quarter was a success for Cypress in many ways. The overall business environment continued to be challenging, but we kept the laser focus on executing to what we can control. As a result, I'm pleased to report our Q1 results met our plan on revenue, operating expenses, EPS, and cash flow. Our Management team and employees continue to drive the company toward our goals of achieving higher than industry revenue growth at greater than 50% gross margin and greater than 25% operating margin targets, and also how fast our commitment of maintaining greater than 20% operating margin to market downturn as evidenced by our ability to deliver a 21% operating margin this quarter. As expected the persisting softness across our automotive and IoT end markets as well as our legacy businesses resulted in sequential and year-over-year revenue declines. We see some signs of stabilization in ordering and backlog patterns starting in Q2 with our MCD backlog increasing specifically for IoT, which we expect to grow approximately 20% in Q2.

We remain cautiously optimistic in our guide and continue to keep the close eye on our channel by carefully matching our replenishment levels to end consumption. In the channel, we are under shipping orders and reducing inventory dollars to prevent any unnatural inventory bubble setting us up nicely for the second half of the year should the early signs of recovery persist. On April 1, we closed the NAND JV with SK hynix system ic, the transaction we announced in October 2018 that effectively exit the NAND flash market. Following this move, approximately 94% of our MPD revenue will now come from differentiated products and the industrial automotive and enterprise end markets. We hosted customers, partners and analysts at three major events in Q1; CES, Embedded World, and our 2019 Analyst Day.

These events underscored our sharp focus on solving problems for IoT and automotive customers in high-growth, high-value applications. In fact, at Analyst Day we shared that 85% of our R&D investments are now concentrated on IoT and automotive. Our pipeline of silicon, software and services will empower customers of all sizes to create winning products for some of the most exciting mega trends of our time. Our customers continue to select Cypress's leading connect and compute solutions as our design win activity in the first quarter increased 15% year-over-year led by automotive. There's no question that everything will become smart, secure and connected. Of the roughly $2 billion IoT demand for wireless connectivity solutions in 2019 almost 75% will be based on some combination of Wi-Fi and/or Bluetooth. This makes perfect sense because developers and users are looking to leverage the most ubiquitous wireless technologies on the planet. The $500 million Wi-Fi networks installed throughout the world and the $4 billion Bluetooth nodes living in the smart homes -- smart phones. We hold all day every day. Cypress brings these two massive networks together, using our Wi-Fi Bluetooth combo solutions. This value proposition is at the heart of our connectivity growth, which increased 2.4 times over the last two years. Cypress is unique portfolio of combination, chips, technologies, and applications expertise, give our customers the coexistence of ultralow power, security integration and cost optimization they need to win.

Today, over 80% of our Wi-Fi revenue comes from these combo solutions. The technology involves and simultaneously and reliably running two very different Wi-Fi and Bluetooth system protocols on the same 2.4 gigahertz spectrum inside one SOC, to the extent of thousands of man years and investment and learning. These very high barriers to entry put Cyprus in a strong competitive position and translate into market leadership at attractive margins.

Further bolstering our connectivity strength is our early lead with Wi-Fi 6 or 802.11ax, the next-generation technology which significantly expands Wi-Fi network capacity and efficiency for IoT applications. As announced in Q1, we are already sampling our Wi-Fi 6 for IoT and automotive customers. As 2019 phone start to ship with Wi-Fi 6, we expect routers and IoT devices to quickly follow in 2020 and beyond.

Of course, our IoT future is not only connected, it is smart and secure. The MCU compute solutions coupled with this wireless IoT connectivity, represents another $1.9 billion in 2019 TAM. Fortunately for Cypress, we also have the best IOT portfolio of MCU products to complement our Wireless Combos. Our PSoC family, which recently expanded with the new PSoC 6 is the industry's only purpose-built IoT microcontroller. The PSoC 6 continues to lead the competition with ultralow power consumption, the security of unique dual-core architecture, highly differentiated peripheral, and a lineup of user-friendly software solutions.

This platform level MCU and connectivity solution allows Cypress to capture cross-selling opportunities across our global sales channel consisting of over 30,000 customers. Our market results show our momentum as Cypress has been consistently gaining share in the 32-bit MCU market. Just last week, Gartner Research reported that Cypress once again significantly outpaced the competition with these products in 2018, growing 25% or 2.5 times faster than the market, and faster than any other player for the second year in a row. Our USB solutions also continue gaining broad adoption with customers and exciting high-growth applications like anchors, new family of power port PD charger, which delivers up to 2.5 times faster charging times than standard USB-C power adapters. We now have 663 USB design and production in Q1 19, up from 592 in Q4 of '18, as we ramp up across a wide range of new docks chargers, well adaptors, and laptops. In the automotive market, we are enabling the megatrends of electrification, infotainment and autonomous mobility. But simply, the autonomous vehicles won't happen without Cypress, customers use our reliable and intelligent memory solutions and 85% of ADAS computing systems and related peripheral sensors because Cypress delivers the high density instant on performance and decades long reliability they need when the drivers turned the key.

These products will contribute to the continuous growth and margin improvement of our automotive business, as these new applications drives demand for high-density storage solutions with ever-growing intelligence and security. We shared a good example of this trend a few weeks ago when we announced that DENSO has selected our latest central (ph) storage solution for Next-Gen digital cockpits because of Cypress's unique reliability and security performance enabled by the on-chip compute power of our differentiated architecture. Although our overall automotive revenue declined in Q1 with the softness we see in the market. Our automotive proprietary MCU and wireless revenue increased 13% year-over-year as we continue to gain content in the car of tomorrow. Looking forward, our momentum with our new trivial product continues to accelerate.

We won major tier one platforms with Traveo II and body electronics, ADAS and instrument clusters as new customers upgrade their architecture which Traveo II taken advantage of its low power and hardware-based security. These latest wins, which only come about once every two or so design cycle, increased our overall design win funnel for Traveo II by approximately 50% in Q1 to $2 billion. As these wins turn to revenue over the next few years, we feel confident in our multi-year automotive growth target of 8% to 12%. And our corporate gross margin target of above 50%, as these products are highly accretive to our current automotive gross margins. In addition to (inaudible) and Traveo II our content growth story in new automotive design is rapidly increasing, thanks to our Wi-Fi, Bluetooth, USBC and Capacitive Touch products. All of these Cypress Technologies are creating the cars of our future, and will more than double our overall automotive content opportunity from $93 of content for high-end vehicle in 2018 to $184 by 2023.

Looking forward, Cypress has a number of exciting new connect and compute product cycles ahead that will help us gain significant revenue and margin momentum beyond 2019. Our revenue pipeline from investments in Wi-Fi 6, PSoC 6, Traveo II, central storage and USBC, will deliver the growth, earnings and cash flow targets, we define as part of our Cypress 3.0 strategy.

With that, I will turn it over to Thad to discuss our financials as well as our guidance, and then we can take some of your questions.

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

Thanks, Hassane. I'm pleased to report another solid quarter of execution by our teams across the globe despite macro headwinds. In Q1, we met or exceeded our guidance for revenue, gross margin, operating margin, and earnings per share, once again demonstrating our laser-focused on our Cypress 3.0 strategy.

We also closed our NAND joint venture with SK Hynix systems ic as planned with the launch of SkyHigh Memory on April 1. Effective Q2 and going forward, Cypress is completely exited the highly commoditized NAND business, and the results of this joint venture will be excluded from our non-GAAP results. The JV will be accounted for under equity method accounting in our GAAP results and future cash dividends from the joint venture will be reflected in our cash flow statement under investment activities, that's not included in cash or loss or free cash flow.

As a reminder, we expect to joint venture to contribute approximately $150 million in cash flow over the next five years. I'll give you more details on the transaction, as I walk through the results and guidance to provide transparency on the results of our core business on a going forward basis.

I'll start with the results for the first quarter. With macro softness on top of normal seasonal declines, our Q1 revenue was $539 million. This is a decrease of 7.4% year-over-year and a decrease of 10.8% sequentially, and as expected, we saw declines in both divisions in all end-markets. The NAND business contributed $31 million in revenue, so excluding NAND, revenues declined 5.5% year-over-year, and 11.7% sequentially, as compared to normal seasonality of down 6% to 7% in the first quarter.

Q1 gross margin came in at 47.4% above our guidance range. This is an increase of 150 basis points through Q1 2018 and down 40 basis points sequentially, driven by unfavorable mix in both divisions. The NAND business was dilutive to gross margins by approximately 10 basis points in Q1, as we focused on high-value customer opportunities prior to closing the transaction. FAB 25 remains loaded with utilization at 83% and we expect this to remain fully loaded for the remainder of the year. Q1 operating margin was 21.1% resulting in non-GAAP EPS of $0.27 for the quarter above the high end of our guidance. As we have noted previously, we have structured the company to provide more stability and predictability in market corrections and these results demonstrate the improved earning quality of our business.

Now turning to the division, MCD revenue was $310 million, down 7.8% from Q1 2018 and down 12.8% sequentially from Q4 with broad declines across all business units. MPD revenue was $229 million, down 6.9% from Q1 2018 and down 8.1% sequentially from Q4, again with broad declines across all business units. Looking at end-markets, our Q1 automotive revenue was $198 million or 37% of revenue, declining 7.9% sequentially and 1.1 compared to Q1 2018 driven by declines in automotive NOR. Automotive microcontrollers and wireless connectivity revenue increased 12% and 17%, 17% respectively year-over-year as large platform wins begin to ramp. Our IoT revenue was $154 million or 28% of revenue declining 19.3% sequentially and 17.2% compared to Q1 2018, as expected, driven by softness and wireless connectivity and consumer end markets and declines at Nintendo. USB-C and our MCU product also saw declines in excess of normal seasonality. Q1 legacy revenue was $187 million or 35% of revenue, declines 5.9% sequentially and 4.6% compared to Q1 2018, due to continued softness and industrial and enterprise customers. Let me give you some additional numbers for your models. Our Q1 operating expenses were $142 million or 26% of revenue. OpEx was up $1 million from Q4 due to normal reset of fringe rates.

Q1 operating income was 21%, increasing 160 basis points over Q1 2018 to $214 million. Our OIE was $9 million, our non-GAAP tax expense in Q1 was $2.7 million, down from $6.3 million in Q4. Our diluted share count was 375.8 million shares. This includes 1.6 million shares for the in-the-money portion of our convertible notes. As I mentioned earlier, this resulted in net income of $102 million or $0.27 per share above the high-end of our guidance range. Also the NAND business contributed $0.04 in EPS in its last quarter in Cyprus's non-GAAP results.

Moving at the balance sheet, cash and short-term investments totaled $285 million, and we had $540 million undrawn on our revolver. Accounts receivable is $266 million, resulting in DSO of 45 days. Cash from operations was $61 million or 11% of revenue. Net inventory increased $25 million sequentially to $317 million, and days of inventory increased to 102 days due to the market downturn, as well as inventory build to support our ongoing optimization, consolidation of our manufacturing footprint.

We expect inventory to increase again in Q2, as we execute our consolidation plans. Our Q1 adjusted EBITDA was $133 million or 25% of revenue. Total debt was $910 million and approximately 83% of our debt is now fixed rate with the converts and interest rate swaps we have implemented. We paid down roughly $26 million of our debt, and our net leverage ratio is one time on an LTM basis.

CapEx was $10.5 million, depreciation was $20 million for the quarter; we paid $40 million in dividends and repurchased $5 million in shares in the quarter. We have now returned 45% of our free cash flow since reinitiating our buyback in Q2 of 2018. As a reminder, our long-term model to return 50% of free cash flow to shareholders through the dividend and buybacks, and we have $170 million remaining on our authorized buyback.

Returning to the demand environment and guidance for the second quarter. As Thad mentioned, we believe the current market conditions remain challenged, but we are encouraged by stabilizing order patterns and booking trends. We continue to be cautious in managing the business within our current visibility.

Inventory in our distribution channel, which accounted for 68% of our revenue in Q1, decreased 6% in dollar value, as we actively manage replenishment orders to match in demand. This resulted in 7.7 weeks of inventory in the channel based on Q1 revenue which is in line with our target of 6 to 8 weeks. We entered the quarter over 90% booked, and our book-to-bill has improved to 0.97 from 0.77 and in Q4 with MCD above one for the first time since Q2 of 2018. We are expecting a return to sequential growth with Q2 revenue in the range of $515 million to $545 million. At the midpoint of guidance revenue would increase 4.4% excluding NAND in Q1. We anticipate strong sequential growth in IoT driven by strong bookings across our broad customer base, including white goods, home automation, gaming and industrial customers. We expect our Q1 gross margins to be in the range of 47% to 47.5% or flat sequentially as always gross margins will vary with product and customer mix.

We expect Q1 operating expenses between $144 million and $146 million for the quarter. The net OIE will be approximately $9 million, tax expense will be approximately $4 million, CapEx is estimated to be $13 million, and depreciation of approximately $20 million. We anticipate the fully diluted share count to be $383 million shares, as a result, earnings per share is expected to be in the range of $0.22 to $0.26 for the quarter. And to wrap things up, in spite of the current macro headwinds, we remain optimistic about our differentiated connect and compute products, with 85% of our investments focused on IoT and automotive. We are well positioned with product cycles addressing the largest megatrends happening in these markets today.

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

Questions and Answers:

Operator

Thank you, sir. At this time. If you do have any questions or comments (Operator Instructions). Christopher Rolland from Susquehanna. You may go ahead.

Christopher Adam Jackson Rolland -- Susquehanna Financial Group -- Analyst

Hey guys, congrats on the great quarter during what's pretty tough backdrop here. I wanted to talk about, I think it was IoT and MCD and maybe just a point of clarification, but also question. I think you said that would grow approximately 20% in Q2, obviously a pretty big deal there. Can you talk about what kind of contribution you're getting there from, is it one high volume win or is it a new win or is it really more broad based and perhaps talk about, you know, the end markets and sub-end-markets that's going into effects?

Hassane El-Khoury -- President, CEO & Director

Sure. This is Hassane. So, yes, you're right. And what I mentioned is, the IoT business will be up about approximately 20% in Q2. The strength is actually very broad, you know, it's, call it, matching our footprint in that business, a lot of customers regionally distributed, we do have a one customer that's also going to start ramping, but the 20% is obviously that one, but a lot of other customers across all end markets and regional deployment. So it's nothing to call one or two or three customers. I'd say it's broad, it's back to, I'm going to call it the growth profile that we have enjoyed prior, you know, throughout the 2018 and 2017. So we are going back to that. To what level? Obviously, we need to wait and see what the macro does. But as far as footprint, we're back to that broad growth footprint.

Christopher Adam Jackson Rolland -- Susquehanna Financial Group -- Analyst

Great, and then ex-IoT, maybe if you guys could give us a little bit more color on what you're seeing in your broader based businesses in terms of linearity, what did you kind of see through 1Q in the first couple of weeks here in 2Q. And then, what kind of signs are you getting in terms of visibility into the second half still?

Hassane El-Khoury -- President, CEO & Director

Yes, I mean, if I take -- I'll compare MCD as kind of a -- the visibility factor. MCD is expected to also grow over 10% in Q2. So that gives you a little bit on the rest of the businesses. Just to remind you, MCD has automotive microcontrollers, it has the wired and wireless connectivity in it. So that gives you an indication of kind of where Q2 is falling in the backdrop of the macro that everybody talks about. As far as signs, you know, we see stabilization in backlog. We do see bookings coming in. So that's what I would call our guide -- cautiously optimistic with all of these signs kind of coming back. And the commentary, I made in my prepared remarks, you know, if the second half turn persist through Q2, and that visibility persist that it is stable and positive, then the second half of the year will be pretty good.

Operator

Thank you. Our next question comes from Harsh Kumar with Piper Jaffray. You may go ahead.

Harsh V. Kumar -- Piper Jaffray Companies, Research Division -- Analyst

Hi, guys. First of all, congratulations, obviously tough environment, you guys are executing well. Hassane, I wanted some more color on China. You talked about MCD picking up, you talked about IoT picking up, what are some of the other things that you're seeing at a broad level relative to some of your other businesses? Are you seeing any signs of pricing pressure also on a monthly basis, is the business accelerating month-over-month, is that the trend you're seeing?

Hassane El-Khoury -- President, CEO & Director

So, let me and then call for that if I forget anything, I think we're at to it. And if I look at obviously the strength that I mentioned IOT the strength I mentioned MCD, in general. Where do we see the rest of it in automotive, we look at it as flattish quarter-on-quarter, which in light of everything you hear around is actually a good position to be in, and that goes back to what I've always said, we will in our automotive business will fluctuate with end demand. And end demand has been, you know, looking at a lot of the automotive peers and customers declining, but with our content we expect that to be flattish. But I'll remind you, I don't look at automotive on a quarter-by-quarter or month ' month-to-month. I look at it for the whole year. And that's why I wanted to talk about really the wins that will start ramping in the Traveo II and so on, so strong funnel there.

No pricing pressure. Basically, regardless of what's going with the macro, pricing is very stable, it's very stable across all of our businesses, including, you know, a lot of people talk about NOR, so I'll take that off the table, NOR pricing has been stable because we are in the high density proprietary products in automotive industrial and we have about 2/3 of our business in long-term agreements. So that gives us the stability, but even across the other businesses, we don't see any pricing pressure. Monthly, I would look at -- yes, it's that's what I would characterize as stabilization over the last few months, you know, we do see bookings strength in bookings specifically in MCD and all of the business that will be growing for us in Q2, which is really where our investment has been, so we see that. We need to see it more persisting before I go from cautiously optimistic to immensely optimistic, I would say, but the signs are there the stabilization is there, it needs to persist for me to make any comment beyond Q2 at this point.

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

And Harsh, I would probably add on your question about China, I would say China remained soft, but is stabilizing as it's on to, you know, late Q1, the first few weeks of Q2 here, you know, we are seeing some stabilization that includes China as well. But I wouldn't, I wouldn't call it a recovery as much as the decline has slowed pretty significantly.

Harsh V. Kumar -- Piper Jaffray Companies, Research Division -- Analyst

Got it. Thanks guys. And if I can ask one more and I'll get back in the queue. So, IoT is coming back pretty strong up 22% I think sequentially in June. At this point, I know this is a loaded question and I'm asking you to look out past June. But if you would venture to estimate or sort of give us your best idea what you think will happen to the rest of the year for IoT in terms of growth?

Hassane El-Khoury -- President, CEO & Director

Look, I won't venture and give you a guide beyond Q2. But what I will tell you is for this business, historically and during, you know, any macro, the seasonality of this business is sequential growth, Q2 to Q3. So sequentially that business would behave as growth. So I'll leave it at that.

Operator

Thank you. Our next question comes from Anthony Stoss with Craig-Hallum.

Anthony Joseph Stoss -- Craig-Hallum Capital Group LLC -- Analyst

Hi guys, my congrats as well on a nice execution. Thad, maybe you can, if you do see normal seasonal strong second half. Give us a sense of where you think gross margins might be at the end of the year and also how much longer do you expect to under ship into inventory? And then lastly Hassane, I'd love to hear your thoughts on kind of USB-C ramp throughout the year?

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

Yeah. So we are currently matching our (inaudible) end demand that's quite seen the revenue declined or the inventory in the channel decline there. So I would say we're matching it. We're not necessarily under shipping it, but we're being cautious to make sure we don't have an inventory bubble that starts to build in the channel. So I think we're managing that proactively and that sets us up to a nice recovery when the market does recover. In terms of gross margin, you know, obviously that's going to depend on what happens in the macro, you know, right now is what we're seeing is we guided Q2 as being essentially flat as we look forward, you know, I think you're going to see some improvement in gross margin, but I think a lot of it's going to be driven by macro and as the macro improves, we will sell more of our differentiated products with higher gross margin and that will be a nice tailwind for us. But right now based on what we're seeing, I would assume kind of a slow growth from where we are today on gross margins.

Hassane El-Khoury -- President, CEO & Director

Yes. For USB-C, just to close on last question. Obviously, for -- with our footprint, I commented in over 600 designs going in production or currently in production, some of them are ramping already and through the rest of the year. Overall, yes, we see obviously it's growth -- it's growth in line with where we expected, outside of our good position in our mobile handset customer. The rest is really broad, which has been our focus and diversification of USB-C customer base. But more importantly the portfolio, you know, going from charging to automotive charging to cables to docks.

Anthony Joseph Stoss -- Craig-Hallum Capital Group LLC -- Analyst

Thank you, guys.

Operator

Thank you. Our next question comes from Blayne Curtis with Barclays. You may go ahead.

Thomas O'Malley -- Barclays Bank PLC, Research Division -- Analyst

Hi guys, this is Tom O'Malley on for Blayne Curtis, nice results. I just had a quick one NOR, you had a competitor come out and basically say that they saw some strength into the back half of the year, and that solutions are moving more toward, you know, high density and that's something that you kind of described over the past couple of quarters here. Can you just talk about your NOR business, what you guys see in the back half, do you agree with them that things should be improving there or are you superior to them or inferior to them in any way, such that you would see different trend?

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

Sure. So first thing I'll say, it's a big complement that somebody's copying our strategy because it is a winning strategy, and we've proven that -- results. Now why we -- why I'm confident with our position in our move forward is in our -- first of all, you know, people talk about investing and moving down in technology. First off, we are already in 45-nanometer. Our technology is more advanced, as far as the size of the product. But all of these, I would say, our technology, if I look at the architectural advantages that those cannot be copied by any competitor today making NOR, is we have embedded microcontroller, an ARM M0 microcontroller into our NOR memory. So it is a higher life form of NOR, it is a higher density, it is an advanced technology, and it's a competitive proprietary technology that we can put more size and similar -- more size of this and a similar footprint or die size. So all of these put us way ahead of the competitor, so although people can talk about having the same strategy and going after our markets, results are the only thing that I would claim, the results over the last three quarters are positioned automotive already, our design wins in automotive when companies like them so and company like Bosch, take a supplier, they're picking Ciphers. So I'll just leave it at that.

Thomas O'Malley -- Barclays Bank PLC, Research Division -- Analyst

Great. Just looking at the segments into June. You guys said IoT is about 20%, automotive flattish, you know, x memory here, it looks like there some additional fall off in legacy. Can you just describe what products are going away there or what price you're seeing weakness in or is that, if just rolling off with NAND business?

Hassane El-Khoury -- President, CEO & Director

Yes. Tom, that's a good question. So if you think about the legacy, you've got to account for the NAND divestiture. So you've got $31 million, it doesn't repeat in Q2. So if you adjust for that, the legacy we think in Q2 will be down, kind of mid-single digits.

Operator

Thank you. Our next question comes from Karl Ackerman from Cowen. You may go ahead, sir.

Karl Fredrick Ackerman -- Cowen and Company, LLC, Research Division -- Analyst

Hi, good afternoon. It's nice to see an improvement in margins from where you got from March. And the margins, of course are holding up well for June. But Thad or Hassane, you know, obviously there's a multitude of things are impacting margins. But how much of an impact to gross margins are you seeing, if at all from the NAND business in June? And kind of going back to the previous question on utilization and margin outlook, how do you think about utilization of relative to Q2 gross margins. And similarly, how do you think about the utilization improvement, as we progressed throughout the remainder of the year? Thank you.

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

Yes, it's Thad here. So in my prepared remarks, I stated that the NAND was dilutive to gross margins in Q1 by 10 basis points. So if you look forward, that's really the impact going forward into Q2. On utilization, we just wrapped up Q3 at 83% utilized. I'll remind you that 85% is fully utilized in that FAB. So you can pretty much assume that we are going to run it fully utilized 85% plus or minus, you know, couple of percentage points from this point forward. As we look through the remainder of this year, you know, we're very comfortable that FAB will remain utilized, and will not be a drag on margins.

Karl Fredrick Ackerman -- Cowen and Company, LLC, Research Division -- Analyst

Understood. If I could just squeeze in one more, you know, in your prepared comments, you stated that in 2018 you are the fastest growing 32-bit MCUs in the industry. You also discussed some of the positive design wins you're seeing in automotive from your Traveo II products. At the same time, you know, IoT and industrial markets have been challenging near-term. So how do we think about the trajectory of your MCU and cumulative business within IoT and industrial markets in June and the balance of this year? Thank you.

Hassane El-Khoury -- President, CEO & Director

Sure. So, we are obviously, we started out the year with the first quarter, just like a lot of our peers. But the trajectory for the rest of the year, I would say, I would only comment on the IoT because I'm not going to look forward that far ahead given our visibility. But for IoT, with the connectivity and the microcontroller is part of that business, we are seeing the growth in Q2 and typically that business with the exposure to their end markets, which are consumer, automotive and industrial, that would be sequential growth in the third quarter. To what level and what compared to seasonality that we'll have to wait through Q2 before I make that call. But we do see growth, we are taking share from some of our competitors, but we are also capturing new content that didn't exist before. So both of these are the reason over the last two years actually, so '16 to '17, '17 to '18 where we have outgrown the 32-bit market in general and we've outgrown our peers and that will -- that will remain with of course the baseline as the macro whatever the market does. We're just gaining share on top of that. So, think about it as relative to the market.

Operator

Thank you. Our next question comes from Charlie Anderson with Dougherty & Company.

Charles Lowell Anderson -- Dougherty & Company. -- Analyst

Yeah. Thanks for taking my questions and my congrats as well on the strong quarter. I had a sort of a two-part around auto. So first of all, it looks like it's sort of shaping up to be kind of flat first part of the year. Who knows on second half, but I know your CAGR there from the Analyst Day is, you know, to be closer to 10% or so from '19 to '23. And you did mention a couple of pretty significant design wins, so I wonder if you could just maybe highlight for us when some of those start to ramp as it in 2020 timeframe do they happen in 2019? And then the second part of the other question is, you did have a kind of a peer who targets auto Wi-Fi asset in the quarter, I wonder how you're viewing that incrementally in terms of competition? Thanks.

Hassane El-Khoury -- President, CEO & Director

Okay. So as far as, you know, the Traveo II or so lot of the design wins that we have been talking about in automotive, we're starting to see the ramp in -- I think about the second half of this year, we'll start to see the ramp, but you know, it won't be material compared to our other microcontroller, you know, signed with all the microcontroller business. But we'll see the ramp get through 2020, 2021 and think about those as 10 year designs, like I mentioned in my prepared remarks, those open up every, you know, one to two design cycles, the specific ones we want, specifically in the body. They were closed off for new entrants for about a decade and we've taken those all off the table, so we're going to be the incumbent, and the revenue will come end of this year 2020 and they'll keep ramping throughout. I always talked about the layering effect meaning as new designs to go to production. They will just layer on top of that to give that 8% to 12% growth that we've seen.

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

Second question I believe was around the Quantenna on acquisition.

Hassane El-Khoury -- President, CEO & Director

Sure. So, if you think about Quantenna and number one it proves that, you know, I'll first talk about the price paid for the multiple that the business got. That shows the scarcity of assets. Those are assets that we have already. Those are assets that have matured at Cypress with exposure to the end markets that are growing, which is automotive and IoT. The Quantenna business is more focused on I think about infrastructure or the backend that's going to take a lot of time to take those high-powered processors into low power IoT level products and automotive. It proves our strategy, our strategy is sound, it proves the scarcity of asset, based on the multiple base, but I'll use one of the terms that, you know, one of my team members here told me, well they got a backpack and they got start climbing the mountain. We're already halfway up. So we'll see them at the top in a few years, maybe.

Charles Lowell Anderson -- Dougherty & Company. -- Analyst

Great, thanks so much.

Operator

Our next question comes from (inaudible) with Needham & Company.

Unidentified Participant -- -- Analyst

This is (inaudible) taking the question for Raj Gill. And my first question is regarding 5G. What makes you better position in 5G than the competitors, maybe like some color on just your competitive positioning in 5G? Thank you.

Hassane El-Khoury -- President, CEO & Director

Sure. This is Hassane. If you talk about, you know, the 5G, we focus on the high density NOR, and everything I mentioned in my prior answer, but why automotive customers pick us, is exactly why 5G or communication customers pick Cypress for storage. It's the reliability, you do want to deploy a new base station and have to service at the year-end, you want to deploy it, and it's got to run for, you know, 10 plus years, and that's what the automotive expectations are, that's the quality and reliability, we do deliver, that's from the call it commitment in the products. In general for the technology, it's the same thing, is that security, the high density, the monolithic high density, which is unique for us, and we are able to service that with advanced technology nodes where the others are not there yet. I would say that's sums it up. And again, the results are exactly the proof of what I'm talking about over Q3, Q4 and Q1, we have operated exactly where we expected that business to operate versus some of our peers that have had strength and strong declines in that same time period because they just don't have what we have.

Unidentified Participant -- -- Analyst

Okay, thank you for that. And just a quick question regarding your Nintendo switch technology. So how should we think about Nintendo switch moving forward on the second half of the year, do you expect the recovery or like, yes, just regarding, some comments about that. Thank you.

Hassane El-Khoury -- President, CEO & Director

Yes. I like, I don't want to comment on specifically that, it is part of our growth in the second quarter, the 20% that I mentioned in IoT. But as far as what they will or will not do and where the projections are for them. I would leave it for them to give that level of detail, and when they are ready to announce.

Operator

Our next question comes from Craig Hettenbach with Morgan Stanley.

Craig Matthew Hettenbach -- Morgan Stanley, Research Division -- Analyst

Yes, thanks for the color and automotive in terms of proprietary versus the rest of the business, can you talk about as you see through the rest of this year, do you expect that similar trend or any kind of puts and takes on the proprietary versus the rest within auto for 2019?

Hassane El-Khoury -- President, CEO & Director

Yeah, this is Hassane, Craig. So in general, the expectation for automotive, and for Q2, like we talked about earlier, is flattish for the second half of the year. There's really a lot of that play here, there's macro, there is new production and there's new designs. So I'm not going to -- I'm not going to project for Q3 and Q4 or the second half of the year, other than to say relative to the market our automotive content will remain as a growth content and I'd say, relative to the market because I've always said, we are growing content we're outgrowing the SAAR. I just don't know what the SAAR is going to do and if it's going to be more negative or less negative and that will fluctuate of where we will come in at. But relative to SAAR, I will tell you we have growth just like we've shown this quarter.

Craig Matthew Hettenbach -- Morgan Stanley, Research Division -- Analyst

Okay, got it, thanks. And then just a follow up with that in terms of matching kind of shipments into (inaudible), can you talk about kind of as you went through the quarter any notable trend in terms of how these behavior -- behaving and kind of as they go into Q2?

Hassane El-Khoury -- President, CEO & Director

Yeah, so I mean I think as we said, we've, we've managed the inventory down roughly about 6% quarter-on-quarter, matching that the replenishment orders to demand, it would tell you that we're under shipping in our backlog, because they are wanting to hold more inventory. We're just not allowing that to happen. Like you may have some of when it wrong. Yes. I also think that depending on region. Yeah, there is. Especially, like in the China area, there is a third more conservative watching inventory waiting to see what happens for the during the trade tariffs and what not.

Operator

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

William Stein -- SunTrust Robinson Humphrey -- Analyst

Great, thanks for taking my question. I really appreciate the discussion about the seasonality from Q2 to Q3. But just want to clarify something on Q2, it looks great to see returning to sequential growth on an organic basis, but it looks like the growth is somewhat below normal seasonality. Is that because of this legacy end market, you talked about? And what is it that's dragging growth in that market, please?

Hassane El-Khoury -- President, CEO & Director

Yeah, absolutely, if you strip out the NAND out of the Q1, as I said the Q2 growth will be roughly about 4.4% at the midpoint of our guide that's because of what we're seeing in the macro, right. So we are seeing some signs of stabilization and improvement but it's not coming back to normal seasonality. And normal seasonality in Q2 would be up 6% to 7%. So it's not -- it's not tied to the legacy per say, t's that if you look across other than the IoT the other -- the other businesses and the other segments are still below normal seasonality. And, you know, if the macro comes back faster, then that's going to be a nice tailwind for us, you know, potentially later in the year. But based on what we see today other than IoT any other the others will be below seasonality.

William Stein -- SunTrust Robinson Humphrey -- Analyst

Great. So it's broad based and macro related that's up the helpful. Thank you. Just one other if I can, does Cypress anticipate having at 10 plus percent customer this year?

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

No, we don't have a 10% customer. We haven't for a long time, and don't plan on having one.

Operator

Thank you. Our next question comes from Suji Desilva from ROTH Capital. You may go ahead, sir.

Sujeeva Desilva -- Roth Capital Partners -- Analyst

Hi Hassane, hi Thad, maybe first for Thad on the OpEx side, can you talk about, you know, sustained 20% plus in the downturn here and we're trying to prior 25 plus levels, does the OpEx trend relatively flattish have to grow in the next few quarters. Any thoughts there will be helpful.

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

Yeah, OpEx will move with revenue a little bit. You've got some variable expense that moves with the revenue levels. If you look at where we are today, we're above our model of 25% OpEx, you know, we believe in what we're seeing is that with the topline growth will come back into that model and we'll be able to run that roughly around 25%. Q2 does go up slightly because of some investments that we're making. But over time, I expect as a percentage of revenue that to come back down into that 25%. So you will see revenue outgrow the OpEx spent over time.

Sujeeva Desilva -- Roth Capital Partners -- Analyst

Okay, great. And then a question maybe for Hassane on automotive and Traveo II, are you talking about these design (inaudible) coming up kind of decade opportunities. What's the win rate you're experiencing with Traveo II because even I have this product in the market versus past, you know, what percent of the wins, are you guys capturing and kind of locking up for the next 10 years, perhaps?

Hassane El-Khoury -- President, CEO & Director

I'll have Mike answer that.

Michael Balow -- Executive Vice President of Worldwide Sales & Applications

Yes. So specifically on Traveo II, you know, we're winning probably opportunities that come up better than 90%, 95% in the body and cluster applications. So it's been really well received in the market. We did a lot of post for it. We've got a lot still in the pipeline to win. So it's very encouraging.

Hassane El-Khoury -- President, CEO & Director

I will tell you the year the percentage point that we don't, it's probably on the -- on the margin. We are very strict of what the value of the products are and are very strict on the margin profile that we expect, which is what we committed to everyone last for our model and updated models above 50% and we're not going to sacrifice margin or value of our products in the market or top line.

Operator

Thank you. Vijay Rakesh from Mizuho. You may go ahead.

Vijay Raghavan Rakesh -- Mizhuo Securities -- Analyst

Yes, hi guys, congratulations on a good quarter. Just a couple of questions here. On the IoT side obviously good pick up here and you mentioned returning to growth. Do you think that segment gross 30%, 40% year-on-year like it did in 2017, especially as you ramp two consoles there this year?

Hassane El-Khoury -- President, CEO & Director

Look, I'm not going to venture to give an annual guidance. But I will just reiterate my answer, 20% in Q2, and usually Q3 sequential growth. Q3, if you look at historically is the high quarter for that type of business for the Christmas build, which means it's a sequentially up from Q2, but I'm not going to quantify it beyond that, it's too soon given the volatility and uncertainty that still remains in the macro.

Vijay Raghavan Rakesh -- Mizhuo Securities -- Analyst

Got it. And on the NOR side, in the past year had pretty good pricing, you know, 70% of it is automotive, now as 5G picks up, any thoughts on how NOR supply and NOR pricing trends for you through the year. Are you still on contract on the 5G side too, how does that look? Thanks.

Hassane El-Khoury -- President, CEO & Director

Yes. Overall, two-thirds of our business is on long-term contract, but specifically on, let me give you the -- on the supply and the price, both of them are stable. From the pricing, you know, whether it's automotive or 5G infrastructure, both of them required to same level of quality and reliability and therefore it's not about the market, it's about the product, and the value that product brings that is defining the pricing for it. And those are stable and holding flat. For supply, you know, there is what you hear a lot of oversupply in the low-density, because that supply was built for cellphones and all that big high volume -- to the story line in our strategy, we're focusing on the high-density, that supply has not changed, that outlook has not changed, we're still enjoying that, and we're still servicing the customers that value our products and therefore give us the margin that fits in our profile, and we'll keep doing that, but that has not changed with anything that's happening today.

Operator

Thank you. This concludes the question-and-answer portion of today's conference. It would be my pleasure to turn the conference back over to Mr. Hassane El-Khoury, for any closing comments.

Hassane El-Khoury -- President, CEO & Director

Okay, thank you all for joining us today. During Q2, we will be presenting at the JP Morgan Global Technology Media and Communications Conference on May 16, the Cowen & Co Institutional Investor Conference on May 30th, and the BAML Global Technology Conference on June 5th. We look forward to seeing any 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: 53 minutes

Call participants:

Colin Born -- VP of Corporate Development & IR

Hassane El-Khoury -- President, CEO & Director

Thad Trent -- EVP of Finance & Administration, CFO & Principal Accounting Officer

Christopher Adam Jackson Rolland -- Susquehanna Financial Group -- Analyst

Harsh V. Kumar -- Piper Jaffray Companies, Research Division -- Analyst

Anthony Joseph Stoss -- Craig-Hallum Capital Group LLC -- Analyst

Thomas O'Malley -- Barclays Bank PLC, Research Division -- Analyst

Karl Fredrick Ackerman -- Cowen and Company, LLC, Research Division -- Analyst

Charles Lowell Anderson -- Dougherty & Company. -- Analyst

Unidentified Participant -- -- Analyst

Craig Matthew Hettenbach -- Morgan Stanley, Research Division -- Analyst

William Stein -- SunTrust Robinson Humphrey -- Analyst

Sujeeva Desilva -- Roth Capital Partners -- Analyst

Michael Balow -- Executive Vice President of Worldwide Sales & Applications

Vijay Raghavan Rakesh -- Mizhuo Securities -- Analyst

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