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Microsemi (NASDAQ:MSCC)

Q3 2011 Earnings Call

July 28, 2011 4:45 pm ET

Executives

Terri Donnelly - IR

James Peterson - Chief Executive Officer, President, Director and Chairman of Executive Committee

John Hohener - Chief Financial Officer, Chief Accounting Officer, Executive Vice President, Secretary and Treasurer

Analysts

Daniel Gelbtuch - Phoenix Partners Group, LP

Richard Schafer - Oppenheimer & Co. Inc.

Andrew Huang - Sterne Agee & Leach Inc.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

Quinn Bolton - Needham & Company, LLC

Erik Rasmussen - Stifel, Nicolaus & Co., Inc.

Christopher Rolland - FBR Capital Markets & Co.

Harsh Kumar - Morgan Keegan & Company, Inc.

Jonathan Smigie - Raymond James & Associates, Inc.

Operator

Good afternoon. My name is Lacey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Microsemi Third Quarter Earnings Conference Call. [Operator Instructions] Thank you. Ms. Terri Donnelly, you may begin your conference.

Terri Donnelly

Good afternoon, and welcome to Microsemi's Third Quarter 2011 Earnings Conference Call. I'm Terri Donnelly, coordinator of this call. In a few moments, you will hear from and have an opportunity to ask questions of Jim Peterson, our President and Chief Executive Officer; John Hohener, our Executive Vice President and Chief Financial Officer; and Steve Litchfield, our Executive Vice President and Chief Strategy Officer. A recording of this conference call will be available on the Microsemi website under the Investors section. Our website is located at www.microsemi.com. Microsemi issues guidance in the form of a limited business outlook on our expectations for the next quarter. This business outlook reflects our expectations as of July 28, 2011, and is continually subject to reassessment due to changing market conditions and other factors, therefore, must be considered only as management's present opinion. Actual results may be materially different. However, management undertakes no obligation to update these or any forward-looking statements whether as a result of new information, future events or otherwise. If an update on our business outlook is provided, the information will be in the form of a news release. We wish to caution you that all of our statements except the company's cost financial results are just our current opinions, predictions and expectations. Actual future events or results may differ materially. For a review of risk factors, please refer to Microsemi's report on Form 10-K for the fiscal year ended October 3, 2010, which was filed with the SEC on November 23, 2010, and our Form 10-Q for our second fiscal quarter of 2011 that was filed with the SEC on May 6, 2011.

That said, I'm going to turn the call over to John to discuss our financial results. And then Jim will address our end markets and overall business strategy. Here's John Hohener.

John Hohener

Thank you, Terri. Net sales for the quarter ending July 3, 2011, were a record $216.7 million, up 4.5% from $207.5 million in the second quarter of 2011 and up 59.3% from the $136 million recorded in the year ago third quarter. Our non-GAAP gross margin was 57.1%, up 90 basis points from the 56.2% in the second quarter of 2011, and up 870 basis points from the 48.4% reported in our year-ago third quarter. This growth with which exceeded our gross margin guidance for the quarter was driven by increased revenue and operational efficiency improvements.

Our non-GAAP gross margin forecast for the next quarter is expected to improve by 20 to 7 (sic) [20 to 70] basis points from this quarter. Our GAAP gross margin was 57%, which differed only from a non-GAAP due to noncash purchase accounting adjustments, and it was up 1,240 basis points from the 44.6% in our second quarter of 2011, and up 860 basis points from the 48.4% in our prior year third quarter.

This quarter, non-GAAP selling, general and administrative expenses were $37.3 million or 17.2% of sales compared to $35.3 million or 17% of sales in the second quarter and compared to $21.6 million or 15.9% of sales in the third quarter of last year. We expect SG&A to be up next quarter between $2 million and $2.5 million in support of the growth of our business. This is slightly higher than the norm, given the increased support that we have targeting future growth, particularly in the Rad Hard, RF and security spaces.

Research and development costs were $29.6 million or 13.6% of sales compared to $28.2 million or 13.6% of sales in the second quarter and compared to $14.8 million or 10.9% of sales in the year-ago third quarter. We continue to invest in the latest generation of our product roadmap and expect R&D spending to increase between $2 million and $2.5 million next quarter.

Our non-GAAP operating income was $56.8 million or 26.2% of sales compared to $53 million or 25.6% of sales in the second quarter of 2011 and $29.4 million or 21.6% in the prior year third quarter. The continuing increase in operating income and margin highlights our strategic success in integrating acquisitions driving organic growth in delivering improved profitability to our shareholders. We continue to be comfortable with our long-term model of 30% operating margins.

We recorded $4.6 million in non-GAAP interest and other expense which was down $500,000 from the $5.1 million we recorded in the second quarter, reflecting the successful refinancing of our existing term loan at the end of last quarter. We expect a similar amount next quarter.

Non-GAAP net income was $42 million or $0.49 per share, $0.01 above consensus estimates compared to $38.4 million or $0.45 per diluted share in the second quarter of 2011 and $24.7 million or $0.30 per diluted share in the year-ago third quarter.

Our non-GAAP effective tax rate for the quarter was 19.5%. We see our non-GAAP tax rate trending down to approximately 18% over the next several quarters as we make continued improvements in our tax structure.

Our GAAP results for the quarter included $2.7 million in severance and other charges and $2.3 million in transaction costs which were offset by a gain of the sale of the facility for $2 million. Also included were noncash expenses of $16.8 million in amortization expense.

Stock-based compensation expense was $6.8 million or 3.1% of revenue, down from $7.1 million in the prior quarter. As a percentage of revenue, our stock-based compensation has trended down from a high of 6.1% in Q1 '09 to this quarter's 3.1%. We expect a similar amount of stock-based compensation next quarter. These noncash expenses were offset by a $3.1 million in noncash gained from the change in the fair value of our debt.

Our GAAP operating income was $28.3 million for the quarter. On a GAAP basis, we booked an income tax benefit of $1.8 million due primarily to the evaluation of our deferred tax balances. GAAP net income was $30.6 million for the quarter compared to a GAAP loss of $16.9 million in the second quarter and GAAP income of $33 million in the year-ago third quarter.

Capital spending was $7.1 million in the third quarter compared to $6.5 million in the second quarter. Depreciation and amortization expense in the third quarter was $23.2 million compared to $24 million in the second quarter. Despite an increase in sales, accounts receivable remains stable at $98.1 million compared to $97.8 million at the end of the second quarter, and down from $114.6 million at the end of the first quarter.

Our DSO for the quarter was 41 days, an improvement of 6 days over last quarter. Our inventories were $145.4 million, an increase of $5.2 million compared to the second quarter. This increase is solely in raw materials to support projected business growth and also included small impact of recent acquisitions. We held 140 days of inventory at the end of the quarter, and expect improvement next quarter. Two years ago, our days of inventory was 186 days.

We ended the quarter with a cash balance of $246.2 million. Our GAAP operating cash flow for the quarter with a record $59.3 million and free cash flow was $52.1 million. For the quarter, our cash disbursements included $5.6 million in transaction costs and acquisition-related items. Excluding these items, operating cash flow would have been $64.9 million and free cash flow would have been $57.7 million.

Reflecting a continued strong growth trend, our book-to-bill ratio was greater than 1:1. Our best estimate of the end market percentage breakout of net sales for the third quarter was approximately: defense and security, 35%; aerospace, 26%; enterprise and communication, 16%; and industrial and alternative energy, 23%.

Now for our business outlook. For the quarter, of fiscal year 2011, we expect our net sales will increase between a range of 4% and 6%, sequentially. On a non-GAAP basis, we expect earnings in the fourth quarter of fiscal year 2011 to be between $0.52 and $0.54 per diluted share.

After Jim's discussion, we will have a Q&A session. In the interest of time, please limit yourself to one question and if necessary, a brief follow-up. With that, I will turn the call over to Jim.

James Peterson

Okay. Thank you, John. Let's jump right to our defense and security markets. As I expect, you'll have questions related to this market. In the June quarter, we were pleased with our results.

Revenues grew in defense by 1% sequentially. Microsemi continues to execute on its revenue growth throughout our expanding product portfolio and our growing dollar content. As I said in last conference call and as I reiterate here and now, I expect organic market growth for Microsemi defense and security markets to be in line with our internal growth targets of 10% to 12% over the course of next year. Again, here's why.

A growth budget for 2011 is in place even if subject to some standard ordering patterns ebbs and flows. Electronic content is growing in defense applications. Microsemi's product portfolio is growing, and we're attacking dollar opportunities we have never seen previously as a result of our dedication to and investment in this business. Microsemi's dollar content is growing as we continue to book [ph] the value chain, providing more and more value to our customers.

Foreign military sales are on the rise and as expected by the Pentagon, they committed approximately $46 billion in 2011, up approximately 20% year-over-year with several years of backlog ahead. The Pentagon's backlog for foreign military sales currently stands at $327 billion. In short, we've invested in this market for years. While others believed headlines, we acted on growth opportunity.

Now let's turn to our industrial alternative energy and end markets. As has been the case in recent quarters, this was our strongest end market performer in the June quarter, growing almost 11% sequentially in dollar terms. Microsemi's saw a broad strength in varied groups. Notable performers in the market were our welding, plasma cutting, medical power products, partially offset by normalized solar revenues and manufacturing burned through inventories. But we expect the continued pause for the solar portion of the business in the September quarter. We also expect this to be a short-term inventory adjustment. However, we expect strength amongst our other energy solutions and we continue to expect strength from the industrial end market as a whole.

Aerospace continues to deliver. The end market was up approximately 4% sequentially from Microsemi in the June quarter. Commercial air, satellite and infrastructure all posted solid billings and bookings, and we expect this strong and steady growth pattern like you see today for foreseeable future and driven by a strong commercial air industry both for new and reconditioned aircraft and then during satellite cycles driven by commercial and defense applications, here in the U.S. and abroad.

Microsemi's continued focus on a growing product offering continue to move up our value chain, providing more solutions to our customers and more dollars for opportunity. Now let's turn to our enterprise and to indications end market which were down a little than 3% sequentially.

While it's difficult for me to accept a down the quarter in any of our end markets, commercial markets do have volatility. And as if you've seen from some of our peers who have already reported, consumer trends are softer given the current state of the economy. This fact plus our ongoing strategy to walk away from less attractive margin businesses, led to the downtick this quarter. However, we are excited about the second half of the calendar year and beyond with RF, power amplifiers and PoE expected to lead the way, complemented by TV, backlighting, solid-state lighting solutions later in the year and into 2012.

In summary, Microsemi delivered another record revenue quarter with improved profitability, record operating cash flows, continuing improvement, financial performance highlighted our strategic success in integrating acquisitions, driving organic growth and delivering improved profitability to our shareholders. Finally, as you are aware, last week, Microsemi released a letter written to Zarlink Semiconductor making a proposal of CAD $3.35 per share, all cash. And the desire to meet with management.

We have been trying to engage in substantial discussions since January. Our proposal is a strong one, representing a 41% premium to the stock price before we announce our intentions. I refer you back to our final presentation from July 20 that outlines both the benefits to Microsemi and Zarlink shareholders. Unfortunately, the update is that we have not achieved much progress to benefit Zarlink shareholders.

We have not received an NDA, no meetings have been scheduled. In fact, Zarlink has done everything possible to stall any progress, putting in place a poison pill and mandating a standstill provision. Further, the company has repeatedly stated that indeed, no future action at all may be the chosen path. The bottom line is I hoped to be able to share more with you today, but simply not possible.

In fact, the only real action that has taken place is our announcement has been the massive trading of Zarlink shares. As of yesterday, some 60.3 million shares have changed hands in the last 6 days. Those 700,000 combined in the 6 days prior to our announcement. There's a new shareholder base at Zarlink, a shareholder base ready for action. But clearly, Zarlink's management is not listening to it's shareholders.

Now Zarlink has stated that it's interested in open, transparent transaction. So are we. The proposal last week was open and transparent to the market. And we've made that announcement because we see real value in Zarlink technology, its excellent engineering team and our vision of what the future could be.

We prefer a friendly deal and have in the past indicated a willingness to increase our offer to as high as CDN $3.55 based upon our ability, due diligence. But we don't see a path to that price at this time. Let me be clear. Our price is CDN $3.35. We will not sign a standstill agreement since the board and the management has simply pocketed our interest and offers in the past, keeping them out of shareholder sight. This is a small industry. It doesn't take long to assess strategic interest, and that we have demonstrated last week that we are uniquely qualified to close this transaction.

I have stated that we are committed to this transaction but that doesn't mean my proposal stays outstanding indefinitely. Zarlink's continued stance of delay in my view is baffling and not to the benefit of Zarlink shareholders. That said, we'll see where things lead and I don't plan on giving a play-by-play on this until it's over one way or the other.

This is all we are prepared to say on Zarlink at this point in time. I don't intend to providing answers to questions on the topic during the Q&A. So please focus your questions and follow-up questions on Microsemi's strong quarterly and strong guide. With that, I'll thank you and turn it over to Lacey for our Microsemi analysts. Lacey?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Rick Schafer of Oppenheimer.

Richard Schafer - Oppenheimer & Co. Inc.

I just got a couple of questions. One, I want to try to sneak one Zarlink question and hopefully you'll give some color. But I guess you guys have been able to really vet the backlog there at all, has there been any kind of opening of the kimono? And part of that question, too, I mean, if -- are you guys willing to push ahead if this starts becoming sort of more of a hostile kind of move?

James Peterson

We haven't fully vetted it because obviously, they haven't opened the kimono. We have a pretty good idea. That have been said, I saw their earnings, I wasn't disappointed but understood it. So their guide. I found that a bit more concerning than I would've expected. As far as what I'm going to do, let's put it down to the question of am I exploring options? And the answer is yes. And I'm also exploring other targets. But I'll tell you this, right. If we do decide to do a tender, it certainly won't be to the high end of that range.

Richard Schafer - Oppenheimer & Co. Inc.

Okay. Another question, I know you hit on a little bit on your prepared remarks on military, but I know you talked about order hesitancies last quarter, sounds like that has kind of moved to the side. Am I right in assuming that? And then if orders are firming up, have firmed up sort of as June quarter went on, I guess what's your visibility there heading into the September quarter? I mean historically speaking, right, September -- am I right in assuming September has been kind of a tougher quarter to predict on the military side for you guys?

James Peterson

Well, you know what, I don't want to accuse you [ph], but you're not right. What's kind of happening here is if you're working just on Tier 1, if you're working for a big order either the military, the aerospace, the marines, you have to expect -- I don't want to use lumpiness but expect lumpiness. What's happening here is we are seeing strong growth in new opportunities, electronic content, electronic warfare, right? We are seeing a lot of success in solar end customers in what we are calling foreign military sales, but was just military sales. This is a growth market, Rick. I mean the content is increasing, chief desk receivers are strong, radar detection, merchant suppliers, UAVs. Just those companies that are focusing on either Tier 1 or quite honestly, things that might get attached to a soldier, boots, Hershey bars, night vision goggles. They're seeing a difficult time. I actually, next quarter when we did our stack ranking here to what's going to give you the strongest growth in the next quarter, number one is going to be defense and security.

Richard Schafer - Oppenheimer & Co. Inc.

So would you comment on our overall book-to-bill and how it compares to the book-to-bill in the defense piece?

James Peterson

Yes. Book-to-bill is greater than 1. I'll leave it at that, my friend. You know that.

Operator

Your next question comes from Steve at Raymond James.

Jonathan Smigie - Raymond James & Associates, Inc.

Just had a pretty solid quarter in a bunch of place but the industrial sort of energy seems to be really great. Can you talk about how that looks going in the next quarter, given that the solar piece pulls back and you continue to have growth there, despite that?

James Peterson

Yes, that's a good question. Let me give my stack ranking of the 4 markets, okay, and then I'll jump right into your answer. Number one, this is just like September growths, right? Number one, defense is the strongest, defense and security related. Number two, aerospace, which is satellite commercial air. Number three is our enterprise, communication, PoE, the RF display. This next quarter, the slowest growing one is going to be industrial and alternative energy. A lot of it is based on solar inventory. There's a pause out there in the industry but we got some upticks in the welding and the energy and the like, so it's ranked number 4.

Jonathan Smigie - Raymond James & Associates, Inc.

Okay. Great. Within defense, can you talk a little bit about the security piece of that? One, how much is defense now versus security? And within security, I think you added some extra Brijot assets there so can you talk about the technology there and what's happening there?

James Peterson

Yes. I mean in defense and security, it goes together, right? I don't feel we need to give a percentage of it, so I don't want to break those out. I actually couldn't give you hard number because I don't have that but we put those together. The Brijot you want to know about that what we've done is that's kind of aggressive technology acquisition and pretty small on the revenue. And what that allows us to do is get up to a niche of 100 gigahertz in millimeter wave technology. And our big play has been millimeter wave technology versus backscatter and x-ray. And I think what you've seen about a week ago, TSA approved the millimeter wave technology, essentially the privacy concerns have been addressed with the new software program. And what's that mean, that means L-3, all right? Millimeter wave technology meets the privacy concerns with the new software package. And strangely enough, right, the backscatter or the x-ray, their competitor, Rapiscan, theirs has not been approved yet. And what I understand from the TSA's article, this was just reading the article that they'll look into that sometime next fall. That's how they kind of bundles in.

Jonathan Smigie - Raymond James & Associates, Inc.

If I could just squeeze one more in, really saw guidance. Is it any of that -- is there a meaningful amount of acquisition revenue in that guidance at all?

James Peterson

Yes, minimal. We get a 4% to 6%. If it's 1% of that I'd be surprised. I mean last quarter guys, that's pretty much organic growth quarter. Going forward this quarter, this is organic growth quarter. So if you want to know what we're doing organically, look at the numbers.

Operator

Your next question comes from Harsh Kumar of Morgan Keegan.

Harsh Kumar - Morgan Keegan & Company, Inc.

Question for Jim. Jim, how confident are you of your sort of your longer-term goal of 60, 30 by September 12. As you said here and you're showing constant improvements every quarter, is that still a pretty achievable goal for your company?

James Peterson

Yes, thanks for noticing. And let me give you a little color as when I think we can do that. It's interesting gross margin, just to be safe and edge, I would guess 6 to 8 quarters would be a nice safe number to get us there from my team. But check it out, better news, the 30% operating margin when I hit those, that's more like 4 to 6 quarters so the profit is actually as you would want it, gaining and growing faster.

Harsh Kumar - Morgan Keegan & Company, Inc.

Got it, and I appreciate the color. And I think you just gave us your ranking of the 4 areas for September, Jim. Can we assume that all 4 areas of your businesses will grow? Or should we think that industrial might be flat or even down?

James Peterson

Yes. Certainly the first 3. The industrial one, it depends on some of this inventory adjustment but I think if you went around and called my senior staff, they would tell you, all 4 our going to grow because that's the marching orders.

Harsh Kumar - Morgan Keegan & Company, Inc.

That's fair. And if I can squeeze one more real quick in, all of your industrial business, could you just categorize how much solar is for you? Is it trivial, meaningful or not meaningful at all?

James Peterson

Solar is meaningful to everybody. It's important to Microsemi. We have some unique technology, it differentiate us from a lot of competitors. The only thing that's sad right now, is there's a little inventory pause that will pass, and I'll put solar on the top of the list.

Harsh Kumar - Morgan Keegan & Company, Inc.

Oh no, I apologize. Like in terms of revenue right now, is it meaningful to your business at this point in time and contribution to revenues?

James Peterson

You know what? At the end of the day, right, as I add up the numbers, every dollar counts. So I don't know exactly what to give you on that. It's an important market to me. I'm investing in it, and it's meaningful.

Operator

Your next question comes from Craig Berger of FBR.

Christopher Rolland - FBR Capital Markets & Co.

This is actually Chris in for Craig. So just on the Zarlink acquisition, first of all, does the poison pill change anything in your guys feel?

James Peterson

Chris, you're probably late on the call. I gave a lot of color in the prepared statements on Zarlink. And I said I didn't want to answer any question. I did take one from Schafer. So what was your question again?

Christopher Rolland - FBR Capital Markets & Co.

All right. Let's mix it up. So on the medical side of things, how do you guys sort of view the growth rates there? And is there anyone else that's sort of in the FDA approval process there and sort of how do you view that TAM overtime?

James Peterson

Look, the Medical business, I find it interesting, right? I think the technology is great. I applaud their engineers. But let's look at some of the opportunities I give you couple of list to this thing, right. There's 3 major customers. They own 95% of that market. Zarlink and their technical team did a great job with St. Jude. They're in there. They ship it. Nice platform, all right. The second customer then, is the biggest out there, right? No real revenue, it's Medtronic's., a lot of platform, right? Being out there concerns me a little but I like the technology and I'm looking to invest in it. The second largest guy, Boston Scientific, let's be quite honest, they seem to be doing quite well without Zarlink. That's where we should come in. We can open the doors of our technology. We ship hundreds of millions of dollars into this space. And last but not least, and my guys are giving me a look in the room, it's a great technology that a lot of people can do it. Anybody that's left Qualcomm that's parked 15, 20 miles around that circle, has a solution to that area. You can kind of do with an ASIC according to my team. So I think it's a great market. I think Zarlink needs scale. I think they need some additional technology to take it to the next level and that's where I come in.

Operator

Your next question comes from Erik Rasmussen of Stifel, Nicolaus.

Erik Rasmussen - Stifel, Nicolaus & Co., Inc.

I'm just wondering if you can give a sense is this kind of a new cadence? You were at the 3% to 5%, seem like that was the growth rate now, you're guiding to 4% to 6%. Is this something we should be expecting going forward and is it really the organic that we should be looking at?

James Peterson

I'm really comfortable with saying that we're going to grow the company. We do it historically about 15%. I am comfortable in giving you 15% to 20%. I don't want to give you quarter-by-quarter blow, because we guide by one quarter. I'm excited that I can go 4% to 6%. If we repeat it next quarter, I'll let you know. But I don't want to get carried away with what's going on with the strength of our business. But it wouldn't surprise you next quarter, if it wasn't near the same.

Erik Rasmussen - Stifel, Nicolaus & Co., Inc.

Okay. And just some follow-up. On commercial air, can just provide us a little more color in that business, some Boeing obviously posted some strong commercial results. But do you see any sort of headwinds besides maybe higher oil prices that might concern you? Where are your expectations for this business might be lower?

James Peterson

Right now, I see tailwinds, Boeing and a large competitor are looking good. The macro thing, I can't say what's going to happen. If your price gets doubled tomorrow and put some hesitancy on this market. What I'm telling you passive traffic is up, cargo traffic is up. Production has increased. We have a lot of new technologies in this market spaces, and I think that if you're in that market space like we are, you're going to do good.

Operator

Your next question comes from Daniel Gelbtuch of Phoenix.

Daniel Gelbtuch - Phoenix Partners Group, LP

Just wanted to ask, first of all, what was your depreciation number for the quarter?

John Hohener

Depreciation was it was $6.4 million. It was down previously from $8.1 million and that has to do with the fact that Scottsdale rolled off.

Daniel Gelbtuch - Phoenix Partners Group, LP

I got you. Excellent. And then, if you just give us a little update on the PoE business in terms of, where you guys are up to on wattage, et cetera? What's going on that space?

James Peterson

We're growing, we're actually driving the standards for the 100-watt device. PoE is doing good. The only adopters are in and the growth market has been very, very beneficial for us. I think you were around when we got involved in that industry years back, and it was a short investment and it's paying off nicely.

Daniel Gelbtuch - Phoenix Partners Group, LP

All right. Great. And then just a little bit of an update on the GPS in the Mortar business. Is that something that's ramped or do you expect that to ramp now or next year?

James Peterson

It's ramping right now. I mean check it out. What's that about, right, is collateral damage. And the most concerning -- should be one of the most concerning points of any kind of war conflict is collateral damage. And the government is attending to it and we're supplying content in that area.

Operator

Your next question comes from Andrew Huang of Sterne Agee.

Andrew Huang - Sterne Agee & Leach Inc.

First question. I just wanted to clarify your comments on the gross margin for the September quarter. Did you say up -- could you repeat the guidance again?

John Hohener

20 to 70 basis points.

Andrew Huang - Sterne Agee & Leach Inc.

And then since everything is going strong on an end-market basis. I just want to focus a little bit on the weakest link, which was I think enterprise and commercial. I guess could you just go into a little more detail on what caused the weakness again? And then what you expect the rebound for the back half of the calendar year?

James Peterson

It's enterprise communications and commercial, let's put that in there, I mean it's common knowledge out there right now, there's some inventory situations with that particular segment. But I think going into the next quarter and beyond, we're launching a lot of new next-generation RF products, PoE is coming into place, DC:DC products are starting to ramp. I think you'll see that just to be a tick once again. Defense is extremely strong. Aerospace is strong and enterprise communications will be up in dollar content and growth next quarter.

Operator

Your next question comes from Quinn Bolton of Needham & Company.

Quinn Bolton - Needham & Company, LLC

Jim, just a question. I feel that every time I have taken a flight in the last couple of months, I've gotten a middle seat. So I guess I was just a little surprised that your Aerospace business or Comair wasn't stronger. It certainly sounded like we got some good news coming out of the Parish show. So can you talk to us a little bit about what you're seeing, how the backlog is building? I know it's longer lead time stuff but some thoughts on the Comair side of the business?

James Peterson

Sure. I think you're right about those middle seats. Thanks for the tip, I'm going to start building some more middle seats. It was a strong business. I mean it's up -- what was it 4% -- 4.5%. That's what I call growth. You see what's going on out there. Just read what Boeing has done. Be very confident, that's a good market, a strong market for us to be in.

Quinn Bolton - Needham & Company, LLC

And backlog continues to fill in. Any comments about what you're seeing on the backlog?

James Peterson

Strong steady with long cycle time. That's one of the beauties of this market space, right? Let's go over cycles times. When you are in the commercial market, not the consumer, which is even less, right? You got lead times up, 4 to 6 weeks. Whether you're in defense business or aerospace business, you're getting cycle time and lead times 15 to 26 weeks to fill it up nicely. And just as a note for highlight for those taking notes, Satellite business, you used to get about 36 weeks of cycle time which is connected with your cycle time.

Quinn Bolton - Needham & Company, LLC

That's great. And just one for -- quick one for John, on the finance side. Earlier this week, it looks like S&P put you on negative watch. Does that have any -- I guess, first, were you surprised by that? And second, does that have any implication on the existing debt or change perspective terms to the extent the Zarlink financing goes through?

John Hohener

So it's not surprising. Anytime you announce that you may increase leverage, they automatically, I believe, put you on what they call a negative watch. We're certainly not committed to this transaction, and we're going to work as we move forward that we'll work with the rating agency to make sure that they understand our ability to drive our metrics in a favorable manner, our debt-to-EBITDA levels, for instance, just talking about our current debt level, which we've had for 2 full quarters. We driven down that ratio down from 1.8 to 1.65 in one quarter. So we expect to show them how are we going to be able to that with the increased leverage, if Zarlink in fact, goes through.

Quinn Bolton - Needham & Company, LLC

And is that, the existing 375, is that now a fixed coupon? Or could that potentially be impacted to extent you did receive a downgrade?

John Hohener

That would not be impacted, no.

Operator

Your final question comes from Tore Svanberg of Stifel, Nicolaus.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

A few questions, follow-ups. First of all, did you talk about the cash flow from operations number?

James Peterson

John?

John Hohener

Yes, we did. Cash flow obviously was a big thing for us. From a GAAP standpoint, it was $59.3 million. Free cash flow, $52.1 million. If you take out the cost of acquisitions that you have to do now the accounting rules and kind of look at on a non-GAAP basis, if those 2 numbers were $64.9 million and $57.7 million, respectively. Great cash numbers for us. Our cash balance is $246.2 million. And as I said to you last time and I'll reiterate, we told you that we're going to do about $200 million plus. Obviously, we think that number may edge up a little bit from there as we move forward.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

Yes, and that's what caught my eye because you did -- I think you did about $30 million last quarter. So what were some of the moving parts there other than obviously your better net income?

John Hohener

Certainly from the standpoint of the linearity of our business that helps in terms of collections. So we were -- and plus, we're managing inventory. We're really focusing on our inventory in terms of our whole operational efficiency, and I think that, that's coming to help us, too.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

Okay, very good. And I know you usually don't talk about backlog and bookings and things like that but you know that's my favorite question. So where do we stand on visibility so far through the month of July?

James Peterson

Hey, I'm quite open when it comes to -- with bookings. We had a positive book-to-bill. I don't give backlog. But again, you know our businesses, you know a lot of our lead time is tied to our cycle time, guiding up stronger than I have in multiple quarters. So things are looking good here, Tore.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

Very good. And then last question, your operating expenses going forward, not just September but beyond September. Do we just going to see a very gradual increase or any significant step up in R&D that you're expecting?

James Peterson

Well, certainly we're investing as we talked about in the prepared remarks but our goal is always to drive our expenses down as a percentage of revenue. Every time we have a little acquisition that may put an incremental step in there. But for the most part we're still focused on driving those expenses down.

Tore Svanberg - Stifel, Nicolaus & Co., Inc.

Very good. Last question, you've been managing the days of the inventory on 140 days here in the last couple of quarters, should I anticipate that same level for the second half?

James Peterson

Yes. I mean again, we're focused on driving that down as we grow the business. So we are going to have to invest in some inventory. But as the days of inventory, we want to see that number continue to come down.

Operator

At this time, there are no further questions. I would now like to turn the call back over to management for any closing remarks.

James Peterson

Thank you. Closing remarks. Simple to the point. Adam? Gary? Let's take this thing to a friendly conclusion. Thanks for joining us and have a great day.

Operator

Thank you. This does conclude today's conference call. You may now disconnect.

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