Good day, everyone, and welcome to this Microchip's 3rd Quarter Fiscal 2020 Financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Mr. Eric Bjornholt, Chief Financial Officer Sir, please begin.
Thank you and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward looking statements regarding future events or the future financial performance of the company, we wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you to our press releases of today, as well as our recent filings with the SEC, that identify important risk factors that may impact Microchip's business and results of operations. In attendance with me today are Steve Sangey, Microchip's Chairman and CEO and Ganesh Moorthy, Microchip's President and COO. I will comment on our third quarter fiscal year 2020 financial performance and Stephen Ganesh will then give their comments on the results and discuss the current business environment as well as our guidance.
Will then be available to respond to conference call on various GAAP and site at www.microchip.com, which we believe you will find useful when comparing our GAAP and non GAAP results. We have also posted 2018, we adopted the new GAAP revenue recognition standard, which requires revenue to be recognized at the time products are sold to distributors versus our historical revenue recognition policy, where revenue on such transactions were deferred until the product was sold by our distributors to an end customer. As discussed in previous earnings conference call, we continue to track and measure our performance internally based on direct revenue plus distribution sell through activity, and each quarter, we will provide a metric for this called end market demand in our earnings release. Therefore, along with our GAAP and non GAAP results based on distributions sell in, we will also provide investors with our end market demand based on distribution sell out. Will not provide a P and L based on end market demand.
End market demand in the December 2019 quarter was $1,324,000,000 end market demand was about $36,100,000 more than our GAAP revenue in the December 2019 quarter. I will now go through will be referring to these results on a non GAAP basis, which is based on expenses prior to the effects of our acquisition activities, share based compensation and certain other adjustments as described in our press release. Net sales in the December quarter were 1,287,000,000 which was down 3.76 percent sequentially and near the high end of our updated revenue guidance provided on January 6, 2020. We have posted a summary of our GAAP net sales and end market demand by product line and geography on our website for your reference. On a non GAAP basis, gross margins were 61.5%.
Operating expenses were up 26.4%, and operating income was 35.1 percent and above the high end of our guidance. Non GAAP net income was $340,800,000, Non GAAP earnings per diluted share was $1.32, which was above the high end of our last provided non GAAP EPS guidance from December 3, 2019, of $1.30. On a GAAP basis, gross margins were 61%, and include the impact of $5,700,000 of share based compensation expense. Total operating expenses were $654,300,000, and include acquisition intangible amortization of $248,700,000, special charges of $17,800,000, $10,900,000 of acquisition related and other costs and share based compensation of $37,800,000. The GAAP net income was $311,100,000 or $1.20 per diluted share, our December quarter GAAP tax benefit was significantly positively impacted by the tax benefit related to the intra group transfer of certain intellectual property rights.
The non GAAP cash tax rate was 6% in the December quarter. We expect our non GAAP exclusive of any transition tax, any potential tax associated with the restructuring of the Microsemi operations into Microchip's global structure, and any tax audit settlements related to taxes accrued in prior fiscal years. We have many tax attributes losses and tax credits as well as US interest deductions that we believe will keep our cash tax payments low. The future cash tax payments associated with the transition tax is expected to be about $245,000,000 and will be paid over the next 6 years. On the Investor Relations page of our website.
Our inventory balance at December 31, 2019 was $708,800,000, We had 129 days of inventory at the end of December quarter, down 2 days from the prior quarter's level. Inventory at our distributors in the December quarter were at 28 days compared to 30 days the end of September. We've only had 1 quarter in the past 15 years which was Q3 of fiscal year 2013, where our days of inventory at distribution had been at lower than the current levels. The cash flow from operating activities was $395,500,000 As of December 31, the consolidated cash and total investment position was $402,300,000. We paid down $257,000,000 of total debt the December quarter and the net debt on the balance sheet was reduced by $254,200,000.
Over the last six full quarters since we closed the Microsemi acquisition and incurred over $8,000,000,000 in debt to do so, we have paid down $1,986,000,000 of the debt and continue to allocate substantially all of our excess cash generation beyond dividends to aggressively bring down this debt. We have accomplished this despite the adverse macro and market conditions during most of this period, which we feel is a testimony to the cash generation capabilities of our business. We expect our trailing 12 month adjusted EBITDA was $2,125,000,000. Our net debt to adjusted EBITDA is excluding a very long dated convertible debt that matures in 2037 and is more equity like in nature, was 4.58 at December 31, 2019. Our dividend payment in the December quarter was 87,700,000 Capital expenditures were $19,100,000 in capital spending in the March quarter and overall capital expenditures for fiscal 2020 to be between $76,000,000 $81,000,000.
We continue to add capital the sourced atmel and Microsemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the December quarter was 41 point $4,000,000. I will now turn it over to Ganesh to give us comments on the performance of the business in the December quarter. Ganesh?
Thank you, Eric, and good afternoon, everyone. Before I get started, I'd like to remind you that the product line comparisons I will be sharing with you today are based on end market controllers. Our microcontroller business was sequentially down 1.1% as compared to the September quarter. We continue to introduce a steady stream of innovative new microcontrollers, including next generation Bluetooth 5.0 dual mode audio solutions, production ready open source tools for managing our Adaptech Smart Storage offerings and industry support for development of the open compute projects accelerator infrastructure through our PCIe switches. Microcontrollers represented 53.6% of our end market demand in the December quarter.
Moving to analog. Our analog business was sequentially down 3.6% as compared to the September quarter. During the quarter, we continued to introduce a steady stream of innovative analog products, including the IEEE 802.3pt compliant power over Ethernet injectors and mid spands that enable up to 90 watts of power without changing switches or Cable. Analog represented 28.1 percent of our end market demand in the December quarter. Our FPGA business was sequentially flat as compared to the September quarter.
During the quarter, we introduced the radiation tolerance Polar fire FPGA, for space and other high reliability applications, as well as the early access program for the Polar Fire System on Chip FPGA, offering the world's first hardened real time Linux capable RISC 5 based microprocessor subsystem. Design wins for the Polar Fire family continue to grow strongly, and we remain optimistic about the prospects for this product family. FPGA represented 6.9 percent of our end market demand in the December quarter. Our licensing, memory and other product line which we refer to as LMO was sequentially down 0.7% as compared to the September quarter. During the quarter, we enabled we delivered a new family of electrically erasable RAM products providing cost effective alternatives to nonvolatile RAM solutions at a number of memory densities.
LMO represented 11.3% of our end market demand, in the December quarter. An update regarding coronavirus and what we're seeing. First, all our employees are safe and what remains and that remains our highest priority. We implemented travel bans in and out of China, Hong Kong, and Taiwan 2 weeks ago. We also implemented self quarantine requirements for anyone who may have traveled to these countries, mandatory medical assessment and clearance for anyone who may have symptoms, a screening questionnaire for all external visitors to any microchip facility and common sense preventive sanitizing steps on a continuous basis in all our facilities worldwide.
As you well know, most provinces in China have extended the Chinese New Year holidays to February 9th. Umbei province, where Wuhan is located, has extended the holidays to February 13th. Our manufacturing footprint in China is small, and we expect little impact to our operations from this extension. Also, at this time, we do not anticipate any significant supply chain issues for materials sourced from China. Some of our customers could be affected by the extended Chinese New Year holidays.
It is too early to determine what impact MAB as most are not yet back from the extended holidays. Because Chinese New Year this year was early in the quarter, there is more time for our customers to catch up lost production within the quarter. We also believe there is slack in manufacturing capacity which can be of help while recovering lost production. These outbreaks are unpredictable and there may yet be other twists and turns to come in the days ahead. We continue to process the news daily as well as monitor information from the Center for Disease Control And the World Health Organization.
We will adapt our response as needed and focus on the things that we can control. Finally, over the last few months, we started to share 6 megatrends that we believe provides significant growth opportunities for Microchip over the next 5 to 10 years, and I'd like to summarize them. First, the 5G infrastructure roll out, which is just getting started and has a decade ahead of it. Each prior generation of wireless infrastructure deployment 2g, 3g, and 4g lasted for about 10 years. The Internet of Things comprised of smart, connected, and secure end nodes is picking up steam, especially for industrial IoT, where there is compelling when there are compelling business models for customers to make money save money and mitigate risk.
3rd, for data center, the data center demand exploding as data is created at a hyper exponential rate. To put this in perspective, estimates are that 90% of the world's data was created in just the last 2 years, and that trend continues unabated. 4th, electric and hybrid vehicles are riding a wave consumer and regulatory forces, which are driving substantial investment in technology and capacity. 5th is the Advanced Driver Assist which is already a growth application and its proliferation to more car models and its natural progression to increasing levels of autonomous driving. 6 is the is finally the artificial intelligence and machine learning, which we see as another explosive growth area.
Not only in the cloud, but even more so at the edge. These megatrends cut across the diverse end markets we serve and guide our product development priorities. We believe these megatrends in conjunction with our total system solutions go to market approach will provide key opportunities for organic growth in the coming years. With that, let me pass it to Steve for some comments about our business. Our guidance going forward.
Steve?
Thank you, Ganesh, and good afternoon, everyone. Today, I would like to 1st reflect on the results of the fiscal third quarter of 2020. I will then provide guidance for the fiscal fourth quarter 2020. Our December quarter was an interesting one in which we revised the midpoint of our guidance upwards twice. Once on December 3, 2019, prior to the Credit Suisse conference.
And second, on January 6, 2020, prior to JP Morgan Conference. Our final December quarter GAAP net sales were on the high end of our latest guidance, and came in at $1,287,000,000, down 3.76% sequentially. Our end market demand based on sell through was $36,000,000 higher than GAAP sales, which we believe, shows that the channel was continuing to manage their working capital conservatively by reducing inventory due to uncertainty. December was the 7th consecutive quarter where our sell through revenue was higher than our sell in revenue. Our consolidated non GAAP gross margin of 61.5 percent was just above the high end of our guidance.
Our consolidated non GAAP operating margin of 35.1 percent was also just above the high end of our guidance. Our consolidated non GAAP earnings per share was $1.32, which was also above the high end of our revised guidance, So overall, December quarter turned out to be a lot better than originally guided. On non GAAP basis, this was also our 117 consecutive profitable quarter. In the December quarter, we paid down $257,000,000 of our debt, Our total debt payment since the end of June 2018 has been about $2,000,000,000. The pace of debt payments has also has been strong despite the weakened uncertain business conditions, underlining the strong cash generation characteristics of our business, as well as our active efforts to Now before I provide you guidance for the March quarter, let me comment on some of the inflection points that we saw during the December quarter.
Our December quarter bookings were up double digit percentage over the September quarter bookings that resulted in our starting backlog for the December quarter. Our starting backlog was up in each of the geographies of North America, Europe and Asia. From an end market perspective, we saw strength in data centers and start of a recovery in industrial and automotive. Continuing on the inflection points. The book to bill ratio for December quarter was well above 1 after multiple quarters of book to bill being below 1.
Our distributor inventory at the end of September was already at low level and lowest in 15 years, except 1 quarter in fiscal year 2013. In December quarter, the distribution inventory went even lower. During December quarter, we saw increased level of customer requested pull ins many of which require factory expedites. Seeing these multiple signs of infection point, we called the December quarter to be a bottom for Microchip for this cycle barring any negative developments on the U. S.-China trade front or the impact of coronavirus.
Now I turn to guidance for March quarter. The backlog from March quarter that started out quite strong, continued to fill in during the month of January. Taking all these factors into consideration, And after rolling up revenue expectations from sales regions as well as business units, we expect GAAP net sales based on sell in revenue recognition for our products to be up between 2% to 9% sequentially in the March 2020 quarter. The midpoint of our guidance for the March 2020 quarter reflects what we believe our business can deliver assuming no extraordinary events. However, the wider than normal guidance range is to help account for the uncertainty associated with the evolving coronavirus situation.
We are still in the early days of how this situation is playing out. We have no way to model how the rest of the quarter will play out but we believe that our guidance range incorporates our best judgment for Regarding CapEx, we expect to finish fiscal year 2020 with a CapEx of between $76,000,000 $81,000,000, a significant reduction from fiscal year 2019 CapEx of $229,000,000. This is consistent with what we have said before that our CapEx is divided between growth capital maintenance capital and new products and technology capital in a fiscal year like 2020, in which our net sales declined, the growth capital, which is the largest portion of the CapEx, declines to virtually nothing. And therefore, the total CapEx declined significantly. For December quarter, it should be for March quarter.
For March quarter, we expect our non GAAP gross margin to be between 61.5% and 61.9% of sales. We expect non GAAP operating expenses to be between 25% 26.2% of sales, We expect non GAAP operating profit percentage to be between 35.3% and 36.9% of sales. And we expect our non GAAP earnings per share to be between $1.35 per share to $1.51 per share. Given all the complications of accounting for our acquisitions including amortization of intangibles, restructuring charges and inventory write up on acquisitions. Microchip will continue to provide guidance and track its results on non GAAP basis, except for net sales, which will be on a GAAP basis.
We believe that non GAAP results provide more meaningful comparison to prior quarters, and we request that the analysts continue to report their non GAAP estimates to first call. With this operator, will you please hold for questions?
Yes, sir. Due to time constraints, questions. You. And our first question will come from Craig Hettenbach with Morgan Stanley.
Yes, thank you. Steve, just a question on the expedite activity. Can you just maybe put that into context with currently kind of where your lead times are and things you're looking to do to maybe kind of address that as business improves?
So, you know, during this down cycle, we built a substantial amount of inventory that is held in the die bank. So when an order comes in, it's really taking the dive from the die bank and, processing it through which can be anywhere to as low as 3 weeks to as much as 6, 7 weeks, depending on where it to go inside or outside or what difficult package or assembly test it might be. What we are finding is that customers stationed a fair amount of backlog just outside the quarter. And then when they need the product, they expedite into the quarter. This way they kind of have both choices.
They could not take it in the quarter and leave it out or push it out further or if they need it, ask us to pull it in. We've been seeing this strange phenomena now, not only this quarter, we've been seeing it for some time, but it really became even more Essentuated. So there's a fair amount of backlog sitting outside the quarter in April and customers are expediting it into the quarter. Does that answer your question?
Yes, thank you.
Thank you. Our next question comes from Vivek Arya with Bank of America.
Thanks for taking my question. Steve, I'm curious what are you expecting, your to do in the March quarter. I think you're giving a net sales outlook. So any color on sell in and sell out trends would be helpful. And in general, What are they saying to you?
Why are they taking down microchip inventory to such low levels? Because it's such an outlier and we don't care of any of your other peers their inventories being taken down to similarly low levels?
Well, no, I don't really know if, as we speak, distributors are taking down inventory further, but they have in the last seven quarters or so through December. We don't really have a guidance for the March quarter on sell through. We We can't really provide both ends of the guidance. It's just too much work. So we're providing the sell in guidance that we have given you And in the December quarter, when we provided the guidance, we expected that distributors will reverse the and we'll start to build some inventory towards normalization.
It did not happen in December. We're expecting it would happen again in March, there's no guarantee distributors will do what they will do. I think part of the reason is for 30 years, our culture at Microchip business unit, sales organization up and down to the change with the distribution. Our conversations with the distributors are winning designs, creating a large funnel and pulling those designs to production and creating sales out. That's how we pay our salespeople.
That's how we payer business units. That's how all the bonuses are structured. And we don't really have, a whole lot of conversations regarding what we give into the distribution, that has often always been less important to us because we manage our business based on sell through. So distributors take the inventory, what they want to run their business and based on getting returns for their business. In contrast, I think we see many of our peers and competitors are more focused on selling revenue recognition, where they they may make deals to put more product into distribution and arresting the fall of the inventory that way.
I would add one more thing. We've always had, low lead times in our products. And I think that gives distributors opportunity to run the inventory to whatever the lowest level they think they can get away with while continuing to focus on sell through. So short lead times, give them the opportunity to carry less inventory as well.
I would also add that sometime, we charge charges for expediting the product. So sometime expedite charges require us to spend weekends, pay over time, or, pay expedites for shipping, you know, going through hand carry products and all sorts of charge in can incur and we often pass those to the customers. It doesn't move the needle in terms of revenue, but If somebody wants to expedite the parts, it's not always free.
But you're not assuming any restocking benefit, any major restocking benefit in March?
We have nowhere to model it.
Okay. Thank you.
Yeah.
Thank you. Our next question comes from Gary Mobley with Wells Fargo.
I want to ask about your relative performance in the microcontroller segment. It looks like for the full calendar year 2019, you outperformed the microcontroller market in terms of sales growth if you believe in the SAA sales metrics. But In the second half of the year, it looks like, in particular, in the 4th calendar quarter, it looks like you might have underperformed the market. To what should we attribute that to? Is it just sort of a short term disruption or anything to look into there long term?
You know, I'm not sure what data it is that you're referring to. So we were sequentially down 1.1% on microcontrollers September to December. If you look at the year over year numbers, we're on microcontrollers, we're down about 5, 5.5% somewhere in that neighborhood. The story is not written. We don't see any annualized numbers that are out, yet, maybe SIA has some early numbers.
We'll get that by March, April, and we'll, at the next, conference call, have the typical Gartner, you know, 2019 numbers nothing in our business that has any indication that something was better in the first half and got worse in the second half. I think if you look
at the quarter results sequentially and compared it to a very large competitor, I think we substantially outgrew them. So either on quarter or by year over year. Yes.
Understood. All right. Thank you guys.
Thank you. Our next question comes from Chris Caso with Raymond James.
A question with regard to gross margins and assuming we are have started recovery, we'd hope to see some gross margin improvement as a result. Perhaps you could answer it in terms of production utilization levels, with some of the better order rates, has that caused you to change any production levels? And then from a cost standpoint, as we go forward, I think you still have some integration benefits still to come. Could you help to quantify those and when they kick in? How that helps leverage, if indeed we're in a recovery?
Sure. This is Eric. So in the December quarter, we incurred about a $16,000,000 factory under utilization charge that was reflected in our cost of sales. That was up about $7,000,000 quarter on quarter. We expect that charge to be lower these higher.
Steve talked about in an earlier response that our die bank is pretty healthy. But back end operations, we've been training finished goods and looking to run the factories harder this quarter, which should help in the gross margin and the guidance that we're giving. So that's a piece of it. We continue to run our reasons efficiently as we can. We're continuing to invest to bring some of the outsourced assembly and test in house at a moderate rate and all those things are going to benefit gross margin long term and lead us to our long term guidance, which is to get to about 63% non GAAP gross margins as a long term model versus of 61.7% we're guiding to at the midpoint of guidance for the current quarter.
All right. Thank you. Our next question will come from William Stein with SunTrust Robinson Humphrey.
Great. Similar topic, only not just gross on operating as well. Maybe, Eric, you can take a step back and frame up relative to where you are now and contemplating your longer term goals. What's the path to getting there? Is it just a modest amount of revenue recovery?
Is mix part of the equation. Is there still restructuring for Microsemi? I know you're still bringing capacity in house. It seems to us that it seems fairly likely that you'll be able to exceed these long term targets given the revenue level that you're achieving today relative to what the next peak could be, for example? Thank you.
Okay. So I think I've kind of touched on gross margin so far and we been told by others that they think that's a conservative forecast, but we're not going to update that model until we get to the target. And on OpEx, we're guiding the current quarter to be between 25% 26.2% of sales and our long term models 22.5%. I would say we have been pretty conservative in how we've been managing the business, during this current cycle And with that, we need to make sure that we're making the appropriate investment, whether it's in R&D, support functions, technical sales, outreach to the customers to make sure we drive the long term health of the business and some of our variable compensation programs to will kick back in as revenue grows. So we have confidence in the long term model, which is just above 40% operating margins.
And we've got a ways to go when we're guiding the current quarter at the midpoint of guidance to about 36.1%. So I'd say be patient, we do need revenue growth to get there. But I think we're well positioned with the investments that we've made to drive to higher levels than what we're seeing
today. Thank you.
Our next question comes from Ambrish Srivatsik with BMO Financial Group.
Hi, thank you very much, Steve. I was wondering if you could give us a little bit more detail on the the source of strength in bookings, whether end markets or geos, I believe last earnings call, you had indicated that China was stronger in terms of geo. So any update on that front would be helpful. Thank you.
So I think from an end market perspective, we said that, data center has been strong all along and we are seeing a start of a recovery in the industrial market and the automotive market. The communication market remains weak and the appliance market remains weak. And Aerospace And Defense is going to always lumpy and it's hard to call. From a geographical perspective, yes, we We saw strength in the China market last quarter, but you would see the weakness in China market this quarter, driven by the Lunar New Year, and nobody knows what's going to happen with the coronavirus. So this quarter, you would see stronger U.
S. And Europe and weaker China.
Okay. Thank you.
Thank you. Our next question comes from Raja Gill with Needham And Company.
Yes, thank you. If we think about the in the business, now that we have some time, How do we think about it coming out of the bottom of the cycle? And kind of perhaps entering into mid cycle recovery, excluding the impact of the coronavirus, I'm just trying to get a
sense of the,
of the seasonality additions post the bottom of the cycle.
I think, I think, Rajiv, seasonality is still hard to measure where the all of the acquisitions that we have completed. The, the events that have happened in the last couple of years, the all the trade tension situation, general economic conditions. Now the coronavirus prior to that, we had a significant inventory correction event on, especially the microsemi inventory. We really haven't finished enough quarters healthy business environment to peg a seasonality. So I would think it still remains difficult.
Thank you. Our next question will come from Craig Ellis with B Riley FBR.
Yes, thanks for taking the question and congratulations on the good execution. I wanted to go back to some of the comments around the performance on debt reduction, which over the last six quarters at almost $2,000,000,000 is very strong. The question is perhaps both to you, Eric, and you Steve, as you look ahead and given the trajectory you're on, it seems like you could be at a 3x net debt to EBITDA level and as soon as four quarters or so. So how do you think about deploying the cash to create value for shareholders when you get to that level would a vast majority of available cash? So go to debt pay down or would you start looking at other things and what would the priorities be at that point?
Thank you.
Let me let me take that and Eric can add to First of all, I don't think I have looked at a model, which will take the leverage down to 3x in four quarters. That seems awfully aggressive, although I don't know what assumption you're making in the revenue growth of the recovery will largely depend on that. But basically, yes, we need to bring the debt leverage below a 3 handle kind of have it somewhere in the high 2s. Once we get there, then we'll still be generating somewhere of the order of well over $1,000,000,000 of free cash per quarter. And we need to figure out what we do.
I mean, we haven't been in that situation in a quite a long time. You have obvious choices you could pay down more debt and bring leverage down further. But more preferably, you could increase the dividend. You can start a buyback program. And that all assuming that there is not a further M and A possibility we have said before that we think, things that we would like to buy probably would have been bought.
And there isn't as much more opportunity there. But there could be one more possibly. But secondly, we think that, the remaining asset very expensive. There is a large amount of M and A bid on them already because every small company is really on sale. And we don't really pay that kind of multiple that we have seen paid in the recent deals.
Cyprus, as well as some of the deals, those, those multiples were way way too high for our case. So if we cannot find a reasonable other acquisition, then our focus will switch to other uses of cash, including higher dividend, more stock buyback and possibly some more debt paydown.
I think what I'm going to add to that is kind of a short term view here as well, because I know I'll get that we'll get this question a lot is, what do we expect for that pay down in the current quarter, the March quarter? And really, we expect that to be somewhere between $225,000,000 $250,000,000. Your last quarter was $257,000,000, but our starting accounts receivable balance is lower just because revenue was down last quarter. So really to get some tailwinds behind us from a revenue perspective as the top line grows, I think, you know, EBITDA, EBITDA will start growing nicely. And that's going to help with the leverage metrics coming down, but kind of depends on what the environment is going to be over the course of the next year.
If we were able to get to that three times number that you mentioned, we as you'd need some pretty good revenue growth.
And our next question comes from Chris Danley with Citi. Hey, thanks,
Steve. Steve, you mentioned that some customers were expediting orders out of the June quarter into this quarter. So do you think that the the June quarter could be at risk of a little bit of a disappointment, like we're robbing from the June quarter to pay the March quarter. And then further to that. You talked a little bit about lead times.
Do you think that there is risk of extended lead times as this expediting continues?
The lead times are not at risk short term because we have fair amount of dye inventory and there's a fair amount of capacity slack in the system since the revenues are down year over year. The the backlog bottomed out some time ago and the total extended backlog, is really growing nicely. So when When people are taking backlog from June quarter moving into March quarter, that's not putting June quarter at risk.
There is a higher and higher backlog. The overall backlog is growing. Book to bill was strongly positive, so it put a very large amount of total backlog on the system. Chris, we had expedites in the December quarter where people had placed backlog in the March quarter and pulled it in. You're seeing a stronger March quarter despite that.
So as you go into an upward trend in the business, it is not unnatural. We've seen it in other cycles where customers start to see their business recovering and wanting to have products sooner than they had originally planned for.
Yes. In addition to those orders that are being pulled in by customers requesting them into the current quarter. We're also receiving orders that are just within our normal our normal published lead times and that can create some expedite activity also.
Often with short lead times.
And Chris, this phenomena is not a new one. We have seen it before in prior cycles, and we've been seeing it in this cycle. It's I kind of call it, have your cake and eat it too. You know, so customers will place an order where they are still in the cancellation of push out window. And if they don't want it, if their business is not strong, they can push it out or leave it out.
But if their business is stronger than they need it, then they ask us to expedite it, kind of have their cake and eat it too. It's not a new phenomenon, but we are seeing it, quite accentuated right now, and that's why I called it out.
Okay. Thanks a lot guys.
Thank you. Our next question comes from Harsh Kumar with Piper Sandler.
Yes. Hey, Steve. I was curious with the sudden pickup in China. Are you aware of any areas shortages, not just in your business, but in the industry overall?
I'm not seeing any shortage I mean, China right now is shut down, so you really wouldn't get any data. They were shut down for the Chinese New Year. They're just about coming back. But most provinces have extended it February 9th. But prior to going for the Chinese New Year, no, I we were not experiencing any shortages.
Fair enough. Thanks guys.
Thank
you. Our next question comes from Christopher Rolland with Susquehanna International Group.
Thanks for the question. Eric, perhaps asked another way. If you could talk about Atmel and Microsemi bringing them in house, remind us kind of where we are on front end and back end. And then also the gross margin benefits that you would get there, also how you're able to do this in such a small CapEx on up as well? Thanks.
Criteria in terms of making those capital investments over the course of the last year when business was difficult So we short in the window, the payback window from a cash flow perspective, from 2 years down to a year. And we really haven't changed that at the point in time. So that's one of the reasons it's been lower. And this is very detailed work. So it's package by package, part by part, And none of these investments are needle movers, but in aggregate, they do help gross margins slowly over time.
So, I think that's responsive to your question unless these guys have anything else I'd like to add?
We can give them the
percentage we have inside and outside for fab assembly and fabs.
Yes. So fab is 39% internal. Assembly is 45% and test is 54%.
That's useful. Thank you.
And we would expect those assembly and test percentages to increase over time as we gradually make these investments.
Thank you. Our next question will come from Harlan Sur with JP Morgan.
Good afternoon, guys. Thanks for taking my question and congrats on the strong start to 2020. I know lead times are still pretty short, but given the strong bookings trends coming off of the depressed September quarter, strong bookings thus far here in the March quarter. And maybe some backlog build for June, exiting out the potential issues for coronavirus, but do you think you're setting up given the backlog that you're seeing at least for a seasonal June quarter, which is typically one of your seasonally strongest quarters?
Well, we are not giving guidance or commenting on the June quarter. Especially, especially in the light of, significant uncertainty because of the coronavirus. Remove those uncertainties and let's say there's no impact and business comes back and the virus is contained rapidly, all that, then your assessment for the June quarter would be correct.
Yes. And I think I would just add, we are very well positioned from a capacity perspective to be able to respond quickly to upside if that develops.
Got it. And then I guess on that note, back in early January when you did your update. It didn't sound like you were going to be increasing front end utilizations near term just because you guys have pretty substantial die banks. But let's say as the March quarter progresses and the backlog is indicating the potential for normal seasonal growth for June September. I assume the team would start to ramp capacity utilization say in the back half of this quarter, is that kind of the right way to think about the potential timing of utilizations going up?
This is Steve. Let me take that. I think, let's start from the back end first and we'll come to the front end. The back utilization is going up as we speak. And as we ramp, it will continue to go up because we depleted the finished goods And when the orders are strong, we got to take the Dibank and finish them.
So that will continue to have a positive effect on gross margin. Pretty much starting now. When you look at the front end, the front end still has a fair amount of die bank, but then also you got separated, on the production we do inside versus the production we buy from outside. The inventory on the products we buy from outside was depleted to a lower level. And there, we are increasing the buy as we speak.
But there's not a utilization impact of that because that was being done outside. What we were doing inside, that's where we have the substantial die bank. And I think it will, you know, at least take it, you know, few more quarters before we have start increasing the production and FX.
Got it. Okay. But then the lowering of the the underutilization charges, here in the March quarter is simply because you are filling out your your packaging and test assembly utilizations are going up, right? Is that the primary driver for the lower underutilization charges?
Yes. Well, there's always lots of moving parts mix and all that. But yes, that is a new phenomena where even in the December quarter, we were depleting finished goods. You know, we were a quarter back end utilization was lower than the September quarter, and the March quarter will be up significantly from the December quarter. I wanted to add one more comment on the question you asked regarding the June quarter seasonality, how it would be?
And and the comment was made, the June quarter will at least be seasonal. I would say I hope that one of these quarters, current quarter as well as June quarter September quarter are well above seasonal because the inventories are so low And if I take, any cues from any prior recoveries, whether it was from SARs or was a recovery from 2009 side or any of the cycle recovery, usually you got 2 or 3 quarters of well above seasonal recovery that takes a business back to the old heights and then goes from there. So I like to think that any kind of forecast here becomes very conservative.
All right. Thank you. Our next question will come from B. J. Rakesh with Mizuh Securities.
Just wondering as you look at, your business, I was wondering if you can give us some color by markets, end markets, automotive, industrial, how you see that playing out to the rest of the year? Thanks.
Mentioned, we're starting to see automotive and industrial picking up from the bottom that they were at. They had pretty bad years in 2019. And our expectation is that barring any outside events as we go through 2020, both those end markets should see continued improvement.
Got it. And on the industrial and other end markets, do you see a similar trend into the back half, or do you see stronger first half year or?
So my comment was for both Automotive And Industrial. We've talked about data center. It was strong. It remains strong. We don't see anything that suggests it's different.
There may be some communication market changes that are driven by what happens with coronavirus. We don't know, but there is a large 5G cycle investment cycle that's starting And then as far as defense and aerospace tends to be pretty, you know, steady in how it goes, It remains steady with where it's at. And then the consumer cycle, we have yet to see if we'll see some benefits It needs further trade resolution for it to see any significant benefits, but nothing new to report on that on the consumer end of the market.
All right. Great. Thanks.
All right. Thank you. Our last question will come from John Fitzer with Credit Suisse Group.
Yes, guys. Thanks for letting me get in. I've been jumping around calls. So I apologize if this is a repeat. But, Steve, if you kind of look at the operating model for the business, historically, you guys have always made good progress and then kind of taking a step back as you've made acquisitions to then kind of forward again.
I'm just kind of curious if we go to an extended period where you're not sort of in the acquisition game, how should we be thinking about operating margin targets and incremental gross and op margins for the business over time.
So, John, you're very correct that we make a substantial progress in gross and operating margin after an acquisition. And then when we do another acquisition, most times we're not buying businesses that are over 60% gross margin and 40% operating margins. So our overall company margin, gross and operating drop, and then we work back up steps only to take a fall again when we buy the next acquisition. Now if you make the assumption that for an extended period of time, we were to not do another acquisition. Then first thing that would happen is that we will reach our operating model.
So our operating model to remind everyone is 63% gross margin and 22.5% operating expenses leading to a 40.5 percent operating profit. So two ends of it, first, the gross margin, we're guiding 61.7 percent gross margin this quarter. So it's 130 basis points away. If you just take the under utilization charge of 16,000,000, that pretty much gets you there, you know, almost. The second issue is the, is the operating expense.
So operating expense, you know, basically, we're guiding 25 to 26.2 And there's a huge leverage there with the revenue increase. The current revenue is, I think, what, a couple of $100,000,000 behind that past record.
That's right.
In a very round number. So once you gain that, you have a significant leverage where the operating expense comes down. Some leverage still remains in, integration of Microsemi but all these go lives and all that that are happening, which will take another 9 months. But once we get all that done, then you have achieved gross margin as well as the operating expense and you have reached the model. Now if your question is, where does the model go?
Do we continue to go higher in gross margin and continue to go higher in operating margin? For that, get in line and we'll talk about it when we get there.
That's helpful. And then just secondly on Microsemi, with an acquisition you kind of made as the industry was going into a correction and you're talking a little bit about kind of the expense leverage there. I'm just kind of curious from a revenue leverage. I mean, one of the things you guys have always done well as you bought these assets is going kind of apply a better pricing discipline to the business. Is there still more to go with the Microsemi acquisition or has that mostly played out?
First of all, I don't think we had the same pricing discipline issues in Microsemi as we did at Atmel. Microsemi, just to remind you, was gross margins that were right around 60% when we, did the acquisition. The product lines at Microsemi are extremely sticky products, and many of them have very long life cycles. And to that extent, those margins will stay high. The product line revenues will stay high.
Now we have in the time we have owned Microsemi started to work on. So how are we going to take advantage of Microsemi's position in the end markets they were strong in, data center communications and airspace and defense? To be able to sell a more complete portfolio. And that worked as well underway and reverse. How can we take Microsemi products into the end market that Microchip was strong in prior to the acquisition, automotive, industrial and home appliances.
And that work is going in. Now we have a 6, 7 quarter window where the environment has been weak And as we as we emerge from a weak environment and we go into a more normal environment, all the hard work that has been done will begin to play itself out. And so I think there are revenue synergies yet to come. But in part, it's work to be done and a lot of that is underway and has been for some time. A lot of it has to come as the environment strengthens.
And John, I think if you, study some of the path cycles, and I know you and other analysts are very good at setting the past analyst, past cycles, What really happens is, nobody believes the depth of the downturn. And the estimates always a high and they get cut multiple times. In this cycle, the estimates probably have been cut four times, not only for Microchip, but for the industry, and various other players could be more than four times. And then when the reverse happens, the estimates always go higher, beaten rates, beaten rates, beaten is for many quarters. I have seen this in prior cycle because nobody has the confidence to, to guess revenue or guide the revenue to be higher than seasonal, and it continues for many quarters in the other direction.
That's what I'm hoping for. But not guiding to.
Turn the call back over to Mr. Steve Sanghi for any closing remarks.
Well, we want to thank everyone for attending this call and We're going to about 3 different conferences, I think, this quarter. So we'll see some of you at those conferences. Thank you.
Thank you, ladies and gentlemen. This concludes today's teleconference and you may now disconnect. Please enjoy the rest of your evening.