Good day, everyone, and welcome to this Microchip Second Quarter Call. As a reminder, today's call is being recorded. At this time, I would like to turn the conference over to Microchip's Chief Financial Officer, Mr. Eric Bjorn Holt. Please go ahead, sir.
Thank you, and good afternoon, everyone. During the course of this conference call, we will be making projections and other forward looking statements regarding future events or the future financial performance of the company. We wish to caution you that such statements are predictions and that actual events or results may differ materially. We refer you 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 Sange, Microchip's Chairman and CEO and Ganesh Moorthy, Microchip's President and COO.
I will comment on our second quarter fiscal year 2020 financial performance and Steve Ganesh will then give their comments on the results. Discuss the current business environment as well as our guidance and provide an update on the ongoing integration activities associated with the Microsemi acquisition. Will then be available to respond to specific investor and analyst questions. We are including information in our press release and this conference call on various GAAP and non GAAP measures. We have posted a www.microchip.com, which we believe you will find useful when comparing our GAAP and non GAAP results, We've also posted a summary of our outstanding debt and our leverage metrics on our website.
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 was deferred until the product was sold by our distributor to an end customer. As discussed in previous earnings conference calls, we continue to track and measure our performance internally based on direct revenue plus distribution sell through activity, and each quarter 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 distribution sell in, We will also provide investors with our end market demand based on distribution sellout, but will not provide a P and L based on end market demand. End market demand in the September 2019 quarter was $1,346,000,000. End market demand was about $8,600,000 more our GAAP revenue in the quarter.
I will now go through some of the operating results, including net sales, gross margin and operating expenses. I 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 September quarter were were $1,338,000,000, which was up 1.15 percent sequentially and modestly below the midpoint of our guidance of $1,349,000,000. We have posted a summary of On a non GAAP basis, gross margins were near all time highs at 62.24%. Operating expenses were at 25.56% and operating income was 36.7 percent.
Non GAAP net income was 365,700,000 Non GAAP earnings 1.9% and included the impact of $5,200,000 of share based compensation. Total operating expenses were $643,900,000 and include acquisition and tangible amortization of $248,200,000, special charges of $3,600,000 10,100,000 of acquisition related and other costs and share based compensation of 40,100,000 The GAAP net income was $108,900,000 or $0.43 per diluted share. Our September quarter GAAP tax benefit included $12,700,000 of net discrete income tax benefits related to tax reserve releases due to statute of limitation expiring, partially in the September quarter and was negatively impacted by a foreign tax assessment that Microchip will pay in fiscal year 2020, but defend its position and seek a refund of these taxes in the future. We expect our non GAAP cash to be between 6% 7%. Exclusive of the transition tax, any potential tax associated with restructuring the Microsemi operations into the Microchipable tax structure, any tax audit settlements related to taxes accrued in prior fiscal years.
We have many tax attributes in net operating losses and tax credits as well as U. S. Interest deductions that we believe will keep our cash expected to be about $236,000,000 and will be paid over the next 6 years. We have posted a schedule of our projected transition tax payments on the Investor Relations page of our website. Our inventory balance at September 30, 2019 was 7 $34,200,000.
We had 131 days of inventory at the end of the September quarter, down one day from the prior quarter's level. Inventory at our distributors in the September 15 years, which was Q3 of fiscal year 2013, where our days of inventory at distribution have been lower than the current levels. The cash flow from operating activities was $396,000,000 in the September quarter. As of September 30 consolidated cash and total $500,000 of total debt in the September quarter, and the net debt on the balance sheet was reduced by $283,500,000. Over the last full five quarters since we closed the Microsemi acquisition and incurred over $8,000,000,000 in debt to do so, We have paid down $1,729,000,000 of the debt and continue to allocate substantially all of our excess cash 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 is a testimony to the cash generation capabilities of our business. We expect our debt levels in the September quarter was $540,200,000 and our trailing 12 month adjusted EBITDA was $2,178,000,000. Our net debt to adjusted EBITDA, excluding our very long dated convertible debt that matures in 2037 and is more equity like in nature, was 4.59 at September 30, 2019. Our dividend payment in the September quarter was $87,300,000. Capital expenditures were $17,700,000 in the September quarter.
We expect between $20,000,000 $25,000,000 in capital spending in the December quarter and overall capital expenditures for fiscal 2020 to be between $90,000,000 $100,000,000 as a capabilities of our We expect these manufacturing activities that we are bringing into our own factories. Depreciation expense in the September quarter was $39,500,000. Will now turn it over to Ganesh to give his comments on the performance of the business in the September quarter and provide an update on some of our ongoing microsemi integration activities. 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 demand, which is how Microchip measures its performance internally. Also, as I go through the product line reports, they will reflect continued broad macro weakness in the markets we serve. This broad weakness was further accentuated in the month of September. Let's start by taking a closer look at microcontrollers.
Our microcontroller business was sequentially down 1.3% as compared to the June quarter. We continue to introduce a steady stream of innovative new microcontrollers, including the industry's first commercially available serial memory solid state drive controller, which won the best of show award in the 2019 Flash Memory Summit. As well as 2 different USB Type C power delivery controllers, which enable fast device charging and simplifies implementation of this functionality. Microcontrollers represented 53.3 percent of our end market demand in the September quarter. Now moving to Analog, our Analog business was sequentially up 0.2% as compared to the June quarter.
During the quarter, we continued to introduce a steady stream of innovative analog products, including the introduction of the trust platform for crypto authentication the industry's first pre provision solution providing secure key storage for small and large volumes. Analog represented 28.7 percent of our end market demand in the September quarter. Our FPGA business was sequentially down 8.9% as compared to the June quarter. As we have mentioned in prior conference calls, the FPGA business does have some lumpiness because of a significant exposure to space, aviation and defense markets, where procurement timing can be a function of programs and their shifting priorities schedules and budgets. During the quarter, we announced our smart embedded vision initiative, providing for designing intelligent machine vision systems, with our low power Polarfire FPGAs.
Design Wins for the PolarFire family continue to grow strongly we remain optimistic about the prospects for this product family. FPGA represented 6.8% of our end market demand in the September quarter. Our licensing memory and other product line, which we refer to as LMO, was sequentially up 10.5% in the September quarter as compared to the June quarter. Strength in our licensing business as well as our timing systems business outpaced the broader macro weakness we experienced. LMO represented 11.2% of our end market demand in the September quarter.
In September, we completed the acquisition of 2 small early stage private companies. Embedded computing solutions for machine learning inference and smart embedded vision applications for our FPGA product families. This acquisition also adds domain knowledge depth in the areas of machine learning algorithms and vector processing. The second acquisition provides digital gate driver solutions for wideband, GAP, MOSFET and IGBT Technologies. The acquisition complements our silicon carbide discrete and modular power conversion offerings and enables us to provide more comprehensive total system solutions.
These two acquisitions were very small and more akin to acquiring intellectual property along with domain experts to help us accelerate our business and hence not material to the rate at which we're paying down our debt. Finally, a quick update about the ongoing Microsemi integration. We continue to plow forward with the business systems and operations integrations. On the business systems front, we went live with a few more systems on November 1, And as I've mentioned on prior conference calls, this is a tedious and time consuming effort, and we estimate that we're about 50% of the way to completion, and have about another year of work ahead of us. We are pleased with the synergies we have achieved since we closed the transaction despite the weaker macro environment, and we expect continued synergy gains for many quarters to come.
Let me now pass it to Steve for his 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 second quarter of 2020, I will then provide guidance for the fiscal third quarter of 2020. Our September quarter GAAP net sales based on sell in revenue recognition was $1,338,000,000, up 1.15% sequentially versus a guidance of flat to up 4%. So we missed the gap sales guidance slightly at the midpoint. Our end market demand based on sell through was $8,600,000 higher than GAAP sales, which we believe shows that the channel is continuing to manage their working capital conservatively by reducing inventory due to uncertainty.
Recall that we call the bottom of this cycle back in February of 2019, contingent on resolution of the U. S.-China trade dispute. This trade settlement did not happen and remains unresolved Since then, our end market and $1,346,000,000 for March, June September quarters, respectively, due to multitude of headwinds from trade tensions and resulting impact on automotive, industrial and consumer clients and markets. Our consolidated non GAAP gross margin of 62.24 percent was just above the high end of our guidance and was near a record high. Our consolidated non GAAP operating san.
The integration of Microsemi continues to proceed very nicely since the closing of the acquisition we are continuing to see strong synergies and improvements in gross and operating margins for Microsemi products. Our consolidated non GAAP earnings per share was $1.43 right at the midpoint of our guidance. On non GAAP basis, this was also our 116th consecutive profitable quarter. In the September quarter, We paid down $315,500,000 of our debt. Our total debt payment since the end of June 2018 has been 1.73 by the weak and uncertain business conditions as we continue to squeeze working capital.
Now, before I provide you guidance for the December quarter, let me comment on geographical and end market sales. While the uncertainty began with U. S.-China trade friction, the uncertainty has become global. The weak business conditions can be seen in all geographies. Our Americas business in September quarter based on end market demand was down 6.1% over the year ago quarter.
Europe was down 12.9% and Asia was down 12.6%. We did experience our business being weaker in September than we had expected in the month of September. This weakness was also reflected inventory exiting the September quarter. From an end market standpoint, industrial automotive and consumer appliances end markets are down significantly. Aerospace And Defense And Communication markets have been flattish.
And data center market has been strong. The uncertainty in all geographies is continuing, In this environment, direct customers and especially the distributors are continuing to manage their working capital by reducing inventory. However, there are some signs of inflection point 2. In the September quarter, distributor inventory was down to 29.6 days, we have had only 1 quarter in the past 15 years, which was the third quarter of fiscal year 'thirteen, where our days of inventory at distribution have been lower than the current levels. Secondly, bookings for the month of October were the highest booking achieved since June of 2018.
While the backlog for December quarter is much lower than the backlog for September quarter, at the same point where the backlog and shipments end up is a guessing game, especially with the holidays coming Our judgment is that the net sales based on selling revenue recognition will take another leg down this quarter. But with several indicators showing inflection point, we may see the forming of a bottom here, even though we saw a false bottom, back in the March of this year when trade dispute was not resolved. We expect GAAP net sales based on sell in revenue recognition for our products to be between minus 2% to minus 10% sequentially in the December quarter. Due to this sharp reduction in GAAP sales at the midpoint of the guidance, we are taking steps to reduce our manufacturing capacity capital expenditures as well as expenses. We are planning to reduce the clean room footprint in our Colorado 6 inches fab that we acquired with Atmel acquisition.
At 6 inches wafer size, the fab is no longer competitive with our other high volume 8 inches fabs. Therefore, we will be turning this 6 inches fab into a discrete and specialty fab doing silicon carbide, field effect transistors, fetch transistors, MEMS, and other discrete devices. We will be transferring high volume atmel products from the 6 inches Colorado fab to our 8 inches fabs in Arizona and Oregon. This transfer will take about 12 months to complete, largely because we brought up the highest volume In addition, we will be transferring some of the discrete products from Microsemi 4 inches fabs to the 6 inches fab in Colorado, These actions will create about $65,000,000 in cost of goods savings per year when completed The 1st phase of this transfer will take about 1 year to complete and will achieve about 2 third of the savings. The balance of the transfers have a long tail and will take another 2 years after the 1st phase.
Regarding capital expenditures, we are reducing our CapEx for fiscal year 2020 to be between $90,000,000 $100,000,000 for the year, a reduction of $25,000,000 from our guidance on CapEx last quarter. Regarding the reduction of OpEx, we're doing 3 things. Some of those are continuation of what we have been doing. First, we are approving new and replacement acquisitions very sparingly. 2nd, we will be managing discretionary spending very tightly And third, our bonus program will yield a lower payout for the reduction in net sales.
For December quarter, we expect our non GAAP gross margin to be between 61% to 61% of sales gross margin to be between 61% 61.4% of sales. We expect non GAAP operating expenses to be between 26.2 percent 28 percent of sales. We expect non GAAP operating profit to be between 33 percent 35.2 percent of sales, and we expect our non GAAP earnings per share to be between $1.12 per share to $1.32 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 poll for questions?
You. All right. We'll take our first question from Chris Caso from Raymond James. Please go ahead.
Yes, thank you. Good evening. I guess the first question, Steve, is the expectations for, selling versus sell through in the December quarter? You've already said that the distribution channel inventory is at a record low. So is this guidance for December suggesting that in demand is actually declining in December.
Could you explain the difference there?
The, the end demand, is declining. There has been There has been some destruction of end demand in various end markets. Automotive, clearly, where the number of units built in automotive were much lower in U. S, Europe and China. The industrial market and demand has been weaker because of all the impact of tariffs and increased cost.
And similar thing we're seeing in the home appliances market, So yes, the end demand is weaker and, sell in, we're guiding down. We do not know what the what the net distribution inventory will be in terms of increasing or decreasing, whether end market demand will be higher than GAAP sales or lower slightly we think that they could be roughly in the same range and could go either way.
Right. Okay. As a follow-up then, maybe you can reconcile that with your comments of the potential of this inflection point. I guess what I understand you're saying is the opening backlog coming into the quarter was lower, but you're seeing stronger fill as you go through the quarter. How are you reconciling that better order fill with the prospect of end demand perhaps a bit weaker?
So how we are reconciling it is the starting backlog in the quarter was significantly more weaker than the minus 6% guidance at the midpoint, significantly weaker. So some of that fair amount of that has closed in the last 5 weeks because the curve of backlog fill is much steeper. And we're expecting that, that kind of curve will continue and we'll end up really close to the guidance we're providing, but where we end up would still be lower than the last quarter. It will require significantly more steeper curve to be even with the last quarter. So we are expecting improvement because of steeper curve, but it doesn't get us to a flat compared to last quarter.
Yes. And it probably is worth repeating what Steve has already said that our October 2019 bookings were the strongest month of bookings we've seen since June 2018.
Right.
All right. Thank you.
There are currently a lot of mixed messages. Weaker backlog, but some inflection points. And she leaves her very hard to read in this environment. We We said back in February that could be bottom, but it was very much tied to the trade settlement. We didn't get it.
So at this time, we're just just being cautious and giving you all the puts and takes.
Thank you. Next we'll go with Gary Mobley from Wells Fargo Securities. Please go ahead.
Hey guys, thanks for taking my question.
You mentioned that, sort of the retooling of your Colorado facility could bring on maybe a 50 basis point positive impact to gross margin long term. The near term looks like we're contemplating 100 basis point sequential decrease. How much of that degradation in the gross margin near term is due to underutilization and how much is due to mix?
So I can address that and see we're going to ask and add on to it. So this quarter we just completed, we had underutilization charge of about $8,900,000. That charge will be higher in the December quarter. So that is having an impact on gross margins that we're seeing on sequential basis. There's always things like product mix that factor into it also.
And then with demand down, you know, it's likely that we'll have some accounting charges related to obsolescence doesn't mean that the product isn't good anymore, but we'll have some obsolescence charges that will also impact the gross margins that we produced this quarter.
Okay. And just I know it's very, very early to call, but Could you give us some sense of seasonal trends in the March quarter based on past history and perhaps how you're feeling about the linearity of your bookings as we sit here today?
Well, seasonality is the hardest one to talk about. Because of various acquisitions that we have completed, you know, prior to the Microsemi acquisition, for example, our end market mix was dominated by industrial, automotive and consumer appliances. With the addition of Microsemi now, we have added 3 other significant end markets aerospace And Defense, Data Center And Communication, where we had very little exposure. And the last year, year or 5 quarters since we have had Microsemi, the environment hasn't been normal. First, a significant inventory correction in the last June September of last year.
And then subsequently fighting through the U. S.-China trade sanctions and all the other issues. So we haven't really seen a combined company normal environment for a year or longer to be able to figure out what the seasonality with the current mix is. So I think that would be my answer that we at the minus 6% at the midpoint, clearly, that is below seasonal. We're not defending that it is seasonal.
Prior to any of this acquisition, I think seasonality for December quarter used to be about minus 3 if I remember. We don't know what it is today.
All right. Thank you guys.
Thank you. We'll next go with Vivek Arya from the Bank of America.
Thanks for taking my question. Steve, I was hoping you could help us understand the chronology here because back in August, you gave some guidance. Then in September, you kind of confirmed the midpoint of that guidance. And at that time, the hope was that September would be a normal month. And since then, the results are about 11 ish million somewhat below.
So not bad, but somewhat below. And since that time, we have just heard such a wide range of views from peers, one of your peers was very weak, but then most others have kind of been in line. And now, you were saying that October bookings are very strong, but backlog is very weak. I think investors are just horribly confused as to what's really going on. What is driving such a weak backlog and what now driving the subside, what is causing all this?
Well, we work in terms of confusion join the party. I mean, this has been a very, very confusing environment. On, on one hand, there have been fits and starts on the trade front. And the 3 largest of our markets, which are industrial automotive and similar appliances are heavily hit with large amount of tariffs. And therefore, there has been a lot of demand destruction And anytime you make any kind of guess with some resolution of the trade dispute, it really hasn't happened.
And then you have had multitude of other issues with ZTE about a year ago, then Huawei, you can ship it, not ship it, then heck IQVision and many other customers added. So there has been a lot of confusion. And every company I think if you look at the number year over year, you would see that our performance year over year is pretty reasonable. But quarter over quarter, It just depends on when somebody went into inventory correction, how long the inventory correction lasted, we measured our September performance to the September performance of last year However, September last year, we were still reporting numbers based on sell through revenue recognition as a non GAAP. If you compare the numbers GAAP to GAAP September quarter to September quarter, we were actually up because last September quarter, there was a substantial reduction in distribution inventory.
I don't know if it's exactly correct.
Yeah. No, we were not up, but the, we had about an $80,000,000 reduction last September in, distribution inventory in that quarter.
Yes. So if you compare to that, the numbers get very confusing. So in parallel, With all these other confusions, last year, we also went through change of revenue recognition. So I would say simply lay out the numbers for various companies and you will find that our year over year performance is better than the other large competitor you talked about.
Vivek, in terms of the chronology, the other thing to keep in mind is, if you remember, I think it was an early August there were additional tariffs that were announced and were going to be taking place at various points in time. I think that creates more uncertainty in the market. And I think what happened was September ended up being a lot weaker as people were trying to sort out. Customers are trying to sort out what are they going to do? And that was reflected in distribution inventory going down, the overall results being less than what we had expected at the midpoint.
Then beginning to reverse as we go into October, and then reflected in the guidance you're seeing today.
Got it. And for my follow-up, Steve, how much do you think distributors will be willing to take down inventory that you mentioned. This is the lowest that you have seen in the last, I think 15 years or so, that you mentioned, so definitely far below historical trends What are you hearing from them? I I understand the uncertainty. But at some point, do you think you see the benefits of perhaps, say, a TI retrenching from the distribution channel, or is it too early, to give a sense for what does a normalize distribution level look for you?
I think the, you know, the macro trends, in the demand destruction by the tariffs and all these confusion created are much larger impacts than the other secular trends of impact of another competitors in distribution and distribution, putting more focus on us. Those things happen over 2, 3 years. And the effect of trade friction and all that is really much more immediate and much more severe So we've been telling you now for a few quarters that the distribution inventory went down the sell through in several quarters now, I would say at least five quarters have been better than sell in and well would think with distribution inventory now, lowest in 15 years, except 1 strange quarter in fiscal year 'thirteen, it wouldn't go down further, but we don't we can't be sure of it. Distributors don't have confidence. They are seeing the same issues we are seeing.
Weakness in industrial market and automotive market and consumer appliance market, aerospace and defense and communications are kind of flattish. If distributors can manage their business by even lower inventories, they probably would.
They're going to leverage our generally short lead times to their to their advantage.
Despite the reporting GAAP numbers based on selling, you're very well aware of our stands. We manage our business to sell through and we do not request any distributor to take any kind of inventory, to stock the shelves. So we are focused on sell through and sell through is weak. And therefore, the selling is weak.
All right. Thanks for the color.
Thank you. We'll take our next question from Harsh Kumar from the Piper Jaffray. Please go ahead.
Yes. Hey, thanks. Thanks, Steve, for all the color so far. I'm trying to square some of your comments. So you're taking some steps on OpEx and CapEx, but October suggests from your commentary, some sort of an inflection point upward.
So should we just read and do it as, okay, maybe we're not going to go down from the current guidance that you gave for December, that's sort of the new base should we look at and you're just adjusting your business to kind of I guess, be more profitable, more cash flow and just optimize it a little bit, or is there something else I can read into it?
Well, I think, I think what I'm reading into it is that we started the December quarter with much lower backlog on October 1st than it was on July 1st. And if that had continued in the last 5 weeks, the guidance would be double digit negative, but we have made up significant gap by the fill being much stronger. And if that strength of that field continues, Then the results could be reasonably good. But there are also holidays coming, short month in November, short month of December, Europe, shuts off in the middle of December. So by all those puts and takes, our guess is that the December quarter still ends up about 6% lower than September quarter.
And that minus 6% is a huge makeup from how low the backlog was on October 1. And then with the strength of the bookings, October was strong bookings. November so far, it looks like good strong bookings. If the bookings continue, then hopefully, the January 1 backlog for the March quarter could be better than what we experienced as a backlog on October 1. And with continued strength of bookings, hopefully, we have some sort of recovery.
But I'm not really giving any guidance for March yet.
Understood. Thanks for the color, Steve. And I think earlier, you mentioned that the classic Microchip, as you call your core business from some acquisition to go. Typically down about 3% in December. Do you think some of that and maybe the Chinese New Year stacked kind of closer to Christmas this time has some effect on some small portion of your consumer business.
You think part of that's going on perhaps impacting September and then coming back up in October?
I think, earlier gentleman asked that we gave guidance in early September that we reconfirmed our midpoint of our guidance. So kind of what happened, Ganesh mentioned, and I mentioned also the month of September was quite weak. We could then be expected causing us to missed the sales by about $10,000,000 to $11,000,000. The month of October was much stronger and November is continuing much stronger. So could it be because of some sort of light at the end of the tunnel on 1st phase of settlement with China could be the inventory has gone low enough.
There are all these puts and takes and we really have put them all on the table. The good points, bad points. And then we give you a judgment and you could make your own judgment or agree or disagree with ours. But that's where it is. Numbers are very hard to call in this uncertain environment.
Thank you. We'll be taking next Sean Harrison from Longbow Research. Please go ahead.
I guess my first would be, is there any way to quantify, I know you've talked about it a lot so far, just how much September disappointed in terms of the backlog or actual sales, would you have been tracking toward the higher end of guidance otherwise?
No. I mean, we when we, reconfirm the guidance, we were essentially tracking towards the midpoint. And September was weak causing us to miss by $11,000,000. Am I correct? Yeah.
And that's the amount that we should consider what the shortfall was also in kind of general backlog as well?
No, the backlog was much, much weaker.
Remember, backlog crosses over into the December quarter and look exceeding quarters as well.
You know, earlier, I mentioned that the backlog started On October 1, the backlog was down in double digits compared to July 1. And if you're giving minus 6% guidance now, even a 4% change would be $52,000,000, right, on a revenue number, and the backlog on October 1 started much worse than minus 10, significantly worse than minus 10. So we have made up a huge amount of gap with significantly steeper slope.
That's very helpful. And just as a follow-up.
Put a ruler on the slope and get to a number and tell you that's the number. Unfortunately, we have seen that when the backlog starts so low, can be a steeper slope, but then the slope can change. And you could end early in the middle of December and not fill during the holidays. So you got to account for all that. And that's why I've been keep I keep stressing that there are lots of puts and takes and putting them all into consideration.
We're giving you a guidance that we believe is where we're headed.
It's very helpful. Stephen, if I may have follow-up, just the incremental weakness you saw in the backlog, was it more on the analog side of the portfolio or the microcontroller side?
It was largely pretty much across the board.
Yes, there's no product specific backlog that was weaker than the other.
Understood. Thank you.
Thank you. We're next going to William Stein from SunTrust. Please go ahead.
Great. Thanks for taking my questions. Steve, you've already told us that the weakness was very broad based by markets and by geo. I wonder if the strength or the very recent strong recovery in bookings trends could be, attributed to anything in particular, any geo, any end market, any event.
So I would say, if you have to pick a geography that is that has shown strength, it would be China.
And it but nothing by end market there. We've heard about China auto recovering significantly. Are you seeing that as well?
Yes, I mean, we manage our business by product line, as you know. So, we have rough end market commentary where we believe that the only stronger end market has been data centers communication and Aerospace And Defense were flattish and Automotive Industrial And Consumer Appliances was the weakest markets. You know, with a 1 month booking in, in October, we can't really, you know, tell you a change in, in that tone. We just don't check it that way.
Thanks. One more, if I can. With regard to the Microsemi system, their ERP integrations that you're doing. Can you remind us of the timing to complete these? And I just forget whether there's a step function cost savings that happens at the end of it all or is it more linear as we go?
And remind us of the size of that, please. Thank you.
So if you recall, we began this a year ago and have had a number of transitions we make every quarter We just did the most recent of that on November 1st this year. In my prepared remarks, I said we have at least another four quarters get to substantially complete. We're about halfway through at this point in time. And the savings are more, over time, rather than a step function change. And as we get through enough of the systems, we take the savings and that becomes the synergies that we add to what we've done.
All right. Thank you. We're next going with Harlan Sur from JP Morgan.
Good afternoon. Thanks for taking my question. I know it's always tricky to reconcile the SIA data with your results, but if I look at the SIA data for calendar Q3, the overall general MCU market grew about 5% sequentially. But almost all of that growth came from 32 bit, while 8 bit declined, 16 bit was relatively flattish sequentially. You've grown the size of your 32 bit pretty strongly, but I think it's still about a third of your overall MCU business.
So mix adjusted because you still have more 816 bit exposure, Is this the potential reason why your MCU business slightly underperformed the general industry in the September quarter?
We we have not analyzed the numbers against the SIS. So I'd rather not guess than make any comments. I think You mentioned our end market demand based microcontroller business was down 1.3%. I I think, many other results we have heard from various needs wouldn't lead us to believe that the business in September quarter was up 5%. I don't know how SIE comes up with the numbers.
If you add up the numbers from TI and others. I don't know whether you can construct that number.
Our 32 bit business is doing, you know, much, much stronger than the 8 and the 16. I think these are businesses that are not as much 816, 32 bit focused. They are broad market trends in automotive, in industrial, in consumer appliances, and they affect all segments of the 32 of the microcontroller market.
Our belief is in history that SIA especially during turbulent times like this, they revised the numbers and there are significant changes reported. And and it's easily causes confusion like it's causing right now. If I look at add up the results of most companies that make micro trollers. I don't really think I can get to the SA numbers.
Yes. That's a fair point. Okay. And then my follow-up, we've been through a couple of quarters of cloud data center spending digestion, but looks like spending is picking up back here in the second half of this year. It looks like you guys are seeing that as well.
Think via the Microsemi acquisition, you guys have a relatively strong position in NVMe Enterprises, the SSD controller, as you got a strong platform for PCIe switching products. And then you've got some of your core products, right? Like secure MCUs and Ethernet products that go into the cloud as well. Roughly, how big is cloud data center as an end market for the team? I assume it's probably a bit easier to track given that these products are purpose designed for data center applications?
So, the product lines that address data center are more than just the microsemi product line came to data center. Clearly, that is a big position that we have. Some of what you mentioned relative to the strength in storage, strength in the SSDs and all that is good. I don't know if I have a good way to break out exactly what our data center, it's in the mid teens is what my my guess would be based on where we had seen the combined company, but that's from several quarters ago.
Great.
Thank you. We also sell products into data center from the classic Microchip business prior to the Microsemi. And some of those products go into power supplies. They go into other IO control in various different areas. So we had some data center exposure before, but obviously, the big one came with Marcus Semi.
Yep. Okay. Thank you.
You.
We'll take our next question from Mark Delaney from Goldman Sachs.
Yes, good afternoon. Thanks for taking the question. I'll give it to 1. The October bookings strength that the company spoke to, are those primarily bookings that are for shipment in the December quarter or are some of those bookings for shipment in the March quarter and maybe giving you a good start on your backlog for the March quarter? Thanks.
Those, those bookings are aged every month from here on and into the future 6, 8 months out. Summer for December quarter, summer for March quarter, some of it even spill beyond the March quarter.
Thank you. We'll next take our next question from John Pitzer from Credit Suisse. Please go ahead.
Yes, good afternoon guys. Thanks for letting me ask the questions. Steve, for the entire December quarter, you've been pretty clear that your assumptions for turns are higher. I'm just kind of curious given the strength you've seen quarter to date from here on out, what's the expectation to turn relative to trend. Do you expect you need that steepness to continue to hit the midpoint?
Or are you embedding kind of a more normal turns business in the second half of the quarter to hit the midpoint of go.
So I'll speak qualitatively rather than quantitatively because we haven't disclosed what the backlog was, where it is now and all that. If the current slope of backlog fill continues, then the results would be very good. We're not expecting this slope to continue. So we, in our judgment, have moderated that slope, current slope. Some just because the backlog started very low and then people placed the order, the slope is high as backlog starts to fill up, the slope will moderate.
And the other is the effect of holidays because you don't do a lot of bookings over the Thanksgiving week. And then December, Europe is a weakest usually U. S. Is the 2nd. And then Asia usually continues to work over the holidays.
So we have based on our experience from our history, we have modeled that in, but I will admit that we have moderated that slope because we think the slope is not sustainable.
I think I'll also point out that we've given a broad range of guidance.
And we've given a pretty broad range of guidance to account for all those puts and takes.
Thank you. We're taking our next question from Chris Stanley from Citigroup.
Hey, thanks guys. I'll try and behave here and just stick to one question. Steve, this, I guess sluggish type of environment continues into the March quarter. Theoretically, what would you be looking to do as far as OpEx goes in your own inventory?
Well, if the sluggish environment were to continue, the OpEx would be basically in the range. We will keep on controlling any headcount additions, sparingly approve any replacement acquisitions, bonus will continue to be lower than the target type of bonuses. CapEx will continue to tighten because if there's no growth, we will need capacity. And a lot of the capital we're investing is just incremental here and there, there's no big capital needed for growth in this environment. So those are the things we would do if the environment seems to be sluggish.
If the environment were to accelerate, I would think we still have sufficient capacity and sufficient inventory ship the upside. So you wouldn't see a growth in CapEx immediately, and you wouldn't see growth in expenses either. So if, if the upside in revenue were to come through, I think there'll be a pretty good leverage for the earnings to go to the bottom.
Great. Thanks guys.
Thank you. We'll next go with Vijay Rakesh from the Mizuho Group. Please go ahead.
Thanks. Just Steve and Eric, just briefly, you talked about this inventory has come down quite a bit. I was just wondering if your visibility extended to the end customer also. Have you seen the end customer stock up ahead of the tariffs or you think inventories, going out to the end customers have come down as well?
We really have no meaningful visibility into end customers and what they're doing with their inventory. They don't report to us. We don't see the change from week to week as we do in the case of distribution. So, they are, we presume doing what they think is the right thing for their business, but we have no color one way or the other.
Got it. And I know you mentioned October, you saw a nice snapback, or a pickup in backlog, mostly from China. Given that Steve mentioned auto and industrial were the weakest, would you expect those to snap back, faster than others if we see some rebound or That's it. Thanks.
So it's very hard to call future by end markets. It's easier to talk about the past. Yeah, if there is some sort of trade settlement, there was to be clear rules where overnight through another tweak, the duties will not go higher or something, then you would see some stability and return to normal MELFI on the industrial market and appliance market. Automotive, there is a settlement with GM and GM now. And so you should see some impact there.
So I think, those are the things that would show strength. Yes.
We'll next go with Christopher Rolland from Susquehanna International Group.
Thanks for the question. Steve, thanks for all this big picture stuff. In your experience, maybe you can talk about how this cycle has been different from prior ones, you know, kind of what most surprised you this time around. And then How do you feel about this being a more of a semiconductor specific driven cycle versus an economic cycle? And do you have any thoughts on an economic cycle given how long this economic cycle has lasted?
Well, that's a that's a tough ball that you have served. You know, that's a I'm not an economic and that's, that's not my field. So I'll give you some feel for really how I'm thinking. Many of the cycles our industry have seen are the cycles created by our own industry through a long lead times, excessive inventory build and then the bubble bursting and going the other way. And complete shipping below demand for a while, and then the cycle correcting.
So those are semiconductor industry and its customer calls cycles by successfully undershipping demand and over shipping demand. This cycle hasn't been caused by the industry. This cycle has been caused by the much larger economic forces. And if I were to name a single one, it would be the U. S.
China trade. It's really been caused by that. I I tried to explain it before, and let me take another shot at it. You know, the the world economy runs on, manufacturers building the product and putting into the inventory, with a forecast that the customers will come and buy that product. And I've given an example of a grocery store or an electronic store, you can go into these stores.
There is lots of inventory and you can come out with bags full of your grocery. You do not order your grocery a week ahead of time and then go pick up the delivery. In fact, if you were to go a grocery store, what you want, it isn't there, you'll go to another store and buy it. So world economy largely runs on inventory. Now enter the tariff uncertainty.
Imagine a customer building the product in China. And and let's say there were no tariffs on it. And bringing it to US, I'm sorry. There were tariffs on it. Let's say there's 25% tariff on it.
So they bring the product to U. S. With 25% tariff on it. And having them the uncertainty to be able to pass on that tariff to their end customer, they don't know whether they can or they can't. And the second risk is to bring the inventory to U.
S. And then there is settlement announced. Once a settlement is announced, no end customer will pay that 25 percent tariff because the manufacturer brought it here with tariff at their own risk. So what it does is it makes everybody stop in their tracks. They cut down the inventory on the loading dock to the manufacturing lines, to the raw materials, to the finished goods, to the transportation hubs everywhere.
People draw down the inventory because they do not know what the landed cost is and what they can pass to their customers. That is the impact we have seen in many, many of the market. And when there is a clarity on the tariff front, then you will see rebuilding of that supply chain inventory, which will have a very positive effect on us.
Got it. Thank you for that extra insight. Very helpful.
Yes, that's great. Thank you, Steve.
Thank you. We're going next with Gil Alexander from the Darphil Associates. Please go ahead.
Good evening.
I assume as you look at your long term model that you still have gross margins at 63% non operating margins at 40.5 once we get over this these problems?
Yes, Gil. We have not changed our longer term model. In fact, the changes we announced today on the restructuring of our Colorado fab and bringing some of those 6 inch products to our 2 higher, higher volume 8 inch fabs. And really creating $65,000,000 in savings in the process. What we have done is we have lowered the revenue at which we achieve our target model.
So prior to that, it required a certain amount of revenue to fill up our factories and remove the underutilization to achieve our 63% target margin. By making those changes, we have we're not dollarized for you how much, but we have lowered the revenue we need to achieve to achieve the target margin. Because we're taking so much cost out of the system.
I thank you. May I just ask one question on China and you can skip it?
Go ahead.
You talk of this 25% tariff. Have you seen any talk that they may that people want to reduce that tariff or is that all open ended?
Well, you have some information you're sharing.
Are you talking about the trade discussion between the U. S. And China? Because I think that is the entire point. The 25% tariff, is creating uncertainty on both sides of the ocean is creating uncertainty in other regions of the world as well.
In phase 1 settlement, there has been touted by the administration, the 25 percent tariff doesn't go away. They only agreed to not increase the tariff from 25 to 30. But there is some talk, whether it's in phase 2 or gets done in phase 1, where certain on $100,000,000,000 worth of goods that tariffs will go down. So those are just talks so far.
Yes, I think we see different news reports that come out. We don't have any direct insight into the discussions and decisions. I think there is a in good faith effort to try to deescalate from where we are. And it may take more than 1 phase, but the rate at which that comes down and the time when it impacts the products that we are designed into, our customers are impacted by is unclear to us.
Even if there's a settlement, which creates a finality that tariffs are not 0, tariffs are some number 10%, 15% but they can't stand. And it's not going to be another tweet, which is going to increase those tariffs. Once the customer's distributors contract manufacturers, everybody has that finality and they can run the business in a normal way and the inventories will get replenished. It is the uncertainty which causes it because they don't know what the landed costs will be. Anything else, operator?
We'll take our next question from Craig Ellis from B. Riley FBR.
Hey guys, this is Carlin Lynch on for Craig. Just wanted to ask a question on the cross selling opportunities with microsemi. I think last quarter you had said that the muted environment had kind of slowed down some of that progress. If we were to get to a normalized environment next year, could we see those cross selling opportunities kind of springboard as is the design activity going on and we're just seeing muted demand everywhere or any kind of quality of color you could give on the cross selling opportunities would be great.
So as you noted, the cross selling opportunities are all at the design and stage. So these are platforms that get designed and then go to production over 18, 24 months of time. The design and activity is going extremely well. And across the board, the combined sales teams, combined business unit teams of Microchip are all highly focused on enabling that on new designs. The environment today is really for products that were designed back in time.
And that muted environment doesn't change. But the seeds that are being planted, new designs and the increased total system solutions we're able to address are clearly will pay off in time as the current as the new designs go to production in 12, 18, 24 months of time.
So just if I could clarify there, so we would expect some of that cross selling opportunity to start to manifest next year, even if the demand environment kind of just skips along the bottom here?
Yes. And you've got to take it over time. This is not a single application, single customer that drives it one way or there's hundreds of applications, customers over which this would happen. But clearly, there is a multiplier that comes from cross selling, from selling a more a complete solution to the customer. And as that ramps in, I don't know if it is exactly first half of next year, second half, but in time, as the environment improves, as new designs go to production, we will see the benefits that come from it.
We're going next to Craig Hettenbach from Morgan Stanley.
Question for Steve. 1 of the secondary impacts of the trade war is just the acceleration of China to try to move to more of a localization effort. Can you talk about just maybe parts of your portfolio where you see maybe some overlap to that versus other parts that you think a lot more immune to what China might be trying to do from a development perspective?
So, you know, we, we hear a lot of talk and, we don't see a lot of action on that front. There may be action on certain product lines. I think they're really maybe trying to build processes and graphic processors and others. We don't do not really see that kind of impact today on our data center products, on our FPGA products, on our discrete in other products, or microcontroller and analog, we hear a lot of talk about it And, longer term, there there could be an issue where they want to either design their own product or not prefer to design with Americans, I think, in a short period of time, less than a year of this trade war, you can't really design a massive portfolio that Microchip has to make a meaningful impact on it. So we're really not seeing that on the on revenue today, but we're seeing it in sentiment.
And I would add to it. The threat from local suppliers in China. It's nothing new. It's been there for many years. It's a question of do they have the types of products, the quality of the product, capability to support the designs, the wide range of applications and customers that you need to be able to serve with it that is a very large task.
And there may be more environment today that says, you should consider more of a local supplier, but task is very, very large for anybody who wants to do it. And if they could, they would have been doing it for several years before.
Got it. Thanks.
Thank you. We're going to Vivek Arya from Bank of America.
Thanks for the very quick follow-up. Actually on those same lines in terms of competition and substitution, Steve, have you seen any design shifts to your, perhaps your European or Japanese competitors who have been in the market for a longer period of time. Does that become a factor going forward?
You know, like I said, first, we have very, very broad customer base serve over 120,000 plus customers. So it's very, very hard to track. We're not seeing any preponderance of evidence to see if there is any design shift. We're hitting in sentiment, the so called non A sentiment. You may have heard that kind of language where government is saying, designed with Chinese customers first designed with high monies or Asian second, designed with the European 3rd and Americans are last.
But 95%, 97% of products build our all proprietary in nature with no pin compatible part available. So in a short period of time, we really haven't seen any of that shift. The shift will first become visible at the design and stage if it does. And I don't think we have strong evidence today that that's happening. We're not losing designs like crazy.
Our funnel size is still very, very large and we're able to leverage a lot of a more commodity like products with more advanced products with a total system solution if they're on the same board.
Thank you.
This call is for concern. We're watching, and we are making the product better finding other sales mechanisms to bundle it and all that. So negative sentiment in China is definitely there, but it's not really being seen in bookings and revenue dollars today.
At this time. Mr. Sanghi, I'd like to turn the conference back to you for any additional or closing remarks.
Well, I want to thank everyone. This has been a difficult year with all the uncertainty, please continue to bear with us. And we'll see some of you on the road as we go to various conferences.
This concludes today's call. Thank you for your participation. You may now go ahead and disconnect.