Good day everyone and welcome to the Microchip's Third 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.

Eric Bjornholt - Chief Financial Officer

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 Sanghi, 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 Steve and Ganesh will then give their comments on the results and discuss the current business environment as well as our guidance. We will then be available to respond to specific investor and analyst questions.

We are including information in our press release and in this conference call on various GAAP and non-GAAP measures. We have posted a full GAAP to non-GAAP reconciliation on the Investor Relations page of our website at www.microchip.com, which we believe you will find useful when comparing our GAAP and non-GAAP results. We have also posted a summary of our outstanding debts and our leverage metrics on our website.

I want to remind investors that during the June quarter of 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 calls, 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 distribution sell-in, we will also provide investors with our end-market demand based on distribution sell-out but will not provide a P&L based on end-market demand. End-market demand in the December 2019 quarter was $1.324 billion. End-market demand was about $36.1 million more than our GAAP revenue in the December 2019 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 December quarter were $1.287 billion, which was down 3.76% 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 at 26.4% and operating income was 35.1% and above the high-end of our guidance. Non-GAAP net income was $340.8 million. 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 $5.7 million of share based compensation expense. Total operating expenses were $654.3 million and include acquisition intangible amortization of $248.7 million, special charges of $17.8 million, $10.9 million of acquisition related and other costs and share based compensation of $37.8 million. The GAAP net income was $311.1 million 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 cash tax rate for fiscal 2020 to be about 6%, 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 and net operating losses and tax credits as well as U.S. 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 million and will be paid over the next six years. We have posted a schedule of our projected transition tax payments on the Investor Relations page of our website.

Our inventory balance at December 31, 2019 was $708.8 million. We had 129 days of inventory at the end of the December quarter, down two days from the prior quarter's level. Inventory at our distributors in the December quarter were at 28 days compared to 30 days at the end of September. We have only had one quarter in the past 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 $395.5 million in the December quarter. As of December 31, the consolidated cash and total investment position was $402.3 million. We paid down $257 million of total debt in the December quarter and the net debt on the balance sheet was reduced by $254.2 million. Over the last six full quarters since we close the Microsemi acquisition and incurred over $8 billion in debt to do so, we have paid down $1.986 billion 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 debt levels to reduce significantly over the next several years.

Our adjusted EBITDA in the December quarter was $503.4 million and our trailing 12 month adjusted EBITDA was $2.125 billion. 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 4.58 at December 31, 2019. Our dividend payment in the December quarter was $87.7 million. Capital expenditures were $14.1 million in the December 2019 quarter. We expect between $20 million and $25 million in capital spending in the March quarter and overall capital expenditures for fiscal 2020 to be between $76 million and $81 million.

We continue to add capital to support the growth of our production capabilities for our new products and technologies and to bring in-house more of the assembly and test operations that are currently outsourced. We expect these capital investments will bring some gross margin improvement to our business, particularly for the outsourced Atmel and Microsemi manufacturing activities that we are bringing into our own factories. Depreciation expense in the December quarter was $41.4 million.

I will now turn it over to Ganesh to give his comments on the performance of the business in the December quarter. Ganesh?

Ganesh Moorthy - President and Chief Operating Officer

Thank you Eric and Good afternoon everyone. Before I get started, I would 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 this performance internally.

Let's start by taking a closer look at Microcontrollers. 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 Adaptec smart storage offerings and industry support for development of the Open Compute Project's 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 802.3bt-2018-compliant Power over Ethernet injectors and midspans that enable up to 90 watts of power without changing switches or cabling. Analog represented 28.1% 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 tolerant PolarFire FPGA for space and other high reliability applications, as well as the early access program for the PolarFire system-on-chip FPGA, offering the world's first hardened real-time, Linux capable, RISC-V-based microprocessor subsystem. Design wins for the PolarFire family continue to grow strongly and we remain optimistic about the prospects for this product family FPGA represented 6.9% 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 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 are seeing. First, all our employees are safe and that remains our highest priority. We implemented travel bans in and out of China, Hong Kong and Taiwan two 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 till February 9. Hubei province, where Wuhan is located, has extended the holidays till February 13. 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 there may be 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 Centers for Disease Control and the World Health Organization. We will adopt our response as needed and focus on the things that we can control.

Finally, over the last few months, we started share six megatrends that we believe provide significant growth opportunities for Microchip over the next five to 10 years and I would like to summarize them. First, the 5G infrastructure rollout 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 are compelling business models for customers to make money, save money and mitigate risk.

Third, for data center. The data center demand to store and process data is exploding as data is created at a hyper exponential rate. To put this in perspective, estimates are that 90% of world's data was created in just the last two years and that trend continues unabated.

Fourth, electric and hybrid vehicles are riding a wave of consumer and regulatory forces which are driving substantial investment in technology and capacity. Fifth 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. Sixth 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 and our guidance going forward. Steve?

Steve Sanghi - Chairman and Chief Executive Officer

Thank you Ganesh and good afternoon everyone. Today I would like to first reflect on the results of the fiscal third quarter of 2020. I will then provide guidance for the fiscal fourth quarter of 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 J.P. Morgan conference. Our final December quarter GAAP net sales were on the high-end of our latest guidance and came in at $1.287 billion, down 3.76% sequentially. Our end-market demand based on sell-through was $36 million 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 seventh consecutive quarter where our sell-through revenue was higher than our sell-in revenue.

Our consolidated non-GAAP gross margin of 61.5% was just above the high-end of our guidance. Our consolidated non-GAAP operating margin of 35.1% 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 117th consecutive profitable quarter. In the December quarter, we paid down $257 million of our debt. Our total debt payment since the end of June 2018 has been about $2 billion. The pace of debt payments has been strong despite the weak and uncertain business conditions underlining the strong cash generation characteristics of our business as well as our active efforts to continue to squeeze working capital efficiencies.

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 March quarter to be up double digit percentage over the 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 one after multiple quarters of book-to-bill being below one. Our distributor inventory at the end of September was already at low level and lowest in 15 years except one 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 it is required factory expedites. Seeing these multiple signs of inflection point, we call 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 for 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 for the Coronavirus situation and what the consequent business impact may be. But we believe that our guidance range incorporates our best judgment for the possible scenarios.

Regarding capex, we expect to finish fiscal year 2020 with a capex of between $76 million and $81 million, a significant reduction from fiscal year 2019 capex of $229 million. 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 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% and 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 poll for questions?

Question & Answers

Operator

Yes sir [Operator Instructions] And our first question will come from Craig Hettenbach with Morgan Stanley.

Craig Hettenbach - Morgan Stanley - Analyst

Yes. Thank you. Steve, just a question on the expedited activity. Can you just maybe put that into context with currently where your lead times are and things you are looking to do to maybe kind of address that as business improves?

Steve Sanghi - Chairman and Chief Executive Officer

So 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 die from the die bank and processing it through which can be anywhere to as low three weeks to as much as six, seven weeks depending on where it has 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 have been seeing the strange phenomenon now not only this quarter, we have been seeing it for some time but it really became even more accentuated. So there is a fair amount of backlog sitting outside the quarter in April and customers are expediting it into the quarter.

Does that answer your question?

Craig Hettenbach - Morgan Stanley - Analyst

Yes, Thank you.

Operator

Thank you. Our next question comes from the Vivek Arya with Bank of America.

Vivek Arya - Bank of America - Analyst

Thank you. Our next question comes from the Vivek Arya with Bank of America.Thanks for taking my question. Steve, I am curious, what are you expecting your distributors to do in the March quarter? I think you are 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 hear of any of your other peers their inventories being taken down to be similarly low levels?

Steve Sanghi - Chairman and Chief Executive Officer

Well, I don't really know if, as we speak, distributors are taking down inventory further, but they have in the last is seven quarters or so through December. We don't really have a guidance for the March quarter on sell-through. We can't really provide both ends of the guidance. It's just too much work. So we are 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 trend and will start to build a sound inventory towards normalization. It did not happen in December. We are expecting it would happen again in March, but there is no guarantee. Distributors will do what they will do.

I think part of the reason is, for 30 years, our culture at Microchip, in our 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 is how we pay our sales people. That's how we pay our business unit. 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 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 focus on sell-in revenue recognition where they may make deals to put more product into distribution and arresting the fall of the inventory that way.

Ganesh Moorthy - President and Chief Operating Officer

I would add one more thing. We always had low lead times on our products. And I think that gives distributors an opportunity to run the inventory to whatever the lowest level they think they can get away with while continue to focus on sell-through. So short lead times give them the opportunity to carry less inventory as well.

Steve Sanghi - Chairman and Chief Executive Officer

I would also add that some time we charge expedite charges for expediting the product. So sometime expedited charges require us to spend weekends, pay over time or pay expedite for shipping, going through hand carry products and all sorts of charge incurred 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.

Vivek Arya - Bank of America - Analyst

But you are not assuming any restocking benefit? Any major restocking benefit in March?

Steve Sanghi - Chairman and Chief Executive Officer

We have no way to model it.

Vivek Arya - Bank of America - Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from Gary Mobley with Wells Fargo.

Gary Mobley - Wells Fargo - Analyst

Hi guys. Thanks for taking my question. 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 SIA sales metrics. But in the second half of the year, it looks like and particularly in the fourth 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?

Steve Sanghi - Chairman and Chief Executive Officer

I am not sure what data it is you are referring to. So we were sequentially down 1.1% on Microcontrollers, September to December. If you look at the year-over-year numbers, we are on Microcontroller were 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 will get that by March, April and we will at the next conference call have the typical Gartner 2019 numbers. There is nothing in our business that has any indication that something was better in the first half and got worse in the second half.

Ganesh Moorthy - President and Chief Operating Officer

I think if you look at the quarter result sequentially and compare it to a very large competitor, I think we substantially outgrew them.

Steve Sanghi - Chairman and Chief Executive Officer

So these are year-over-year.

Gary Mobley - Wells Fargo - Analyst

Yeah. Understood. Thank you, Guys.

Operator

Thank you. Our next question comes from Chris Caso with Raymond James.

Chris Caso - Raymond James - Analyst

Yes. Thank you. Good evening. A question with regard to gross margins and assuming we just have started recovery, we would 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 and how that helps leverage if indeed we are in a recovery?

Eric Bjornholt - Chief Financial Officer

Sure. This is Eric. So in the December quarter, we incurred about a $16 million factory under utilization charge that was reflected in our cost of sales. That was up about $7 million quarter-on-quarter. We expect that charge to be lower in the March quarter. Particularly in our backend assembly and test operations, we are running the factories higher.

Steve talked about it in an earlier response that our die bank is pretty healthy. But backend operations, we have been training finished goods and looking to run the factories harder this quarter, which should help on the gross margin and the guidance that we are given. So that's a piece of it. We continue to run our factories as efficiently as we can. We are 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 the 61.7% we are guiding to at the midpoint of guidance for the current quarter.

Operator

All right. Thank you. Our next question will come from William Stein with SunTrust Robinson Humphrey.

William Stein - SunTrust Robinson Humphrey - Analyst

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 are still bringing capacity in-house. It seems to us that it seems really likely that you will be able to exceed these long term targets given the revenue level that you are achieving today relative to what the next peak could be, for example? Thank you.

Eric Bjornholt - Chief Financial Officer

Okay. So you know, I think I have kind of touched on gross margin so far. And we have been told by others that they think that's a conservative forecast. But we are not going to update that model until we get to the target. And on OpEx, we are guiding the current quarter to be between 25% and 26.2% of sales and our long term model is 22.5%. I would say, we have been pretty conservative in how we have been managing the business during this current cycle.

And with that, we need to make sure that we are 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 too 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 got a ways to go when we are guiding the current quarter at the midpoint of guidance to about 36.1%. So I would say, be patient. We do need revenue growth to get there. But I think we are well positioned with the investments that we have made to add to drive to higher levels than what we are seeing today.

William Stein - SunTrust Robinson Humphrey - Analyst

Thank you.

Operator

Thank you. [Operator Instructions] Our next question comes from Ambrish Srivastava with BMO Financial Group.

Ambrish Srivastava - BMO Financial Group - Analyst

Hi. Thank you very much. Steve, I was wondering if you could give us a little bit more detail on 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.

Steve Sanghi - Chairman and Chief Executive Officer

So I think from an end-market perspective, we said that data center has been strong all along and we are seeing startup 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 kind of always lumpy and it's hard to call.

From a geographical perspective, yes, 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.

Ambrish Srivastava - BMO Financial Group - Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from Raji Gill with Needham & Company.

Raji Gill - Needham & Company - Analyst

Yes. Thank you. If we think about the seasonality 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 Coronavirus? I am just trying to get a sense of the seasonality acquisitions [Phonetic] of the bottom of the cycle. Thank you.

Steve Sanghi - Chairman and Chief Executive Officer

I think, Raji, seasonality is still hard to measure where all the acquisitions that we have completed. The events that have happened in the last couple of years, all the trade tensions situation, general economic conditions and 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 in a healthy business environment to peg a seasonality. So I would think it still remains difficult.

Operator

Thank you. Our next question will come from Craig Ellis with B. Riley FBR.

Craig Ellis - B. Riley FBR - Analyst

Yeah. Thanks for taking the question and congratulations on the good execution. I had wanted to go back to some of the comments around the performance on debt production, which over the last six quarters at almost $2 billion is very strong. The question is, perhaps both you Eric and you Steve, is as you look ahead and given the trajectory you are on, it seems like you could be at a 3X net debt to EBITDA level in 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 will go to debt pay down? Or would you start looking at other things? And what would the priorities be at that point? Thank you.

Steve Sanghi - Chairman and Chief Executive Officer

Let me take that and Eric can add to it. 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 are making in the revenue growth of the recovery. It will largely depend on that. But basically, yes, we need to bring the debt leverage below a three handle, kind of have it to somewhere in the high twos.

Once we get there, then we will still be generating somewhere of the order of well over $1 billion of free cash per quarter and we need to figure out what we do. I mean we haven't been in that situation in 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&A possibility.

We have said before that we think by the time we come up for air, majority of the companies or smaller company 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 assets are very expensive. There is large amount of M&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 other deals, those multiples were way, too high for our case. If we can not 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 pay down.

Eric Bjornholt - Chief Financial Officer

I think what I am going to add to that is just kind of a short term view here is, because I know we will get this question a lot is, what do we expect for debt pay down in the current quarter, the March quarter. And really, we expect that to be somewhere between $225 million and $250 million. Last quarter, it was $257 million but our starting accounts receivable balance was lower just because revenue was down last quarter.

So really to get some tailwinds behind us, from a revenue perspective, as the topline grows I think EBITDA will start growing nicely and that's going to help with the leverage metrics coming down. But it 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, I think we would need pretty good revenue growth.

Craig Ellis - B. Riley FBR - Analyst

Got it. Thanks guys.

Operator

Thank you. [Operator Instructions] Our next question comes from Chris Danely with Citi.

Chris Danely - Citi - Analyst

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 June quarter could be at risk of a little bit of a disappointment like we are robbing from the June quarter to pay the March quarter? And then further to that, you talked a little about lead times. Do you think that there is risk of extended lead times if this expediting continues?

Steve Sanghi - Chairman and Chief Executive Officer

The lead times are not at risk short term because we have a fair amount of die inventory and there is a fair amount of capacity slack in the system since the revenues are down year-over-year. The backlog bottomed out some time ago and the total extended backlog is really growing nicely. So when people are taking backlog from June quarter moving into March quarter, that's not putting June quarter at risk. There is 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.

Ganesh Moorthy - President and Chief Operating Officer

Chris, we had expedites in the December quarter where people have placed backlog in the March quarter and pulled it in. You are seeing a stronger March quarter despite that. So as you go into and upward trend in the business, it is not unnatural. We have see it in other cycles where customers start to see their business recovering and wanting to have products sooner than they had originally planned for.

Eric Bjornholt - Chief Financial Officer

Yes. And in addition to those orders that are being pulled in by customers requesting them into the current quarter, we are also receiving orders that are just within our normal published lead times. And that can create some expedite activity also.

Ganesh Moorthy - President and Chief Operating Officer

Often with short lead times, yes.

Steve Sanghi - Chairman and Chief Executive Officer

And Chris, this phenomenon is not a new one. We have seen it before in prior cycles and we have been seeing it in this cycle. I kind of call it, have your cake and eat it too. So customers will place an order where they are still in the cancellation or push-out window and if they don't want it or if their business is not strong, they can push it out or leave it out. But if their business is stronger and 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.

Chris Danely - Citi - Analyst

Okay. Thanks a lot guys.

Operator

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

Harsh Kumar - Piper Sandler - Analyst

Yeah. Hi Steve. I was curious, with the sudden pickup in China, are you aware of any areas of shortages not just in your business, but in the industry overall?

Steve Sanghi - Chairman and Chief Executive Officer

I am not seeing any shortages. 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 are just about coming back. But most provinces have extended it till February 9. But prior to going for the Chinese New Year, no, we were not experiencing any shortages.

Harsh Kumar - Piper Sandler - Analyst

Fair Enough. Thanks guys.

Operator

Thank you. Our next question comes from Christopher Rolland with Susquehanna International Group.

Christopher Rolland - Susquehanna International Group - Analyst

Thanks for the question. Eric, perhaps asked another way, if you could talk about Atmel and Microsemi, bringing them in-house, remind us where we are on front-end and back-end? And then also the gross margin benefits that you would get there? Also, how are you able to do this in such a small capex envelope as well? Thanks.

Eric Bjornholt - Chief Financial Officer

Okay. So there is a couple pieces to that. So we did tighten our investment criteria in terms of making those capital investments over the course of the last year when business was difficult. And so we shortened the window, the payback window, from a cash flow perspective, from two years down to a year. And we really haven't changed that at this point in time. So that's one of the reason the spend has 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 they want to add.

Steve Sanghi - Chairman and Chief Executive Officer

You can give them the percentage we have inside and outside for fab, assembly and tests.

Eric Bjornholt - Chief Financial Officer

Yeah. So fab is 39% internal, assembly is 45% and test is 54%.

Christopher Rolland - Susquehanna International Group - Analyst

That's useful. Thank you.

Eric Bjornholt - Chief Financial Officer

And we would expect those assembly and test percentages to increase over time as we gradually make these investments.

Operator

Thank you. Our next question will come from Harlan Sur with J.P. Morgan.

Harlan Sur - J.P. Morgan - Analyst

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, ex-ing out the potential issues for Coronavirus, but do you think you are setting up, given the backlog that are you seeing, at least for a seasonal June quarter, which is typically one of your seasonally strongest quarters?

Steve Sanghi - Chairman and Chief Executive Officer

Well, we are not giving guidance or commenting on the June quarter, especially in the light of significant uncertainty because of the Coronavirus. Remove those uncertainties and let's say there is no impact and business comes back and the virus is contained rapidly and all that, then your assessment for the June quarter would be correct.

Eric Bjornholt - Chief Financial Officer

Yeah. And I think I would just add that we are very well-positioned from a capacity perspective to be able to respond quickly to upside if that develops.

Harlan Sur - J.P. Morgan - Analyst

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 progress and the backlog is indicating a potential for normal seasonal growth for June and 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?

Steve Sanghi - Chairman and Chief Executive Officer

So this is Steve. Let me take that. I think, let's start from the back-end first and we will come to the front-end. The back-end 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 have got to take the die bank 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 there also you have got to separate it 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 know as we speak. But there is not a utilization impact of that, because that was being done outside.

What we were going inside, that's what we had the substantial die bank and I think it will at least take it few more quarters before we have to start increasing the production in our fabs.

Harlan Sur - J.P. Morgan - Analyst

Got it. Okay. But then the lower, the lower underutilization charges here in the March quarter is simply because you are filling out your packaging and test assembly utilizations are going up, right. Is that the primary driver for the lower underutilization charges?

Steve Sanghi - Chairman and Chief Executive Officer

Yes. Well, you know, there is always lots of moving parts, mix and on that. But yes, there is a new phenomenon where even in the December quarter, we were depleting finished goods. 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 in and the comment was made that June quarter will at least be seasonal. I would say, I hope that one of these quarter, current quarter as well as June quarter and September quarter are well above seasonal because the inventory is at so low and if I take any cues from any prior recoveries whether it was from SaaS or it was the recovery from 2009 cycle or any other cycle recovery, usually you have got two or three quarters of well above seasonal recovery that takes the 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.

Harlan Sur - J.P. Morgan - Analyst

Yeah, I think that's a fair point, Steve. Thank you.

Operator

Thank you. Our next question will come from Vijay Rakesh with Mizuho Securities.

Vijay Rakesh - Mizuho Securities - Analyst

I was wondering, as you look at your business, I was wondering if we can get some color by markets, end-markets, automotive, industrial? How you see that playing out the rest of the year? Thanks.

Ganesh Moorthy - President and Chief Operating Officer

So as Steve mentioned, we are 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.

Vijay Rakesh - Mizuho Securities - Analyst

Got it. And on the industrial and other end-markets, do you see a similar trend in the back half? Or do you see stronger first half year?

Ganesh Moorthy - President and Chief Operating Officer

So my comment was for both automotive and industrial. We have talked about data center. It was strong. It will remain strong. We don't see anything that suggests that's different. There maybe 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 a defense and aerospace tend be pretty 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 will see some benefit. 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.

Vijay Rakesh - Mizuho Securities - Analyst

All right. Great. Thanks.

Operator

Thank you. Our last question will come from John Pitzer with Credit Suisse Group.

John Pitzer - Credit Suisse Group - Analyst

Yeah, Hi Guys, thanks for letting me get in. I have 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 make good progress and then kind of taken a step back as you made acquisitions to then kind of move forward again. I am just kind of curious if we go to an extended period where you are 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?

Steve Sanghi - Chairman and Chief Executive Officer

So John, you are very correct that we make substantial progress in gross and operating margin after an acquisition and then when we do another acquisition, most times we are 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 a few steps only to take a fall again when we buy 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% percent operating expenses leading to a 40.5%, operating profit. So two ends of it.

First, the gross margin. We are guiding 61.7% gross margin this quarter. So it's 130 basis points away. If you just take the underutilization charge of $16 million that pretty much get you there almost. The second issue is the operating expense. So operating expense basically we are guiding 25% to 26.2% and there is a huge leverage there with the revenue increase. The current revenue is, I think what, a couple of hundred million dollar behind the past record?

Eric Bjornholt - Chief Financial Officer

That's Right.

Steve Sanghi - Chairman and Chief Executive Officer

And 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 with all these go-lives and all that are happening which will take another nine 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 dies the model go? Do we continue to go higher in gross margin and continue go higher in operating margin? For that, get in line and we will about it when we get there.

John Pitzer - Credit Suisse Group - Analyst

That's helpful. And then just secondly, on Microsemi. It was an acquisition you kind of made as the industry was going into a correction. And you are talking about a little bit about kind of the expense leverage there. I am 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 and 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?

Ganesh Moorthy - President and Chief Operating Officer

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 revenue 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 aerospace and defense to be able to sell more complete portfolio. And that work is 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 six, seven quarter window where the environment has been weak and as we emerged 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 lot of that is underway and has been for some time but a lot of it has to come as the environment strengthens.

Steve Sanghi - Chairman and Chief Executive Officer

And John, I think if you study some of the past cycles, I know you and other analysts are very good at studying the past cycles, what really happens is nobody believes the depth of the downturn. And the estimates will always stay high and they get cut multiple times. In this cycle, the estimates really have been cut four times, not only for Microchip but for the industry and various other players. It could be more than four times.

And then when the reverse happens, the estimates always go higher, beat and raise, beat and raise, beat and raise, for many quarters. I have seen this in prior cycles because nobody has the confidence to guess the revenue or guide the revenue to be higher than seasonal. And it continues for many quarters in the other direction. That's what I am hoping for but not guiding to.

Operator

All right. Thank you. And at this time, there are no further questions in the queue. So I would like to turn the call back over to Mr. Steve Sanghi for any closing remarks.

Steve Sanghi - Chairman and Chief Executive Officer

Well, we want to thank everyone for attending this call and we are going to about three different conferences, I think, this quarter. So we will see some of you at those conferences. Thank you.

Operator

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MICROCHIP TECHNOLOGY INC

Q3 2020

Earnings Transcript

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