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Microsemi (NASDAQ:MSCC)

Q1 2012 Earnings Call

January 26, 2012 4:45 pm ET

Executives

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

Terri Donnelly -

James J. Peterson - Ceo, President, Director, Chairman of Executive Committee and Member of Special Committee

Analysts

Harsh N. Kumar - Morgan Keegan & Company, Inc., Research Division

Patrick Wang - Evercore Partners Inc., Research Division

Andrew Huang - Sterne Agee & Leach Inc., Research Division

Daniel M. Gelbtuch - Cantor Fitzgerald & Co., Research Division

Quinn Bolton - Needham & Company, LLC, Research Division

Christopher Rolland - FBR Capital Markets & Co., Research Division

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Mark Delaney - Goldman Sachs Group Inc., Research Division

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

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

Operator

Good afternoon. My name is Patrick, and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter earnings conference call. [Operator Instructions] I would now like to turn the call over to Ms. Terri Donnelly to begin the conference.

Terri Donnelly

Good afternoon, and welcome to Microsemi's First Quarter 2012 Earnings Conference Call. I am Terri Donnelly, coordinator of this call. In a few moments, you will hear from and have an opportunity to ask questions of Jim Peterson, our President and Chief Executive Officer; John Hohener, our Executive Vice President and Chief Financial Officer; and Steve Litchfield, our Executive Vice President and Chief Strategy Officer.

A recording of this conference call will be available on the Microsemi website under the Investor section. Our website is located at www.microsemi.com. Microsemi issues guidance in the form of a limited business outlook on our expectations for the next quarter. This business outlook reflects our expectations as of January 26, 2012, and is continually subject to reassessment due to changing market conditions and other factors, therefore, must be considered only as management's present opinion.

Actual results may be materially different. However, management undertakes no obligation to update these or any forward-looking statements, whether as a result of new information, future events or otherwise. If an update to our business outlook is provided, the information will be in the form of a news release. We wish to caution you that all of our statements, except the company's past financial results, are just our current opinions, predictions and expectations. Actual future events or results may differ materially.

For a review of risk factors, please refer to Microsemi's report on Form 10-K for the fiscal year ended October 2, 2011, which was filed with the SEC on November 23, 2011.

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

John W. Hohener

Thank you, Terri. Net sales for the quarter ended January 1, 2012 were a record $240.9 million, up 6% from the $227.3 million in the fourth quarter of 2011, and up 30.7% from the $184.4 million reported in the year ago first quarter. These results include a partial quarter of contribution from our Zarlink acquisition.

As forecasted, our non-GAAP gross margin decreased from the fourth quarter to 54.7% as we incurred additional costs dealing with relocation from Thailand to new sites, the under absorption of some costs due to our lower sales, overall product mix and the inclusion of Zarlink revenues at an initial gross margin lower than that of our core businesses.

Our non-GAAP gross margin was up, however, 110 basis points from the 53.6% reported in the year ago first quarter. We expect our non-GAAP gross margin to increase between 20 and 30 basis points next quarter due primarily to product mix. Our GAAP gross margin was 52.2%, which differed from the non-GAAP due only to non-cash purchase accounting adjustments related to the Zarlink acquisition and was down 490 basis points from the 57.1% in the fourth quarter of 2011, but up 70 basis points from the 51.5% in our prior year first quarter.

This quarter, non-GAAP selling, general and administrative expenses were $40.5 million or 16.8% of sales, compared to $38.1 million or 16.7% of sales in the fourth quarter and compared to $32.5 million or 17.6% of sales in the first quarter of last year. This dollar increase was due to the acquisition of Zarlink.

For the second quarter, we expect total SG&A to decrease between $0.5 million and $1 million. Compared to the first quarter, the SG&A change includes the addition of Zarlink for a full quarter, but will be offset by savings as a result of cost controls and spending efficiencies within the company.

Research and development costs were $39.6 million or 16.4% of sales, compared to $32.4 million or 14.3% of sales in the fourth quarter and compared to $24 million or 13% of sales in the year ago first quarter, again, with the increase in dollars due primarily to Zarlink.

For the second quarter, we expect total R&D to increase between $300,000 and $800,000. Compared to the first quarter, the R&D change includes the addition of Zarlink for a full quarter.

Our non-GAAP operating income was $51.8 million or 21.5% of sales, compared to $59.7 million or 26.3% of sales in the fourth quarter of 2011 or $42.4 million or 23% in the prior year first quarter.

We recorded $11.8 million in non-GAAP interest and other expense in the first quarter, compared to $4.5 million in the fourth quarter, reflecting the refinancing of our term loan from $375 million to $800 million. We expect the total amount to be approximately $12.4 million in our second quarter.

Non-GAAP net income was $33.6 million or $0.39 per diluted share, compared to $45.6 million or $0.53 per diluted share in the fourth quarter of 2011 and $31.1 million or $0.37 per diluted share in the year ago first quarter.

Our non-GAAP effective tax rate for the quarter was 16%, reflecting ongoing improvements in our tax structure. We are expecting our non-GAAP tax rate will trend down to approximately 10% next quarter as we had implement further changes in our worldwide strategy, including the integration of Zarlink's business into our existing structure.

For the quarter, we recorded a GAAP operating loss of $700,000 compared to GAAP operating income of $28.8 million in the fourth quarter of 2011 and $6.3 million in the year ago first quarter. We recorded a GAAP net loss of $44.6 million for the first quarter compared to GAAP net income of $42.1 million in the fourth quarter of 2011 and a GAAP net loss of $1.3 million in the year ago first quarter.

Our GAAP results for the first quarter of fiscal year 2012 is a $34 million charge related to the refinancing of our credit facility from $375 million to $800 million that was accounted for the debt extinguishment under GAAP.

Our GAAP results also includes $7.8 million in restructuring and other charges and $6.1 million in acquisition-related costs, as well as non-cash expenses of $24.9 million in amortization, $7.5 million of stock-based compensation, $6.1 million in inventory purchase accounting entries, $3.5 million in fixed asset impairments primarily associated with the floods in Thailand and $5.1 million in income from fair value adjustments to our debt and derivative instruments and the related tax effects.

We estimate stock-based compensation expense to be $8.2 million to $8.6 million next quarter or 3% to 3.5% of revenue, which incorporates incremental costs related to the inclusion of Zarlink personnel.

GAAP diluted loss per share for the quarter was $0.52, compared to income of $0.49 in the fourth quarter and a loss of $0.02 in the year-ago first quarter. Capital spending was $12.4 million in the first quarter, compared to $6.5 million in the fourth quarter, primarily reflecting recovery and diversification efforts following the Thailand floods.

For the next 2 quarters, we will incur incremental onetime capital spending associated with consolidation of facilities both in Northern and Southern California, the sum total of which will equal approximately $15 million net of allowances. Thereafter, we expect capital spending in support of our ongoing operations to return to our more normal spending rate of approximately $7 million per quarter.

Depreciation and amortization expense in the first quarter was $33.3 million, compared to $24.3 million in the fourth quarter primarily due to increased intangible asset amortization from the Zarlink acquisition. Accounts receivable was $139.3 million compared to $110.9 million at the end of the fourth quarter, and inventories were $164.8 million compared to $140.8 million with both increases due to the Zarlink acquisition.

DSO was 47 days, up from 42 days last quarter, and days of inventory were 128 days, a decrease of 6 days from last quarter and a decrease of 15 days from our year ago first quarter.

We ended the quarter with a cash balance of $133.5 million. Our GAAP operating cash flow was $18.8 million, which we have forecasted will be down due to year-end payments and expenses associated with the Zarlink acquisition. We expect cash flow will resume its normal trend in our March quarter, sending us well on our way to our goal of surpassing an annual operating cash flow of $250 million.

We recorded a book-to-bill ratio greater than 1:1. Our best estimate of the end market percentage breakout of net sales for the first quarter, which now includes the blending of a partial quarter of Zarlink's business, was approximately: enterprise and communication, 31%; defense & security, 29%; aerospace, 20%; industrial, medical and alternative energy, 20%.

Now for our business outlook. Microsemi expects that for the second quarter of fiscal year 2012, our net sales will increase between 1% and 5%, sequentially. On a non-GAAP basis, the company expects earnings per diluted share for the second quarter of fiscal year 2012 to be $0.43 to $0.48.

In March, we will have a full quarter of revenue contribution from Zarlink. While the communication infrastructure markets are softer in the March quarter than we have previously forecasted, coupled with exiting lower-margin business, we currently estimate the total revenue contribution from Zarlink to be in the mid-$40 million range.

In the December quarter, our core revenue, excluding the Zarlink contribution, was approximately $203 million. In the March quarter, we expect the core business to be flat to up slightly.

With that, I will turn the call over to Jim.

James J. Peterson

Okay. Thank you, John. Let's get right to our end markets and their performance in the first quarter. Let's start with our Growth Communication end markets, our best performing end market in the first quarter and our largest revenue driver at 31% of sales. Revenues here were almost 75% sequentially to over $75 million. While the partial quarter of contribution from Zarlink was clearly a factor, we were also optimistic about this end market on many fronts.

Our Power over Ethernet business continues to gain traction, driven by strong quarterly performances from both our Midspan Systems business, as well as our IC products, and we are taking market share of the top tier customers as a result of our industry-leading technology and product roadmaps.

Our wireless LAN power amplifier devices paused in December quarter, but we expect a strong second half driven by strong design share with leading baseband suppliers and we're also well poised to benefit from the coming adoption of the 802.11ac standard. WiFi enabled devices are forecasted to grow to over 3 billion units annually in 2015, up from 1 billion units last year. And we are confident our industry-leading monolithic silicon germanium RF technology will allow us to take more than our fair share in this growth opportunity.

As I stated to our investors last quarter, as well as the new employees we welcome from Zarlink, we are fully committed to extending our leadership position in the voice circuit, network timing and the synchronization markets. I expect that last week's acquisition of the network timing and synchronization business and design team from Maxim is further evidence of this commitment.

Together, these 2 pieces create the most advanced and complete timing, sync and synchronized portfolio in the market today, further extending our technology lead and better positioning Microsemi to capture sockets in this high-growth arena.

While the end market is softer in the current environment than we had forecasted last quarter, we know that the demand on today's voice and data networks continue to grow unabated, and we are confident on our prospects in the coming quarters.

While our emerging Power Management business suffered in the quarter as a result of the flooding in Thailand, we are pleased to report they were back in production as other facilities and are shipping product to customers. Although it is fair to say we're unable to fully meet the demand of our customers at this time, we expect to be at full production and full recovery from the effects of the flooding in Thailand by the end of this quarter.

Our Defense & Security markets accounted for 29% of our total revenue last quarter and as forecasted, were down sequentially. Here in the U.S., the lack of the 2012 budget throughout the first fiscal quarter and the uncertainty surrounding defense budget, kept our customers cautious in the near term. But recent news is much more encouraging, and our customers' sentiment is bottoming. As you may have seen, we now have a budget in place for 2012, which promises strong growth in the procurement budget to over $113 billion with a major emphasis on intelligence, reconnaissance, surveillance and modernization.

At Microsemi, that means electronics. As we said in our yearend earnings call, and I said all along, we continue to expect growth in this business quarter-over-quarter for the year as a result of these factors. One, electronic content is certainly growing; International markets, including foreign military sales, all for higher growth opportunities. Microsemi continues to feature rapidly expanding product portfolio, and we are taking market share on Radiation Hard space level FETs.

Our Aerospace end markets declined in December quarter due to the slowdown in satellite billings, and accounted for approximately 20% of our total billings. Bookings in the September and December quarters were very strong, leading us to believe that year-over-year growth is on track and, December's downtick was nothing more than a lumpy pattern. The Commercial Air end markets continued their growth trend, and we see no change in the trajectory with the foreseeable future.

Our Industrial, Medical and Alternative Energy end markets grew over 3% sequentially in dollar terms, accounting for 20% of revenues. Medical has increasingly stable growth component of this end market, both from the addition of Zarlink revenues, as well as growth in our MRI product portfolio.

Our Solar Energy business continues to bounce along the bottom and is what we expect to be an enduring inventory correction. All things considered in the near-term, we expect slow growth off the bottom, driven by steady medical and other industrial contributions with the strong contributions, leader in the calendar year as we ramp our exciting new ultra-low power wireless medical products and prepare for increased content opportunity in the ICD and other wireless medical markets.

One highlight not yet reflected in our results are in our forecast, is our upcoming reduced tax rate. I want to take a brief moment to applaud the tremendous job that our operations team has done to drive the manufacturing operations cost down, taking gross margins from the low 40% level 2 years ago to approximately 55% today. The lower-cost manufacturing regions that were targeted also had lower tax rates, which we will start to see reflected in our numbers going forward.

We believe that 2012 will be a great year for Microsemi. In the challenging environment, we've transformed the company, adding more organic growth product capability that we've ever had at any time of the company's history. Our continuing operational focus, as we streamline the business, will provide the leverage necessary to drive our profitability to new heights and more dollars to the bottom line. To the benefit of our shareholders, Microsemi will remain focused on these goals.

With that, I will thank you for your interest and support. We'll now take questions from our analysts. [Operator Instructions] Patrick?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Rick Schafer from Oppenheimer Funds.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Just a couple of questions. On Zarlink, can you talk about -- give -- maybe give a little bit of an update on how the integrations going, and is it going as planned? Are there any surprises there? And do you still expect to have that business at the -- up at the target model by the end of this quarter?

James J. Peterson

Okay. Yes, let me give you a little color on Zarlink. One, when we announced the acquisition, we said, "Hey, this will be $0.24 to $0.26 accretive. And from a -- on a year-to-year target, that's right on track." We announced that we had cost savings, which would exceed $18 million to $20 million. We hit, and actually exceeded most of those targets in headcount, overhead, reduction in the materials. We guided a revenue of $32 million to $36 million, we did slightly more. Going forward, we got a little headwind in the communications marketplace, so we got it pegged somewhere around the mid-$40 million, and we're certainly still on target, and we're going to aggressively do a 60-30 gross margin, operating margin target for that group. And I'll tell you another thing, the talent of the engineers and the willingness of the people to work side-by-side with the rest of the Microsemi team is better than I expected.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

But -- so, Jim, should we just include that? I mean, to be clear, so we should be modeling that portion of revenues at roughly that kind of 60-30 split as we look into the June quarter? Is that right?

James J. Peterson

Yes, June quarter or a little beyond, most certainly without a problem. I think that's certainly our plan.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Okay. And then you mentioned the POE business. I mean, I guess, we've been talking about this for years, but I mean, is this the year where we start to see Cisco come in and be a Midspan and an Inspan customer for you guys?

James J. Peterson

Well, we really don't want to mention them by name, but I would say, yes.

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Okay. All right. Well that was really -- One just final question on defense. You mentioned that you expect quarter-to-quarter growth. Can you just put a number to what you -- what you think that business grows for the year in 2012?

James J. Peterson

Did you say defense business?

Richard E. Schafer - Oppenheimer & Co. Inc., Research Division

Yes, the defense business.

James J. Peterson

Well, yes. If you dialed in 8% to 12%, you will probably pretty dead on. I mean, it's a good business, world class business, foreign military sales is up. That would be a good range for you.

Operator

Your next question comes from Tore Svanberg from Stifel, Nicolaus.

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

First question, Jim, can you talk a little bit more about your visibility? I know you usually don't comment on backlog and bookings, but just sort of how things have tracked so far this quarter and how you feel from that backlog perspective?

James J. Peterson

Yes, I feel tremendous about the strength of the backlog. I normally will get back 2 quarters, but 2 quarters ago, we had a positive book-to-bill. This quarter, we had a positive book-to-bill. And so I'm more confident now in the growth and the success of Microsemi that I think I had been since I've been running the company. It's good solid backlog, Tore.

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

Very good. And you mentioned the Satellite business slowing down a little bit. It's obviously very lumpy. But as we look at both near term and for the year, could you talk a little bit more on how you expect that business to evolve?

James J. Peterson

We'll check it out, right? Last quarter, I mentioned, we used the word lumpy. There was great uncertainty in budgeting and the like, but now I'm here to tell you right now, right, we have the strongest bookings that we've had in the last 4 quarters last quarter in the Satellite business. It's going to the right direction. We've had great success in our Rad Hard components in our core competency. We're taking market share from ASICs with our SoC product in the Satellite business. So I don't want to sound like I'm confused from quarter-to-quarter because I'm not. It went from a cycle of lumpy to very strong bookings.

Operator

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

Quinn Bolton - Needham & Company, LLC, Research Division

Jim, I'm wondering if you could give us some update on Thailand. It looks like the core business is sort of flat to maybe up a little bit in March. How much of that is still trying to ramp up the production -- new production in Thailand? And how much of a drag, maybe I should ask, is the -- is Thailand still on the March quarter?

James J. Peterson

Thailand was a bigger drag than I think most people give it credit for. The fact of the matter is, last quarter, we said that it could be as much as a 5% hit in revenue, and I'm here to tell you it certainly was. This quarter, the drag in revenue is on or about 2%. We guided up this quarter revenue 1% to 5%. I probably would've thrown 2% more on that. I would have guided 3% to 6% to 7%. We had that much drag. However, it's pretty much behind us. Our operation job has done a pretty good job. They've identified where we have redundancies in our manufacturing, and I think by next quarter at this time, we're looking at that behind us.

Quinn Bolton - Needham & Company, LLC, Research Division

Would you think then that, that kind of actually comes back in June? Would you put that 2% if you guys are typically 1% to 3%, 2% to 4%, would June be 2 points higher than that if Thailand is fully behind you, or is that sort of business that you think is just lost?

James J. Peterson

That's not lost business. That will be gain to us going forward.

Quinn Bolton - Needham & Company, LLC, Research Division

Okay. And then a similar question just on the gross margins. I think some of the factors that led to the lower margins were under absorption in Zarlink. It sounds like both of that should start to turn positive for you in March and June. I guess, I'm surprised you're not doing better than 20 to 30 basis points in March. Can you walk us through sort of the changes in gross margin? And do you expect to see acceleration in the gross margin as you get out to June and get out from some of these headwinds?

James J. Peterson

I can agree with the 20% to 30%, but I'll give John the evil eye. I'd like to see more of it as well. So, John?

John W. Hohener

Yes. No -- certainly, I think as we get past March, we'll start to see a little bit greater uplift in the gross margin. We do have some of the headwinds that we just talked about primarily addressing the Zarlink business. But from the standpoint of product mix, we do see favorable product mix coming in. As the sales go up, the absorption issues starts to go away. And again, we're starting to get away from Thailand coming past March.

Quinn Bolton - Needham & Company, LLC, Research Division

Great. Just a clarification, John, the tax rate of 10%, is that a good rate to kind of use in the go-forward model for this year and next fiscal '13?

John W. Hohener

Yes.

Operator

Your next question comes from Steve Smigie from Raymond James.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

I was wondering if you could just do a quick discussion of any impact that the Maxim business has in terms of revenue profitability.

James J. Peterson

Yes. First of all, let me just tell you that the Maxim carve-out, it was predominantly a strategic technology acquisition in carve-out, certainly evidenced in our commitment to this market space, not only for our employees, but we're kind of new in this market space that I think kind of lets those that want to compete against, so let them know that we're serious. Yes, I've seen more -- the acquisition of carve-out was more for technology, kind of less in the revenue component than I normally would do. That's been in R&D, if you'd like.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

With regard to the com business, you mentioned some weakness there. And hearing a little bit of data points that Q2, with the meaningful pick up in orders coming, I was just wondering if you're seeing that, how this kind of weighs out, but just sort of any color for com business? And sort of tied to that, just to refresh on where you think Zarlink com business can grow over the next several years now that you had a chance to look at it a little bit closer?

James J. Peterson

Yes, I think it's a great growth market. I think to the short, there are some headwinds, and that's a wonderful time to go take market share from Microsemi and our new team. It's certainly everything I expected and more.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Okay. And -- so the PA business, you said that was a little soft, but it seems like that should recover, or you're just saying that it's got -- obviously, you mentioned of the size of the coming opportunity. But if you'd just comment a little bit on if you see that recovering in this quarter and then, overall, when you see ac starting to ramp?

James J. Peterson

It was sizzling down. Ac, certainly, your guess is as good as mine, but I think it kicks in this year. I think it's going to be a great component. We in particularly have made investments in products and technology and roadmap around the 802.11ac with some very significant partners. We're very excited about our silicon germanium monolithic solution. I think it -- so from a technical point view, it certainly, outperforms anything that's out there. So just a little seasonal down tick in December and strengthening going forward certainly throughout the second half of the year, and I'll leave next year's comments to probably even much more aggressive.

Operator

Our next question comes from Harsh Kumar from Raymond James.

Harsh N. Kumar - Morgan Keegan & Company, Inc., Research Division

Actually, Harsh Kumar from Morgan Keegan still. So a question on March quarter. Jim, I was wondering if you could rank the areas of your category of revenues by growth, which one do you think is going to grow the fastest and so on and so forth.

James J. Peterson

Good question. Just to remind everybody, we have 4 areas. One is Enterprise & Communication. That was 31% of my revenue last quarter. That is certainly going to be stronger. The second one, let's stack rate that second one, Defense & Security. Last quarter, it was 29% of our revenues. That will be up next quarter. The third one of the 4, Aerospace, including Satellite, Commercial Air and radar products, that will be up next quarter. The last, but not least, Industrial Medical and, oh my gosh, Alternative Energy. We had -- that was about 20% of our revenue last quarter. I've got my team to have that as flat, and I'm telling them, let's go for the slightly up.

Harsh N. Kumar - Morgan Keegan & Company, Inc., Research Division

Okay. And well put, well put. And Jim, if I can slide one more in. So you've had a lot of acquisition. Can you remind us what your goal was in terms of where you want to see this company? Was it a billion-dollar run rate because you're right there? What are you trying to do in terms of top line? What are you shooting for with these deals on and what time frame?

James J. Peterson

Well, we want to get the infrastructure both up on or about $1 billion or $1 billion-plus. We want to focus, as we are, in the free cash flow. I think John mentioned that our cash component should be in excess of calendar year over $250 million. I'd say, let's do that and more. We certainly -- we're in the markets that we know or in markets that we're growing. Now I'm looking a little more aggressively, that's okay. Let's look at some strategic technology acquisitions. Perfect example is the recent carve-out that we did with Maxim. And thanks, Maxim, for allowing us to do that. And that's what we're focusing on here, probably to the next 12 to 18 months.

Operator

Your next question comes from Daniel Gelbtuch from Cantor Fitzgerald.

Daniel M. Gelbtuch - Cantor Fitzgerald & Co., Research Division

I was wondering if you could just give a little more color on the ac -- 802.11ac environment in terms of competition. And I understand that model that it should makes a big difference, but if you could just give us a little more color around what the competition looks like here?

James J. Peterson

I'd love to. I think the largest that -- I would even say the best position baseband partner out there in the industry has verified to us and our engineers that it's ours to lose. I think we have the best-in-class technology. We had the best-in-class roadmap, and we're looking forward to fulfill that like we've done in other market areas, to fulfill that ever-growing need that's going to be out there.

Daniel M. Gelbtuch - Cantor Fitzgerald & Co., Research Division

All right. And then anything going on different? Are there anything new in the Millimeterwave space?

James J. Peterson

Yes, a lot of good stuff there. I'm glad you brought that up. Millimeter would -- the space for everybody else is body scanners. The big thing is it's budgeted. The EU, the entire EU has decided that hey, guess what guys, there's 2 solutions. One, Millimeterwave, the other is x-ray. I don't have to remind everybody on this call, anybody that had gone to the dentist or a doctor knows x-ray is not good for you. So EU is not going to expand. They're going to expand their scanners, but they're not going to expand any of the x-ray. For our total dollars last year, we said, "Hey, we can do upwards of $10 million to $15 million." And we didn't. We were less than $10 million last year, and that was based on oh my gosh, guess what? Privacy concerns over security concerns. We have now solved that. The TSA has approved the new privacy concerns, but check this out, they approved it whether they're going to support at this point, only Millimeterwave technology and the software component are approved for domestic in the United States. It's an ever-growing market. I think we're still in the early innings. I think 400 million metal detectors are antiques, heading towards the bone yard. I think it's a great business for us, and we say this year, we could do $10 million to $15-plus million. I expect them to be towards the high side, and the purchase orders we received certainly are testimony, too.

Daniel M. Gelbtuch - Cantor Fitzgerald & Co., Research Division

All right. And then last question. Just if there's any way you could probably break up the 29% of the Defense business. I know that, obviously, it's not all military or fighting-related. So anyway, give us a more exact number or ballpark of what is just sort of allay the fears that are out there, what is the pure military portion of that, or is that 1/2? Is that 2/3?

James J. Peterson

Well, it's kind of blended. Let's just say we all think its 29%. But I'm here to tell you, they're tremendous profitable business. Although they we're going to enter the market, write all these Johnny come lately's over the last 3 or 4 years, they're not in play. We're taking market share. We've invested in this space. I think United States has done a great job in working with allied nations and increasing their technical capabilities in the defense space, it's -- for us, it's a fabulous market. And if it was all 29% base for just military, the electronic content, the component I have, I can be very happy with that as well.

Operator

Your next question comes from Craig Berger from FBR.

Christopher Rolland - FBR Capital Markets & Co., Research Division

This is Chris Rolland in for Craig. You guys talked about the fab consolidation on the call. Can you talk to us a little bit about what's sort of changing in capacity there and how it might affect the gross margins?

John W. Hohener

I'm sorry -- CapEx, okay. Yes, certainly, we have -- from a CapEx perspective, we are going through some consolidations. We have a number of sites in California, and we're consolidating them into San Jose and also into Aliso Viejo. So we did have some initial build out of facilities, and that's going to give us kind of a onetime CapEx spend over the next 2 quarters of $15 million and incremental to our normal operational spend of around $7 million. And then that will drop down to $7 million.

James J. Peterson

This speaks to the operational efficiencies of a larger company and building a strong infrastructure going forward. That's pretty much what this touched on.

Christopher Rolland - FBR Capital Markets & Co., Research Division

Okay, Those weren't fabs? Those were operational facilities outside of production?

James J. Peterson

Yes, exactly the case. I mean, quite frankly, this is a way also to cut our operating expense in terms of having multiple sites and then we're reducing it down to a lesser number of sites. So our ongoing lease expense will reduce when we're completed with this exercise.

Christopher Rolland - FBR Capital Markets & Co., Research Division

Okay, great. For a second question, where do you think your customers are now in terms of their inventory? So are we talking hand-to-mouth? Should be have some inventory replenishment maybe coming in Q2, something like that?

James J. Peterson

I assure you, we are lean on inventories everywhere, maybe with the exception of -- certainly the exception of solar products. Other than that, we are lean in the inventory category here at Microsemi.

Operator

Your next question comes from Andrew Huang from Sterne Agee.

Andrew Huang - Sterne Agee & Leach Inc., Research Division

So I think you said that you expect Zarlink to contribute like a mid-$40 million in revenue for the March quarter?

John W. Hohener

That would be right, my friend.

Andrew Huang - Sterne Agee & Leach Inc., Research Division

Okay. Can you tell us or share with us what the contribution was for the December quarter that you just reported?

James J. Peterson

We guided around $32 million to $36 million last quarter. We said we did slightly more. So I think if we said $32 million to $36 million, and we said we did slightly more, setting one at mid-point or slightly more. I mean, it was a good quarter.

Andrew Huang - Sterne Agee & Leach Inc., Research Division

Okay, great. And then given that the impact of Thailand kind of goes away by the June quarter, do you think it's reasonable that you could get gross margins up to like a 57% by the September quarter?

James J. Peterson

Well, as you know, my target to get gross margins certainly to stay higher than that going forward. But I think it's a contribution. John?

John W. Hohener

Yes. Certainly, what we've said publicly is that we will continue to increase it. We have a long-term goal of 60-30, which we said we'll get to in the second half of fiscal year '13. We've talked about 20 to 30 in this next quarter and increasing after that. I'm not going to give you absolute numbers in the out quarters.

Operator

Your next question comes from Patrick Wang from Evercore Partners.

Patrick Wang - Evercore Partners Inc., Research Division

Jim, just the first question for you. On that defense & security bucket, I think earlier you said that you're looking for that to grow 8% to 12% year-over-year. It sounds like it's an uptick from how you sounded before. And then also earlier, you said that customer sentiments was bottoming. So, just hoping you could talk about some the particular things you've actually seen or heard from customers?

James J. Peterson

Yes. Flat out. I'm excited that the budget concerns seem to be diminishing. I mean, the fact is that the budget that was talked about last August is the same budget that we've talked about by the Super Committee and oh my gosh, the same budget that was released. A Wilshire journalist had a great article. Oh my gosh, what a great thought. Service had more drones, let's take the troops home. That's not a new idea to Microsemi and to our customers. We've mentioned many times that electronic content is certainly expanding. Foreign military sales, you look at the Pentagon papers. I mean, look at the size of foreign military sales. And then I want to compliment my engineering team for the expanding product portfolio, whether we mentioned earlier a little kudos to the SoC group, our Rad Hard technology in taking market share from the ASICs and particularly in new space. I think the customers are now a little more confident in what programs are going to get blessed, which ones aren't. I think there's been great focus on the fact that 40% of the budget was wasted on administrative costs. That's being put under control. So I think it's not clear sailing everywhere, but certainly, I think the industry and our customers are much more comfortable than they were a quarter, 2 quarters and certainly a year ago.

Patrick Wang - Evercore Partners Inc., Research Division

Okay. And then when I take a look at just the numbers here, in order to get that type year-over-year growth number, we're looking for a much more robust second half, is that right?

James J. Peterson

Yes. I mean, again, there's forced modernization going on, there's great success in electronic content for the drones. If you look at these intelligence, the surveillance, the reconnaissance needs that are out there, and the fact that we're taking market share, people really got to understand that Microsemi and our product portfolio and we're dedicated investor in this market space, we're taking market share. So we can all haggle over -- is it 4 to 8, or 8 to 12, or 10 to 20? I'm here to tell you, we're taking market share, and that's our goal. And we're usually are the kind of company that say we're going to do it, we do it.

Patrick Wang - Evercore Partners Inc., Research Division

That's right. I guess I just want to follow up on one thing, just in the -- and I'm saying you talked about hitting that 60-30 target for growth in operating margins, perhaps in the June quarter. I'm just curious, what do you need to see happen?

James J. Peterson

Well, let me help you. I said on the second half of FY '13, which would be a June quarter, right, just to help there. And as a company, we're going to do it. I have actually greater confidence that the 30% might even be hit sooner than I would on the 60%. But that's what we're driving towards.

Patrick Wang - Evercore Partners Inc., Research Division

Yes, well, I guess I'm just curious, within that framework, what do you need to see happen to get there?

James J. Peterson

That's all getting particular. Steve, whisper in my ear that you're speaking Zarlink. Are you speaking Zarlink, or you're speaking companywide?

Patrick Wang - Evercore Partners Inc., Research Division

I'm just talking companywide.

James J. Peterson

Yes. I think more and more of what we've done. Two years ago, we're at 40% and much less than we were in operating income. I think we just talked some of the operational efficiencies. We applauded so many accomplishments, which showed their way in taxes, but certainly showed their way in gaining market share. I think we stayed on track with what we're doing, gaining market share, introducing new product, work on our efficiencies, be selective in margins we go after and how we approach them, and lo and behold, others can do 60-30, and I certainly will.

Operator

Our final question in queue comes from Mark Delaney from Goldman Sachs.

Mark Delaney - Goldman Sachs Group Inc., Research Division

Maybe first, you could talk about what your expectation is for pricing in 2012?

James J. Peterson

That's a good question. I think if you look at our product mix, our end markets, we have good solid steady pricing. I tend not to compete a lot in the multi-sourced 7 or 10 consumer spaces out there, especially in my Defense & Security markets, Aerospace markets. I'm glad to see in the Communication market that if you offer a better product, you get a better price. That's confidence building since we got involved in the Zarlink business. So I don't think you're going to see me being in competitive situations where my income for those products are going down by 50%. Therefore, the silicon content has got to go down 30% greater than that. I'm confident in strength of my pricing going forward.

Mark Delaney - Goldman Sachs Group Inc., Research Division

That's helpful. And then as a follow up, within your outlook for 8% to 12% growth business in your defense business, you talked about some market share gains that you're planning to do this year. How much of the growth is coming from those market share gains?

James J. Peterson

Probably, if -- I'm just going to take a swag and say a good 25%, 30% could be taking some market share. If a little less that, a little bit more, I'd be happy with the direction with my eye on the target.

Operator

I'll turn it back to management for closing remarks.

James J. Peterson

Okay, this closing remark is plain and simple. Thanks for joining us today, and have a great day.

Operator

And this concludes today's quarterly update. You may now disconnect.

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