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Fairchild Semiconductor International, Inc. (NASDAQ:FCS)

Q4 2008 Earnings Call

January 29, 2009, 09:00 ET

Executives

Steven Leibiger – Investor Relations

Mark Thompson – President and CEO

Mark Frey – Executive Vice President and CFO

Daniel Janson – Vice President of Finance

Analysts

Ross Seymore – Deutsche Bank

Romit Shah – Barclays Capital

Shawn Webster – JP Morgan

John Pitzer – Credit Suisse

Steve Smigie –Raymond James

Tristan Gerra – Robert W. Baird

Parag Agarwal - UBS

Operator

Good day ladies and gentleman and welcome to the Fairchild Semiconductor four quarter and year end earnings conference call. Please note that today’s conference call is being recorded. At this time I would like to turn the over to Mr. Steve Leibiger, please go ahead sir.

Steven Leibiger

Thank you. Good morning, and thank you for dialing in to Fairchild Semiconductors fourth quarter and full year 2008 financial results conference call. With me today is Mark Thompson, Fairchild’ President and CEO, Mark Frey, our Executive Vice President and CFO, and Daniel Janson, VP of Finance.

Let me begin by mentioning that we will be attending the Thomas Weisel Tech’s conference in San Francisco on February 10th.

Mark Frey will start today’s call with a review of the fourth quarter financial results and discuss or outlooks for the first quarter of 2009. Mark Thompson will then discuss the company’s operational performance in more detail and update you on how the company is managing through the current market environment.

Finally, we will reserve time for questions and answers. The call is scheduled to last approximately 60 minutes, and is being simultaneously web cast from the Investor Relations page of our website, fairchildsemi.com. The replay of this call will be publicly available for approximately 30 days.

Fairchild management will be making forward looking statements in this conference call. These statements include all those about future results in performance and are made based on assumptions and estimates that involve risk and uncertainly. Many factors could cause actual results to differ materially from those expressed in forward looking statements.

A discussion of these risk factors is provided in the quarterly and annual reports to be filed with the SEC. In addition, during this call, we may refer to adjusted or other financial measures that are not prepared according to generally accepted accounting principles. We use non-GAAP measures because we believe they provide useful information about the operating performance of our businesses and should be considered by investors in conjunction with GAAP measures that we also provide.

You can find a reconciliation of non-GAAP to comparable GAAP measures at the Investor Relations section of our website at investor.semifairchild.com. The website also contains the 2008 Q4 fact sheet, an updated financial section with our latest unaudited financial high lights including detailed breakups of segment and regional revenues gross margin, EBIT, and EBITDA.

Now I will turn the discussion over to Mark Frey.

Mark Frey

Thank you Steve, good morning and thank you for joining us.

The progression of our business throughout Q4 2008 was unprecedented. We entered the quarter with a little over 340 million of backlog scheduled to ship. Our final sales were 320.9 million, which was 25.1% sequential, and 25.7 year to year decrease.

Gross margin for the quarter fell 340 basis points sequentially, to 26.5% due mainly to lower factory utilization, which was partially offset with significant decreased in spending, reversal of bonus and certain equity accruals, and favorable currency and commodity prices.

For the fourth quarter, the company posted a net loss of 218.1 million, or $1.76 per share, compared to a net gain of 26.7 million or $0.21 per diluted share in the prior quarter, and new income of 34.0 million or $0.27 per diluted share in the fourth quarter of 2007.

The loss is mainly due to four special charges taken in the quarter. The first is a non-cash goodwill impairment of 203.3 million, necessary on a US GAAP, mainly due to the drop in the company’s market capitalization.

Second, we recorded a 19 million non-cash impairment of auction rate securities. We believe these investment grade securities will continue to pay interest normally and will yield expected value on maturity. 17 million of this impairment had previously been recorded on the balance sheet in other comprehensive income, but due to the continued instability of financial markets, we concluded that we should record this impairment on the income statement as well.

Third, is a 15.9 million restructuring and asset impairment charge. This charge is primarily associated with the previously announced headcount reduction and company streamlining, and includes 4.5 million of non-cash asset impairments.

Finally, we reduced our reserves for potential litigation outcomes by 3.3 million due to the recent favorable court ruling that reduced the damages awarded in currently active power integrations litigation.

Excluding these and some other small charges, the company reported fourth quarter adjusted net income of 7.7 million, or $0.06 per diluted share compared to adjusted net income of 34 million, or $0.27 per diluted share in the prior quarter, and adjusted that income of 41.8 million, or $0.33 per diluted share in the fourth quarter of 2007.

Net interest and other expenses were 6.2 million in the fourth quarter, a 15% sequential increase driven by an increase in liable rates at the end of the third quarter.

These liable rates have recently dropped below prior levels, which will have a beneficial impact on Q1 2009 interest rate expense.

Fourth quarter GAAP taxes were a net favorable 11.4 million, and reflected a 14.9 million benefit related to the impairment of goodwill.

For the quarter ended December 2008, the adjusted effective tax rate was 29.4%, and included a special charge for the write down of deferred tax assets due to corporate tax rate reductions announced in Korea. Without this charge, the adjusted effective tax rate would have been about 17%.

As I said earlier, we started the fourth quarter with much higher revenue expectations. As the market climate continues to deteriorate we reduced our bill plans and shipments into distribution channel to control inventories.

To manage our costs in this environment we had two weeks of factory shut downs, to transport volumes from our subcontractors to our internal factories, required mandatory employee vacations, and implemented additional discretionary cost reductions/

In November, we took additional actions accelerating our restructuring program to reduce headcount by more than 1,100 employees. These actions combined with the reversal of our bonus and performance paid equity accruals maintained gross margin of 26.5%.

R&D and SG&A sending was reduced 16 million sequentially to $68 million.

The 2008 bonus cancellation and reduction in equity compensation accounted for approximately 8.5 million in one time OPEX savings.

Our cash flow from operations was 14.7 million in the fourth quarter, and capital spending was 35.6 million.

As we completed previously announced projects, including package in-sourcing, and the 6 to 8 inch wafer fab conversion at our main facility. Now that this work is done, we expect to dramatically reduce capital expenditures for 2009 to a full year target of approximately $60 million.

We continue to maintain a strong balance sheet, with 386.9 million cash and securities on hand.

Now, I would like to review fourth quarter and year end highlights of sales and gross margin performance for our product group.

For MCCC, revenue for the fourth quarter was 125.7 million, down 27.3% sequentially, and 28.6% compared to the prior year. Gross margin was 35.9%, up 70 basis points from the prior quarter. MCCC gross margins benefited from favorable product mix, and smaller inventory charges offset partially by decrease in factory utilization.

PCIA had 121.3 million of revenue in the fourth quarter, down 24.5% sequentially, and 23% annually. Gross margin was 24.9% compared to 30.2% in Q3. PCIA margins were negatively impacted primarily by unfavorable product mix and reduced factory utilization.

For SPG, revenue for the fourth quarter was 73.9 million, down 22% sequentially, and 24.9% annually. Gross margin was 14.5% compared to 21.2% in Q3. This decrease was primarily the result of inventory charge offs and lower factory loadings.

Turning to the first quarter of 2009, the restructuring actions announced in November are in the process of being implemented and are designed to reduce costs by about 33 million on an annualized basis relative to a Q3 2008 baseline

We expect partial savings from these actions in Q1, and then nearly full impact in Q2, and the rest of 2009. In addition to these restructuring actions, we planned further temporary cost reductions from additional time off and benefit adjustments, which we believe will save $5 million per quarter.

We anticipate these measures along with strict discretionary spending controls, and a significantly reduced capital budget will improve our cash generation and lower our cash break even point to about 250 to 275 million of sales per quarter once all restructuring is complete.

In light of the level of uncertainty in the current market environment, measures we typically use to forecast sales, such as current backlog and historical order rates, no longer enable accurate guidance.

Nevertheless, we want to provide current information to investors, therefore we are changing our normal guidance policy until further notice.

Today we are disclosing our current backlog, in our view of first quarter business expectations. However, we are not assuming any obligation to update this information, although we may choose to do so before we announce first quarter results.

As of today, we have about 205 million of backlog for Q1. Based on order patterns observed so far in January, we should post additional turns business in the quarter. Assuming we continue to record positive fill, we presently expect first quarter sales to be between $220 and $245 million.

Based on our distributors’ forecasts for sell-through, this amount of revenue would result in a significant channel inventory reduction. Assuming this level of business, gross margin would be 14 and 18%.

Operating expenses for the quarter are currently estimated to be in the range of 73 to 76 million. We expect to incur an additional cash restructuring charge of about $7 million in connection with staffing reductions announced last quarter.

Capital expenditures are expected to be limited to about 60 million for all of 2009. Interest expense for the first quarter is projected to be between 4 and 5 million, while our tax expense is anticipated to be around zero.

We reiterate that, although this information reflects our best available information as of today, this should not be reviewed as equivalent to guidance we have historically given.

Now, I will turn the call over to Mark Thompson.

Mark Thompson

Thank you Mark, our industry saw a significant reduction in demand in Q4 driven by broad based weakness in virtually all end markets and regions. The speed and magnitude of the slowdown in orders, coupled with the more modest decline forecasted by our customers end market suggest the industry is working through a temporary but significant inventory reduction.

We are using this slowdown as a catalyst to accelerate our existing transformation plans, and have detailed in this call an extensive list of restructuring and cost reduction actions that are under way.

The additional temporary cost reductions Mark discussed will remain in place through the first half, or until demand reaches levels well above Q1.

We are well positioned to manage through this cycle given our improved cash break-even point and strong balance sheet.

Let me now summarize our inventory situation we responded quickly in cutting our factory output in line with the rapid decrease in demand during the fourth quarter. We maintained inventories roughly flat in dollars compared to the prior quarter, throughout our extended supply chain.

We reduced our internal inventory by $2 million sequentially by cutting production starts and implementing a two week factory shut-down over the holidays. In terms of days, the internal inventory grew from 72 days to almost 90 days in response to the large decrease in sales.

Inventory to our distributors grew by less than 2 million, even though their sell-through was significantly below projections. This significant reduction in revenue out of the channel caused week’s inventory to increase to approximately 15 weeks.

Overall average product selling price is down between 1 and 2% sequential, which is normal for us. Lead times exiting Q4 are in the four to six week range allowing us to be very responsive to turns business.

Utilization decreased to the low 70s in the quarter, and we expect this rate to fall again in Q1.

I would now like to talk a bit about our product lines. I think it is important for all products success of last year not be overshadowed by the recent events. Our focus remains on creating new and exciting products that meet our customers’ needs and solve important problems.

On this front, Fairchild Semiconductor made considerable progress in 2008. We believe we can hold market share on our baseline business, while gaining share in our target applications with innovative new products.

Our mobile computing consumer and communications group continue to concentrate on high value analog products, and on forging partnerships with top tier OEM in the handset and mobile computing market.

We were especially successful in mobile power solutions, analog switch, and signal conditioning products. Mobile power solutions revenue almost doubled in 2008, relative to 2007, driven by multiple design wins major handset OEM.

Significantly, we have leveraged the success of our world-class switching power regulators with collateral design wins and other product types, including analog switch USB transceivers and USB charters.

This lateral movement from our core competency and power to other high value product areas with our key customers is one of our goals.

Signal conditioning increased revenue more than 50%, and improved gross margin several percent in 2008, versus the prior year driven by video filters and mobile application specific semiconductor products.

In 2008, analog switch increased revenues and gross margin again over the prior year.

MCCC had several important technology developments in 2008. A [wafalit] lever chip scale packaging development project remains on schedule for production in mid-2009 and will result in significant cost savings compared to using subcontractors.

Initial low voltage (inaudible) products were released using our new Power Trench VII technology. This advanced process enables us to significantly reduce dye size to reduce costs in this very competitive business segment.

Our power conversion, industrial, and automotive groups continue to focus their efforts on products that convert and save energy in the consumer, industrial, and automotive sectors.

The auto team was able to validate their strategy of using focusing on smart modules and protective switches, as revenue grew by nearly 4 million annually in these two areas.

IGPT revenue increased 6%, and gross margin improved year end year by six points.

Our smart power module business continues to gain traction and had a very strong year in 2008, growing by more than 45% annually in revenue.

In power conversion we captured significant adaptor business, using our primary side regulators at one of our Tier 1 power supply customers.

Lighting grew more than 25% during the year. We also launched our T series devices, and gained traction in both TVs, as well as LED lighting applications.

Our 85-plus solutions for PC power supply applications was launched at the end of 2008.

On the technology side, we have qualified the in-house high-voltage IC process, thus giving us the ability to lower the costs on our foundry fabricated products and also giving us a platform to develop additional process technology intellectual property.

Our standard products group reported results separately for the last time in Q4 2008. Beginning in Q1, SPG will be merged into our other two product groups and cease to exist independently. This is being done as both a cost cutting measure and as a way to further enhance the value within SPG.

The Logic products, including our growing family of voltage translators for cellular applications will become part of MCCC. The opto-coupler products will be moved topics, creating synergy with the power supply and industrial products that we make.

Finally, we are keeping the standard discreet and standard linear business separate as we manage them for cash.

For the quarter, SPG had revenues of 73.9 million and gross margin of 14.5 %, while for the year revenue was 359.4 million and gross margin was 19.8%. About 35% of sales were Logic, about 18% opto-couplers, and about 47% standard discreet and standard linear combined.

I would like to quickly summarize our ongoing legal actions with power integrations, since there were several important events on that front in the last quarter.

as we announced in December, the court overseeing the case reduced the jury damage award against us from 34 million to 6 million. The court also ordered a new trail on the issue of willful infringement. These rulings came only days after the US Patent Office rejected all but one of the unexpired patent claims asserted against us during the trial.

The Patent Office found those claims invalid because of prior art. Although the court granted an injunction against the limited number of Fairchild products, the judge in the case quickly granted a temporary stay of injunction after we brought the Patent Office’s decision to his attention on an emergency basis.

We are now seeking a permanent stay of the injunction pending our eventual appeal of the entire case on several grounds. That appeal cannot occur until after the new trial willfulness, which we expect will take place later this year.

We are gratified by these recent decisions by the courts and the Patent Office, with substantiate positions that we have always taken in this lawsuit. Of the 22 unexpired patent claims that (inaudible) asserted against us during the course of the litigation, 20 now stand rejected by the Patent Office.

I should also point out that as a precaution we voluntarily suspended sales of affected products from the US market in late 2007, and offer a full line of replacement products that would not be affected by the injunction if it were to come back into force.

I will conclude with a few comments about how I see the company right now. While the macroeconomic forces buffeting our industry present many challenges, they also create opportunities.

Fairchild has seized this opportunity to accelerate our streamlining and process simplification programs. The current environment is a catalyst for us to take a fresh look at everything we do, and to focus on the essential actions needed to drive better profitability while delivering greater value to our customers.

We believe the changes we have made and continue to make prepare Fairchild to be an even more successful enterprise once business picks up.

Our costs are down significantly, and we are effectively managing our supply chain to hold inventories in check. Our product pipeline is wide, deep, and growing, our operations team is ready to deliver world class cycle time, cost, and quality. We are ready to weather this current cycle, and we will emerge a better company than ever.

I want to thank our customers, employees, and shareholders for their support in 2008, and look forward to expanding on our success in 2009.

Thank you, I will turn the call back to Steve.

Steve Leibiger

Thank you Mark, we will now open the call to questions. I ask that in order to allow more of you to ask questions we limit each person to one question and one follow up. Thank you, now let’s take the first question.

Question-and-Answer Session

Operator

Thank you ladies and gentleman. (Operator instructions). We will go first to Ross Seymore of Deutsche Bank

Ross Seymore – Deutsche Bank

Thank you, on the inventory front I was a little surprised that the channel inventory did not come down, or yours did not come down given how you said that the channel wanted to bring inventory down, first question is how much do you think the channel of inventory can come down in the first quarter, and what do you expect your own inventory to do in the first quarter?

Mark Thompson

Ross, a couple of things, if you look at the fourth quarter, it was a bit of a guessing game that we had to engage in because the forecasts were weakly reduced by our channel partners and it was trying to hit a bit of a moving target.

Clearly we would have preferred to reduce them, but we were actually aiming for a reduction in but the end re-sales came in below the original forecasts, so that was the reason for that small $2 million increase there, which was roughly offset by a $2 million decrease internally.

Our goal is to reduce channel, based on current forecasts by some multiples of $10 million, again it is a pretty broad range, it is a hard to take forecast at face value, but I will be multiples of $10 million based on the current bill plan and resale estimates. With that, we would also anticipate a small internal inventory reduction, but not of the same order of magnitude as the channel reduction.

Ross Seymore – Deutsche Bank

You have given it more in the channel on a weeks bases, I think it went from 11 weeks to 15 weeks, from the third to the fourth quarter. What does that multiples of 10 million mean on a weeks basis?

Mark Thompson

I have not done that calculation. The weeks basis is obviously a denominator effect.

Ross Seymore – Deutsche Bank

What if the absolute dollars go down by that math, because we do not know the total amount on dollars?

Mark Frey

It would still get us to around 12-ish, because you still have a denominator effect in Q1, as we think our distributors’ customers are still reducing some level of inventory.

Ross Seymore – Deutsche Bank

In the gross margin dropping by about 10 points, how do we think about what is included in that drop, under utilization charges, inventory write-offs, etcetera?

Mark Frey

It is primarily under utilization charges, plus the bonus reversal that we incurred in Q4 does not recur in Q1, that is about $6 million.

Ross Seymore – Deutsche Bank

Thank you.

Operator

Next we will hear from Romit Shah with Barclays Capital

Romit Shah – Barclays Capital

Good morning guys, you announced a number of cost saving initiatives, and ou talked about cash break-even of 250 to 270, Mark, when do you think we could get to that break-even, is it the second half of the year, or do you think it is earlier?

Mark Frey

It is early second half of the year, it is towards the end of the first half because the restructuring actions are underway right now.

Romit Shah – Barclays Capital

That is helpful. On the bookings in January, I was curious how does that, there is another company that have talked about a pick-up in bookings in January, I am guessing versus December, which was a pretty weak month. I was wondering how January compared to October-November, are orders up versus those months, or are they down?

Mark Thompson

Romit, it is a little bit of a complex calculus on that, what we saw was a net backlog reduction across the fourth quarter. If you look at the numbers that Mark offered in his commentary, we shed backlog across Q4, which is a negative order rate. What we have seen is that our turn occurred in the early part of January, so it is really difficult to trend that. We don’t have a lot of data on that slope. We always have the noise of the Chinese New Year, which we are in now, so I think that it is not going to be, this is, I would say, a general industry statement, not just a Fairchild statement. I think it is going to be March before any of us would be comfortable doing a trend line on that incoming order rate and saying, “Okay, this is what it means.”

But certainly from a backlog point of view, a very clear bottom was marked for the end of December, early January.

Romit Shah – Barclays Capital

Yeah, Mark, I am just trying to get some perspective on this – if this is just kind of a [Headsake] or the mark of a major inflection point. Is it normal for you to see a pick-up or an improvement in your backlog, coming into January?

Mark Thompson

I think it is fair to say that all the normal things are different this year, so, no it is not. Normally, the typical pattern is for there to be obviously, Q3 to be very strong, incoming orders continuing to be strong through the first two months of the fourth quarter, and then slowness in December and then a coma-like state for January. And so, this is a different pattern and so although the backlog is low, certainly in my history with the company, this is the first time we have seen a turn in that during January. But again, all the patterns, as we have tried to comment are different in this current cycle. And so, until we get some new trends, it is going to be really difficult to construct a model.

Romit Shah – Barclays Capital

OK, granted, that is helpful, and just lastly, can we get a D&A and stock option expense guidance for the first quarter, please?

Mark Frey

It is about 5 million. 31 – That does not include the intangibles, so it would be 36 with intangibles.

Romit Shah – Barclays Capital

Then stock comp?

Mark Frey

About 5 million.

Romit Shah – Barclays Capital

Thank you.

Operator

Next we’ll move on to Shawn Webster of JP Morgan.

Shawn Webster – JP Morgan

Yeah, thank you. Can I get some clarity on a couple of things? One is the bookings and backlog and the other is your OPEX, last quarter when you entered Q4, you were 88% booked, what was that number this time?

Mark Frey

Well, we told you the backlog coming in is 205.

Shawn Webster – JP Morgan

That’s as of today.

Mark Frey

Yes, and the range that we gave you – do that math – and we have booked positive orders in the first few weeks into that number, but I don’t have the specifics on that.

Mark Thompson

We have booked 15 to 20 million.

Shawn Webster – JP Morgan

But am I correct in thinking that is not a comparable number to what you have given in the past, your 88?

Mark Thompson

Yes, normally we would give a guidance number and then a fill rate, we can’t offer a guidance number, therefore a percent filled doesn’t have a meaning and that is why we have offered simply the backlog number, but the current number is 15-20 million higher than it was entering the quarter.

Shawn Webster – JP Morgan

What was your head-count in Q4?

Mark Frey

About 9700 people.

Shawn Webster – JP Morgan

Was that flat, up, down from Q3?

Mark Frey

Down, but most of the restructuring actions are happening right now.

Shawn Webster – JP Morgan

I see. And for the OPEX that your guidance for the low 73 in Q1, that is up sequentially, is the right comparable the 68 million in Q4?

Mark Frey

Q4 was 68 and if you added the impact of the accrual reversal, it would have been about 74.

Shawn Webster – JP Morgan

Okay, so what’s happening is that you don’t have the accrual reversals happening in Q1 and that’s why its popping up again?

Mark Frey

Correct. Remember, Q4 did include already – you know, the run rate prior to that with a modest bonus accrual was in the 88 range. And so, Q4, even without the accrual reversal was a significant decrease, which was forced vacation, discretionary spending items, so those items just come across to Q1. There are additional restructuring actions that were taken in Q1 that will push OPEX probably lower than this 73-75 level as we advance through the year. However, a couple of things come into Q1, which is FICA matching and other regulatory costs.

Shawn Webster – JP Morgan

So as we set up our models for OPEX throughout the year, given the restructuring plans, should OPEX be stable at the 73 kind of run-rate, or will it come down from there?

Mark Frey

It will be stable to down in the second quarter. In the third quarter it remains to be seen. The items that we have announced that are $5 million are temporary, so for our planning purposes we expect to put them back in the second half. But we will really have to determine that as we see the backlog evolve in April and May.

Shawn Webster – JP Morgan

What was the dollar amount of your inventory write-downs, in the quarter?

Mark Frey

It is about normal, about a million more than we normally would have done.

Shawn Webster – JP Morgan

Last one, as you go into Q1, can you rank the strength of your end markets – I understand that everything is weak, given the guidance, but is there anything that is relatively stronger or the most weak?

Mark Thompson

The thing that stands out for its strengths are some of the industrial spaces, particularly some of the motion control; the DC motor drive business is up sequentially, significantly in Q1 versus Q4, that’s been on a very strong trend line. I think that some of the efficiency-driven designs in appliance and in general motion control have driven those. So those are clearly strongly up, sequentially. Most of the consumer mobile spaces are working through a variety of layers of inventory change, which make it difficult to figure out what the exact end demands are. But certainly, if you look at the typical equipment space, whether it is cellular or notebook computing, versus the sales into those, as we commented, we see Q1 significantly below end demand. So, whether that delta ends in the first quarter or trickles into the second, I think, is one of the things that makes it difficult to get at what the core demand is going to head back toward.

Shawn Webster – JP Morgan

Thank you very much.

Operator

And from Credit Suisse, we will hear from John Pitzer

John Pitzer – Credit Suisse

Yeah guys, thanks a lot. I think you said in your prepared comments that utilization in the December quarter was in the low 70s, I am trying to get a sense of where that might go in Q1, is it kind of the low 60s? And I guess, given where lead times are, given where inventory is, why not try to take a more aggressive stand in lowering inventories into Q1, on your own balance sheet?

Mark Frey

We do expect utilization to go down, closer to the lower 50s, and we are prioritizing getting our channel inventories down. We will target reducing our internal inventories, but we are prioritizing doing that at the channel because, obviously, its farther away from the customer if its in our inventories and if we have a bounce back then we would be more flexible to use it.

John Pitzer – Credit Suisse

You made the statement that you believe that production is well below consumption in the calendar first quarter. I guess, just given that you fell a little bit short of that expectation in the calendar fourth quarter, which had some positive seasonality, why so confident that the gap between production and consumption is as you guys put it, “significant in the March quarter”?

Steve Leibiger

I think that the math is easy to characterize but harder to quantify. So, if you look at the reduction in demand for sales and to take a couple of key segments like cellular and computing, they are down on the order of 50%, and that’s across two quarters. Sales of cell phones and PCs are not down 50% across the same time period. So, clearly they are down, but every major OEM at one level or another has said that everyone is actively reducing inventories. We are actively reducing inventories, the OEMs are actively reducing inventories, the resellers are actively reducing inventories. So, the simple numbers tell you that. The pace at which it will swing the other way is the unknown.

John Pitzer – Credit Suisse

On the cost side you have clearly done a lot there. I wonder if you could help me understand the two buckets between sort of temporary cost reductions and more permanent cost reductions and help me quantify the size of each one of those buckets as you look through the balance of ’09.

Mark Frey

Well, the temporary is 5 million per quarter and it consists of things like continued vacation taking, 401K matching – items like that. The 1100 people specifically, is about 33 million on an annualized basis. Obviously, like any semiconductor company, we have all kinds of cost reductions; whether it is converting our gold traces to copper or cheaper lead frames, etcetera – we don’t quote what that is, but that does give us positive cost momentum. Then the continuance of discretionary control over services, over travel, etcetera, is in the $5 million plus, as well. Is that what you were looking for?

John Pitzer – Credit Suisse

Yeah, that was exactly what I am looking for, guys, I appreciate it. And then lastly, if I can sneak it in, pricing was pretty normal in the December quarter, but pricing is usually pretty normal the first couple of quarters of a downturn. Your expectation, as units start to come back, given where industry utilization levels are, what are your expectations around pricing, in the recovery environment?

Mark Frey

I would expect that it would be a little more than seasonal, for the same reason. It’s hard to reduce prices when you are not buying anything. I think when there are orders to be let, we will see that pressure emerge.

John Pitzer – Credit Suisse

Any magnitude that you would like to share?

Mark Frey

I don’t think it will be like the last cycle, but it is really hard to say at this point.

John Pitzer – Credit Suisse

Great, thanks guys, appreciate it.

Operator

We will next hear from Steve Smigie with Raymond James.

Steve Smigie – Raymond James

Great, thanks. I was wondering if you could talk a little bit about the variables in coming in at the high end or low end of your gross margin guidance, and what that might look like going throughout the course of the year.

Mark Frey

The principle variable would be whether we come in at the high end or the low end of our revenue suggestion and that’s really the major driver. The cost calculations and all that have been determined, and they are based on action plans and the timing of factory shut-downs, etcetera.

Steve Smigie – Raymond James

Any sense – obviously it’s heavily revenue dependant, but – other factors going on there that might give you some sense of what the cost margin could like throughout the course of the year?

Mark Frey

Well, the major additional factors is particularly: the value of the log, which has a big impact on our cost structure – that is a little favorable at the moment, in the mid 1300 range, the price of gold is on the opposite end of the range, it’s $875 today, those kinds of things.

Steven Leibiger

Steve, the one thing I would add to Mark’s comments is that we are operating outside of the normal bounds, so everything winds up – when we are below 80% utilization – everything winds up being period expensed. So, whereas normally we see this effect of, what we build in one quarter affects the cost structure of the next. Because it is all period expensed, when demand turns the other way, we expect that to improve gross margins more rapidly than normal.

Mark Thompson

And Steve, the other thing I would add, too, is that one of the things you have heard us talk about are some pretty substantial baseline cost productions, which over time should improve our gross margins at comparable revenue run rates going forward. So, there has been a real structural change made to the cost basis for the company.

Steve Smigie – Raymond James

Alright, great, and if I could squeeze in one more, just something about the (inaudible) security impairment and I apologize if I missed it, but did you comment on if you see potential for future further impairment?

Mark Frey

We have six or seven securities that are generally insurance products. They are investment-grade rated and we give them investment-grade risk profiles when we discount the value. If that situation changes, then we will discount them at a higher rate and produce a larger impairment. But, so far, they have held up because they are not sub-prime, they are not due to loans and things like that.

Steve Smigie – Raymond James

Great, thank you.

Operator

We will next hear from Tristan Gerra, Robert Baird.

Tristan Gerra – Robert W. Baird

Hi, good morning. When do you expect a return to normal utilization rates, given the 45% or so revenue decline over the past 6 quarters and are you looking at a potential more permanent reduction in actual manufacturing output?

Steven Leibiger

Tristan, that is one of the key questions that we obviously have two scenarios for. Every model that we can construct suggests that the first half demand is less than the true end demand and therefore we would expect some demand recovery in the back half of the year, maybe even in the second quarter. Obviously, if that turns out not to be the case, then we will do more aggressive structural things to permanently size ourselves, so again, we have really two sets of plans – one is based on all the current macro-economic models and inventory models that we are currently operating to, and we also have another plan which is to your point – a permanent elimination of capacity which would obviously resize the utilization rate.

Tristan Gerra – Robert W. Baird

Could you qualify the central expectation you have for Q1 and say again what it was in Q4?

Mark Frey

We don’t disclose our sell-through dollars. Sell-through in Q4 was obviously down about the same percent as sell-in, because the inventories remain roughly flat. But, we expect that the sell-through will reduce by a substantially less percent in Q1 relative to our shipping in, and that is why we think the channel inventories can contract. That’s based on the forecasts that we received from our distributors to date.

Tristan Gerra – Robert W. Baird

Great, thank you.

Operator

And from UBS, we will hear from Parag Agarwal

Parag Agarwal – UBS

Hey guys, just a question about your capital structure. Do you guys have a possibility to buy back the debt at lower prices?

Mark Frey

Our debt is trading at about $70 and we do, but you can’t just do it on the market, we have restrictions, so we would have to go to the bank group and offer to do that. We have no plans to do that at the current time.

Parag Agarwal – UBS

Could you give that cash flow from operation and free cash flow for the December quarter, please?

Mark Frey

Cash flow from operations was 14.7 and free cash flow was a negative 20.9, because we were paying off the last of the capital installments on the 8-inch expansion.

Parag Agarwal – UBS

Okay, thank you.

Operator

Craig Berger from FBR.

Craig Berger – FBR Capital Markets

Hey, thanks for taking my question. Getting back to the pricing, you said you expected to intensify as business comes back a bit, I mean, do you intend to use price as a (inaudible) to get more business?

Mark Thompson

Well, Craig, as we commented, we intend to maintain share in our course basis so I think what that means is that some combination of availability feature and price will be required in order to do that, but we’ve not –what I’d say- bought share in the past, and we don’t expect to all of a sudden; we won’t be the ones that will be driving price decline. I guess that’s probably the best way to put it.

Craig Berger – FBR Capital Markets

Can you update us on where you’re at, what’s you back-end in-sourcing transition?

Mark Thompson

That’s done.

Craig Berger – FBR Capital Markets

How much is internal?

Mark Thompson

Today we’re about 75% internal.

Mark Frey

70%, so in a sense, we do settle in-sourcing at this point. The in-sourcing we’ve talked about is capabilities that we didn’t really have before, that we’ve put (inaudible) primarily for higher power packages like the TO220. Across the spectrum of packages, we have sub continently had internal capacity, and we lowered the loading with subcons significantly more in Q4 than we did for internal factories in Q4, and we will continue that trend in Q1 to a point where we’ll get to more like 70% in 30 hours without really capital investment.

Craig Berger – FBR Capital Markets

Are the gross margin benefits related to that, already kind of baked into the Q1 guidance or is there more post-benefits to be had going forward?

Mark Frey

No, they’re baked in. Going forward, the same leverage factor will occur. We will load our factories until we get them back to normal utilization before we go to subcons, and therefore, when we do get revenue upside, we expect a lot of drop-through of the revenue upside.

Craig Berger – FBR Capital Markets

What should we be thinking about for taxes for the year: the subzero in Q1?

Mark Frey

When you actually get into a loss situation or even a break-even situation, there’s about $2-3 million cash tax that we incur in our distributor countries in our basic cost structure. After that, our profits either are in Korea or in the U.S. In the U.S., the tax rate is zero so it doesn’t matter. If they’re in Korea, then we get a tax credit. We believe that that expected credit in Korea will be about the same amount as the $2-3 million of absolute dollar expenses, so it’s about zero.

Craig Berger – FBR Capital Markets

With substantial losses likely to continue through the year, at least based on what we see now, is zero the right way to think about the future orders?

Mark Frey

Yes, I’d think about it as about zero going forward. I would not view some major tax; structural shipped occurring there. It could move slightly into a credit mode, depending on whether the losses were in Korea or in the U.S.

Craig Berger – FBR Capital Markets

How much cash are you comfortable burning this year? I know you’re taking you CapEx down so you get a $60 million benefit from phantom depreciation but you could still burn $60, $70, $80 million in cash. How long would you let that continue before you take additional actions?

Mark Thompson

We expect to consume a modest amount of cash in the first quarter and we expect to be cash positive on the year.

Mark Frey

In terms of comfort, we want to generate cash. We want to generate cash all the time. We’ve taken very serious measures on CapEx so you can expect a $10-12 million range in the first two quarters of the first half. We said $60 million for the year, but if things don’t strengthen, then we’ll take a look at that number.

Mark Thompson

The $10-12 million isn’t per quarter, then. That’s cumulative for the first half so: single digit.

Craig Berger – FBR Capital Markets

Last question: What was the reasoning behind the segment re-class again; it seems like every few quarters we re-class.

Mark Frey

It was simply to reduce an overhead structure. We thought that the two principal product lines that we moved into MCCC and PCIA could be well-managed by their management teams because they overlapped in the same market applications, and then there was a small business left over that is very distribution-oriented and doesn’t take a lot of attention. We just thought we could eliminate several right positions by doing that.

Craig Berger – FBR Capital Markets

Thanks.

Operator

[Operator instructions]. From Banc of America Sumit Dhanda.

Sumit Dhanda - Banc of America

Thanks for taking my question. Just want to circle back to your comments about the break-even point and also the OPEX savings. Mark, just to be clear, based on what you suggest, it does sound like we should be looking at OPEX decline of roughly $15 million off of the 3Q of 08 level sometimes by the June quarter, is that fair?

Mark Frey

(inaudible)

Sumit Dhanda - Banc of America

You suggested that you’re looking at break-even, the [Isume] on cash EPS, sometime by late June quarter or the September quarter on: call it $260 million in revenues, is that fair?

Mark Frey

There are two components. I don’t want to commit to a time. We said June because the break-even is based on the restructuring actions that are underway right now so we’re taking our costs down, primarily in Q1 but some more in Q2. In terms of the $250-275 million, that is just the sizing that we think we would be at. We’re not saying that we think revenue would be in that range.

Sumit Dhanda Banc of America

I understand, but if I were to look at your internal scenario, it would seem to imply - just given the OPEX that you have talked about plus some more OPEX declines that you just referred it- it would seem to imply that you’re looking at, call it 12-point swings and gross margins. I understand you are not [committing (1:00)] to anything, but can you just give us a road map as to how you think you can achieve that just off of a $30 million increase in revenues? That’s my question.

Mark Frey – EVP and CFO

I’m not sure I understand your question.

Unidentified Analyst Banc of America

In other words, you’re expecting revenues on $260 million, given the OPEX reductions that you referred to. In order to achieve break-even point, you are probably looking at 12-point swings, like from 16% all the way to like 28% [you will take (1:37)].

Mark Frey

For cash break-even, it doesn’t take a 12-point gross margin swing to get them.

Sumit Dhanda - Banc of America

Could you provide a number on how much you will take, then?

Mark Frey

First of all, the $33 million both affects gross margin and below the line, but our cost reductions; there are all kinds of cost reductions that we don’t have in that number. That’s the surgical number for the 1,100 people and I don’t want you to think of that as the only thing we got going from a cost-reduction standpoint, but in the middle single digits, a gross margin improvement would be factored in because, remember, those are still very low revenue levels.

Sumit Dhanda – Banc of America

Sure, I understand, but you’re saying: mid single digits gross margin improvements?

Mark Frey

Over where we’ve got it, say in the mid 20s. Don’t confuse cash break-even with earnings break-even, we’re not saying that.

Sumit Dhanda – Banc of America

I get that part, so mid-20s would imply like 25, 26, is that fair?

Mark Frey

24, 25.

Sumit Dhanda - Banc of America

Alright, so again, the question remains the same which is: off of $30 million increase in revenues to the midpoint, so you got into 232, the midpoints of your break-even scenarios, call it 260ish; you still would expect like a 10-point swing to gross margins just off of $30 million. The question is: how do you think you can get there just of off $30 million increase in revenues?

Mark Frey

It’s a very large fall-through, and let me correct: it’s more like $22 million, I was looking at it wrong, so it would be up about 5, 6 points for that amount of revenue growth and I see there is more like $40 million of growth and it’s almost dollar-for-dollar fall-through.

Sumit Dhanda Banc of America

Okay.

Mark Frey – EVP and CFO

It’s not just related to that incremental revenue, it’s also the catching up of this whole prospect rolling in.

Sumit Dhanda - Banc of America

That is all I had, thank you.

Operator

[Operator instructions]. From Miller Tabak, Brendan Furlong.

Brendan Furlong – Miller Tabak

Good morning, a couple of questions. In the standard product segment, there had been some sub-segments within that (inaudible) margins, and you’re looking to why they sell them, (inaudible) them, we’re doing something with them in this downturn. What’s your thought process on that initiative?

Mark Thompson

If you look at what we did with standard products, there is roughly three pieces of that, but two pieces that each fit into the existing segment structure; we move into those segment structures. We left behind the very low end of that which is the small signal business. There is still an active process to consider divestiture of those, but of course, there are very few transactional events these days as you know, so it cashes, our credit is not available and so forth, so we see at least for the first few quarters of 2009, we’ll simply be managing that business for cash and squeezing as much cash out of that as we possibly can and so that is really the plan for that. If there is a return to normal fee or some new normal fee during the middle of the year, then we would see the potential for a transaction in that, but we are not counting on it.

Brendan Furlong – Miller Tabak

Would it ever make sense just to shut them down?

Mark Thompson

It depends on how you define. I tend to think of shutdown as an aggressive closure, whereas when you run stuff for cash, you are really looking for places where you can make price increases stick and so forth, and so you are essentially slowing shrinking the business but increasing the cash output of the business, and so that’s really more of the model that we’re looking at.

Mark Frey

We also don’t have a lot of fixed costs or assets related to these product lines there, largely outsourced that we sell it to distribution, so it’s not like they drive a lot of complexity for us.

Brendan Furlong – Miller Tabak

Understood, My second is going back to several other questions early in the call: given the revenue run-race, you got to take your internal inventories down substantially over the next 4 or 6 quarters and the dynamics of taking this internal inventory down given the run-race, how down that impact your gross margin for the balance of 09’?

Mark Thompson

The current margin assumptions that we’ve put out for the first quarter is significant under-build of demand, as Mark commented. As we have partitioned it now, we expect multiple tens of millions of dollars in the channel to come down and a smaller decrease internally in dollars. The following quarter, then, one would expect it as similar. Maintaining that build rate, you would then see a similar reduction in internal inventory, so it shouldn’t be a sustained drag. In fact, I think we have to pay close attention to service level, because again, the dollar amount is pretty well. The resale has gone low so the denominator winds up in weeks looking large, so we have to very carefully balance service with working capital utilization.

Brendan Furlong – Miller Tabak

Obviously, things have fallen off but they will probably stay weak for a while, so the days of inventory, your (inaudible) need to come down. When will we get tens of millions of dollars off internally off the balance sheet?

Mark Frey

We are not going to commit beyond Q1 because we don’t know, but obviously, we are going to look at the run race. Overall, we have probably had the lowest inventory in the industry and we started the cycle that way, so it’s an instinct within the company to do that but we’re just speculating about what the second half would look like. If we saw something is permanent, then we would work on the (inaudible) driving them down.

Brendan Furlong – Miller Tabak

Thank you very much.

Mark Thompson

I think we have time to get one more question.

Operator

There are actually no further questions at this point.

Mark Thompson

That’s good. Thank you very much, bye.

Operator

Ladies and gentlemen, that concludes today’s conference. We thank you for your participation. Have a great rest of your day.

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Source: Fairchild Semiconductor International, Inc. Q4 2008 Earnings Call Transcript
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