Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Fairchild Semiconductor (NASDAQ:FCS)

Q3 2009 Earnings Call

October 15, 2009 9:00 am ET

Executives

Dan Janson - Vice President of Investor Relations

Mark S. Thompson - Chief Executive Officer

Mark S. Frey - Executive Vice President and Chief Financial Officer

Analysts

Ross Seymore - Deutsche Bank

Terence Whalen - Citigroup

Parag Agarwal – UBS

Romit Shah – Barclays Capital

Tristan Gerra – Robert Baird

Steve Smigie – Raymond James

Kevin Cassidy – Thomas Weisel Partners

Craig Berger – FBR Capital Market

John Pitzer - Credit Suisse

Brendan Furlong – Miller Tabak

Shawn Webster – J.P. Morgan

Bill Ong – Merriman

Operator

Good day and welcome to the Fairchild Semiconductor third quarter earnings call. Today's conference is being recorded.

At this time I would like to turn the conference over to Dan Janson. Please go ahead.

Dan Janson

Good morning and thank you for dialing in to Fairchild Semiconductor's third quarter 2009 financial results conference call.

With me today is Mark Thompson, Fairchild's President and CEO, and Mark Frey, our Executive Vice President and CFO.

Let me begin by mentioning that we are attending the FBR Investor Conference on December 1st in New York as well as other investor road show meetings during the quarter.

We'll start today's call with Mark Frey, who will review our third quarter financial results and discuss the current status of fourth quarter business. Mark Thompson will then discuss our product line results and markets and operational performance in more detail. Finally, we'll reserve time for questions and answers.

This call is scheduled to last approximately 60 minutes and is being simultaneously webcast from the Investor Relations section of our website at FairchildSemi.com. A replay of this call will be publicly available for approximately 30 days.

Fairchild management will be making forward-looking statements on this call. These statements, including all statements about future results and performance, are made based on assumptions and estimates that involve risks and uncertainty. 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 we filed with the SEC.

In addition, during this call we may refer to adjusted or financial measures that are not prepared according to generally accepted accounting principals. We use non-GAAP measures because we believe they provide useful information about the operating performance of our businesses that 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.FairchildSemi.com. The website also contains a 2009 third quarter fact sheet and a financial section with updated unaudited financial highlights, including detailed breakouts of segment and retail revenues, gross margins, EBIT and EBITDA.

Now I'll turn the discussion over to Mark Frey.

Mark S. Frey

Thanks, Dan. Good morning and thank you for joining us.

Fairchild posted solid financial progress in all major aspects of our business during the third quarter.

We grew sales significantly even as we reduced channel inventories by roughly two weeks sequentially.

We delivered gross margin at the high end of our guidance range, kept R&D and SG&A spending low, and reported strong earnings growth from the prior quarter.

Our balance sheet continues to improve as we added another $29 million of cash, brining our cash and securities level to $453 million and improving our net debt or cash and securities minus debt to $64 million. We expect to accelerate our cash generation as sales and earnings improve this quarter and through 2010.

For the third quarter of 2009 Fairchild reported sales of $331.8 million, up 19% sequentially and 23% lower than the third quarter of 2008. We further reduced distributors' inventory of our products by approximately $11 million sequentially, which impacted third quarter sales.

Gross margin on a GAAP basis was 26% and included $3 million of accelerated depreciation and a small favorable inventory reserve release related to our previously announced fab closures. Adjusted gross margin excluding these items was 26.9%, up 210 basis points from the prior quarter due primarily to higher sales, which drove increased factory loadings, favorable product mix and the realization of ongoing cost reduction efforts such as manufacturing overhead optimization, yield improvements, improved material costs and more competitive subcontractor pricing.

R&D and SG&A expenses were $68 million, down slightly from the prior quarter as we continued to maintain tight controls on spending. In Q3 we recorded a $4 million charge for restructuring and impairments. Net interest and other expenses were down slightly from the prior quarter to $4.4 million due to our lower debt level and continued decreases in borrowing costs in the third quarter. We still have an open tender offer to pay down bank debt at a discount as we continue to look for cost-effective ways to further delever.

Now I'd like to review third quarter highlights of our sales and gross margin performance for each of our product groups.

In our MCCC business sales increased 11% from the prior quarter, driven primarily by a 27% increase in mobile power. Overall, MCCC's adjusted gross margin was down about 2 percentage points sequentially to 30% due primarily to a reduction of internal inventory.

We grew PCIA sales nearly 28% sequentially as we significantly increased shipments of our power conversion and auto products. Adjusted gross margin increased 7 percentage points from the prior quarter to 28% due primarily to higher factory loadings and a more favorable product mix, partially offset by the impact of reducing inventories.

Standard discrete technology and standard linear product sales increased roughly 26% and adjusted gross margin improved 6 percentage points compared to the prior quarter, also due primarily to higher factory loadings.

Turning to our balance sheet, we reduced internal inventories by more than $15 million or 17 days to a lean 72 days of inventory. Our bias remains to keep inventories as lean as possible while maintaining customer service levels. If we need to add inventory in response to higher demand, we prefer to maintain maximum flexibility by adjusting internal inventories before adding more to the channel.

We improved our DSOs by another 2 days to 36 days in Q3. Days payable also decreased to 40 days.

Turning now to the current status of fourth quarter business, our scheduled backlog for fourth quarter shipments is currently about $333 million, which is roughly $33 million higher than this point a quarter ago. Included in this amount is approximately $20 million of backlog that we booked in the first two and a half weeks of this quarter.

Given that bookings typically moderate after mid-November and we are focused on maintaining the current weeks of inventory level in the distribution channel, we believe sales in the range of $333 to $343 million are possible in the fourth quarter. For this range of revenue we anticipate gross margin to be between 28% and 30%. We expect R&D and SG&A spending to be roughly $70 million in Q4. Interest expense for the fourth quarter is expected to be roughly $4.5 million, while our adjusted tax rate should be in the range of 15% to 20%. We anticipate recording approximately $3 million in charges and $2 million of accelerated depreciation in the fourth quarter associated with previously announced fab closure actions.

As with last quarter, we are not assuming any obligation to update this information, although we may choose to do so before we announce fourth quarter results.

Now I'll turn the call over to Mark Thompson.

Mark S. Thompson

Thanks, Mark.

We once again delivered results at the high end of expectations while taking actions we believe will position us well for the fourth quarter and 2010.

As we transition from a period of inventory correction and realignment of sales to consumption demand to a more normal end market demand-driven environment, it's important to understand the long-term growth drivers for Fairchild. I'll begin my comments with a brief recap of our efforts to drive long-term profitable growth caused by a review of our recent operational performance.

The semiconductor industry faced difficult and uncertain times as we entered 2009. Fairchild recognized early that this recession would require us to make many tough decisions to adjust our costs and manufacturing capabilities to current market conditions. We also realized that these difficult times could be a catalyst to remake Fairchild into a leaner, more focused and more profitable company.

We significantly reduced our staffing levels with an emphasis on overhead costs, refocused some R&D spend, cut capital spending dramatically and announced the consolidation of our front-end manufacturing from six fabs to four by the end of 2010, all while maintaining a very lean supply chain. The impact of some of these actions is already apparent in our results, as we guide for gross margins in Q4 that previously required a higher sales level to achieve.

Looking forward to 2010, we expect to further improve profitability as we benefit from the manufacturing consolidation, the continued roll off of depreciation, improving utilization and pricing trends as demand recovers, and greater sales of higher margin new products that I'll discuss in a minute.

I believe that Fairchild is well positioned to have a breakout year in 2010 and look forward to building on the momentum we have exiting 2009.

Now let's review third quarter results in some more detail. Recall that a year ago we estimated - a quarter ago we estimated consumption demand for Q2 to be about $300 million and expect continued demand growth for the third quarter. We also guided for further channel inventory reductions to roughly 10 weeks of supply. Our actual Q3 sales were $332 million, well above our initial expectations, even as we made significant reductions in channel and internal inventory. Adding the reduction in channel inventory to our sales puts Q3 consumption demand at approximately $343 million.

Breaking demand down a bit further, order rates were solid across a broad range of end markets, with the greatest strength in computing, consumer and industrial end markets. Geographically, sales into Asia continued to be strong, followed by significant improvements in North America and Europe. Sales were up significantly from the prior quarter in both our OEM and distribution channels.

Overall, product pricing in Q3 improved to down about 2% sequentially, which we believe marks the inflection point for prices in this cycle.

Factory utilization increased to roughly 77%, up from 67% in Q2, and lead times increased to a more normal range of 6 to 8 weeks during the quarter.

Due to stronger-than-expected demand we announced earlier in Q3 that we extended the closure date of one to two quarters for the factory consolidation program we announced in Q1. Therefore, we now expect the full savings impact of this program to start in either Q4 2010 or Q1 2011. We expect the favorable financial impact of the higher sales that are driving this extension will more than offset the delayed cost savings in the second half of 2010.

In the distribution channel, sell through was up 11% sequentially and inventory decreased about $11 million, resulting in nearly a two-week sequential reduction to roughly 9.6 weeks of channel inventory. Based on current booking trends and discussions with our distribution customers, we expect sell through to be - sellout to be approximately flat in the fourth quarter with the third.

I've read some analysts' reports recently questioning the degree to which customers are double ordering in the industry, so let me address that topic now. As demand has improved and customers are now concerned about product availability, there is sure to be some amount of over ordering. This is normal for the industry, especially at this time of year. Given that our lead times are at historic normal levels and we have effective management policies to recognize and deal with excess backlog, we're confident in our ability to accurately match supply to real demand.

Looking at this from another angle, the high end of our guidance range is still about 18% to 19% below the consumption levels of a year ago. Given that the end markets we support are projected to be down less than 10% this year compared to last, this level of sales does not appear to be excessive.

Finally, the best way to manage through these cycles is to keep your supply chain lean and be very responsive to customer demand. Fairchild has historically low inventories and a world class supply chain to meet our customer needs.

Turning now to our product line results, MCCC sales increased 11% from the prior quarter driven primarily by higher demand for mobile power and analog switch products for the handset market as well as the low voltage MOSFETs for computing. We're now shipping our latest multimedia USB switches to a leading handset supplier. We hold the lead share for these solutions and expect as many as 60% to 80% of their handsets will use this new technology in 2010.

These multimedia switches provide accessory detection through an innovative use of varying resistance levels which allows our customers to convert a single USB port for all physical connections to the external world. We're leveraging this basic technology to develop unique solutions for other customers that we expect to begin shipping in 2010.

In mobile power we are expanding our success in high frequency voltage regulators to address other critical power management functions within the handset. We're engaged with all the top handset manufacturers to expand our market for those innovative analog power management solutions.

The low power MOSFET transition to our new Power Trend 7 fab process is under way. These products are optimized for the Montevina and Capella notebook platforms and feature smaller die size and lower cost while providing better performance and power efficiency.

PCIA sales were up 28% sequentially, driven by broad-based strength across all product lines and end markets. We substantially grew sales of our analog power conversion solutions across a variety of consumer, industrial and computing-related applications. We won a significant design with our advanced multi-chip AC to DC power conversion products in a leading LCD TV customer. We expect to begin shipping in volume later this quarter and anticipate shipping about 15 million units in 2010 for this program.

We continue to ramp our proprietary primary side regulator or PSR products which enable standby power consumption as low as 30 milliwatts at a number of major handset manufacturers. We expect to expand this new product line rapidly in 2010 as customers increasingly focus on improving battery charger efficiency.

We are steadily gaining share with our latest deep trench high voltage MOSFET solutions for power supply application. Our supreme MOSFET technology provides greater performance at higher switching speeds than previously possible, and while our competitors struggle to keep pace using older, plainer technology, we're already working on our next generation products.

We forecast strong sales growth for these products for many years as momentum builds in this market, which is typically very deliberate in adopting new technology. We expect to increase our penetration into the LCD display power supply market by more than 60% in 2009 compared with 2008 and our latest MOSFET solution that integrates four fast recovery diodes in a single package.

We're now on track to grown SPN sales in China by more than 50% this year versus last. We won a number of new power management designs for room air conditioners and other appliances by leveraging our extensive experience in power modules for this market.

In closing, I think Fairchild is well positioned to grow and succeed in the coming years as a result of the aggressive actions we took this year. Our focus on energy efficiency and wireless technologies should provide excellent long-term growth opportunities. We continue to expand our signal path and power management portfolio as we build a high-value analog franchise. Our leadership in MOSFET technologies allow us to deliver exceptional performance and cost to a wide range of growing end markets.

We're on track to realize substantial cost reductions in 2010 and beyond as we complete our manufacturing consolidation and continue to reduce our depreciation run rate. We continue to effectively manage our supply chain to be lean and very responsive. Finally, we plan to keep tight control on OPEX spend to drive solid improvement in EBIT margins and earnings as sales improve in 2010.

Thank you, and I'll turn the call back to Dan.

Dan Janson

Thanks, Mark.

We'll now open the call to questions. I would ask that in order to allow more of you ask questions we limit each person to one question and one follow up. Thanks.

Let's take the first question, please.

Question-and-Answer Session

Operator

Your first question comes from Ross Seymore - Deutsche Bank Securities.

Ross Seymore - Deutsche Bank Securities

I guess the first question is just on the guidance looking out into the next quarter. It seems like this is the third quarter in a row you're basically guiding to backlog, not assuming any turns. You've upsided the last two quarters you did that. Are you being equally conservative again or does the seasonality change some aspect of the turns potential that you have in this quarter?

Mark S. Frey

So, Ross, you read it right. I think there's two moving parts here, I think.

The first is that I think all of us recognize that this cycle is not your average cycle, and so we're making sure that our own expectations are on the careful side of things to make sure that we don't get inventory out ahead of ourselves and so forth.

I think the second part is also important, which is that normally there is a dead period in the OEMs at the end of December and early in January. And, again, this year could play out differently, but certainly the historical pattern is that it will be down slightly. So we've tried to reflect that in our estimates.

Ross Seymore - Deutsche Bank Securities

I guess a follow on question, kind of with the same general idea behind it, is by my calculations you guys have earned about $85 million worth of channel inventory. Do you think there's something in the channel that either leads them to be able to operate at a lower inventory level more sustainably or is that something that, when we get into 2010, you know, even if your total revenue didn't change from a demand perspective, you would have to refill some of that channel?

Mark S. Thompson

Well, Ross, we certainly put a lot of effort into trying to manage with less inventory, so I guess I would regard our current stance in the mid 9s as a little bit experimental. And, you know, obviously we've never operated the company there. We have good reason to believe that we can, but we always know when we get there that we're going to have to do a little bit of tuning.

We've certainly created a lot more granularity and are bringing on some supply chain tools which will actually give us much more real-time visibility, translating the POS reports directly back to consequences at the factory.

So I think the range is reasonable, but we're certainly going to need to tune it a bit during 2010.

Operator

(Operator Instructions) Your next question comes from Terence Whalen - Citigroup.

Terence Whalen - Citigroup

The first one relates to the computing end market revenue. By my calculation in the model I think that increased about 10% sequentially. First of all, is that an accurate number? And second of all, can you comment on that growth relative to market growth in computing, which seems to be a little bit higher than that, maybe let us know what amount was affected perhaps by channel inventory reductions?

Mark S. Thompson

Sure, Terence. I think that the 10% number is a pretty good number. We think that it certainly kept pace - we didn't draw down channel inventory significantly in that space in the third quarter. It's a period of build in the computing industry, and so it's not a time when you'd want to risk having shortages. So the actual reported number is going to be very close to actual consumption.

Mark S. Frey

And, Terence, the other thing I would add is it doesn't include the products that we would make for power conversion or products that would go into power supplies that would go into the computing applications. Obviously, you heard that PTI numbers were up fairly strong last quarter.

Terence Whalen - Citigroup

Then my follow up question is really regarding the first quarter of 2010. I think you've given us pretty good ideas of consumption level in the fourth quarter. Given the dynamics that you're seeing in terms of lead times stretching, perhaps supply beginning to catch up a little bit with demand in the fourth quarter, would you expect first quarter activity to be seasonally normal, which I think for you is down about 5% or 6% or what factors should we be evaluating to determine whether a reasonable 1Q estimate would be a little bit better than seasonal or sub seasonal.

Mark S. Thompson

Let me try to comment. You're correct that the typical seasonal would be down kind of 3% or 4% in the first quarter versus the fourth.

We've certainly seen that the cycle is unusual. If you look at it, there's a lot of new product activity, both on the part of our OEMs and also on our part, and inventories are at a record low level in most corners of the industry. So, again, without risking offering real guidance about where it's going in the first quarter, I think it's a safe assumption to say that it's probably going to be down a little bit would be the expectation, but I would -- my guesstimate would be it'll be down less relatively than normal given the very, very, lean inventories that exist in the industry.

Operator

Your next question comes from Parag Agarwal – UBS.

Parag Agarwal – UBS

I just wanted to follow up on the previous question. Do you see increasing [inaudible]? With all the commentary about the industrial end market, what are you seeing from your industrial customers?

Mark S. Thompson

Let me try to answer the question in two parts.

Visibility is probably as good as it's ever going to get, I suspect. With very lean inventories and very short lead times, you're never going to carry a lot of backlog, which, frankly, is a good thing because it allows us to redirect the supply wherever the demand appears.

In terms of the industrial segment, I think that it's going to be a good year in 2010. There's tremendous interest in the kinds of high efficiency solutions that we've been offering, beginning to offer and are really ramping at an accelerated pace, and so you know the recognition of the cost of power and that you can really change the design. The power supply drives a lot of the features of design, including air flow and noise and all kinds of things, and there's really a tremendous traction that's occurring right now in the industrial space, recognizing the power of efficiency, great sleep modes and so forth.

So that's one area that we're quite excited about for 2010, and I think it's going to do well.

Parag Agarwal - UBS

Looking into your target gross margin of [28%], with [inaudible] does this mean that there would be [inaudible] reaching your target gross margin number as well?

Mark S. Frey

We haven't updated where - that model. And as we communicated I think fairly consistently to the analyst community, we'll be doing that in terms of tuning up the model that exists on the website.

If you look at the consequences of the shifting of the fab closure by a quarter or two, obviously it will move the savings associated with that out, so that gross margin improvement associated with that won't occur until the fab closes; however, it would only move in response to needing the capacity to do something else with, so the earnings would be the same or better.

So if you go to the bottom line, it should be relatively insensitive to it in the sense of it's a flexible thing, but it'll just change what the income statement looks like. So it would be more sales at slightly lower margins producing the same EPS if the fab stays open, and if it closes in response to, say, a downturn in demand, if we pulled it in or something, if 2010 softened, then what you'd see is higher margins and the same EPS.

We don't expect it to have a material impact on the earnings, only what the income statement looks like and, again, only for that range of one or two quarters.

Operator

Your next question comes from Romit Shah – Barclays Capital.

Romit Shah – Barclays Capital

Mark, the lead time number you quoted, six to eight weeks, is that an average number or is that the range across the product portfolio.

Mark S. Frey

It's a blended average.

Romit Shah - Barclays Capital

Could you give us what the range is?

Mark S. Frey

We don't provide that level of granularity. I think it's fair to say that for some of the computing products, some of the MOSFETs, it was higher than that, and for other products it was lower.

Romit Shah - Barclays Capital

Does it concern you that at some point in the quarter you may start to see cancellations on the computing side where the lead times are in excess of 8 to 10 weeks?

Mark S. Thompson

Well, there's sufficient excess booking level that we haven't included in our estimates that that would have to be a pretty dramatic amount of cancellations to affect the results.

Again, we don't focus on the backlog when we set our estimates; we focus on the trending of the POS.

Romit Shah - Barclays Capital

On Q1, if I remember correctly, normally you get a bump up in OPEX. Should we continue to expect that going into next year as well?

Mark S. Frey

Yes. We will reinstate an accrual for our bonus programs. The FICA matching comes online and the final benefits are restored. So you ought to model that it would step up to somewhere between 76 and 77 per quarter.

Romit Shah - Barclays Capital

Right. And then after that it normally flattens out or [inaudible] down.

Mark S. Frey

Even down because Q1 tends to be all bad seasonal influences on OPEX in terms of people's vacation patterns, the tax matching, the way we accrue the equity comp plan, etc., and then it'll tail slightly then as the year progresses.

Operator

Your next question comes from Tristan Gerra – Robert Baird.

Tristan Gerra – Robert Baird

In terms of some of the double ordering that you suspect is taking place and your confidence that you can shift and align with real end demand, are you turning down some order requests and is your Q4 guidance reflecting less growth quarter-on-quarter than the actual level of demand that you're seeing from customers?

Mark S. Thompson

Tristan, yes, the process that we use for that is - I don't want to wade too deep into our supply chain mechanics, but there's always a requested number that's substantially higher than what we report as backlog. And so the $333 million that we estimated, the actual requested number is substantially higher than that by multiple tens of millions of dollars.

And so that delta is the filter that we apply, then we look at - so, again, if you take the notebook space, it's not a secret roughly what the industry intends to build in terms of notebooks. We will then explode that into the program, into what's the supply chain, what's the part number, and what's our expected share, and then make sure that we run that cycle so that we essentially can reconcile it both from a bottoms up and a top down basis. We run that engine several times a week as we get updated information on point of sale and so forth.

So, again, that's sort of the sausage making side of this thing that we try not to drag the investment community into and is reflected - when we say $333 million, that's already netted out a lot of stuff that we don't think is real and/or that we don't intend to ship.

Tristan Gerra - Robert Baird

So perhaps you'd say that you're looking basically at what you think is a reasonable or maybe seasonal order pattern, [high] customer to [commence] with the backlog amount that you provided?

Mark S. Thompson

That's correct.

Tristan Gerra - Robert Baird

Given the normal seasonality in the first half and given where your utilization rates are in the quarter, any particular product that you think could help mix in with [inaudible] on a secular basis? And maybe a quick update on your goal in terms of fixating previous gross margin piece for 2010.

Mark S. Thompson

There's a couple of moving parts there. Certainly it is our goal as a company to set new gross margin records in 2010. We're not relying on utilization to achieve that. So if you look, there's a couple of different moving parts, but there's certainly a richer flow of new products than we've ever had, great traction as to OEMs that are winning, and a very constrained, deliberately constrained, capital environment.

So I think we have unusual adaptability to drive the income statement in 2010 with all those levers at hand. And, again, we also have the flexibility of the Mountain Top closure, for example. Again, if demand is really strong, it'll be toward the end; it could get pulled in if it softens.

So certainly in the time I've been with the company we've never had a more adaptable set of tools to drive the income statement than we have in 2010.

Operator

Your next question comes from Steve Smigie – Raymond James.

Steve Smigie – Raymond James

If you could talk a little bit about gross margin in terms of MCCC versus PCIA, what those would sort of periodically look like as we move throughout the cycle? Are there particular drivers in terms of mix coming on? Which one would you expect to be higher just in [inaudible] utilization environment and which would be higher after the closure of Mountain Top?

Mark S. Thompson

MCCC should normally be a couple points higher, but they will both ramp up from kind of the current situation as we move towards our corporate gross margin goals.

Steve Smigie - Raymond James

I know you had certain new products that you were mixing in. Will that change that [inaudible] dynamic?

And just [inaudible] stuff, you said you'd had lower gross margins, I think, at MCCC this quarter. Is that just due to inventory reductions? Does that go away next quarter?

Mark S. Thompson

Well, the gross margin trend of our divisions kind of moves over time. So MCCC stepped up last quarter pretty aggressively and PCIA less so, and therefore PCIA grew a bit more this quarter. You sort of have to look at that on kind of like a continuing six-month basis as their inventories go up and down and as they go through - you know, their seasonality factors are slightly different. And so that's why they move not necessarily in lockstep.

But the underlying things that will drive their margins are new product at richer margins and combinations of cost reductions within manufacturing.

Steve Smigie - Raymond James

But is there anything particular about what comes out of Mountain Top that would change the dynamics specific to either one of them?

Mark S. Thompson

Mountain Top produces products for both MCCC and PCIA.

Steve Smigie - Raymond James

You had some very nice cash flow improvement. How much of that over, say, the coming year would you plan to use to pay down debt versus other activities? And what does cash flow look like given the paydown in debt and your current CapEx [inaudible].

Mark S. Thompson

Well, our approach to CapEx is unchanged. We're going to keep a lid on it. Our profitability has obviously been expanding, and our asset management programs have been effective and we will continue to keep them in place. And so we think we'll continue that trend and really accelerate it.

And what we do with it, obviously we've delevered almost every - four out of the last five years, including this year, and we would continue to look at opportunities to do that next year. We don't have a specific amount involved. We pay less than 3% on our debt, so it's not a real expensive item, but as you can see from our disclosures, we're tracking our net debt. [Inaudible] we would, you know, expect to see that become net cash around the midpoint of next year. But we don't have an artificial target for how much debt we're going to pay down next year.

Operator

Your next question comes from Kevin Cassidy – Thomas Weisel Partners.

Kevin Cassidy – Thomas Weisel Partners

What was your utilization rate for the third quarter?

Mark S. Frey

77%, Kevin.

Kevin Cassidy - Thomas Weisel Partners

And you expect that to increase going into the fourth quarter?

Mark S. Frey

Yes, I think that's fair to say. Obviously, we'll be responsive to what the order rates look like.

Kevin Cassidy - Thomas Weisel Partners

And I guess the closing of the fabs, does that change utilization rate? You're going to moving the equipment, so does that change the utilization rate?

Mark S. Frey

It will, and we consider that every quarter. The utilization rates that we give are based on equipped capacity, so obviously if equipment's coming offline that would [inaudible] capacity for some period of time until it was transported to the new location and brought up and running.

Kevin Cassidy - Thomas Weisel Partners

You also mentioned on the lead times that it was a blended average. What products are the longest lead times and how long is that?

Mark S. Frey

Well, I think we talked about some of the MOSFETs in computing as probably some of the products with the longer lead times. That's probably a fair approximation.

Operator

Your next question comes from Craig Berger – FBR Capital Market.

Craig Berger – FBR Capital Market

Can you just discuss what the historical turns levels have been as a percentage of revenue in the fourth quarter, and as part of that maybe how much of your increased fourth quarter backlog is due to higher lead times on your product?

Mark S. Frey

I haven't computed that, Craig, but I think 90% has been kind of a - or 10% has been an average that we've looked at over the years.

It will tend to be a little higher than that in quarters like the third quarter, which is an accelerating quarter, than in Q4, which is generally a decelerating quarter. So, obviously, as we guided, we are not counting on a lot of turns because seasonal patterns more typically cause the order flow to die down as the quarter continues.

Craig Berger - FBR Capital Market

So $333 million backlog and historically 10% turns.

A follow up question: Since you guys did push out the closure of two of your six fabs, what does that do the quarterly depreciation schedule that you walked us through one quarter ago?

Mark S. Frey

We gave a couple of data points for the depreciation rollout. So the first one was by the end of this quarter, the fourth quarter, which was going to be down about $1.5 million, and then we said by the fourth quarter of next year we'd be down around $3 to $3.5 million. And since we plan on closing the fabs by then, those numbers are still okay.

Obviously, extending the closure has changed the accelerated depreciation portion, and you've seen that reflected in the numbers that we've presented in the P&L.

Craig Berger - FBR Capital Market

So essentially 50 basis points of gross margin improvement sequentially into Q4 '09 and then another roughly point or so by Q4 2010?

Mark S. Frey

Depending on revenue, sure.

Operator

Your next question comes from John Pitzer - Credit Suisse.

John Pitzer - Credit Suisse

Just again getting back on the timing of the fab closure and how that relates to end demand level, is this the right revenue level we should think about, where you just have to push out the fab closures, or could you grow sequentially on top line throughout next year and still be able to kind of hit the dates you have out there if the sequential growth is modest?

Mark S. Frey

If you look at the moving parts of that, as we commented previously, the capacity that currently is supplied by Mountain Top is replaced in two ways. Some of the equipment gets moved to other fabs in MOSFET, but we're also bringing up a significant foundry partner which will be online during the second quarter of next year. So that significantly deconstrains the situation, because obviously to move equipment you have to build a buffer inventory. And so the movement of the schedule is the result of basically selling our buffer inventory, if you will. But that gets significantly deconstrained in the second quarter.

So what I would say is that more or less regardless of end demand environment we feel confident that we should be able to deliver on the closure in the second half of next year.

John Pitzer - Credit Suisse

Mark, do you mind sharing with us a revenue level at which that would have to be pushed out or is that too many moving parts right now?

Mark S. Frey

I would say it's too many moving parts right now. And I think given, you know, again, when we first did the estimate, of course, the prospects for the industry were incredibly bleak if you looked at the numbers. And so there really wasn't a demand picture that would cause us to need the equipment for supply.

I think what we've all seen is that the overall demand environment is actually much better than anybody would have guessed, so even if it went down for a quarter I think it would be an unnecessary risk to take that capacity offline.

So, again, I think we've got at this point quite a robust plan, and we'll stick with it.

John Pitzer - Credit Suisse

And then, Mark Thompson, in your prepared comments you talked about pricing being down sequentially about 2% and you said you thought that was an inflection. If you can clarify that a little bit? I'm assuming that means you think pricing gets better from here, and if that's the case, why and what's the implication for gross margins?

Mark S. Thompson

The pricing, let me make sure that we're - understanding of that gets better as, you know, pricing always goes down except in pure commodities, which we have a pretty small component of. So certainly in 90% of our business it's not priced like a commodity. We are raising some pricing on some commodity stuff, but in aggregate it's a question of how much down.

We've historically seen 1% to 2%. We saw a quarter that was higher than 2% and now it's moderating, which is consistent with the overall picture, which is when there's significant excess capacity, of course buyers have a lot of leverage, and when they start to worry about supply, then that becomes the dominant dimension.

So all the moving parts are consistent with a pricing environment that's moderating, and that was reflected in our comments. But all of those moving parts are baked into our gross margin estimates.

Operator

Your next question comes from Brendan Furlong – Miller Tabak.

Brendan Furlong – Miller Tabak

I want to circle back on a statement you made earlier. You said that Q1 would be down less than normal given the lean inventory in the industry. Were you referring to your OEM and EMS customers or were you referring to the lean inventory of the semiconductor industry?

Mark S. Thompson

It was a customer and channel inventory remark.

Brendan Furlong - Miller Tabak

That's good news. And then if you look at apples to apples, you're going to be down your guidance implies roughly flat to down 1% or thereabouts for Q4. Within consumer, industrial, computing, etc., can you just walk us through, give us a little bit of color on what you're expecting in the quarter?

Mark S. Thompson

Well, our estimates are up from the third quarter, not down.

Brendan Furlong - Miller Tabak

I was just looking - if you back in the $11 million, if you look at the consumption numbers.

Mark S. Thompson

Oh, I see.

Brendan Furlong - Miller Tabak

I'm just looking apples to apples, if you will.

Mark S. Thompson

So that would include some Q4 softening, which is a typical seasonal pattern. So we've simply in that estimate baked in a normal Q4 ending, which is a roll off in demand.

Brendan Furlong - Miller Tabak

No, I understand that. I'm just - I think it's fine; I'm not saying it's anything negative. I'm just, you know, if you could give us some color on end markets on that usual seasonality. Is it just normal seasonality across all your end markets, what the dynamics are, how that's computing, industrial, communications, etc.

Mark S. Thompson

It's more focused on consumer stuff, obviously, so if you look at displays, handsets, set top boxes, all those kinds of things, there's a tendency to shut those down. Although we also saw that there were a lot of furloughs and lengthy holidays in the industrial space as well, certainly at the end of 2008, although it's not as pronounced typically as it is.

We would certainly not expect that to be so severe this year, so I think what you'd expect to see is, for that amount, more concentrated toward computing, handset and consumer, less concentrated toward industrial.

Brendan Furlong - Miller Tabak

And my last question would be, getting back to the lead time question and over ordering, etc., it's 6 to 8 weeks blended now. What was it last quarter and where does it get to when you get worried?

Mark S. Thompson

This quarter was up a couple of weeks, so we were roughly five to six weeks in the second quarter, six to eight in the third.

Brendan Furlong - Miller Tabak

And 10 gets you worried? Is that kind of the way to look at it?

Mark S. Thompson

We don't like double digits for sure.

Operator

Your next question comes from Shawn Webster – J.P. Morgan.

Shawn Webster – J.P. Morgan

For your Q4 inventories, what is your expectation? Do you expect them on a dollar basis to be flat, down, up?

And then also for your lead times, do you expect them to continue to extend into Q4?

Mark S. Thompson

We're generally counting on that inventory neutral in Q4.

And, Dan, in terms of lead times -

Dan Janson

Lead times, it's going to depend on order rates, right, Shawn? So if order rates follow a more seasonal pattern then I would think they would not change all that much, maybe even come down a little bit towards the end of the quarter. If demand is stronger than lead times would probably be flat and even up a little bit.

Shawn Webster - J.P. Morgan

And then on the income statement line, as we look into 2010, what is your estimate for the tax rate we should be modeling?

Mark S. Frey

There's a lot of variables in 2010 but generally model in 15% to 20%.

Operator

Your next question comes from Bill Ong – Merriman.

Bill Ong – Merriman

You [inaudible] some color on the new products for the LCD end market with [inaudible] incorporating [inaudible] backlighting. Do you have any plans of participating in the LED drivers? I know you do that on the low voltage side, but other LED applications?

Mark S. Thompson

Yes. We certainly have a very broad approach to lighting and controlling LEDs from the power supply through the drivers.

Bill Ong - Merriman

Okay, any other end markets that you plan to participate in, particularly since this seems to be a pretty growth end market segment going forward in 2010 and beyond?

Mark S. Thompson

Yes, actually, my statement was intended to be very broad. If it involves lighting up an LED, we've got plans to do it, ranging from the - in fact, we have some quite active programs on the AC/DC, some of the PSR products that I commented on, there's versions of those that adapt an LED to the AC environment.

So we agree with you that it's a very exciting and important market that will drive growth for quite a few years, and we have very active programs really in every significant implementation space.

Operator

Your next question comes from Tristan Gerra - Robert Baird.

Tristan Gerra - Robert Baird

Your comments about doing a level of tuning in your channel in [inaudible] in 2010, something I understood is you could potentially get back closer to the normal levels of [inaudible] weeks. Is the current level below 10 weeks you currently have at [inaudible]? Is that below or in line with what distributors actually want or is it just the result of supply constraints with some of your products.

Mark S. Thompson

Tristan, let me correct a misconception I must have created. We do not - we believe that we can operate significantly leaner than 11 weeks. So historically our supply chain tools only allowed us to operate at 11 without having risks of service issues. As we've improved them we have then opportunity to operate a lower level.

If you look at the mechanics, what we decided as a first step was to take a week off that. And so instead of being targeted at 11, we were targeting ourselves at 10. We came in a bit underneath that, which we think is an opportunity to test the case a little bit, which is what we're doing presently. We think that there could be opportunity to run it even a bit lower than that but not committing to it nor having it as a target.

So I think the correct interpretation is that it's approximately in range right now. We're going to try to operate it at that level, but don't have enough data on service levels yet to reflect that as a hard target. So that's the reason that I softened the language a little bit because I didn't want to create a misconception that we had enough day to say absolutely we can run this thing at 9.5 weeks. We'd like to and we're going to try to, but we might back off in a few places - to 11, absolutely not.

Tristan Gerra - Robert Baird

So have the distributors been pushing back? We know that they have received some pressure from OEMs about potentially carrying a little bit more, but I guess they're comfortable with those levels?

Mark S. Thompson

I think they are, yes. They all tend to have asset management goals and so clearly less inventory helps them achieve their goals, so it's good all around.

Dan Janson

We have time for one more question.

Operator

Your final question comes from Craig Berger - FBR Capital Market.

Craig Berger - FBR Capital Market

Can you guys just talk about how utilizations will drive future gross margins and what type of leverage is still left given that you're running at 77% in the third quarter?

Mark S. Frey

Well, obviously, as utilizations improve and move closer to 90% that will drive better gross margins and lower average unit cost for inventory. I don't have a specific calculation for you. It depends on the product mix. But we view it as a positive.

Craig Berger - FBR Capital Market

Are there any impacts or benefits in the fourth quarter from utilization still being low earlier in the third quarter?

Mark S. Frey

Yes, and that's built into our guidance.

Craig Berger - FBR Capital Market

And can you just confirm that you said Q1 OPEX heads towards 76 and then declines from there? Was that what I heard?

Mark S. Frey

Declines modestly.

Dan Janson

All right, thank you and that's all that we have time for now for right now. Operator, that's the end.

Operator

That concludes today's conference. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Fairchild Semiconductor Q3 2009 (Qtr End 9/27/09) Earnings Call Transcript
This Transcript
All Transcripts