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Fairchild Semiconductor International Inc. (NASDAQ:FCS)

Q4 2009 Earnings Call Transcript

January 21, 2009 09:00 am ET

Executives

Dan Janson – IR

Mark Frey – EVP, CFO and Treasurer

Mark Thompson – Chairman, President & CEO

Analysts

Ross Seymore – Deutsche Bank

Terence Whalen – Citi

Romit Shah – Barclays Capital

Parag Agarwal – UBS

Craig Berger – FBR Capital Markets

Tristan Gerra – Robert W. Baird

John Pitzer – Credit Suisse

Steve Smigie – Raymond James

Kevin Cassidy – Thomas Weisel Partners

Brendan Furlong – Miller Tabak

Bill Ong – Merriman Curhan & Ford

Eric Ghernati – BoA/Merrill Lynch

Operator

Good day and welcome to the Fairchild Semiconductor fourth quarter and year-end 2009 earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Dan Janson. Please go ahead.

Dan Janson

Good morning and thank you for dialing in to Fairchild Semiconductor's fourth 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 will be attending the Thomas Weisel Technology and Telecom Conference on February 9th and the Morgan Stanley Technology Media and Telecom Conference on March 2nd, both in San Francisco, as well as other investor road show meetings during the quarter.

We'll start today's call with Mark Frey, who will review our fourth quarter financial results and discuss the current status of first quarter business. Mark Thompson will then discuss our product line results, end 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. The replay of this call will be publicly available for approximately 30 days.

Now, Fairchild management will be making forward-looking statements in this conference call. These statements, including all statements about future results and performance, are made based on assumptions and estimates that involve risk 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 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 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 Q4 fact sheet and a financial section with updated unaudited financial highlights, including detailed breakouts of segment and regional revenues, gross margins, EBIT and EBITDA.

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

Mark Frey

Thanks, Dan. Good morning and thank you for joining us. I’m sure most of you have had a chance to review our earnings press release that was issued earlier this morning. So I’ll focus on just the key points in my comments. Strong sales growth coupled with disciplined cost and asset management allowed us to post solid improvements in our financial results for the fourth quarter.

We exceeded our gross margin guidance for the quarter. We are well positioned to continue this trend in 2010. Cash flow generation was one of our primary goals for last year. And I’m particularly pleased to report that we generated record free cash flow in 2009. The result of our solid earnings growth and cash flow is that we entered 2010 with the lowest level of debt and one of the strongest balance sheets in our history.

Let’s review some of the details starting with the income statement. For the fourth quarter of 2009, Fairchild reported sales of $354.5 million, up 7% sequentially and 11% higher than the fourth quarter of 2008. Gross margin on a GAAP basis was 29.7% and included $2 million of accelerated depreciation. Adjusted growth was 30.3%, up 340 basis points from the prior quarter, as we benefited from a better mix due to new products and our focus on higher value sockets as well as firmer pricing and higher factory loadings. This represents an 80% fall-through of incremental revenue, gross profit in the quarter.

R&D and SG&A expenses were $73 million, up $5 million from the prior quarter, due primarily to the reinstatement of employee benefits and higher expenses driven by our activity level. Employees took less time off than planned over the holidays, which resulted in higher payroll costs as we worked to support increased customer demand.

We also had higher variable cost associated with our greater than expected revenue volume. Other expenses in the quarter included a $6 million charge for litigation and $6 million in restructuring and impairments. We also recorded a $1.2 million gain associated with debt buyback, which caused net interest and other expenses to decrease to $3 million for the quarter.

Fourth quarter adjusted net income of $30 million benefited from a 1% adjusted tax rate, which was the result of the recognition of certain discrete tax benefits in the quarter and a favorable distribution of profits in legal jurisdictions with low tax rates. Adjusted EPS was $0.23.

Now I’d like to review fourth quarter highlights of our sales and gross margin performance for each of our product groups. In our MCCC business, sales increased 5% from the prior quarter, driven primarily by a 16% increase in mobile power products as well as stronger low voltage and logic sales. Overall, MCCC's gross margin was up 5 percentage points sequentially to 35% due primarily to better product mix, lower manufacturing costs, and higher factory loadings.

We grew PCIA sales nearly 8% sequentially, driven primarily by higher demand for high voltage MOSFETs, IGBTs and modules. Gross margin increased 3 percentage points from the prior quarter to 31% due primarily to a more favorable product mix, better pricing, and higher factory loadings.

Standard discrete technology and standard linear product sales increased roughly 10%, and gross margin improved 3 percentage points compared to the prior quarter, due primarily to favorable product mix and pricing.

Turning to our balance sheet and cash flow, we reduced internal inventories by three days to 69 days, and sales growth more than offset a $7 million increase primarily in finished goods. We improved our DSOs by another two days to 34 days in Q4, while days payables outstanding increased four days to 44 days.

We generated $43 million of free cash flow during the quarter and $129 million in 2009. We used this cash flow to pay off another $44 million in debt during Q4, bringing the total for the year to $63 million. That represents a 12% decrease in our total debt since the beginning of 2009. We bought back this debt below par where possible and recorded a $2 million net gain in 2009 as a result of these actions. We expect to accelerate our cash flow in 2010, as sales and margins improve, and plan to further reduce our debt level during the year.

Turning now to the current status of first quarter business. Our scheduled backlog for first quarter shipments is currently at $369 million, which is roughly $33 million higher than at this point a quarter ago. Included in this amount is approximately $20 million of backlog that we booked in the first 3.5 weeks of this quarter.

We expected both distributor sell-through and OEM demand will continue to track above seasonal levels in Q1. Given the solid order rates this quarter and our starting backlog position, we expect the first quarter sales to be roughly $370 million while further improvements in product mix help drive adjusted gross margin to a range of 31% to 32%. We expect R&D and SG&A spending to be approximately $78 million in Q1.

Interest expense for the first quarter is expected to be roughly $3 million, while our adjusted tax rate should be in the range of 15% to 20%. We remain disciplined in our capital investment plans with spending forecast to be between 6% and 7% of sales in 2010.

We anticipate recording approximately $2 million in charges and $2 million in accelerated depreciation in the first 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 first quarter results.

Now, I’ll turn the call over to Mark Thompson.

Mark Thompson

Thanks, Mark. Before I address our performance in Q4, I want to share my perspective on 2009 and why I believe the actions taken during this year created more focus to streamline Fairchild capable of delivering strong sales and margin growth in 2010 and beyond. Recall that the industry began 2009 with a weak backlog position and very limited demand visibility, as customers scrambled to adjust their inventories. We’ve quickly made a number of difficult decisions to reduce costs and align our business to the new environment.

The recession and challenges in the credit market caused us to focus on cash generation, and our employees responded to a tight cost controls, CapEx discipline and excellent working capital management. We also sharpened our R&D focus and improved new product execution through a series of process improvements. By the end of 2009, we posted 11% Q4 sales growth from the year-ago quarter, generated a record $129 million of free cash, retired 12% of our debt, and broke even for full year on an adjusted basis.

We entered 2010 with a leaner and more focused company. Our pipelines of new products have never been better, which I’ll review in more detail in a few minutes. We’ve spent years developing the technology necessary to achieve greater energy efficiency in electronics and improved functionality in wireless products. The markets for these products are rapidly gaining momentum. I believe Fairchild is uniquely positioned to capitalize on this growth.

On the cost side, we are reducing our manufacturing footprint and expect significant cost savings late in 2010 and early 2011. We are spending less on capital than our depreciation run rate, and we expect to have a cost tailwind for us for years.

Putting this all together, it’s clear that Fairchild is poised to break through to much higher margin and earnings levels. Finally, I’d like to express my thanks and admiration to Fairchild employees. 2009 was a year of great challenge, but through hard work and determination, they have created a very exciting future for the company and the shareholders.

Turning now to current quarter performance, we delivered results in the fourth quarter that exceeded our initial expectations in virtually all aspects of the business. We grew sales 7% sequentially in what is typically a flat quarter while further reduced our days of inventory both internally and in our distribution channel.

Our channel inventories are at record low levels while the mix of fast turning products is very high. We pushed adjusted gross margin over 30% and have strong momentum heading into the first quarter to exceed past gross margin records. Strong execution on sales growth, margins and cost reductions has enabled us to generate record free cash flow in 2009, and we expect to accelerate our cash generation in 2010.

Since design wins and share gains are the primary driver of our growth, I want to begin my discussion today with some details on our progress in this area and why I believe Fairchild is well positioned to deliver strong results in 2010. MCCC sales increased 5% from the prior quarter, driven primarily by higher demand for mobile power and logic products, as well as low voltage MOSFETs in computing.

Q4 is typically a strong quarter for our mobile power sales, as we continued to convert design wins into production. We’re particularly pleased to add a significant new customer during the quarter for our high efficiency voltage regulators and expect to build on this relationship in 2010. This customer is a top tier supplier of smart phones with an extensive lineup of innovative products.

Demand for our latest multimedia USB switches that enable accessory detection and routing in multiple signals, passing through a single five-pin USB port was quite strong. We are widely viewed as the industry leader in this technology, building on our extensive experience in providing innovative analog switch solutions to the handset market.

We extended our customer base beyond the top handset OEMs into leading Chinese manufacturers in 2009 and are poised for significant sales growth for these solutions in 2010. We are gaining share with our new generation of low power MOSFETs, targeted at the Montevina and Capella notebook platforms.

These new devices provide exceptional switching performance and the die size is much as 50% smaller than the previous generation. This combination of performance and size gives us a solid advantage over our competitors. This die size reduction also significantly improves our margins. Demand is robust for these products, which enable us to focus more on higher performance and therefore higher value sockets at key customers.

PCIA sales were up 8% sequentially, driven by continued broad-based strength across most product lines and end markets. We converted a number of design wins for our multi-chip single package power conversion solutions into production volumes at a couple of leading LCD TV makers. We expect these products to generate substantial sales growth at above average margins in 2010. Our power conversion solutions continued to gain share in the PC and printer markets as well, growing 10% sequentially in Q4. We also leveraged these products to pick up multi-million design win at a major gaming platform.

We announced the new design win with OSRAM for an integrated IC LED driver solution that competes favorably with discrete solutions while doubling element-wise. We used our proprietary PSR technology for LED lights up to 5 watts and our QR technology to extend our coverage range to 40 watts. We have years of experience and the right technology to support this fast-growing market as it transitions to more efficient IC LED drivers from old discrete designs.

Our high voltage products posted a solid 11% sequential gain in sales led by strong demand in the LCD TV backlighting, power supply, server power appliance and industrial markets. We offer customers to seek greater efficiency, a very compelling lineup of high voltage power management solutions. Fairchild is the expert in high voltage power management technology, whether customers use a discrete approach using our industry-leading SupreMOS switch or – and high-voltage ICs or an innovative turnkey module.

The pipeline of new products, silicon and package technologies has never been more exciting for Fairchild. As the world economy continues to expand, I believe Fairchild is well positioned to capitalize on the fast-growing demand for more efficient electronics and greater functionality in wireless devices.

Now, let’s review fourth quarter results in more detail. Recall that a quarter ago, we estimated consumption demand for Q3 at about $343 million and expected continued demand growth in the fourth quarter. Our actual Q4 sales were $355 million, well above our initial expectations, even as we made further reductions in channel inventory.

Adding the reduction in channel inventory to our sales plus Q4 consumption puts Q4 consumption demand at roughly $363 million, well above normal seasonality. Breaking demand down a bit more further, order rates were robust across a broad range of end markets, with the greatest strength in computing, consumer and industrial end markets.

Geographically, we posted double-digit sequential sales gains in North America and Europe, while Asia continued to be very solid. Sales growth was well above seasonal in both our OEM and distribution channels, and we expect this trend to continue in the first quarter.

In the distribution channel, sell-through increased nearly 8% sequentially, which exceeded our initial expectations. The strong sell-through drove reduction in channel inventory of about 7% from the prior quarter resulting in a record low 8.3 weeks of inventory. While this level of inventory is quite low historically, the mix of fast-moving products to slow turning inventory is the best ever.

Overall, product pricing in Q4 moderated to be down less than 1% sequentially, which is better than typical and reflects customers increasingly shifting their focus to product availability. Factory utilization increased again in Q4, and we are now operating in a very efficient loading range for our business.

Lead-times also increased during the quarter and are now in the low-double digit range on average. We are working closely with key customers and believe we have excellent visibility to their demand. We have a great supply chain management process and are effectively managing our factories, subcontractors and foundries to meet increased demand.

In closing, I believe Fairchild is uniquely positioned to gain share and accelerate the improvement of our business in 2010 and beyond. We identified the importance that our customers have placed on greater efficiency in electronics and improved functionality in wireless early in our history and have since built a great combination of technologies, products and supply chain capabilities to support these fast-growing markets.

In addition to new product and mix driven margin improvements, our financial model provides excellent leverage to convert incremental sales growth to higher margins and earnings. We also forecast significant cash and depreciation savings from our previously announced factory closures at the end of 2010.

Finally, we expect to accelerate our cash flow generation in 2010 from the already record levels of 2009. We reduced our debt level by roughly 12% in 2009 and anticipate de-levering further in 2010, which should benefit our income statement through lower interest expense and our shareholders with a higher valuation.

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 to ask questions, we limit each person to one question and one follow-up. Thanks. And let's take the first question, please.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We’ll go first to Ross Seymore of Deutsche Bank.

Ross Seymore – Deutsche Bank

Congrats on the strong results. Just a question on the first quarter guidance, it looked like you’re guiding two-year backlog, same methodologies in the last few quarters. You’ve beaten that in the last few quarters, any reason why seasonality leads to a lower likelihood of turns in the first quarter?

Mark Thompson

So, Ross, I think you’ve hit it on the head. The mechanics that we’ve put out are the same that we’ve been using, where we take our – rather than necessarily just look at raw backlog, we take our OEM business and then add to that our POS forecast and then use that to provide the estimate. And so as we’ve seen the channel to be stronger than we expected in fact in Q4, both OEM went up a little bit, but the channel was significantly stronger than we thought. And so we upped our shipments to match that. So the estimates we’ve put out there are equal for the first quarter or equal to our OEM estimate plus the point-of-sale estimate that we have from our distribution partners. If the point-of-sale is stronger than forecast, then of course we will ship more, and that will drive the number up. But those are the mechanics that produce the 370 estimate.

Ross Seymore – Deutsche Bank

And what’s the general assumption on the channel inventory levels in the first quarter?

Mark Thompson

Roughly flat. We don’t intend to allow them to go much lower. We think we are at an optimum of asset management and service levels right now. So the estimates are approximately flat point-of-sale from Q4 to Q1 and that we will match that as closely as possible.

Ross Seymore – Deutsche Bank

And I guess the last question, a quick one, you said lead-times have now extended to the low-teens, is that across the entire company and does that create any concerns that they have extended to almost double where they were last quarter?

Mark Thompson

Well, obviously, it’s easier to manage the business when lead-times are shorter. But they've stabilized, and in fact, we’ve pulled them in a little bit. And I think the customer base has become more confident of its demand picture. So somewhat offsetting the risk of longer lead-times is much improved visibility from our customers. And so that is somewhat mitigating to that.

Operator

And we’ll go next to Terence Whalen of Citi.

Terence Whalen – Citi

Hi, thanks for taking my question. Just one on gross margin, I think at the midpoint of your gross margin range, you’ll be at your sort of recent historical maximum gross margin – I guess my question is, what’s the reasonable gross margin range going forward for the company? And if you can comment versus prior maximums relative to that increase, what amount is just leaner factoring, what amount is fundamentally different in product mix?

Mark Frey

Thanks a lot. On your – on your first question, I think on our last Analyst Day, we published a model for the company with a gross profit of 38%. We are going to re-look at that and probably have an event later on in the year. But in the meantime, we feel more confident that we are moving towards that in the one to two-year timeframe than we have in the past. And the reason gets to your second question, which is that product content, product mix, new products is having a much bigger impact than just cost reduction and leverage. So – whereas manufacturing cost reductions, additional manufacturing leverage, pricing and product mix are all having and will continue to have a positive impact going forward, we think the product mix component of that is the most exciting and the most ability to be leveraged and to continue.

Mark Thompson

Terence, maybe to add one more comment to Mark’s, if you look at the 340 basis points of progress, the – about a third of that was primarily new product driven mix stuff. So if we are to conclude that the factories were at about where we wanted them loaded, then that gives the picture of progress that can be made in a quarter from pure new product-driven mix.

Operator

And we’ll go next to Romit Shah of Barclays Capital.

Romit Shah – Barclays Capital

Thanks, guys. Very nice job on the quarter. I have two questions. The first one on gross margins, your fall-through in the quarter was a very respectable 80%. But I think relative to the guidance you provided at the beginning of the quarter, it was below that number. And I was just wondering was there – did the mix come in not as you expected or were there some other factors? Thank you.

Mark Frey

No. I mean, I guess I didn’t – I wouldn’t have thought the guidance as a fall-through. The fall-through is sort of a cumulative function. And you can’t really dissect it within a particular quarter. There is obviously operational factors in your margin, like pricing environment, mix, et cetera. But there is also some accounting. And accounting isn’t strictly volume related. So if you end up with an actual different volume, you can’t dial in the fall-through. So as you know, the midpoint of our guidance in Q1 would be more like a 60% fall-through. That’s going to oscillate around a number north of 50.

Operator

And we’ll go next to Parag Agarwal, UBS.

Parag Agarwal – UBS

Thank you. Thank you for taking my question. I have a question about your guidance for the March quarter. I’m just wondering if you can provide a (inaudible) end market which are driving the guidance and also how much of the guidance is driven by the demand from Chinese New Year.

Mark Thompson

Okay. So let me try to offer a little bit of color. There is no one big driver for the Q1 guidance. We see demand quite strong really across virtually all markets, even automotive. And so it’s really quite well distributed in terms of markets and geographies and products. So it’s very difficult to see specific granularity like Chinese New Year event. I think what we see over time in this industry is that it becomes less and less seasonal. There are certain things that do tend to be seasonal, obviously gaming and such can be seasonal. But industrial markets et cetera just aren’t that seasonal. So I wouldn’t say that there is very much specific seasonal event in the estimate.

Parag Agarwal – UBS

Okay. And the thing beyond the March quarter, are you hitting anything from our customers regarding how the rest of the demand during the rest of the year is going to shape out?

Mark Thompson

So if you look – I mean, typically we’ll see roughly 1.5 to two quarters ahead in terms of demand. So certainly – so right now – I mean, we can see in the fourth quarter, of course, Q1 building out quite strongly. We certainly don’t see any diminishing of that trend as far as we can see. But I don’t think anybody has got a lot of visibility to the back half of this year. But certainly what we can see is good.

Operator

(Operator instructions) We’ll go next to Craig Berger of FBR Capital Markets.

Craig Berger – FBR Capital Markets

Hey, guys. Nice job. Thanks for taking my question. Can we just recap on the gross margins, I guess, and on your move to being fab-lite, kind of where are we in the qualification of new foundry partners, how much your production is moving over to foundry now, kind of what’s your target as we exit the year, and how do the cost savings roll in over the next year? Thank you.

Mark Thompson

Sure. So, Craig, there are couple of moving pieces. So the – the analog portion is already in foundry, particularly for some interface products. So it’s already on and running as we speak. The big next chunk is MOSFET, which we expect to begin to sell that product sometime on the cusp of the end of Q1, early Q2. And we’ll then be ramping that and have that available for the rest of the year. And so we could see numbers that by year’s end that are in the 10% range of wafer starts. Again, it’s of course mix sensitive. But that would be the range of expectation on a run rate basis by year’s end. And then of course, that’s a key enabler for us to do our footprint consolidation with the Mountaintop closure that we’ve got slated for, again, the cusp of 2010 and 2011.

Craig Berger – FBR Capital Markets

Can you talk about the timing and magnitude of cost savings from that Mountaintop closure?

Mark Thompson

The estimate is the same as it’s been.

Mark Frey

Craig, it’s about $5 million per quarter in cash overhead expenses and about another $3 million in depreciation. And that would begin to fall through in Q1 of 2011 under the current plans.

Operator

And we’ll go next to Tristan Gerra of Robert W. Baird.

Tristan Gerra – Robert W. Baird

Hi, good morning. Just to – as a quick follow-up to something you started to discuss earlier on the call, how much was China and the pre-Chinese New Year a factor in the recent trends? And what type of visibility do you have post February 14, if you can bring any comment on that?

Mark Thompson

In terms of the Chinese New Year, as I tried to comment on earlier, I wouldn’t say that there is any discrete factoring of that into our current estimates. And I – so in terms of visibility, post Chinese New Year, all of our forecasts and estimates are for the full quarter. So they do encompass the picture of what it looks like both during and post. There is always a little bit of a ripple effect, particularly in point-of-sale for distribution where people will typically take a little more prior to the New Year holiday then take a little less if there is time-off and then pick up again afterwards. We think that that ripple this year will be less than average. Certainly the estimates that we’ve heard from our various customers are that Chinese New Year is going to be fairly minimized. Everybody is working hard to try to keep up with demand. And so we think that the overall sort of discontinuity associated with Chinese New Year will be smaller than average this year.

Tristan Gerra – Robert W. Baird

Okay. And then in terms of pricing trends, we’ve seen passive pricing already going up in Q4, what would be your expectation for the first half of this year?

Mark Thompson

Well, if you look at pricing, I mean, normally when supply is fairly tight as it currently is in the industry, then it’s a better pricing environment. So again, I think the sense of visibility would be that the second quarter is most likely to look like the first quarter in overall profile. What the second half would look like, again, I think we’ll probably want to wait a quarter before we make much comment on that, because I think relatively little visibility other than major new product platforms. But overall demand picture is nobody is forecasting that yet.

Operator

And we’ll go next to John Pitzer, Credit Suisse.

John Pitzer – Credit Suisse

Yes. Congratulations, guys, and thanks for taking my question. Guys, when you look at the $9 million work-down in the calendar fourth quarter, I think that brings the total for the year as far as inventory work-down to something north of $50 million. And I guess you commented that you thought channel inventory to be flat in the March quarter. Help me understand, are we working at a new norm or do you expect at some point you’ll recoup that $50 million plus of inventory work-down that we saw in ’09, sometime throughout the year in 2010?

Mark Frey

I think the answer is yes, it is a new norm. We want to – we believe we can operate in the eight to nine-week range without impacting service. The reason we can do that is two things. Number one, the mix of our inventory is much higher quality. It’s much higher moving products. And our supply chain management tools have simply continued to evolve. And of course, we desire to operate in that level, because when you are operating in the eight to nine-week sort of inventory versus a 11-plus, there are a lot less problems and headaches as the cycle goes through. So from an operational standpoint, it allows us to I think have a higher margin model. Obviously it’s more efficient for our distributors. So the supply chain overall is more efficient. So it’s a very desirous operational upgrade. And we’re going to hold on to it.

John Pitzer – Credit Suisse

And then just as a follow-up, CapEx in the September quarter was well below trend, in the December quarter it was slightly above that 6% to 7% range you got it for the full year. So just kind of curious what you spent on. And if we think about capacity growth, did the CapEx spend in Q4 start to come on this quarter or is that really a Q2 phenomenon?

Mark Thompson

The CapEx is always very lumpy in terms of how it’s spent. And if you look at – if we average a little bit over a couple of quarters, at any given time, you will typically see one or two big plant upgrades of some kind, like an eight-inch conversion or a new trench technology or something like that coming on line. And there is the steady stream of debottlenecking that goes on. And so that’s – those are kind of the two big chunks. If you look at the estimates for 2010, that’s roughly what it looks like. We are driving an eight-inch conversion in our Salt Lake plant, and we’ve got active debottlenecking things that are going on all over the factories, which is how we will be driving capacity up across the year.

Operator

And we’ll take our next question from Steve Smigie of Raymond James.

Steve Smigie – Raymond James

Great. Congratulations on the quarter. Just curious, if you could provide an actual utilization percentage, I think you have qualitatively gave it, but where you are and where you’d be at the end of Q1. And then just as follow-up on Q2, you’ve talked about some already, but I’m not sure I understand, would you expect Q2 to sort of be up seasonally from Q1 even though you had a better than seasonal Q1? And along those lines, would you consider Q2 seasonality?

Mark Thompson

Steve, let me try to answer your question in reverse order. I guess – so we can’t – we're obviously not going to guide the second quarter at this point. So in terms of sort of the question on first half outlook is the current trends – so Q2 trend-wise looks kind of more like Q1, I would say, is a general outlook of a general strength in demand. But quantifying that, we are obviously not prepared to do that yet. And can you repeat the first part of your question? The utilization question, right?

Steve Smigie – Raymond James

Yes.

Mark Thompson

It’s – utilization is as always a little bit different by factory. What I would say is that we like our utilization now. And so we would not like it to be a lot higher or a lot lower. It’s a good balance of service level and cost. So if you look in our MOSFET plants, that means that they are running in the 90s and then in the analog space it’s kind of running in the 80s. And again, that mix will squish around a little bit depending on what the actual mix is. But that’s – so you should think about those are the components of our current utilization and we would like to keep them roughly there across the year. And if you look at our capacity plants, they will try to scale our capacity to our demand projections while maintaining utilization in that range. So that’s the way to think about it. And then again if you look at the margin progression that builds on that from cost reductions and, but more importantly, mix improvement via new products, again it was about 140, 150 BPs sequentially. And so that gives you a picture of how you can think about the progress of our income statement.

Steve Smigie – Raymond James

Great, thank you.

Operator

And next we’ll go to Kevin Cassidy, Thomas Weisel Partners.

Kevin Cassidy – Thomas Weisel Partners

Thanks for taking my question, and congratulations on a great quarter and great outlook. In the last quarter, you had mentioned double bookings. And I’m wondering if you could just say a little more about that and how you are controlling that.

Mark Thompson

So – let's see, double bookings. I guess last time when the question came up, what do we do about it. I guess the answer is the same now. And I think with another quarter under our belt of strong evidence that it isn’t a problem for us in the sense of any time supply gets tight, supply is tight, there is some speculative ordering that goes on. If you look at what we have done with our channel, we took the channel down even though we had the opportunity of course to ship much more into it than we did. And so that I think provides clear evidence that we have very good picture – real-time picture of sell-out, and that we align our factories and our shipments with the sell-out.

And so again, we can keep careful track of what’s really being turned into product by the OEMs and make sure that we align with that. And so we’ve talked a lot about our supply chain processes. We've made huge upgrades. We think we are one of the stronger supply chain companies around now. And I think we are starting the evidence – we've got the evidence to substantiate that. So again in a tight environment, there will be excess orders floating around out there, but we don’t believe that they skew our results at all.

Kevin Cassidy – Thomas Weisel Partners

Okay, great. Maybe we could turn to your plans for cash if you are going to be generating more cash flow this year. I wonder what your plans are. Is it pay down more debt or what other options you have?

Mark Frey

The current activities will continue. The primary focus is to continue to delever. I don’t have a ratio as to what’s comfortable. But frankly, no doubt, would be fine. We are, I think, negative 20 in terms of net cash right now. So obviously we’ll go materially positive in net cash next year. And our goal is to be in a position to retire the debt if necessary. And then the other priorities are opportunistic acquisitions, which we continue to take a look at a number of assets that become available. We bought a couple small ones in 2009. We expect to have transactions in 2010. And then we’ll begin to assess how to use the cash to return to shareholders, whether it be stock buybacks or dividends. But I think it’s a little premature for that kind of discussion until we get into a stronger net cash position.

Operator

And we’ll go next to Brendan Furlong, Miller Tabak.

Brendan Furlong – Miller Tabak

Good morning, guys. Thanks a lot. I don’t think you addressed this question. But on the OpEx for Q1, up to $78 million, is there like a seasonal bump in that because of entering new year and then we fall off a little bit in Q2 or is that the new run rate?

Mark Frey

Yes, it’s a seasonal bump. The primary driver from $73 million to $78 million is the reinstatement of variable compensation. And so that will vary across the year and not tail. But the other primary driver is, number one, the fact that employees tend to not take much vacation in Q1 because there aren’t many big holidays. And two, the employer tax matching and other benefits come back into place early in the year. And then people max out in their FICO withholding et cetera and then it tails off later on. So it is a new run rate that I think will mildly tail. We do not have plans to add basic course spending of any more than, say, $1 million until we get the basic OpEx structure to 20% or below.

Brendan Furlong – Miller Tabak

Understood. Thanks a lot.

Operator

And we’ll go next to Bill Ong, Merriman Curhan & Ford.

Bill Ong – Merriman Curhan & Ford

Yes. Congratulations on the execution. You mentioned earlier your relation with OSRAM LEDs. Can you talk more specifically about the LED applications and TV backlighting and general outdoor/indoor lighting? What type of market opportunity you could perhaps participate in driver ICs? Thanks.

Mark Thompson

Sure. In PCIA, we have been investing heavily over the last couple of years in broad variety of solutions for those. And so we are really seeing a much greater acceleration and acceptance of these in LCD in backlight units for LCD TVs and a broad range of industrial and consumer lighting.

Bill Ong – Merriman Curhan & Ford

Any sense of what type of revenues you can expect from that going forward just given how strong the LED market is taking off?

Mark Thompson

I don’t have that off of the top of my head, but we’ll get that – we'll make sure that we comment on that in future calls.

Operator

And we’ll go next to Eric Ghernati of BoA/Merrill Lynch.

Eric Ghernati – BoA/Merrill Lynch

Yes, hi. Thanks for taking my question. Just a question on the sequential decline that you witnessed in the computing segment in Q4. Can you just give a sense on what drove that?

Mark Frey

Ask that question again, please.

Eric Ghernati – BoA/Merrill Lynch

The sequential decline that you saw in your computing segment, I believe it’s down like around 3% to 4%. Can you just give a sense on what drove that?

Mark Frey

Dan, do you want to handle that?

Dan Janson

Yes. I have – I think that – I'm not sure that we were down. I have to look at the numbers. If we were down, it was – I think it was more of kind of flattish. But basically what you’ve got is the normal peak in Q3. We typically expect things to be a little bit lighter in Q4 for computing. Usually that’s when consumer is stronger and actually saw a little better strength than we typically see in the fourth quarter.

Eric Ghernati – BoA/Merrill Lynch

Just some more clarifications, please. Expectations for internal inventory in Q1?

Mark Frey

Our basic management is roughly to keep our days of inventory below 70, not counting the inventory that we’re going to put in place for the Mountaintop closure.

Eric Ghernati – BoA/Merrill Lynch

And then you had talked previously about in fact that you are exploring opportunities, a little more inventory, especially for distributors that are targeting the computing segment for your MOSFET products. Can you just give a sense on where you are on this front and whether you expect that to impact your internal inventory in coming quarters? Thanks.

Mark Frey

We are as lean as we’ve ever been in the computing and in the channels that are Taiwanese and Chinese ODMs. And it is typical to build inventories in those locations in late Q1 and Q2 because they will tend to peak in Q3 with the pre-Christmas builds and then tail slightly in Q4. That obviously wasn’t the pattern this year. We had a pretty good growth in Q3 and then we grew again in Q4 in spite of the channel reductions. But that would be typical. So I would see us adding at least in the Q2 environment to those inventories, but it’s basically an operational strategy of matching capacity to what is typically lumpy demand.

Operator

And we’ll take a follow-up question from Terence Whalen of Citi.

Terence Whalen – Citi

Hi. Thanks for taking my follow-up. This one relates to OEM inventory levels. I think you were very clear in stating that the inventory at distributors declined about 7% or 8%. What’s your insight and level of confidence and observations on inventory at OEMs and also distributor and customers? Thank you.

Mark Thompson

Terence, we don’t have nearly the visibility into OEMs inventory. Of course, it’s not generally shared. So we have to triangulate on it a bit, whereas of course we get exclusive reports from distribution on inventory. I would say I think the inventory situation at the OEMs in general is pretty healthy. I think that they are at roughly the days that they would like to be. So I don’t think that we will – I don’t expect that they are adjusting it either up or down.

Mark Frey

IBM is only one that I’m aware of that’s reported and they reported flat. And I think just to recite some of the channel checks that the people on this call have made, I think Christmas sell-through was for electronics, viewed as robust better than expectations and I think there were cautious inventory strategies that were put in place going into Christmas. So my personal view is that they haven’t built anything beyond their own seasonal oscillations.

Terence Whalen – Citi

Okay. And then as a last follow-up, regarding lead-times, is there an expectation for lead-times to stay about flat, actually creep up a little bit or decrease as some incremental test capacity comes online? Thank you.

Mark Thompson

We pulled lead-times down a little bit in the last month. And so we would expect them to be stable to modestly down as our goal, as we head across the year.

Operator

And we’ll take another follow-up question from Romit Shah of Barclays Capital.

Romit Shah – Barclays Capital

Hey, Mark or Dan, could you guys just give us your view on how you expect your major end markets, PCs and such industrial consumer to perform here in Q1?

Mark Frey

Typically industrial is seasonally stronger in Q1 than computing and consumer. And we are seeing that – we are seeing a lot of momentum in power conversion in industrial and auto for all the reasons Mark pointed out in his script. I think the other markets or application areas are benefiting from the fact that they did have a good Christmas sell-through. There has been again high expectations for the consumption aspect of Chinese New Year. And then of course we are seeing strong early January builds for those markets as well.

Romit Shah – Barclays Capital

Okay. So better than seasonal growth from your consumer businesses and seasonal growth in the industrial and auto segment.

Mark Thompson

I call the industrial better than seasonal as well. So it’s seasonally supposed to be up, but it’s up robustly I would say.

Operator

And we have a follow-up question from Craig Berger, FBR Capital Markets.

Craig Berger – FBR Capital Markets

Hey, guys, thanks for the follow-up. One housekeeping, how do we think about the tax rate moving forward in 2010? And then the second question is, how much either equipment or headcount capacity do you have to be able to respond to upside? Meaning, can you do 400 a quarter, if you have demand? Can you do more than that? What’s the capacity threshold?

Mark Frey

I’ll take care of the tax rate and Mark can handle the capacity threshold. We expect 15% to 20% adjusted tax rate, depending on all of the variable factors that usually play into that in the future. It’s very hard to nail it down lower than that range.

Mark Thompson

Craig, of course, any capacity analysis is inevitably a bit mix dependent. But if we look at most probable mix, we are comfortable at this point up to in the 400 per quarter range and of course we’ll be driving that across the year with debottlenecking and various other capacity projects that are accommodated in our CapEx budget that we put out.

Craig Berger – FBR Capital Markets

And can you just comment on hiring or re-hiring?

Mark Thompson

Well, we are being very cautious about that. A lot of the progress that we’ve made has been on – we took the opportunity of very dead period a year ago to really get aggressive with some of our factory layouts with lean. And so we are trying to be very, very careful about what we bring back. So if you look at the – in the factory side, inevitably the direct labor does somewhat scale with volume. But it’s – we'll certainly keep our headcount far below where it was. On the OpEx side, Mark’s comments are that we remain committed to our 20% OpEx goal. So we are pretty close to that. So you would expect to see that that – we won’t be adding headcount there until we can afford it basically with higher top line, better growth, giving us the opportunity to invest more in R&D. And that could result in some hiring, but certainly for 2010, I don’t expect to see a lot of headcount addition.

Operator

(Operator instructions) And we’ll go to Steve Smigie of Raymond James.

Mark Frey

Okay. This will be our last question too.

Steve Smigie – Raymond James

Great. Appreciate the opportunity. I was hoping you could comment a little bit on capacity constraints in the industry, how overall that’s been impacting you and your own particular position relative to that? And then if you could just give any color you may have on share count for the quarter? Thanks.

Mark Frey

Share count, around 128 would be a good modeling number. And what was the other question?

Mark Thompson

It was capacity constraints. Yes. Broad-based industry capacity constraints, that’s a tough one to comment on. I mean, we haven’t – we haven’t seen ourselves at this point yet to be impacted by, say, an ability to get silicon or packaging capacity or those kinds of things. Again, there is indications that the foundry is getting tighter. But at this point, we feel pretty comfortable that we’ve got a map for what we need in order to accommodate our plans.

So I would say overall that capacity is tight, but it’s actually, I would say, fairly healthy, in the sense that it’s not – there aren’t huge pinch points that’s requiring careful execution and management, but I wouldn’t say it’s high. At this point in time, it’s not limiting us in a significant way. And based on projections that we’ve got in our estimates and models and so forth, I would expect it will remain that way for certainly the balance of 2010, I think a reasonably healthy supply and demand picture.

Dan Janson

Okay. That’s all we have time for.

Operator

And that does conclude today’s conference. We thank you for your participation.

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Source: Fairchild Semiconductor International Inc. Q4 2009 Earnings Call Transcript
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