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Executives

Dan Janson – VP, IR

Mark Thompson – President and CEO

Mark Frey – Executive Vice President and CFO

Analysts

Ross Seymore – Deutsche Bank

Terence Whalen – Citigroup

Parag Agarwal – UBS

Craig Berger – FBR Financials

Tristan Gerra – Robert Baird

Venkatesh Nathamuni – JP Morgan

Suji De Silva – ThinkEquity

John Pitzer – Credit Suisse

Steve Smigie – Raymond James

Kevin Cassidy – Stifel Nicolaus

Brendan Furlong – Miller Tabak

Fairchild Semiconductor International, Inc. (FCS) Q2 2011 Earnings Call July 14, 2011 9:00 AM ET

Operator

Good day and welcome to the Fairchild Semiconductor second quarter 2011 earnings call. Just a reminder, today's conference is being recorded.

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

Dan Janson

Good morning, and thank you for dialing into Fairchild Semiconductor's second quarter f 2011 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 Canaccord Genuity Growth Conference on August 9 in Boston; the Citi Technology Conference in New York on September 8; and the Deutsche Bank Tech Conference on September 14 in Las Vegas.

We'll start today's call with Mark Frey who will review our second quarter financial results and discuss the current status of third 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 web cast from the Investor Relations section of our website at fairchildsemi.com. The replay for this call will be publicly available for approximately 30 days.

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 risks and uncertainties. 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 file, 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 the reconciliation of non-GAAP to comparable GAAP measures at the Investor Relations section of our website. The website also contains the 2011 Q2 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. I'm sure most of you have had a chance to review our earnings press release, so I'll focus on the key points.

We delivered strong second quarter sales growth, and improved gross margin and EPS despite the impact of higher input costs. We also generated excellent free cash flow, paid off another $20 million in debt and ended Q2 with the highest net cash position in our history. Let's review some of the details starting with the income statement.

For the second quarter of 2011, Fairchild reported sales of $433 million, up 5% sequentially and 6% higher than the second quarter of 2010. Adjusted gross margin, which excludes accelerated depreciation, inventory reserve releases and write-offs related to fab closures was 37.2%, up 30 basis points from the prior quarter. Margins benefited from higher utilization and a customs duty settlement, which offset higher input costs, unfavorable currency exchange and 8 inch fab start up costs.

Input cost increases have been a steady headwind to margins for some time now. In total days these higher costs over the last three quarters created 230 basis points of gross margin headwinds, that we have so far offset with improved product mix and other cost reductions. We expect some of these cost elements to stabilize in the second half, while the impacts of metals and energy pricing, FX and China wage inflation are more difficult to forecast.

R&D and SG&A expenses were in line with guidance at $98 million, up 6% sequentially, due to increased R&D sales and application engineering investments to drive our sales growth. We also absorbed our annual merit pay increases in the second quarter. Our third-quarter guidance reflects the leveling off of OpEx now that we have ramped up a number of key new product development efforts.

If we sit back and compare our OpEx spending in Q2 to the year ago quarter, an interesting trend becomes apparent. We increased R&D spending from 7% of spending in Q2 2010 to 9% of revenue in Q2 2011, while decreasing SG&A as a percent of revenue by 30 basis points. Included in these numbers are the recent silicon carbide and MEMS acquisitions plus continued funding for technology development in high-voltage, mid-power and mobile analog.

These investments in R&D are what will drive our future sales growth. Fairchild’s OpEx as a percent of sales remains one of the lowest in our peer group.

Second quarter adjusted net income was $55 million, the highest second-quarter performance since the year 2000. Adjusted EPS was $0.41. Now I would like to review second quarter highlights for our sales and gross margin performance for our two major product groups. PCIA sales were up 7% sequentially and 18% from the year ago quarter, due to strong demand for our innovative high-voltage solutions, driven by ongoing content gains. Gross margin increased more than two points to 39.7% due to improved product mix, greater new product sales and the non-recurring duty settlement referred to earlier.

In our MCCC business, sales increased 3% sequentially due to seasonally higher demand. MCCC gross margin was down two points from the prior quarter, as we shipped a greater mix of lower margin computing related products.

Turning to our balance sheet, we grew internal inventory dollars by about 5% to hold days of inventory flat with the prior quarter. Days of sales outstanding or DSOs were flat at 34 days, while days of payable were down a day sequentially to 53 days.

We continue to strengthen our balance sheet due to strong earnings, coupled with disciplined asset management. Free cash flow was $39 million for Q2 and we ended the quarter with total cash and securities exceeding our debt by a record $167 million.

We announced in Mid May that we entered into a new $400 million revolving credit facility, which replaces our existing revolver and term loan. We used the proceeds from the refinancing plus $19 million in cash to retire the old revolver and term B credit facility. We currently have $300 million drawn on the revolver, with $100 million of undrawn capacity. This new facility matures in 2016, and allows us to borrow at the rate of LIBOR plus 175 basis points. We were pleased to complete this debt reduction and refinancing, while taking advantage of favorable market conditions. It was also great to see the deal significantly oversubscribed, which allowed us to narrow participation to just a select group of key relationship banks.

Turning now to forward guidance, we expect sales to be flat to up 3% during the third quarter. Our current scheduled backlog is sufficient to achieve this range. We expect adjusted gross margin to be down 25 to 75 basis points as the impact of better mix is offset by higher input costs. Factory utilization will also be lower as we follow our normal process of reducing internal and channel inventory during the second half.

We anticipate R&D and SG&A spending to be approximately $99 million. Net interest expense is expected to be roughly $1.5 million per quarter going forward. The adjusted tax rate is forecasted at 15% plus or minus 3%. As with last quarter, we are not assuming any obligation to update this information, although we may choose to do so before we announce third quarter results.

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

Mark Thompson

Thanks Mark. We delivered solid sales growth in the second quarter and expect this momentum to continue in Q3 as we ramp our shipments to support numerous design wins.

I will begin today with a discussion of why we believe our sales growth is sustainable given underlying content gains, coupled with our ever increasing share position in the fast-growing smart phone and tablet markets. I will wrap up with a more detailed review of current quarter results.

Fairchild is focused on increasing energy efficiency from our beginning. And we believe the possibility to help our customers improve is virtually limitless. Industrial and major appliance customers are currently adopting variable speed motors in an effort to dramatically improve efficiency. Imagine the cost savings for our large office buildings if every air handling den were converted to highly efficient variable speed motor using 50% to 60% less energy than the earlier single speed AC motor technology.

The value proposition to our customers is very compelling [ph]. When industrial or major appliance manufacturers make this conversion to variable speed motors it creates content gain opportunity for Fairchild of anywhere from $4 to $12 per unit. Remember that there is basically no systemic conductor content in the single speed AC motor, so this move to variable speed, which requires silicon control and power management is all new content for us.

We are still in very early stages of this conversion to variable speed motors, and our demand in these markets are driven much more by the adoption curve of this technology than the end market unit sales for appliance or industrial motors. When weak economies are strong, this huge cost of ownership savings possible by converting variable speed motors makes this market very resilient.

Our Smart Power Module business, or SPMs, is the best proxy for the growth of the new variable speed motor technology. Our SPM business is now approaching 10% of our total sales in Q2 and it increased 20% sequentially, and it was more than double the year ago quarter. We have good demand visibility for the rest of the year, and expect continued growth for these products.

Our auto business is also focused on improving efficiency, in this case fuel efficiency through the use of more efficient ignition products and a conversion to electronic power steering or EPS. Here again, the primary growth driver is new semiconductor content and application where there previously was none. The EPS technology is a great illustration of this trend, Fairchild is the industry leader in providing powered modules for EPS systems that improve fuel efficiency by 5% to 10%.

Our content is more than $10 per electronic power steering unit compared to 0 in the previous hydraulic model. Again, it is not so much used in sales of cars and trucks that drives on roads, it is the rate of transition for this energy-saving technology. We are shipping significant volumes of these power modules to an industry leading customer, and expect to begin ramping shipments to a second large customer in the end of the summer.

Our overall sales into the automotive sector increased 3% sequentially, and 26% from a year ago. The customer base is largely outside the Japanese auto supply chain, so the disruptions from the quake have little impact on our auto business. Demand visibility is solid through the end of the year, and we expect to continue our strong growth momentum.

In the alternative energy sector, we have experienced strong growth for our most efficient high voltage power management solutions. The payback on these solar and wind projects is dependent on the overall system efficiency, so customers in this industry need extremely efficient silicon power management solutions. We believe IGBTs power modules will be the preferred technology in this sector given their greater efficiency and reliability compared to discrete solutions. This is all new content for us and it comes with very attractive margins.

In addition to these ongoing content gains, we are also increasing our share in a number of growing end markets. We continue to expand our mobile analog portfolio beyond our traditional strength in high-frequency voltage regulators and USB switches into new audio solutions, RF voltage regulators, intelligent load switches, mobile high-definition link switches, ultra efficient power convergent solutions, and switching regulators.

We are now ramping shipments of our IntelliMAX load switches, audio switches and integrated [ph] MOSFET into a fast growing smart phone manufacturer. Our latest power conversion solutions that provide industry leading 10 milliwatts of standby power also shipping in to this customer and others in the second half. We are the first to market with the mobile high-definition link switch that allows HDMI signals to be routed through a standard USB connector, and expect to ship a significant number of these devices to a large smart phone customer in the second half.

Our switching chargers are designed into another handset OEM, and are now shipping in significant volumes. These innovative switching chargers replace less efficient linear regulators and reduce charging times by up to 50%. We are also developing an impressive portfolio of wins with all the major reference design providers. A good example of our success in this area is the numerous wins we have had reference designs as well as OEMs for our latest RF voltage regulators.

These analog solutions support constantly varying output to optimize our power levels to the distance from the cell tower. This feature increases talk time as much as 30%. We believe these wins and reference designs will enable us to capitalize on the growing sales and emerging smart phones manufacturers, particularly in China. Each design win represents increased share for us in these new application areas.

We expect to ship as much as $20 million of incremental new product sales in these application areas in just the second half of 2011. These are sockets that we did not have in the first-half of the year.

Turning now to the second quarter results, I will start with an end market commentary and then review a number of key metrics for our overall company performance. Demand was generally in line with expectation for all segments. We continued to see good demand for our high-voltage solutions from the industrial, automotive, and appliance end markets. Handset demand was also solid and we have excellent design win momentum going into the second half. As expected we saw muted but seasonally better sales in computing and consumer markets.

We did see a slowdown in demand from inverter applications as the alternative energy sector adopts the changes in their markets. Given the rapid price reduction of solar panels and fresh concerns about nuclear power, we are optimistic about the long-term demand from our inverter customers.

Our third-quarter guidance reflects a bit more caution around consumer and computing end demand, as well as current softness in the inverter market. Distribution sell through is up 7% sequentially in Q2, and channel inventory remained within our target range. Factory utilization was in the low to mid-90s in the second quarter. MCCC lead times are up slightly due to normal seasonal order strength, while solid industrial, automotive and appliance demand keeps PCIA lead times extended.

Overall product pricing in Q2 was down roughly 1% from the prior quarter. In closing, Fairchild continues to grow sales due to ongoing content and share gains. We believe we are still in the early stages of major technology transitions in the industrial appliance, alternative energy and automotive markets that will drive our business for years to come. In the mobile space, Fairchild is steadily gaining share with our extended portfolio of new analog products. On the short run we are absorbing some higher input costs, we are also confident that sales growth for our high-voltage and mobile analog solutions will enable us to continue a steady margin progression towards our target model.

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. Now let's take the first question please.

Question-and-Answer Session

Operator

The first question will come from Ross Seymore from Deutsche Bank.

Ross Seymore - Deutsche Bank

Hi guys, congrats on the solid results. Earlier this week we had a negative preannouncement from another chip company, talking about pretty general and overall softness. From your district [ph] sell-through data points and your results, it doesn't seem like you've seen that, but any color you see on things slowing down throughout the second quarter?

Dan Janson

So, losses again [ph]. So, as we said in the prepared remarks, we did see muted but still seasonally better computing and consumer demand. We had an increase in our shipments in the computing space as we expected. You know, I think there is clearly some amount of cannibalization that's going on from tablets, but you know for us that's a little different play, that actually is a content gain for us, because we don't have a lot of content in the net books, which are the primary losers in the content shift that's going on between computing and tablets.

We actually have more content in tablets and into higher margin content. So, while we did see some weakness in computing, we also see the strength showing up more on the tablet side. The one area where clearly we did see some weakness that we talked about was in the inverter market, and I think everybody knows that there is a reset going on in the solar and wind markets right now as a lot of the big projects that were incented by governments around the world are starting to finish up and that market is adjusting to the new market going forward. We still see a lot of potential for growth in that market, but clearly there is a period of digestion right now of what's already being built and then we think the market will pick up again going forward.

Ross Seymore - Deutsche Bank

One quick follow-on on the gross margin side of things, a question for Mark Frey. Can you give us any quantification of what that unfavorable currency exchange did to your gross margin by itself just so we can get an idea is that unwinds? Because I would have thought going forward mix would have improved, utilization probably won't change that much, I wouldn't think, and the input costs, like you said, will be stabilizing, so I guess I'm a little surprised that the gross margin guidance is down roughly 0.5%?

Mark Frey

Well, you are right about the factors. The mix, we continue to expect to improve, the utilization will have a negative impact until sales strengthen again. In terms of the input cost, they filter through the system at different speeds because the currency themselves we actually hedge. I don't have just a currency number, but out of the 230 points that we mentioned in my script, at least 100 of it is currency, although you mentioned a few things that would slip I'm not expecting those currencies that strengthened to turn around and weaken. I think it would primarily the Yuan and the Won.

Ross Seymore - Deutsche Bank

The other input cost you're talking about the gold, copper, silicon, those are what you mean is going to stabilize or you expect to stabilize?

Mark Frey

Yes, I think, there is – copper has kind of peaked in December, it has been down, obviously it's still volatile, but it was trending down in the first half. So, it obviously hit another high this morning, so I don't – who knows what's going to go on there. We think silicon will moderate. I saw an article this morning on a channel, said that companies have over ordered raw wafers due to the earthquake and that's what maybe those pricing factors are going to resume their decline.

Ross Seymore - Deutsche Bank

So generally those things are pretty much the consistent pressure and then on top of that you have utilization dropping and somewhat offset by mix, that's the easiest summary?

Mark Frey

That's easiest summary.

Ross Seymore - Deutsche Bank

Perfect.

Mark Frey

As you know Ross, I mean we always look to drain our channel inventory and our internal inventory a bit going in the second half. So we're giving ourselves some room to have a lot of latitude to be able to do that.

Ross Seymore - Deutsche Bank

Great. Thank you.

Operator

Moving on, we will take our next question from Terence Whalen from Citi.

Terence Whalen - Citigroup

Hi, thanks for taking the question. This question is on capital expenditures, it seems to come in a little bit above my expectation for this quarter. Can you talk a little bit about the allocation of that and the timing of when that becomes productive I'm trying to understand the degree to which utilization might decline in the next couple of quarters? Thanks.

Mark Frey

Sure. First of all, we think the capital spending will stay at around these levels for another few quarters and it's related to three major programs. We're in the process of shifting our main fab capacity from a mix of 6-inch and 8-inch to a 100% 8-inch and that accounts for the cost decreases that you think you've already seen and the announced reduction in force that we made in December. The biggest project is Bucheon, where we're adding an 8-inch factory, which we expect to begin to ramp up in the second half of next year.

So that's when we'll actually see the revenue impact of the Bucheon 8-inch. And we've got an Alpha 8-inch line in Salt Lake that we're qualifying currently. One thing I should mention is that the expansible or the period expenses related to those programs in our balance sheet currently are bit over 100 basis points in gross margins and obviously, once those improvements become ramped up, those current expenses will go away.

Terence Whalen - Citigroup

Okay, terrific. And then as my follow-up, I was wondering if you could comment on your expectations, or I think you said one part of the business where you saw a little bit more softness was in computing. Can you just characterize that in a little bit more detail? Thank you.

Mark Frey

Sure. Q2 begins to be a ramp up in MOSFETs for computing simply because of the back-to-school and the Christmas build, which for some reasons usually start a little bit earlier than handsets, and our margins in those markets are less than the margins in our mobile analogs. In Q3 the MOSFETs will continue to be high and then they will trail off in Q4 and then in Q4 typically our Mobile Analog will increase which generally will drive actually stronger product mix improvement at that point.

Terence Whalen - Citigroup

Great. Thanks again.

Operator

Moving on, we will take our next question from Parag Agarwal from UBS.

Parag Agarwal - UBS

Hi guys, thanks for taking my question. Just wanted to drill down further on gross margins. Now, you have talked about the start of conversion [ph] to 8-inch and also there is conversion going on in NAND. So, I was just wondering apart from the period cost when should we start seeing the gross margin impact of this 8-inch conversion.

Mark Frey

Well, we're seeing the main impact really currently. We'll see the full impact in the fourth quarter. So, we'll – well the flip will be completed I believe at the end of the third quarter. In Bucheon, you'll begin to see the revenue in the second half or late 2012 and in Salt Lake about the same time.

Parag Agarwal - UBS

So, you're trying to fit your gross margin trajectory that means Q3 could be a low point is that the best way that we could think about it?

Mark Frey

You mean Q3 of this year?

Parag Agarwal - UBS

Yes, and you should start seeing gross margin going up in Q4?

Mark Frey

We don't guide Q4, but as we delineated with Ross the factors are product mix is expected to improve and contribute to gross margin. Ongoing cost reductions are expected to contribute to gross margin, currencies and metal prices are very hard to say what they are going to do. Utilization would – if it improves than that would contribute to better gross margin, but if we continue to have soft demand then obviously that headwind will continue. And the period expenses related to the fab upgrades, you're right they will peak in Q3, and begin to trail off but only trail off slightly for a couple of quarters, and then as we get further into 2012 they'll trail off more frequently.

Parag Agarwal - UBS

Okay. In terms of end market demand could you provide some more color on your industrial and appliance market going forward? I know the alternators or inverters are weak, but other than that any other weakness in that market?

Dan Janson

Yes, this is Dan Parag. So, other than the inverter market, everything on the industrial side continues to be quite solid. We've got good demand visibility. As you saw in our numbers, our Smart Power Module business is running very strong and we see that continuing, it's basically paced by our ability to add capacity, which we have been doing steadily. If you look at our discrete business there again, especially on the IGBT side, it's been quite strong.

One of the interesting sidelight stories out of the Japanese quake is that we have seen some of those large Japanese customers that historically have been very difficult to break into, approach us and look for other suppliers, and there aren't many in the world that can offer the kind of quality that you will get from a company like Mitsubishi. Fairchild is one of them, and so we are getting people coming to us, asking us to participate in some of their new designs. So, we see this as a long term opportunity. So, the strength looks good and we are seeing plenty of new opportunities to make us optimistic about the future for industrial.

Parag Agarwal - UBS

Thank you very much guys.

Operator

Moving on, we will take our next question from Craig Berger from FBR Financials.

Craig Berger - FBR Financials

Hi guys. Thanks for taking my question. I just wanted to dig in a little bit more on the MCCC business. It's at its lowest revenue level in five quarters. Is that more macro driven, is it something company specific and kind of what's the outlook there for the second half?

Mark Thompson

So, Craig let me – the moving parts to MCCC, the largest part of that is the low-voltage MOSFET business, which is one of the places that we've been driving some mix shifts in. And particularly core computing is a place that we've been taking – the core computing here being primarily classic notebooks, we've been taking steadily down. It's just not – it is not a place that we think can long-term drive target gross margins, and we don't expect it to be a growth segment either as that market fragments into tablets of varying stripes, so we've been trying to manage that in a systematic way.

If you look at what we're supplanting that with, is really much more sort of industrial mid-voltage applications, but that's a slow process. So that does wind up – is a place that we have not been posting growth and in fact have been posting a little bit of shrinkage as we've been managing through, putting that in position to drive gross margin and share gains, particularly in places like tablets and mid-voltage. If you look at the mobile analog, that's been a pure growth trajectory for us for now a number of years, and we expect to continue across the year.

As I commented at the beginning in our presentation, we see a lot of new designs going into volume in the second half of the year in mobile analog. We really like the position in the smart phone space in general, particularly with some of the players who are taking share and the features there continue to proliferate – and our offerings continue to proliferate, and that is some of if not the highest gross margin segment for the company. So, we do see certainly the inflection in the middle of this year in MCCC, but we're very bullish about where we're at in smart phones and expect to see progress in the LDMOSFET space.

Craig Berger - FBR Financials

Okay, and as a follow-up, I guess it's a two part follow-up. The PCIA revenues gapped up. Is this now a sustainable level that we can kind of grow from or see seasonal trends from? It had a really strong June. And then as part of that, I know you guys have talked about $500 million a quarter driving 41% gross margins, you've talked about some of the headwinds. Is that still a model that you are comfortable with or do we need to sort of readjust our thinking on that given the commodity and currency headwinds? Thank you.

Mark Thompson

Craig, our long-term model remains as it has been. We still have been largely or entirely driven by both the structural transformations that Mark talked about earlier, particularly the 8-inch conversion, especially in high-voltage, the segment wins. So we expect that to continue to drive us. Earlier on, in earlier conference calls we talked about becoming a, what we'll call, a post-seasonal or a non-seasonal company. So if you look at the procurement for particularly mobile, it tends to be stronger in the second half of the year.

If you look at PCIA, it tends to be stronger in the first half of the year. So, if you put those two elements together, we are deliberately driving ourselves towards muted or non-seasonality. So, if you look at that, as Mark commented, we expect mobile to strengthen in the second half of the year, but that's not the strongest period for PCIA. So, while there are – there continues to be the design win component and as option ramps for PCIA the market typically doesn't help us in the second half of the year and so that's the way we would expect that. So, expect more MCCC mix in the second half and proportionately a bit less PCIA, but we expect to see continued revenue progress across the year and into next for PCIA.

Craig Berger - FBR Financials

Thank you, and nice on the post seasonal. I haven’t heard that before.

Operator

Moving on, we will take our next question from Tristan Gerra from Robert Baird.

Tristan Gerra - Robert Baird

Hi, good morning. Inventory days has been in the range of 67 to 75 days in Q3 for the past four years. Is that the range you expect to reach in Q3 and you still – what type of utilization rates is implied in your Q3 guidance and also do you think your utilization rates in Q3 will remain above 90?

Dan Janson

Tristan could you repeat the first part as far as the days that you mentioned?

Tristan Gerra - Robert Baird

So, your inventory days internally has been in a range of 67 to 75 days, so it's quite lower than what you had in Q2.The question is what type of inventory days range you expect to reach in Q3 that will be embedded in your guidance and what type of utilization rates are implied in that inventory reduction for Q3?

Mark Frey

Okay, I'll address most of those Tristan and maybe Dan can contribute. First of all, yes, our inventory target in the low 70s, although we're very comfortable in the low 80s. Most of our peer competitors are frankly triple digits when it comes to inventory. So in Q3, we do plan and we typically plan to bring our inventories down. So I don't have a number for you but it will be lower than the 83 days we currently have. In terms of utilization, say we are in the low 90s in Q2, and we expect them to go down probably high 80s in Q3, and then Q4 they will be what they need to be depending on the market. Does that address everything you wanted?

Tristan Gerra - Robert Baird

Yes, it does. I appreciate that. And could you comment about the book-to-bill currency, sorry if I missed the comments earlier?

Dan Janson

We don't give, I can say Tristan, we don't give specific book-to-bill, we can talk about some of the booking activity though, Mark.

Mark Frey

Yes, so if you combine book-to-bill with current backlog you get a complete picture. So if you look at those the match set as we commented on at the beginning of this, we entered the quarter with our guidance range before we booked already. And the Q2 book-to-bill was slightly less than one. So if you take a look at that and if you look, a big component of that was us continuing to clean up PCIA backlog, which again, if you look at our lead times has been, tends to lead to a inflated quarter. So the book-to-bill presently plus the backlog it gives us a lot of visibility into the second half of this year and the position for that is strong.

Tristan Gerra - Robert Baird

Very good. Thank you.

Operator

Moving on, we will take our next question from Venk Nathamuni from JP Morgan.

Venkatesh Nathamuni - JP Morgan

Hi guys. Thank you for taking my question. Given the pretty decent revenue guidance for the next quarter, can you comment on what the linearity was during the just concluded quarter given especially some of the comments that we've heard from Microchip just a couple of days back?

Mark Frey

So, in general I think our orders were – it kind of follows a normal seasonal pattern. We saw good strength early on, I think the orders for our industrial business just continue to be typical stable, long good visibility on the backlog. And we mentioned inverters; clearly we saw some choppiness in that and that was pretty much across the quarter. I think that's been something that has been well understood, which is going to start to slow down. Although I think the magnitude of what we saw for a slowdown was still caught us a little bit by surprise just as the quarter progressed, and then computing and consumer, we kind of expected it to be muted and it kind of played out the way we expected.

Venkatesh Nathamuni - JP Morgan

Okay, great. Thanks for the color, and then you did talk about your plans for internal inventory for next quarter, bringing it down slightly perhaps, but we're getting some signs that distribution inventory is being drawn down, what is your expectation for where distribution inventory will be, I assume that this quarter it was approximately 8 to 8.5 weeks. Where do you expect it to be next quarter?

Mark Frey

So, our distribution inventory has been in a steady range for years now and we've been managing it in the low mid-8 weeks range. So, we will continue to manage it there. If you look at what we shipped to, we don't ship to backlog. We typically in fact have big frame orders with our distribution partners. What we do is we match point of sale, moving things up or down depending on the trends that we see in point of sale. So we have a good stable process for that and we're confident in how well it works and so we wouldn't expect a systematic migration outside of that relatively tight range [ph].

Venkatesh Nathamuni - JP Morgan

Okay, great. Thank you very much.

Operator

Next we will take our question from Suji De Silva from ThinkEquity.

Suji De Silva - ThinkEquity

Thanks. Nice job on managing the quarter guys. In PCIA, you talked about the backlog being extended here. Is that a situation you expect to alleviate in the next few quarters or persist?

Mark Thompson

So, if you look at the key elements to that, the single biggest part right now is wafer capacity, that's been driven our 8-inch investment in Bucheon as Mark mentioned. That will start to ship in the second quarter and add meaningfully to the second half of 2012. Until then we expect that that market will remain pretty constrained and therefore lead times will be longer than we like, which has really contributed to the pattern of us entering the quarter essentially fully booked and scheduled.

Suji De Silva - ThinkEquity

Okay, great. Then a question about two areas of uncertainty here, autos in Europe, it seems like autos – you talked about Japan impact, whether it has had impact on you and then Europe, it seems like it was up sequentially, have you seen any macro concerns there? Thanks.

Mark Thompson

So if you look at the elements of our European business, the general industrial business has been as expected. Dan commented on solar inverter for us in Europe has been a very rapidly growing part, that's taken a quite a big pause right now. I think most people expect that to be fairly quiet for the rest of the year. In the inverter space there was quite a lot of overbuilding that happened in late 2010 and early 2011.

Most people think it will take the second half to bleed that off. If you look at the there was a big – there is a big mobile player in Europe that has been losing some share, but the aggregate for Europe, and then the automotive piece has been – is our biggest part of our European business and that's extremely strong. And it's strong not necessarily because of the unit volumes, but as I commented in my section earlier, the growth of electronic power steering and sort of conversion to very efficient small engines, which use a single coil per cylinder and direct injections, so there is an IGBT in each of those, and we've got best-in-class solutions and are well situated with the Tier 1s.

So, if you sort of take all those sort of two net downs and couple of net ups, we're very bullish about our position in Europe, both for the rest of this year and into next.

Suji De Silva - ThinkEquity

Okay. Thanks for the color Mark.

Mark Thompson

I am sorry. Japan, essentially no impact in the short-term that was as expected. We didn't think there would be an impact, there has not been one. As Dan commented, we see actually the potential for some very beneficial shifts in procurement attitudes coming out of this. There were lot of Japanese OEMs that were left quite stranded and concentrating all of your component sourcing in the same place that you built stuff in a seismically active land, is a strategy that we think is very clear that people are reconsidering.

I spent a week there surveying customers in June, and we think particularly in the mid-sized industrial space, which was not well served in the second quarter by their local suppliers, we see some really great technology mapped to our PCIA strategy and very receptive procurement volume. So we actually think that the net change for us in Japan will be a positive, but that won't impact 2011. That's really one that you will probably start to see in 2012.

Operator

Moving on, we will take our next question from John Pitzer from Credit Suisse.

John Pitzer - Credit Suisse

Yes, thanks for taking my question. Mark, just to go back to the microchip comments earlier in the week, but you are clearly kind of arguing both for content growth and share gains is helping you guys here. I'm just kind of curious, if you were to divorce those two positive issues, would you kind of have the same underlying view of consumption relative to the macroeconomic backdrop? When you look at the guidance for September, are you assuming kind of a weakish base line consumption/macro?

Dan Janson

John this is Dan. So, let me take a stab at this. So for us a large part of our company now – more than half our company is focused on industrial, appliance and automotive market. So, the growth in those markets is kind of inextricably linked with this growing content story. So, that's really the time driver of long term growth, coupled that with what's going on in mobile. Now mobile, whether it is smart phones or tablets are clearly growing, and so there it's not so much content growth, although clearly on the tablet side, as I mentioned earlier, that's a content growth story for us as well as we move away from net books into tablets that's a content gain for us at higher margin.

So there it's really more of a unit growth story, and this conversion or this transition from feature phones to smart phones and tablets. So, in both cases the underlying market dynamics I think are pretty favorable for us. On the mobile side as Mark said, we've got a very strong pipeline of orders and that's always been one of our key components to growth. We have said right along that growing our share in the mobile space was going to be key to us being able to achieve the growth numbers that we've talked about, and I think as we outlined, we're expecting significant increase in new programs ramping up in the second half, at least $20 million of incremental new product sales in the second half with Mobile Analog, pockets that we didn't have in the first half.

So, those are kind of the key underlying trends. I think the mobile space is solid and it looks like it's going to grow nicely. The industrial space is not so much dependent on unit volume growth, it's more a content gains for us and that frankly is going to be the way it's going to be for quite some time we believe.

John Pitzer - Credit Suisse

Then guys, as my follow-up for Mark, Mark when you look at the gross margin line, all of last year you had kind of nice sequential progression and clearly kind of the revenue growth was a big driver at least a help to that. March quarter was down, June is now up, September is kind of down again, I'm just kind of curious, as you think about from September to target is this going to be just a choppy trajectory with a trend up or help me understand by the time we get into sort of the December quarter and beyond, are the new product mixes and the leverage to mobile going to be a sustainable trend where gross margin progression should be up into the right quarter-on-quarter?

Mark Frey

So your last question first, yes, we think it is a sustainable trend, but it's not a solid line quarter-to-quarter. Last year it was probably above trend. We had volume ramp ups. We had a very good pricing environment and we had a very good mix of environments. The currency and input cost situation really had not had an impact yet. So the product mix improvement continues on, the input costs obviously were a headwind that caught up to us this quarter, and as we get our inventories lower, the utilization picture will soften a bit. So, we don't guide beyond Q3, but as Mark said earlier in his commentary, will still very much be our model as implementable in a two-year timeframe.

John Pitzer - Credit Suisse

Great. Thanks guys.

Operator

Moving on, we will take our next question from Steve Smigie from Raymond James.

Steve Smigie - Raymond James

Great. Thank you. If you could comment on and I know the business is changing in terms of the mix of world. So what the reserve in the near-term would seasonality be for Q4?

Mark Thompson

Go ahead Mark.

Mark Frey

So Steve as I commented before there's, if you look at the moving parts of seasonality, we'll see the second half of the year tend to mix shift toward MCCC and towards mobile, and we would expect the first half of the year to be mix shift towards more towards our PCIA and general industrial. So, how those flow through as I – it's certainly our goal to have that be up pretty – talents in the sense of able to show nice linear progression for the company, linear progression in revenue and linear progression in improvements – in overall earnings.

It's like anything with where you have offsets it won't always be perfect. So, for the second half of the year as we commented, we feel very good about the trajectory of mobile and we expect to continue to get design wins and content progress from PCIA, but no help from the market.

Steve Smigie - Raymond James

Okay, and with regard to the PCIA being I guess less or I guess you could say in the back half does that necessarily suggest that that would have to be down in the back half relative to the first half or just less growth relative to MCCC in the back half?

Mark Thompson

I wouldn't necessarily say down, which doesn't mean it can't be down, right I mean these things I mean there is always puts and takes in that. So, the procurement season in the first half it tends to be stronger in the first half. So, as I said the procurement component of it will be mitigated relative to the first half and the share story will be a positive and how those two net out is difficult to call. But I wouldn't assume that it's down, but you can never guarantee it's up either. So just it will play out how it plays out.

Dan Janson

If I could add a foot note to what Mark said, historically, our SPM business has been highly air conditioning oriented and they tend to be begin to be built in the first half of the year as Mark said. As we broaden our SPM business to include automotive, fan motors, other appliances, we expect that seasonality to average out and therefore our PCIA situation is in flux and we – the secular trends have overpowered the seasonal trends for two years, and as Mark said, I think we will actually exit this thing as kind of a post seasonal company.

Steve Smigie - Raymond James

Okay, if I could just sneak one last one in on that, is that, it seems like if I were to look historically anyway, your Q4 might be sort of flattish, may be down a little bit and Q1 will be down. So, it seems that utilizations might come down again, on the other hand as we look into say like Q1 a timeframe it seems like, just think, okay, we have got air conditioners kicking in and so that's going have a mix up. So, I mean would it necessarily be the case that gross margin has to fall in the Q1 timeframe or can that can be flat to up depending on the factors?

Mark Thompson

So, Steve you have to pick right history, and I think you picked – for the down Q1 you go back some ways to an earlier incarnation of the company. So, if you look at our Q1 this year it was up relative to Q4 and it was up based on the strength of PCIA. If you take a down Q4, there can be two things that can pull it that way. It could be PCIA to your earlier question.

Typically computing, it softens a lot in the fourth quarter, and we will always tend to want to have very clean inventories exiting the year, basically always have the year – maybe a year, and each year would be a new year for us and our shareholders. So, if you look at how all that nets out, I think to expect both pieces of that to occur – again, I'm not guiding, I'm just talking about the components for that, assuming no macro disasters in the market, if we saw a softening or a lower Q4, we would expect the probabilities to be for a stronger Q1.

Steve Smigie - Raymond James

Okay, great. Thank you.

Operator

Moving on, we will take our next question from Kevin Cassidy from Stifel Nicolaus.

Kevin Cassidy - Stifel Nicolaus

Yes, thanks for taking my questions. Just on Japan, what's your revenue exposure to Japan?

Mark Frey

It's quite small, about 5%.

Kevin Cassidy - Stifel Nicolaus

And I guess some of these opportunities you've mentioned which seemed interesting for the mid-size industrial companies, would there be a material increase would you say by 2013?

Mark Thompson

I think that would be a good timeframe to think about. I think we'll be mapping it carefully during 2012, probably beginning to see movement then, but it becoming potentially material in 2013.

Kevin Cassidy - Stifel Nicolaus

Okay, and it's fairly material – I mean sticky designs where you'd be the primary source?

Mark Thompson

Yes, if you look at the map, I mean Japanese sockets are stickier than the rest of the world and these kinds of industrial sockets are stickier than that, so it's very sticky.

Kevin Cassidy - Stifel Nicolaus

Okay, and just one other general question. Could you remind us what percentage distribution is for revenue?

Dan Janson

It's about two-thirds.

Kevin Cassidy - Stifel Nicolaus

Okay, great. Thanks, congratulations.

Dan Janson

Thanks Kevin.

Operator

Moving on, we will take our next question from Brendan Furlong from Miller Tabak.

Brendan Furlong - Miller Tabak

Good morning, thanks for squeezing me in here. A couple of questions. I don't know if you can allude to who the second customer in the auto on the EPS side and if you are continuing to – you spent a lot of Capex this quarter obviously for that ramp in the second half of the year. When do you think you will not be capacity constrained on this smart phone modules stuff? Do you think this new second customer in auto will be as big as the first?

Mark Thompson

So couple of things. First is, all of our engagements with our customers are under non-disclosure, so we can never name names. If you look at the scope of additional customers is also always hard to call because of share, but certainly we're talking names, well recognized names with significant global share. So if their products do well, then it could become a big deal. If you look at it magnitude-wise, roughly equivalent to what it is today as an addition. If you look at when do we expect to catch-up and have a more balanced supply and demand situation in PCIA, we don't expect to get to that until the second half of next year.

Brendan Furlong - Miller Tabak

Okay, and then on the handset side, it sounds like you won some design wins at the leading smart phone provider out there. You kind of alluded to it earlier in the call, I missed it; on that leading smart phone vendor, can you just say what the content is, it on the analog side or where was it on that vendor? Thanks.

Mark Thompson

It is overwhelmingly analog but not entirely. There are some very high efficiency MOSFETs that we also have present and I don't – the dollar content is a little hard to address because it comes in layers and we don't know what that is, but suffice to say it's substantially more than the current exposure.

Brendan Furlong - Miller Tabak

I'm sorry I guess I meant to ask you on the analog side what specifically in analog are you providing?

Mark Thompson

So, if you look in the adapter we got a controller let say a very smart, very efficient controller and has 10 milliwatts off stake, which is best-in-class by several X has gotten tremendous interest both for its screen and its packaging beauty. It can be packaged in a very small form factor. If you look in the – if you look inside the phone there is a wide range of things that we're offering at the USB port charge management on the inbound side of the phone. So, both the charger adapter, as well as charge management inside the port, if you look we're offering HDMI, high definition supported HDMI out.

So, you can use your phone as a receiver and watch it on your television. There is a raft of regulation schemes inside the phone, the RFPA modulation comes in through chipset reference designs and those kinds of things audio, amplifiers and other key part of this. So, if you look at those the reason I was saying that the content is a little hard to get you kind of have to take a point in time and so depending on what chipset ramp, which phone it is et cetera, the ramps occur over time. But each of those things that I described you can think of having prices that are somewhere in the high teens through or let's say $0.40 to $0.50 in that range. So you can start to add those up and then construct your menu from that. So that's the way to think about it.

Brendan Furlong - Miller Tabak

Thanks, and that is great color. I appreciate it. Thanks.

Dan Janson

Thanks Brendan. Jim we have time for one more question please.

Operator

All right. We will take a follow up question from Terence Whalen from Citi.

Terence Whalen - Citigroup

Great. Thank you very much. This one actually has to do about capital structure, you are close to your $200 million net cash probably in the third quarter how going forward do you think about buying back stocks versus retiring debt additionally? Then also if the stock were to be about $17 in the third quarter what is a reasonable share count as well? Thanks.

Mark Frey

So breaking that down Terence, first of all, the bogey we give ourselves is $250 million net cash. We actually bought a modest amount of stock in the second quarter, it is more, we consider it more of a compensation governance program to keep the share count flat as we issue options et cetera. And so you can expect the share count in the 131 million range in Q3. We have not completed our plans about what we will actually do on share repurchase. In terms of the debt pay down we are on a revolver structure now, so we could do some large pay downs because we could redraw it later on. So we look at that more or less as the economics of the interest that we're paying relative to the amount of cash we have and specifically the cash we have in the U.S.

Terence Whalen - Citigroup

I appreciate the help. Thanks Mark.

Mark Frey

Thanks Terence.

Dan Janson

Thanks Terence. With that we'll close the call today. Thank you for your interest in Fairchild.

Operator

Thank you. That will conclude today's call. We thank you for your participation.

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