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Executives

Mark Thompson – President, Chief Executive Officer

Mark Frey – Executive Vice President, Chief Financial Officer

Dan Janson – Investor Relations

Analysts

Ross Seymore – Deutsche Bank

Terence Whalen – Citigroup

Parag Agarwal – UBS

Craig Berger – Friedman Billings and Ramsey

Tristan Gerra – Robert W. Baird

Venk 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 Corporation (FCS) Q3 2011 Earnings Call October 13, 2011 9:00 AM ET

Operator

Good day everyone and welcome to today’s Fairchild Semiconductor Third Quarter 2011 Earnings conference call. This call is being recorded. At this time, it is my pleasure to turn the call over to Mr. Dan Janson. Please go ahead, sir.

Dan Janson

Thanks. Good morning and thank you for dialing into Fairchild Semiconductor’s Third Quarter 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’ll be attending the UBS Global Tech and Services Conference on November 16 in New York and the Credit Suisse Technology Conference in Scottsdale later in November.

We’ll start today’s call with Mark Frey, who will review our third quarter financial results and discuss the current status of fourth quarter business. Mark Thompson will then discuss our product line results and markets and operational performance in more detail. Finally, we’ll reserve time for questions and answers. This call is scheduled to last approximately 60 minutes and is being simultaneously webcast from the Investor Relations section of our website at fairchildsemi.com. The replay of this call will be publicly available for approximately 30 days.

Fairchild management will be making forward-looking statements on 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 file with the SEC.

In addition, during this call we may refer to adjusted or financial measures that are not prepared according to generally accepted accounting principals. We use non-GAAP measures because we believe they provide useful information about the operating performance of our businesses that should be considered by our 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 of our website at fairchildsemi.com. The website also contains a variety of useful information for investors including an extensive financial section to facilitate your investment analysis.

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, so I’ll focus on just the key points in my comments.

In the third quarter, our distribution sell-through was down 9% sequentially, which was well below our original expectations, while sales into our direct OEM customers were modestly higher. Accordingly, we reduced shipments and factory loadings during the quarter, which impacted margins but will allow us to maintain a lean supply chain as we manage through the current cycle. We are controlling costs very aggressively and will keep the reins tight until we are able to start growing sales and margins again.

Let’s review some of the details, starting with the income statement. For the third quarter of 2011, Fairchild reported sales of $403 million, down 7% sequentially and down 3% from the third quarter of 2010. Adjusted gross margin, which excludes accelerated depreciation and write-offs related to fab closures, was 36%, down 120 basis points from the prior quarter. Gross margin was impacted by lower factory utilization and roughly a full point now of 8 inch fab start-up costs.

R&D and SG&A expenses were $92 million in the third quarter, down 6 million sequentially as we aggressively manage OPEX. We continued to invest in R&D and applications engineering to support our future growth, but all other spending is being tightly controlled.

Third quarter adjusted net income was $45 million and adjusted EPS was $0.34. Diluted share count was down nearly 2 million shares in the third quarter. We bought back 1.4 million shares as we capitalized on the lower stock prices during the quarter.

Now I’d like to review third quarter highlights of our sales and gross margin performance by our two major product groups. PCIA sales were up 5% from the year-ago quarter but down 10% sequentially due to weaker demand from appliance, consumer and solar end markets as customers continue to reduce inventories. This is also a seasonally weaker period for most of the PCIA end markets. Gross margin decreased two points to 38% due primarily to lower factory loadings and increased start-up costs for the transition to 8-inch wafers, which was partially offset by favorable foreign exchange trends.

In our MCCC business, sales were flat sequentially as strong mobile analog sales were offset by weak demand from consumer and computing customers. MCCC gross margin was flat with the prior quarter at 37% as a richer mobile analog mix offset lower factory loadings supporting consumer and computing products.

Turning to our balance sheet, we grew internal inventory dollars by about 2%, which resulted in an 8-day increase to 91 days at the end of Q3. We like to maintain internal inventories closer to 80 days, so we plan to work this down over the next one to two quarters. Days of sales outstanding, or DSOs, were flat at 34 days while payables decreased to 49 days.

Free cash flow was $19 million for Q3, and we ended the quarter with total cash and securities exceeding our debt by $165 million.

Turning now to forward guidance, we expect sales to be in the range of 350 to $370 million in the fourth quarter. Our current scheduled backlog is nearly sufficient to achieve the low end of this range. We expect adjusted gross margin to be between 32 and 34% as we adjust factory loadings lower in the fourth quarter to reduce inventory. We anticipate R&D and SG&A spending to be approximately flat with the third quarter. The adjusted tax rate is forecast at 15% plus or minus 3% for the quarter. As with last quarter, we are not assuming any obligation to update this information, although we may choose to do so before we announce fourth quarter results.

Finally, as you update your financial models for us in 2012, be aware that there will be 14 weeks in our first quarter as our fiscal calendar once again synchronizes with the actual calendar.

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

Mark Thompson

Thanks Mark. Before I get into the specifics of the quarter, I want to talk more generally about the current cycle and how we plan to manage through this period. The current semiconductor cycle has certainly reduced demand visibility, but there are a number of current and historical data points to help us manage through the environment.

Let’s start with what we know. Our Q4 guidance has us down as much as 18% from our peak sales in 2011, which we believe is well below true consumption levels. Recall that in the last recession, our major end markets were down just 9% in 2009, according to iSuppli. Unlike 2009, demand for mobile customers continues to grow, and other end markets in automotive and industrial sectors seem to be following a more normal seasonal pattern. We also see the progression of our Q1 backlog still following the normal pattern, which is much different than the late 2008/early 2009 environment when orders effectively stopped across the time horizon.

We also know that the secular growth drivers in our business are still very much in place. We’re clearly seeing this in the strength of our mobile business. While demand from the appliance sector is softer now as customers reduce inventories, we know the rate of conversion from single-speed AC motors to variable speed inverter-type motors will drive continued growth, even in a weak unit sales environment. This is also true for automotive and industrial markets where increased silicon content continues to be the primary growth driver.

Solar inverters is another market that is very weak right now, but I think we can agree that it will eventually return to a source of growth. The industry has been through many cycles in the past, so history can also help us manage through this environment. We know based on our history that distribution sell-through has never been down more than two quarters sequentially. Q3 was our first quarter of lower sell-through, and we expect Q4 will be the second. Even in the 2008-2009 recession, we saw sell-through recover after just two down quarters. Also, our peak channel inventory going into this correction is more than 50 million less than our level entering the 2008-2009 cycle, so we expect to get inventories in line more quickly with less impact to margins.

Given these data points, we will continue to manage cost and inventories aggressively. Our objective in Q4 is to aggressively reduce channel inventory to a comfortable level to support first half 2012 consumption demand. We want to enter 2012 with the inventory correction behind us, ready to take advantage of normal seasonal strength in our high-voltage business so we start growing sales and margins once again.

Turning to our product lines, sales were flat from prior quarter for our MCCC business as strong mobile sales were offset by weak demand in consumer and computing sectors. Our mobile analog business was up 11% sequentially due to sales growth across a wide range of new and existing products. We have broad customer exposure with solid content at all major manufacturers, which helps us to grow even as market share shifts among our customers. We are now shipping a full range of voltage regulators beyond just core power to include RF lighting and charging solutions. We also increased sales for our growing line-up of audio and application-specific analog solutions. Our comprehensive portfolio of analog switches, including USB, multimedia, and accessory detection products continues to post strong growth. Finally, we stepped up shipments for our IntelliMAX intelligent load switches in Q3 to support a number of new model launches.

MOSFET sales into the computing and consumer markets were well below seasonal as customers continue to reduce inventory in response to concerns about western economies. There has also some shifting in demand for us in the computing sector to the tablet market, which we include in our mobile business. Our advanced trench processes allow us to supply industry-leading performance and form factors, including our innovative 3x3 dual MOSFETs that are ideal for ultrathin notebooks and tablets.

In our PCIA business, sales were down 10% sequentially. In addition to normal second half seasonality, the appliance, TV, computing and solar markets all posted weak sell-through as customers reduced inventory. Our IGBT business has held up well as solid industrial demand offset some of the weakness in the solar sector. Our automotive business also performed well due to continued growth of our ignition solutions and modules for power steering. We also began shipping a smart ignition module which integrates our innovative ignition IGBT with a controller in a single module. This module provides superior quality, reliability, and performance compared to existing discrete solutions.

As I mentioned earlier, first quarter backlog fill is progressing normally and indicates a seasonal increase in demand for appliance and industrial markets. We have a tremendous portfolio of power modules and discrete solutions to support our customers’ transitions to significantly more efficient appliances, fans and pumps, and remain confident in the growth potential for our PCIA business.

SPG sales were down nearly 19% from the prior quarter due to generally weak demand and our increasingly selective approach to this business.

Turning now to Q3 results, our direct sales to large OEMs and EMF customers was up slightly from the prior quarter as many of these customers are in the mobile and automotive sectors, which are running relatively better. Distribution sell-through decreased 9% sequentially, which was more than expected and resulted in a $5 million build of channel inventory. We expect to reduce channel inventory substantially in the fourth quarter and had adjusted factory loadings accordingly.

Factory utilization was about 80% in the third quarter and we expect it to decrease again in the fourth quarter. Lead times decreased in all areas except mobile and are effectively at normal levels for all of our products. Overall product pricing in Q3 was down less than 1% from the previous quarter.

In closing, we remain excited about the secular growth drivers for our business. We continue to grow our mobile analog sales as we capitalize on strong smart phone and tablet demand. While many of our high voltage markets are working through an inventory correction, it’s clear that the transition to more efficient motors, appliances and cars will drive long-term growth. There are a number of current and historical data points that indicate we’re nearing the end of this correction, and Fairchild is committed to clearing the decks in Q4, tightly controlling costs, reducing channel inventory to be ready to start growing sales and margins again in 2012.

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 to one follow-up. Thanks, and let’s take the first question, please.

Question and Answer Session

Operator

Thank you. If you would like to ask a question, you may do by pressing the star key followed by the digit one on your telephone keypad. If you are using a speakerphone, we ask that you please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that’s star, one. We’ll pause for just a moment.

We’ll take our first question from Ross Seymore with Deutsche Bank.

Ross Seymore – Deutsche Bank

Good morning, guys. The first of the two questions is on the disti side of things. Can you remind us what your original assumption was for disti sell-through in the third quarter, what it got adjusted to on your negative three, and what your assumption then is going forward for the fourth quarter for disti sell-through?

Mark Thompson

So Ross, in point of sale, which has some distribution margin in the, I think, 11, 12% range, the original forecast from our distributors was in the 340 million range and it ended in the low 290s. The current forecast has that down another increment from—in 260, up to flat at the high end; and in terms of our sell-in, we’re targeting to give us a cushion of about $30 million, which obviously could turn into channel inventory, or if POS trends toward the high end of that, it could turn into additional revenue. So we are baking in the possibility of continued erosion in the event that it were to occur.

Ross Seymore – Deutsche Bank

I guess one clarification on that – from the mid-quarter update, it seemed like the implied guidance assumed kind of a 5% POS drop at the mid-quarter, or the negative three in September. Is that correct, and I guess did it get worse from there or was it kind of in-line with your expectations?

Mark Thompson

No, it was roughly in line with expectations. If you look at the kind of $25 million-ish that we took out, that was all—directly came out of POS. So that would turn into kind of a $30 million POS reduction, which was—we never target the high end, anyway. We typically target the low end. So it was roughly—all but 5 million of it, so our ability to mass ship and POS was off by about 5 million in the quarter, but otherwise, we tried to exactly match the POS trend.

Ross Seymore – Deutsche Bank

Got you. Then I guess the one follow-up is remind us how that flows through on utilization to the gross margin side of things. Is the hit in the fourth quarter where we feel the majority of that, or is the utilization falling in the fourth quarter, as you said, likely to impact the first quarter gross margin as well?

Mark Frey]

Ross, you’ll see most of the hit in Q4 because the utilization decrease began in Q3, so it gets—it kind of rolls into Q4 in terms of its cost of goods impact.

Mark Thompson

But in terms of—in being aggressive early in the fourth quarter should allow us to increase utilization in the first quarter, and therefore you’d see margin progress—positive margin progress starting again in the first quarter.

Ross Seymore – Deutsche Bank

Okay, thank you.

Operator

Moving on, we’ll hear from Terence Whalen with Citi.

Terence Whalen – Citigroup

Great. Thank you for taking my question. It sounds as if regarding the distributor channel, the abruptness of the reduction in sell-through both in 3Q and 4Q gives you confidence that distribution sell-through will grow in the first quarter of 2012. Are we to then interpret that overall revenue will be up in first quarter 2012 sequentially, or is there a possibility that direct sales might seasonally decline and overwhelm an up disti?

Mark Thompson

So Terence, for starters we’re clearly not ready to guide the first quarter, so I’ll talk in general terms. Certainly the magnitude that we intend to under-ship to channel in the fourth quarter would have us at least matching an uptick in POS in the first quarter; and so that would be—that would follow naturally from that. We would not intend to reduce the channel in the first quarter. We would at least maintain it, so any increase in POS that we would see in the first quarter would flow naturally to our revenue.

In terms of our OEM business, that’s generally been very steady through this. We would expect some uptick particularly on the PCIA side in the first quarter, which at least in 2011 we saw, as you’ll recall, more than offset the normal seasonal softness in mobile. So we would expect that to be at least steady heading into the first quarter.

Terence Whalen – Citigroup

Okay, terrific. And then the follow-up question is regarding gross margin. It sounds like you’re proactively taking down the utilization in the fourth quarter, giving you confidence that utilization will increase in the first quarter. Can you walk us through some of the other gross margin drivers? Is it a correct assumption that if utilization increases in the first quarter, that gross margin will increase in the second quarter; or are there outstanding one-time issues regarding the 8-inch conversion that might make a gross margin uptick more a 3Q event than a 2Q event then?

Mark Frey

Right. So starting with all the factors that affect gross margin, pricing was a little less than seasonal in Q3 and we expect it to be roughly seasonal, so we’re not seeing anything out of bounds from a pricing standpoint. Mix has continued to be positive, particularly within the MCCC business. The utilization is the biggest impact, and since it started in Q3 and early in Q4, we do expect most of that impact to be embedded in our guidance for Q4 and would position us to begin to expand the gross margin in Q1, obviously, if we’re able to reload the factories again.

The period expenses are about a 1% detractor from gross margin that’s been growing steadily across 2011. We expect it to stay that way for about another two quarters and then trail off as the 8-inch capacity becomes live towards the end of 2012.

Terence Whalen – Citigroup

Okay, that’s perfect. Thanks Mark.

Operator

And now we’ll hear from Parag Agarwal with UBS.

Parag Agarwal – UBS

Thanks for taking my question. This first question is about the linearity of the orders, and that is for the distribution further out as well. So did you see any drop in orders as you went through the quarter? Did you see a push-out from December to the March quarter? And also, can you comment about the level of capacity that comes on following 8-inch conversion? Are you kind of moderating CAPEX going forward?

Mark Thompson

So Parag, a couple of things. First, in terms of the incoming order rate, it is on an up-trend right now and so it roughly bottomed in the third quarter, and particularly what we’re seeing, as we commented in the general section, they are primarily filling in to Q1, which is again consistent with what you’d expect for a lot of the community trying to effect its inventory correction in the fourth quarter. So while we are assuming a fairly limited fill opportunity in the fourth quarter, we are seeing very clear fill patterns so far into the first quarter, and so that’s the overall picture of the incoming order rate.

In terms of the capacity coming online for BK8, our 8-inch conversion in Korea, we don’t see much in terms of capacity addition in the first half. We expect it to begin to come on during the second half, but obviously we have some ability to either move that out or pull it in depending on the way we see the demand progress across the year. We’re obviously managing the expense side of that as tightly as we can while making sure that we get it committed during the middle of next year. So we can slow it down a bit if we don’t need the capacity, or we can pull it in a bit with additional expenditure if the market heats up more than expected.

In terms of capital, overall it was a big expense driver, as we commented, resulting in above-average CAPEX during 2011, and it’s really—finishing it is the only big capacity project that we have, and most of it has been spent and committed. So it is certainly our expectation and intent that capital expenditures in 2012 will be sharply lower than they were in 2011, although we haven’t formalized a budget yet. But certainly we’d expect to see that come down significantly.

Parag Agarwal – UBS

Okay. And the second question is about your mobile business. Obviously it is very strong. Just wondering if the strength is coming from existing customers or are you seeing any major ramp in any new programs?

Mark Thompson

Well, our best, biggest customers are the best, biggest mobile solution providers in the smart phone space; and as you know, they are constantly launching new platforms. One here local in the Valley just put one out last week, and so our content in that is good and growing. There’s a steady stream of new products that occur and new features that occur that we’re actively participating in, so it isn’t—there aren’t strictly speaking new customers to add, because we already are strategic suppliers to all the major players.

Parag Agarwal – UBS

Thank you very much.

Operator

And now we’ll open the floor up to Craig Berger with Friedman Billings and Ramsey.

Craig Berger – FBR

Hey guys. Thanks for taking my question. I guess my first question is can you tell me—I guess you thought disti sell-through was going to be 340; it was actually 290. What was it at the peak of the cycle and how much of that is downstream inventory burn beyond the distis? What’s your view on real end consumption of chips right now? Thank you.

Mark Thompson

So Craig, it’s a little hard to quantify the overall end market, but the POS is easy to quantify. So the POS in the second quarter was approximately 320 million, and so a normal seasonal build in POS, or I guess I’ll call it an average seasonal build, would have carried it up from there. So if you look at the process that we use to estimate that, it’s heavily informed by the resale expectations from our distribution customers themselves—or our distribution partners themselves, and they look at sort of who wants what and their own trends, and so they give us that. We massage it a little bit and it turns into our point-of-sale forecast.

It’s generally been pretty accurate, and so it was, I think, unexpected that it was weak. It took some time for our distribution partners to come to grips with what it was likely to be, so it took a couple of iterations to get it defined. And so it wound up by about mid-quarter, we had a pretty good grip on what it turned out to be, so I think everyone is continuing in that vein in Q4 but rather than reacting to it partway through the quarter, which we clearly saw going on, I think people have their arms firmly around it and are aggressively trying to get it adjusted in the early part of the fourth quarter, and we’re seeing that kind of behavior.

So in terms of what the true end demand is, you really have to go in a segment at a time. So it’s clear that there was equipment built in the second quarter that didn’t sell through as rapidly as people expected it to. Probably the most extreme was in the solar inverter space, where there wound up being a lot of inverter inventory and the build plans for inverters turned down very sharply. How much you could subtract from the actual demand in Q2, it’s a little bit hard to do. Again, with many small customers as you often see in distribution, the visibility into the granularity of where all the stuff goes isn’t that good. So again, I think we could subtract some from what the overall Q2 demand was, but I don’t think it was a radical over-build, for example. I think it appears right now to have been a combination of a modest over-build and increased availability, allowing people to draw down inventories; and those things compounded have turned it into what appears to be a fairly sharp but likely contained inventory correction.

Craig Berger – FBR

Thanks for that detail, Mark. And then just how do we think about spending items as we begin 2012? Are you guys going to be holding the line, or do you have annual spending and salary increases? How do we think about the growth in OPEX?

Mark Frey

Craig, this is Mark. Yes to both of those questions – we do have some seasonal factors in Q1 that add to expenses. However, we are holding the line. We expect to kind of stay in these low 90 areas for OPEX until we actually see how the cycle plays out and when the inventory correction transitions into growth again. And for capital, I think Mark talked about that. We’re reassessing all of the capital projects and expect to take that investment down going into 2012.

Craig Berger – FBR

Last question – sorry. Did you guys actually say whether you thought Q1 might be up? I mean, I know you’re not guiding that yet, but what are your thoughts there?

Mark Thompson

So Craig, we aren’t guiding it; but let’s talk about the moving parts. So if you look historically, we’ve never seen—we’ve got POS data going back to around 2002, so almost a decade of POS data. We’ve never seen three sequential reductions in point-of-sale in all that time through all the various cycles, so with a sharp POS reduction in Q3 and another one in Q4, it would be unprecedented to see other than a step-up in the first quarter. Not to say it can’t happen, but it would break precedent in order to do that.

If you look at the fill patterns that we’re seeing, we are seeing normal fill patterns in the first quarter, which is to say that it matches the rough demand for the end markets. And so obviously if you look at the aggregated end markets for all the various places that our products go, they aren’t down anything like this; in fact, they’re in reasonable shape. So if you tie it to that end demand, the real driver—again, you have to conclude that either the end markets will have to go sharply down or the revenues will have to catch up. And so again, if you look at that, that partly informs our decision to aggressively make sure that our inventories are in line, particularly in the channel, which in turn should allow us to at least follow POS back up again in the currently likely event that it will go up in the first quarter. And again, we see the direct business also filling very naturally and nicely in the first quarter as well.

So all those things would point to it being more likely than not that we would see the beginnings of our recovery in the first quarter.

Dan Janson

And Craig, this is Dan. Just one other thought here, too – we are draining a fair amount of inventory—at least, that’s certainly what our plan is for the fourth quarter; and of course, you have to recognize that if we don’t drain inventory in the first quarter, even if POS doesn’t go up, it’s going to look like revenue growth, right, because we can now ship more in line with consumption. So keep that in mind as well.

Craig Berger- FBR

What’s the disti inventory burn in Q4?

Dan Janson

Well, that’s the question. What we’ve laid out for you is a pretty substantial burn. We’ve talked publicly about something on the magnitude of $20 million-plus.

Craig Berger – FBR

Thank you.

Operator

And now we’ll hear from Tristan Gerra with Robert W. Baird.

Tristan Gerra – Robert W. Baird

Good morning. Where do you think the trough is on your utilization rate based on the trends that you described and your current visibility, but also taking into account your internal inventory base position, because I think you’re back to a level exiting this quarter that is the highest since Q2 ’09? And the secondary question would be what is your target in terms of internal inventory base by end of this year?

Dan Janson

Hi Tristan, this is Dan. So we are at about 80% utilization at the end of Q3. We would expect utilization to probably dip a little bit lower in Q4 as we continue to drain inventories. As Mark indicated, we would expect it to trough out in fourth quarter for utilization because we would expect to get our inventories where we want them by the end of this quarter. Internal inventories, we’re probably, as Mark said in his comments earlier – Mark Frey – we’re probably looking at one to two quarters to get that back where we want. Partly it will be from actually lowering inventories and partly it will be because kind of normal sales growth that we would expect in the first half of next year.

Tristan Gerra – Robert W. Baird

Okay, so basically at this level, would you say that you could come back to, let’s say, high 70s inventory base by when? Is that a target that you think is achievable by Q1? I’m assuming it would certainly not be achievable by end of this year. Just wondering if that could have an additional impact on your utilization rates, even if you’re seeing a little bit of a rebound in terms of shipments to distis in Q1.

Dan Janson

Well I think, as I said, one to two quarters, so we’ll make some progress in fourth quarter on internal inventories. We’ll make a lot more progress in Q1, likely, with a little more of a tailwind from sales. So that should get us where we need to be. Low 70 or in the 70s, that would be great. We target closer to 80, so anything around 80 from where we are right now, I think, would feel pretty comfortable for us.

Tristan Gerra – Robert W. Baird

Great, thank you.

Operator

And now we’ll go to Venk Nathamuni with JP Morgan.

Venk Nathamuni – JP Morgan

Hi. Thanks guys for taking my question. Mark Thompson, you laid out the case for how the cycle is different from the downturn in ’08, early ’09; and you already talked about utilization rates going down a bit for the next quarter. But if I compare the ’09 number, utilization was down to about 50%. Do you expect a similar fall in utilization rates in fourth quarter, or do you think it’s going to be more in the 70% range?

Mark Thompson

We haven’t quantified it, in part because we aren’t sure ourselves yet. We’re still refining the build plan, but we would expect the pullback—the reduction in utilization in the fourth quarter won’t be that great; and I mean, certainly the utilization in the first quarter of 2009 was unprecedented. So we expect it to be trimmed but not drastically cut.

Dan Janson

Venk, one to consider – as Mark mentioned earlier when we talked about the difference between this cycle and the recession, what we didn’t see in the 2008-2009 timeframe was order fill into the current quarter plus one and current quarter plus two, effectively ordering stock across all time horizons. So that’s a very different situation from a manufacturing perspective because obviously what we’re building today is what we expect to ship next quarter and the quarter after. So in this case, we are getting a normal fill projection for Q1 – you know, it’s kind of following our normal pattern. So that’s really what we’re using to judge what we want to load in our factories in Q4, so we have better visibility now.

Venk Nathamuni – JP Morgan

Okay. Thanks, Dan, for that color. And then a question for Mark Frey – you talked about cost reductions. If you were to put them in buckets in terms of what is temporary and what is permanent, could you help us understand what the cost structure is going to be in 2012? Thanks.

Mark Frey

So in terms of how we would face something like that as the cycle progresses, obviously the first actions you take are on discretionary items such as recruiting, headcount additions, vacation time taken, travel, outside services, et cetera. And that’s kind of driven us from the high 90s to the low 90s, and we think that’s sufficient for our expectation of how the cycle would play out. If things become more severe, then you talk about taking heads out, you talk about taking out—we took out vacation benefits in the last cycle. We eliminated 401 matching. We did not do a merit, et cetera. We converted all variable compensation to a stock program, et cetera, and that would be the next phase.

Obviously, we know how to do that. We can put those plans in place if we see that the external environment requires them, but we don’t see that currently in our view of the business.

Venk Nathamuni – JP Morgan

Okay, thanks Mark. And if I may, just one last question – any inventory write-downs, and if so, what the dollar amount is? And also, what is the view for pricing as you look forward to the next couple of quarters? Thanks.

Mark Frey

We had a slightly higher inventory write-down in the quarter as inventories went up a bit, which was maybe a 25 basis point impact on the normal trends that we’ve been seeing. In terms of pricing, as I said earlier, it was a bit less than seasonal in Q3. We expect that to continue at sort of seasonal. There’s anecdotes of some very vicious price negotiations out there, which you would expect in this cycle; but overall, I’d say that our peer companies and ourselves have been fairly disciplined in terms of moving prices at a time like this.

Venk Nathamuni – JP Morgan

Perfect. Thank you very much, everyone.

Operator

Moving on, we’ll hear from Suji de Silva with ThinkEquity.

Suji de Silva – ThinkEquity

Thanks. Good morning, guys. So I don’t know if you clarified specifically the disti inventory level in terms of weeks now versus target and where you think it would be in the fourth quarter.

Dan Janson

Hey Suji, this is Dan. So we are a little bit north of nine weeks. Our target is 7.5 to 8.5 weeks, so we are a bit above our target. Obviously we are working and assuming, based on our shipping plans compared to what our distribution customers are forecasting for POS, to have a pretty substantial inventory drain. Now, the POS part is a variable that isn’t as easy to quantify and forecast this far ahead of time, but that’s what we’re planning on; and where that will land and the number of weeks, we’ll make some pretty good progress, we think, in fourth quarter getting ourselves back to that target level. And as Mark said, we feel like whatever we do coming out of the end of this year, we should have effectively no overhang for inventory going into the first quarter.

Suji de Silva – ThinkEquity

Okay. And then on the end market side—the mobile analog segment rather, up double digits. How much of that do you think was end market versus share gains, and do you expect to sustain above-market share gains through 2012 in mobile analog? Thanks.

Mark Thompson

So that’s a hard question to answer. It’s easier to track on an annual basis than on a quarterly basis, and we certainly are seeing steady share gains if we look cumulatively in 2011 versus 2010. We’ve clearly got gains in the smart phone space. Certainly our plans expect us to continue to do that. That, of course, is laid onto a growing market, and growing in two different ways. Obviously one is the phones themselves are growing at double digit pace; but equally significant that the architectures are being carried over into the tablet space by—all the serious contenders in the tablet space are largely carrying their smart phone architectures with bigger batteries and a few more features into the tablet space. So it’s a two-for in terms of how you look at the gain, and it’s that architecture reason why we actually aggregate tablets with smart phones rather than with traditional Intel generic notebooks.

Suji de Silva – ThinkEquity

Thanks for the color, Mark.

Operator

And now we’ll go to John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yeah, thanks for taking my question, guys. You mentioned earlier in your prepared comments you’ve never seen two—more than two consecutive quarters of distribution point-of-sales being down sequentially. Can you just remind us what the average peak to trough declines have been through past cycles, and maybe what it was in ’09 and how this compares?

Mark Thompson

So we actually didn’t compile that data, but the trough in 2009 was the most extreme trough we’ve seen that went down to around 200, was the number—again, put a bit of an error bar on these numbers because I’m reciting them off the top of my head. But I think 200-ish, which would have been down—you know, if you backed—so that was Q1 of 2009. If you backed up to the previous peak, it would have been in the high 200s at that point, let’s say. So that would be the most extreme we ever saw; and average, I don’t have, but I see Mark Frey here furiously working with his calculator, so he may have one shortly.

Mark Frey

The ’08-’09 was around 37% over a two-quarter period. All prior, call them supply-related cycles, I haven’t calculated them but it would be in the 10%--

Mark Thompson

Yeah, 10 to 15%, I think, would be a typical one. So this one is actually a more severe than average, depending on whether you throw highs and lows out of your average or not. But this is an above-average inventory cycle but nothing like 2009.

Mark Frey

So we’ve built in in the high teens, basically.

John Pitzer – Credit Suisse

And guys, the other question I have for you – earlier in the year with the Japan earthquake, we were all struggling to figure out both the direct and indirect exposure that companies had to that. We’ve now got kind of a similar natural disaster in Thailand. I’m kind of curious – indirect, direct impact that you guys foresee, and has that already been embedded into your guidance for the December quarter?

Mark Frey

Well, we haven’t mapped the process, primarily I believe, on semiconductors, the impacted party. But it’s certainly not in our guidance because it just happened. We have yet to map what exact product specs are affected and whether that’ s going to have an impact on us or not.

John Pitzer – Credit Suisse

Okay, thanks guys.

Dan Janson

And of course, John, we don’t have any manufacturing assets in Thailand, so it wouldn’t be anything that would impact us directly. It would be through a customer of some sort.

John Pitzer – Credit Suisse

Got it. Appreciate it.

Operator

And now we’ll hear from Steve Smigie with Raymond James.

Steve Smigie – Raymond James

Great, thanks guys. If I heard correctly, I think you indicated the March quarter is a 14-week quarter; and if that’s the case, should we just add revenue and expenses sort of on an equivalent (inaudible) basis, or is there something about Chinese New Year or new year that means more holiday days that we wouldn’t add as many expenses or revenue?

Mark Thompson

No in general, Steve, I’d take what you would have done for 13, divide it by 13, multiply by 14 revenue, (inaudible), et cetera.

Steve Smigie – Raymond James

Okay. And then with regard to the 8-inch—Mark Frey, I think you indicated you expected a one percentage point impact for two quarters. Is that Q4/Q1, or is it more Q1/Q2?

Mark Frey

Ask the question again, Steve? I’m sorry.

Steve Smigie – Raymond James

I think you indicated that there was about a one percentage point impact to gross margin from the 8-inch, and you expected to have that hit you for another two quarters. I was just curious if those two quarters you were referring to were calendar Q4 and calendar Q1, or is it Q1/Q2?

Mark Frey

Q1 and Q2 of next year, and then it will tail off towards the second half of 2012.

Steve Smigie – Raymond James

Okay. Great. And then with regard to OEM demand, you guys indicated it was up a little bit. With that said, you guys have been gaining share on that MCCC business in (inaudible). Some of the customers you have there – Apple, for example, or I’m assuming Apple – is obviously doing very well, unusually well. So if you sort of back that out, would you say OEM demand is more slightly below seasonal, or how should we think about that excluding your share gains and unusual customer success?

Mark Thompson

You know, Steve, it’s really hard to answer that question. You’ve highlighted that certainly a couple of—you know, the top two smart phone players have done extraordinarily well, and we’ve clearly benefited from that. On the flipside, we also have some very large customers that are seeing some inventory burn-off as well, particularly in the appliance space, which several of those are aggregated into our direct business. So there’s a number of puts and takes that go into that, and I wouldn’t be prepared to declare whether it was better than, typical, or worse than seasonal.

Steve Smigie – Raymond James

Okay. Last question is just as I look at gross margin by segment going into Q4, I’m sure you won’t guide specifically but just color-wise, would you expect MCCC or PCIA or your spare parts business to suffer—which one would suffer the most gross margin loss, which one would be the strongest?

Mark Frey

I would expect the PCIA would be impacted the most because that’s where we’re going to be constraining our shipments and our load plan the most.

Steve Smigie – Raymond James

Okay, great. Thanks guys.

Operator

And now we’ll hear from Kevin Cassidy with Stifel Nicolaus.

Kevin Cassidy – Stifel Nicolaus

Thanks for taking my question. Just wondering as the market comes back and as demand returns, do you think there’s going to be any change in distribution—I know you say your target is 7.5 to 8 weeks of inventory, but do you think they’re going to start running at lower levels of inventory going forward?

Mark Thompson

It’s a little hard to answer that, but I don’t think that there’s a lot of opportunity to take the overall inventory level down much more than—we set them jointly with our distribution partners that are really targeted at maintaining service levels. So if you look at it, we’ve got about 9,000 part numbers that go through distribution into a wide range of end applications, and so it looks one way on a dollar turn but if you start to look at all the combinations of line items, it becomes pretty difficult to maintain good service levels and availability, which of course is one of the things that distributors offer, as you dip much below 7.5 weeks. So we’ve conducted some experiments—you know, certainly with fulfillment distribution, smaller numbers of part numbers, more concentrated end markets, you can run with lower levels. But with the very fragmented industrial marketplaces, I don’t think there’s much precedent for anybody running those lower than 7.5 weeks.

Kevin Cassidy – Stifel Nicolaus

Okay. So it’s more tied to your throughput than coming out with a product? Is that why eight weeks is about right, or--?

Mark Frey

It’s tied to our supply chain’s capability to provide service levels, and the tools get better all the time but you hit a complexity point at 7.5 weeks where, when you go below that, you’ve got your main items turning every other week at that point. And then your core inventory still has, you know, a lot of fairly slowly moving parts. As Mark would say, that’s the classic 80/20 rule that you hit up against.

Dan Janson

Hey Kevin, this is Dan. Just another thing to consider – you know, we just went through a couple of natural disasters here. Certainly the Japan one was one that was a tough one for the supply chain, and the fact that there was inventory out there was why we were able to manage this one pretty well. I suspect to the extent that we have any issues around this flooding in Thailand, I think the same would hold true there as well. There are real valid reasons for having a certain amount of inventory in the channel, and it’s a pretty valuable part of the supply chain so it’s been working pretty well, I think.

Kevin Cassidy – Stifel Nicolaus

Okay, thanks for clearing that up.

Operator

And now we’ll hear from Brendan Furlong with Miller Tabak.

Brendan Furlong – Miller Tabak

Good morning everybody, and thank you. I want to go back to a question that I think several people have tried to get you to answer, but I’m going to take another stab at it. The inventory draw-down in the channel, the sell-ins versus sell-out that you try to manage and the OEMs – you put all those dynamics together, you’re guiding down 11% roughly at the midpoint. Is the industry going to be down, just because the fertile only dynamics have you down 11% (audio interference) 7%--you know, 6, 7% in the December quarter?

Mark Thompson

So Brendan, by industry, do you mean the end OEMs or do you mean the semi--?

Brendan Furlong- Miller Tabak

The semi—call it your analog peers, let’s say.

Mark Thompson

I can’t comment on any other business than Fairchild. I just don’t have any data.

Brendan Furlong – Miller Tabak

Okay.

Mark Frey

It’s a function of both what happened in Q3 and what happened in Q4, so you pretty much have to look at context for everybody.

Brendan Furlong – Miller Tabak

Okay. Another question I have was assuming my European cousins don’t blow us all up in the next couple of months and we don’t go into an ’08-’09 cycle, do you think the current cycle we’re going through is like ’03-’04, or is it like the 2006 inventory correction?

Mark Thompson

So my experience of cycles is that there are no two cycles that look the same, and so there are some characteristics that can be similar, but—we do a lot of analysis on historical cycles and every time we do, what we see is that each one has its own new manifestation. And so based on that, I’d say that this will be its own cycle that will become a part of history, and then the next one will be new again.

Dan Janson

Brendan, this is Dan. One thing that I would add is that we do know from history is that typically cycles, no matter how bad they are, even to the 2008-2009 recession, they get cleared out in two quarters. So it isn’t that they take longer for resales to be down and correct; it’s that the severity of the drop changes. So what we’re dealing with right now is, as Mark characterized I think quite accurately, a little more than a normal supply type correction; but the longevity, the period that resales are actually down looks like it’s following the same old pattern. It’s the first quarter, it’s kind of the recognized reality – everybody’s trying to get their head around why things are falling. The second quarter of the correction is when everybody is now onboard and they’re making the hard production cuts to get inventories down, and then you start to see the recovery. You start to see POS start to accelerate again. So it isn’t so much that the bigger corrections or the recessions last longer; it’s just that there are more severe drops.

Brendan Furlong – Miller Tabak

Understood. I guess my last question is on two end markets, handsets and appliances. On the handset side, typically your Korean customers take inventory down in the December quarter and then kind of start to rebuild in Q1. Do you expect to see the same thing this time around? And then secondly on the appliance side, typically the appliance OEMs seasonally start to kind of replenish the channel and start to build in Q1. Do you expect your appliance business to see the same thing in terms of seasonality this time around as well?

Mark Thompson

So two things. First is that for handsets, the Q4 is normally not a time when people adjust inventories. Q1 is actually more typical for when people will adjust inventories, and there doesn’t seem to be a nationalistic element to that. That seems to be generally true of all the major global handset makers. But if you look at appliance, particularly air conditioning, Q1 is strong and we are seeing an order trend so far for Q1 that’s consistent with that.

Brendan Furlong – Miller Tabak

So Samsung usually takes—forgetting the geographic aspect of it, Samsung usually adjusts their inventory into the end of the year and then kind of rebounds in Q1. Are you expecting the same dynamic this Q4?

Mark Thompson

So if you look at—it would depend on the product segment. The three major places that product like ours would go into a Samsung – you know, handsets, appliances, and then large displays, for example – each have their own distinct inventory cycle which would be—the handset would typically be pulled back, actually, in Q1 from an inventory point of view. The appliance would typically have a build in the first quarter, and there is not an obvious seasonality, at least that I’ve observed, to display.

Brendan Furlong – Miller Tabak

Great. Thanks a lot.

Dan Janson

Thanks, Brendan. We have time for one more question, Operator.

Operator

And we have a follow-up from Craig Berger.

Craig Berger – FBR

Hey guys. Can you—thanks for the follow-up. Can you just refresh us on your fab transition? Which 6-inch facility are you closing? Which 8-inch facility are you ramping? Where are you in the transition, and what are the gross margin benefits as we look into 2012?

Mark Thompson

So if you look at—during 2011, we completed conversion of our main fab to 8-inch and closed the 6-inch line during the third quarter. We are seeing the benefits of that now, and obviously that will be a full-year benefit that’s reflected in the improving margins in the mobile space, because that fab largely maps into the mobile space and is now complete.

If you look in Korea, the next one is not actually an 8-inch conversion; it’s installation of a brand-new 8-inch facility in Korea. There we’ve had a number of—it’s actually multiple fabs on one site. There’s a 4-inch fab, there was a 5, there’s a 6. We’ve closed the 4-inch, or in the final stages of closing the 4; are adding the 8-inch, which will come online during the middle of the year, and begin to ship but materially probably won’t advance margins until 2013. The potential for improved margins is the rolling off of the period expense that Mark mentioned, which should happen pretty sharply the middle of next year.

We are in the middle of a conversion of our Sault Lake fab, which we are going to be turning on our first 8-inch line there for production during the first quarter, and would expect that to begin to benefit us in the second quarter and then across the year. And then the rate at which we convert, we flip the other sixes, will be determined by strength of end market and so forth. So those are sort of the big moving parts associated with some of our fab conversions.

Craig Berger- FBR

Thank you for the detail.

Dan Janson

Great, well with that, we’ll conclude our call today. Thank you for you interest in Fairchild.

Operator

Ladies and gentlemen, that does conclude our conference call for today. Again, thank you for your participation.

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