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Fairchild SemiconductorInternational, Inc. (NASDAQ:FCS)

Q3 2007 Earnings Call

October 18, 2007 9:00 am ET

Executives

Dan Janson - VP, IR

Mark S. Thompson - President andCEO

Mark S. Frey - EVP and CFO

Analysts

Ross Seymore - Deutsche Bank

Craig Ellis - Citigroup

Romit Shah - Lehman Brothers

Shawn Webster - JP Morgan

Steve Smigie - Raymond James

Tristan Gerra - Robert W. Baird

Quinn Bolton - Needham

Operator

Good day and welcome to theFairchild Semiconductor Third Quarter Earnings Call. Today's conference isbeing recorded.

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

Dan Janson

Good morning and thank you fordialing into Fairchild Semiconductor's third quarter 2007 financial resultsconference 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 thatwe are attending a few investor conferences this quarter including the ThomasWeisel Power Conference in New York, the CreditSuisse Tech Conference in Scottsdale, LehmanBrothers' Tech Conference in San Francisco aswell as the Raymond James Conference in New York.

Mark Frey will start today's callwith a review of our third quarter financial results and discuss our forwardguidance for the fourth quarter of 2007. Mark Thompson will then address inmore detail our product line results, end markets and operational performance.Finally, we will reserve time for questions and answers.

This call is scheduled to lastapproximately 60 minutes and is being simultaneously webcast from the InvestorRelations section of our website at fairchildsemi.com.

The replay for this call will bepublicly available for approximately 30 days.

Fairchild management will bemaking forward-looking statements in this conference call. These statements,including all statements about future results and performance are made based onassumptions and estimates that involve risk and uncertainty. Many factors couldcause actual results to differ materially from those expressed inforward-looking statements. A discussion of these risk factors is provided inthe quarterly and annual reports we file with the SEC.

In addition, during this call wemay refer to adjusted or other financial measures that are not preparedaccording to Generally Accepted Accounting Principles. We use non-GAAP measuresbecause we believe they provide useful information about the operatingperformance of our businesses that should be considered by investors inconjunction with out GAAP measures that we also provide.

You can find a reconciliation ofnon-GAAP to comparable GAAP measures at the Investor Relation’s section of ourwebsite at investor.fairchildsemi.com. The website also contains 2007 Q3 factsheet and updated financial section with updated, unaudited financialhighlights including detailed breakouts of segment in regional revenues, grossmargins, EBIT and EBITDA.

Now, I'll turn the discussionover to Mark Frey.

Mark Frey

Thanks Dan. Good morning andthanks for joining us. I am sure most of you have had a chance to review ourearnings press release that we issued earlier this morning. So I'll focus onjust the key points in my comments.

We recorded a healthy 4%sequential increase in sales in the third quarter which was at the high end ofour guidance range. This solid sales growth coupled with better product mix andlower bonus accruals contributed to 190 basis points sequential improvement inadjusted gross margin, which was also at the high end of our guidance range.

We reduced adjusted operatingexpenses to $84.2 million, which is $4.9 million less than the prior quarterand favorable to our guidance range of $88 million and $90 million. Webenefited from a continued focus on spending control, lower bonus accruals, aswell as the sale of our RF business in early September. Our net interest andother expenses improved slightly to $5 million in the third quarter due to a higheramount of invested cash and better interest rates on our investments.

Altogether, higher sales andgross margin coupled with tight OpEx control drove a 400 basis point increase inadjusted operating margin and more than 90% sequential increase in adjusted netincome compared to the third quarter. Our adjusted operating margin, up 10.6%in Q3 is already a 110 basis points above the peak of the last cycle.

I'd like to take a minute andexplain the $7.8 million net charge we booked for potential litigation outcomes.This item consists of a charge related Power Integrations’ lawsuit as well asadjustments to reserves related to other litigation matters. We recorded the PowerIntegrations’ litigation charge for the purposes of SFAS-5 accountingrequirements which in no way reflect any conclusion or belief by us that we areliable for patent infringement or that we've concluded that the asserted PowerIntegrations patents are valid.

To the extent we do not prevailthe inequitable conduct phase of the current proceedings, or in post trialmotions before final judgment is rendered. We expect to continue to litigatethis matter through appeals based on issues affecting infringement, validity ofthe patents and damages.

Now I would like to review thirdquarter highlights of our sales and gross margin performance for each of eachof our product groups. The Analog Products Group recorded a 9% sequentialincrease in sales to $92 million, even as they significantly reduced inventoryin the distribution channel. This revenue performance was driven primarily bystrong demand for analog switches in voltage regulators.

APG adjusted gross marginimproved to 170 basis points from the prior quarter even as we drained 10 daysof analog internal inventory. Higher factory loadings and a richer mix of highmargin analog products as well as lower bonus accrual drove the third quartergross margin improvement.

In our Functional Power Group,sales totaled $235 million, a sequential increase of 4% driven by strongcomputing and handset end market demand for low voltage MOSFETs.

Adjusted gross margin was 220basis points higher than the prior quarter due primarily to improved factoryutilization and operational efficiency, better product mix and lower bonusaccrual.

Standard Products Group saleswere up slightly and adjusted gross margin improved 90 basis pointssequentially due largely to better factory utilization and operatingefficiencies.

Reviewing our balance sheet,internal inventories decreased about 1 day to 74 days driven by higher salesand a slight increase in inventory dollars. DSOs were essentially flat with theprior quarter at about 39 days. Cash and marketable securities increased $3million to $451 million in the third quarter, which reflected cash flow fromoperations of $58 million and capital spending of $48 million.

Our capital spending was focusedon backend in-sourcing and capacity increases, which we expect will drive costdecreases in 2008.

Turning now to our forwardguidance. We expect fourth quarter revenues to be up 1% to 3% and gross marginto be approximately 50 to 150 basis points higher sequentially.

At the start of the fourthquarter, we had about 90% of this sales guidance booked and scheduled to ship.We expect R&D and SG&A spending to be approximately $86 million to $88million in the fourth quarter, as we continue to exercise strict control overspending.

Net interest and other expensesare expected to be $5 million to $5.5 million for the fourth quarter.

Now, I'll turn the call over toMark Thomson

Mark Thompson

Thank you, Mark. Fairchilddelivered strong third quarter results for both sales and gross margin at thehigh end of our guidance range which drove excellent earnings. These resultswere even more impressive given that we also improved our inventories andreduced our lead times during the quarter.

We continue to show greatertraction for our new products in analog which helped APG grow to revenue morethan twice as fast as the company average.

In fact, APG accounted for 22% ofthe total company’s sales in Q3, our highest analog ratio in company history.

There are many positivedevelopments to review. So let's go into some of the details, starting withproduct lines, end market dynamics and new products.

As expected our Analog ProductGroup led the company with 9% sequential sales growth in the third quarter.Sales of our analog switches for handsets and ultra-portable applications grew21% while bookings increased more than 60% from the prior quarter.

We recorded strong sales for ourvoltage regulators that support the computing market with sales up 13%sequentially and a very positive book-to-bill during the quarter.

We also shipped our first highfrequency voltage regulators into the handset market and expect this businessto grow rapidly in the fourth quarter and 2008.

As expected, our micro-SerDessales were basically flat with the prior quarter, but bookings increasedsignificantly as additional customers qualify these solutions and our leadcustomer for this product adjusted their order rates higher. We expectsignificant growth for these products in Q4 and 2008.

Power conversion sales were upslightly and distributor resales were strong which enabled us to further reducechannel inventory.

Overall, these results areparticularly impressive when we consider that the strong distributor resale andgood channel management enabled APG to reduced channel inventory by 16 days inthe quarter bringing them in line with the company target. We expect our newproduct momentum to build in Q4 and 2008 as we drive greater penetration of ouranalog switch solutions in the handset and ultra-portable markets. We seesignificant opportunities to extend our leadership position in this market ascustomers standardized their interfaces. The opportunities we see in China areincredible and our business is growing rapidly in this market.

We won a number of important newdesigns for our micro-SerDes and we expect to increase sales in 2008. We arevery excited about the potential for our high frequency voltage regulators asour relationship with our lead customer continues to expand. This is a classicexample of how increasing our focus on solving more important problems for ourcustomers, phased off with deeper technical and business relationships.

In the power conversion businesswe released a new line of highly efficient multichip power switches for themerchant power supply market and are already shipping volume into our largercustomer. The investment we made in analog over the last two, three years ispaying off, as we see the impact of these new products starting to ship involume.

Turning now to the functionalpower group, sales were up 4% sequentially due primarily to strong high voltageMOSFET demand in the computing and handset markets. We also expect normalseasonal growth in the consumer markets driven by appliances and panel TVswhich should drive solid high voltage sales in Q4.

Our IntelliMAX load switchesroute to portable applications posted record sales in Q3 and double theirbookings from the prior quarter. We won a number of new designs in Japan and Europefor a highly efficient Smart Power Module and a variety of air-conditioning,washing machine and fan loaded control application.

We are particularly excited withour penetration of certain key European account and expect this trend to continuein Q4 in 2008. We also posted significant sales gains in our new ultra-smallCSP and MLP low voltage MOSFET packages for the ultra portable and notebookcomputing markets. These packages give us further performance and costadvantage over current solutions.

SPG sales were essentially flatwith the prior quarter as solid sales growth of Logic and Opto products wasoffset by our selective approach to the bipolar transistor business. Our newfamily of logic translators posted 25% sequential increase in sales and had apositive book-to-bill in Q3.

Let me now review end marketdemand and some key operational metrics. Sales of our products and service tocomputing and handset market were robust in the third quarter while the otherend markets were generally in line with seasonal expectations.

Order rates remain quite healthyas we enter the fourth quarter, providing us with an excellent starting backlogposition. Distributor sell-through was up 8% sequentially in Q3, setting a newrecord for the company. Our sale into our distributors was well below thislevel which resulted in about a 1 week decrease in channel inventory. At lessthan 11 weeks of channel inventory we are now on the low end of our range butstill at a comfortable level to support Q4 demand.

Sales to the OEM channel were upmore than 15% sequentially as the number of our handset and computing customersincrease demand during the quarter. We expect our OEM channel to lead thecompany in growth again in the fourth quarter.

We reduced lead times in thequarter through enhancements to our order management system and effectiveinventory management. This is an ongoing focus for us as we transition thecompany to be a more important supplier to our customers. We improved our leadtimes to 9 to 10 weeks in the third quarter, and we believe we can maintainthis level even as we increase sales and factory loadings in the fourthquarter.

In summary, I believe our thirdquarter results are further proof of the progress that we are making to developa more the valuable analog and card solutions for our industry leadingcustomers. Our strong OEM sales growth reflects our greater focus on these keycustomers. The APG business is at the heart of this effort with exciting newproducts developed in close cooperation with leading customers and shipping ingreater volume each quarter.

On the operational front ourstrong supply chain and inventory management are helping us to achieve some ofthe best inventory levels in the industry, while improving both lead times andservice levels.

Finally, effective cost controlsenable us to show significant earnings leverage as we grow our business asevidenced by our 400 basis points, sequential improvement and adjustedoperating margin in Q3.

I believe this is just the previewof what Fairchild is capable of delivering and we look forward to building onthis momentum in Q4 in 2008.

Thank you. And I'll turn the callback to Dan.

Dan Janson

Thanks Mark. We'll now open thecall to questions and I would ask that in order to allow more questions that welimit each person to one question and one follow-up. Go ahead and take thefirst question please.

Question-And-Answer Session

Operator

Thank you. (Operator Instructions).And we will take our first question from Ross Seymore, Deutsche Bank.

Ross Seymore - Deutsche Bank

Thanks guys and congrats on thestrong earnings power. A couple of questions, on the OpEx side of things. Howshould we think about OpEx longer term in the growth rate in that line versusrevenues?

Mark Frey

Ross, as you know our target forOpEx is about 20% of revenue and we expect to get pretty close to that nextyear.

Mark Thompson

Let me also embellish a littlebit on Mark's comment. I think pretty consistently stated in and have shownprogress toward also shifting the mix, so we've both been targeting a 20% OpExlevel but also steadily reducing G&A and increasing R&D and we expectto increase that trend in 2008.

Ross Seymore - Deutsche Bank

Great. Then the follow-up onthat, the mix on the revenue side went favorable as well, the inventory thatyou guys burned on the APG side both internally and it sound like in thechannel are you in both cases down to where you want to be or is there stillsome of the analog accesses in the channel or again on your books.

Mark Thompson

We are close to where we want tobe, but we have probably another quarter or two trimming to do their but themajority of the realignment is complete, Ross.

Ross Seymore - Deutsche Bank

Great and one quick follow-up.You have talked about inventory management, you did a very good job on itacross the board. How would we think about the seasonality of revenues as we gointo the first quarter given the fact that you don't seem to be following thekind of traditional trend of stuff in the channel a little bit the back half ofthe year and having to burn it in the first half?

Mark Thompson

Well certainly we are trying tolearn from past experience and to the extent in the past inventories went off,it was misalignment rather than deliberate placement of inventory. So werecognized that particularly in the very end of December point of sale is quitehard to predict, because often people do shut down, sometimes not plannedbetween Christmas and New Year. And so we deliberately positioned ourselves soeven in the event that's on the high side of expectation we should becomfortably in the middle or even on the low end of our channel inventorieswhich of course will position us well going into 2008.

Ross Seymore - Deutsche Bank

Great thank you.

Operator

We will go next to Craig Ellis,Citigroup.

Craig Ellis - Citigroup

Thanks guys. Mark it looks likein the business so far this year we've had functional power gross margin thathave been increasing at a faster rate than analog product group, it looks likethe new product introduction activity is happening. Should we expect as we moveinto the fourth quarter and into next year that our sequential changes in grossmargins in analog will start to outstrip functional power?

Mark Frey

I don’t know which Mark you meantCraig, but I will handle that. I think that's true, we are seeing the positivemix impact of the analog programs but as we've said we've have done moreinventory corrections for those products lines as well. So at the operatinglevel, we had to burn through that.

Craig Ellis - Citigroup

Okay. And then is it possible tohelp quantity the degree of improvement that we might expect as we look outover the next three to four quarters relative to what we have seen in the past?

Mark Thompson

So, if we look at immediatelyinto the fourth quarter and Craig I believe you are asking an analogspecifically?

Craig Ellis - Citigroup

Yeah, I am focused just on theanalog.

Mark Thompson

Okay. Good. I just want to makesure I understand that correct. So if we look to the fourth quarter, we expectprogress to be at a minimum what we saw in the third quarter and most likelyaccelerate. If we look at our mix plans across 2008, we have a number ofprograms that we have talked about. We expect particularly voltage regulators, micro-SerDesand higher margin power conversion products, all to be really driving thegrowth for the company and for APG across 2008. Those are all positioned at thevery high end of our margin distribution and so we feel very optimistic thatyou'll see very strong margin progression across 2008 as those products grow.

Craig Ellis - Citigroup

Alright, guys. Thank you verymuch.

Mark Frey

Craig, just a follow-up on that.Just another way to think of that is that if you look at where our targets arerelative to where we are today.

Craig Ellis - Citigroup

Right.

Mark Frey

Analog has obviously the biggestimprovement to show. As you've seen we've been draining a lot of inventorywhich has been a bit of a headwind for that group and yet they've still beenable to expand margins at almost the company average. As that inventory drainheadwinds sized a little bit and these new products kick-in, I think it'sreasonable to expect that analog is going to have the best gross marginperformance of the company. So, we will see how that plays out over in 2008,but that certainly the way it looks in Q4.

Craig Ellis - Citigroup

Can you give us the utilizationfor third and fourth quarter again?

Mark Frey

Well, I won't give you thespecific numbers, because as we started getting closer to the 90% level and wetry to give too much detail here, but I would say that utilization rates weregenerally up in most of the factories with the exception of the main fab wherewe actually brought on our first 8-inch capacity. So that actually gave us alittle more room and brought utilization rates down a little bit which we thinkwill help us going forward as we fill up that factory with new analog products.

Craig Ellis - Citigroup

Okay. Thank you.

Operator

We will go next to Romit Shah,Lehman Brothers.

Romit Shah - Lehman Brothers

Thanks. Nice job on the quarter.I noticed in your monologue you mentioned several instances where bookings forcertain product lines were up 50% to 100%.

Are you guys taking a closer lookat your backlog or scrubbing your backlog a little bit more closely than youhave in the past and is that part of the reason why you are guiding to slightlyslower growth in Q4, and what I think generally is a pretty quarter forFairchild.

Mark Thompson

So, Romit two things, first isthat the mid point of our guidance range is actually equal to the averageprogression from third to fourth quarter over a couple of year period of time.So it's actually in the middle of the pack. We think that as I commented to aprevious question that its wise to be a little bit cautious about the fourthquarter because the -- recall last year for the industry it was a dramaticslowdown in the last two weeks of December. December is always the hardestmonth to call and so fourth quarter is all about the last two weeks of Decemberand none of us know what that looks like when we get to it. So, we felt it'swise to accommodate the potential for a soft -- last two weeks of that quarterin our expectations. Clearly if it doesn’t come than that will be a good thing.

In term of scrubbing backlogwe've put enormous effort into backlog integrity and so we make sure on anongoing basis and it’s a daily process that we run, that we really understandwhat the demand requirements are and that when we look across all of ourcustomers that we sum all the demand for a certain segment what our expectationfor a market share are and make sure that those don't add up to more than whatwe believe the market is, and when let us go to a number that's above what wethink they are to be then we re-double our effort to validate and correct andso every single week we go back and we take our orders off the books.

So, we feel very comfortable thatwe have a process that's probably as good as anything in the industry to makesure that in the advance that double order does creep into the system that ithas taken out very quickly prior to putting it into the factory and building itand putting on shop simply.

Romit Shah - Lehman Brothers

Yes, I would have thought thatthe last two weeks of December would be a non-event for you guys and everyoneelse, because most people go on holiday. Your visibility in the Q4 would bebetter or front-end loaded because most of what you book and check happens inOctober and November.

Mark Thompson

Actually typically it stays quitestrong into the first half of December and if you look at the pattern, it'sactually alternate years, so in the up inflection December is typically hadstayed strong and in the down inflection years it usually go pretty quite. Soevery year December or usually the back half is soft and odd year is strong,but I wouldn’t place too large a bet on that to predict the value, but that'sactually been the pattern over the last six years.

Romit Shah - Lehman Brothers

Okay. And if I could as afollow-up…

Mark Thompson

Excuse me, one second, Romit, Ileft an important part. I am talking here about point-of-sale now, so thepoint-of-sale is the part that we obviously don’t control, we only control tothe extent of the right stuff is on the channel. So, what I am reallyaddressing here is what happens to the point-of-sale, actually you are correctthat our OEM business is very easy to predict. However, remember that that's aonly third-ish of the company, so the two-thirds of the company, theuncertainty that I am talking about is how accurate the point-of-sale forecastthat we receive from our distribution partners are and we have learned to becautious about those for the back half of December.

Romit Shah - Lehman Brothers

But you recognize revenue whenyou sale in not when on POS or when you sell-through, correct?

Mark Thompson

Correct, that is correct.However, so if we use Q3 as an example we plan to reduce our channelinventories, but not by as much as we did because point of sale in the lastmonth of the quarter were unusually strong. So remember we get our forecast, sowe scrub our forecast, and we ship into the channel roughly speaking to ourforecast. If our distribution customers ship more than they forecast out thanthere are weeks of inventories in the channel windup go down when weconsolidate the inventory reports.

So, remember it's a trailingindicator. So, we try to anticipate some of those things and then applycorrections to the forecast that we receive from our distribution partners. Soyou are correct we can recognize revenue as sell-in, but we try to align thatwith expected sell-out and that's why there is inevitably a little bit of aphase delay in the way those numbers get reconciled.

Mark Frey

Hey Romit.

Romit Shah - Lehman Brothers

Yes.

Mark Frey

Romit, I guess what you justheard is that we manage the business on sell-through. I mean, that's kind ofthe subtext here, Right? Your comment about recognizing on sell-in is correct,but we watch POS like a hawk, that's how we manage our business and that's whywe are concerned about it and we are going to watch it. So we try to match thatconsumption rate at POS and that's how we manage everything here.

Romit Shah - Lehman Brothers

I guess Mark, what I am trying toget out is, have you seen anything in October in the last 30 days that in termsof retails or bookings that are causing you to maybe guide a little bit moreconservatively?

Mark Thompson

No.

Romit Shah - Lehman Brothers

Okay. Just as a follow-up. Mark,prior you mentioned there was a lower bonus accrual and that positivelyimpacted gross margin. Can you quantify that in impact and tell us when you'llactually accrue a higher amount for bonuses.

Mark Frey

Well I am not going to quantifyin dollars, but in general last year we were accruing bonus a bit above ouraverage, this year we were below the average. We tend to plan in future year'sto be around average, and that's incorporated in our 20% OpEx goals.

Romit Shah - Lehman Brothers

Okay. Alright thank you.

Mark Frey

Thanks Romit.

Operator

And we'll go next to ShawnWebster, JP Morgan.

Shawn Webster - JP Morgan

Yes, thanks for taking myquestions. Can you characterize the pricing environment for us in Q3 and whatyou expect for Q4?

Mark Thompson

Yeah, pricing actually was fairlymuted. I mean we were still down 1% to 2% same power pricing decrease which isa very comfortable range for us and given the fact that we've got 90% of ourguided revenues on the books, we kind of already know what the pricing is in Q4and its in that same range.

Shawn Webster - JP Morgan

Okay. So pretty stable than.

Mark Thompson

Yes.

Shawn Webster - JP Morgan

And can you quantify at all howmuch of your backlog grew and what your total company book-to-bill is?

Mark Thompson

We don't give specificbook-to-bill, we did say that our 13 week backlog was up which we were prettypleased with, I mean the overall we took our lead times down a couple of weekswhich we are very excited about because we think that helps to stabilize ourbusiness and provide better service levels to our customers and yet we werestill able to grow our 13 week backlog at a pretty healthy rate.

Shawn Webster - JP Morgan

And can you help connect some ofthe dots on the lead time is pulling back and does the inventories at the lowend of your normal range and your backlog growth parts of that was dots that Ican't quite connect with each other.

Mark Thompson

I will try to view that and wedon’t have a -- we did a quite a bit of work on our planning systems which iswhat allowed us to reduce our lead time. So the thing to remember is that therewas a bit of a system discontinuity there. So, clearly when your factories getheavily loaded then inevitably your lead times will go out as they getcompletely loaded but we did some work on how we stage orders and how webasically put gaps in the line that have allowed us to reduce our lead times toour key customers.

And so that certainly help ourturns business in the third quarter we believe and so we expect that tocontinue to help our turns business. So an escalating 13 week backlog enteringthe quarter, I believe is probably the clearest metric for escalating demand.The reduction in lead times should also put us in the position to respondfavorably to turns business opportunities as they appear, which should also bea favorable one. So, the thing to I guess to do and I think at the route ofyour question is don’t put the reduction lead times in the category ofreduction of demand. It's in the category of a fundamental system andprocessing improvement in our management tools that's allowed us to do that forour key account.

Shawn Webster - JP Morgan

I see. And then I guess maybe onelast question for you Mark Thompson is on the broader economic environment,clearly the PC handsets have been doing well for you guys. Can you give anycolor on consumer and if you or maybe just characterize where you seen relativeweakness in your businesses and specifically in consumer if you have seen anyimpact from housing markets, so I think you have some exposure in the whitegoods area there?

Mark Thompson

Well, so the white goods havebeen very strong for us, but that's not that much of a US business. So, if you look at alot in China, Japan and Europe.And so the issues in housing haven't extended beyond the boundaries of the US.So, we've not seen that and don't necessarily expect, I couldn't rationalizewhy we would see it. It's always difficult to predict the future, but I don'tsee that as a particularly big issue.

So, the overall demandenvironment right now really across the board is one that's quite good.

Shawn Webster - JP Morgan

Okay. Thank you very much.

Operator

(Operator Instruction). And wewill go next to Steve Smigie, Raymond James.

Steve Smigie - Raymond James

Great. Thanks. I was wondering ifyou could talk a little bit more about the success of the analog switchproduct. What have you done there that's allowed you to have such successfulresults and are you transferring that to other product sets?

Mark Thompson

So, if I were to try tocharacterize our success there. It's really been one where we have a number ofdifferent building blocks. We put into the switch depending on whether peopleare focused on analog, whether they are focused on video. There is, a switchsuperficially is a simple thing but there is usually some dynamiccharacteristic of the signals that people are putting through the switch thatcreate some specific requirements.

Our team has really done twothings that will allow them to be successful. First, is from an engineeringpoint of view they've got all the right building blocks in order to respond tocustomer request and we've done a very good job of penetrating all the keycustomers engineering programs, understanding early what it is that they need,and getting those things turned out in time, in the right IC, in the rightpackage, in the right volume and we've been rewarded with share growth as aresult of doing that successfully.

So, the second half of yourquestion Steve is that absolutely the model for success in the analog space.So, we are in every place in the company where we have a success formula we'remaking sure that we study it and replicate it and embed those methodologiesinto the other product lines.

Steve Smigie - Raymond James

Great. And later question is ifyou could talk little bit about the manufacturing side of business, anythingparticularly you intent to do with your footprint dreams of optimizing that onthe front end and looking at the past it has been some indication that youalready have discussed stays somewhat in sourcing and so what's the outlook forthe back-half as well?

Mark Thompson

So as Mark mentioned we have beenwe think that our average level of outsourcing balance for the backend has beenwe would benefit by shifting it toward some more in sourcing. And so we've beencapitalizing little bit more aggressively on that. So, that's definitelyhappening, we have the space in our backend plans to accommodate that. Recallthat the number of years ago the company built a large facility in Suzhou inChina that has not only some space left but we have large lot next to it, soit’s a very expandable site. And Penang isalso not completely utilized from a footprint point of view, so we certainlydon’t expect that our in-sourcing efforts will require us to expand ourmanufacturing footprint. We can accommodate everything and recall that we arealso steadily squeezing out the lower end and particularly some of the highvolume businesses like small signal and so forth. So that we don’t expect todrive any change in our manufacturing footprint.

We are always looking atopportunities to streamline our manufacturing footprint if we can find sort offavorable mechanisms to do that, but we don’t have any eminent plans to dothat, although we are constantly examining opportunities to simplify and havefewer overall manufacturing sites.

Steve Smigie - Raymond James

And just as a follow-up on theback-end stuff, is there a percentage of product manufactured that you havein-sourced and is there a percentage goal target that you have or…?

Mark Thompson

Yes, we are less than 50%in-sourced today and we would like to take that to approximately 60% in-source.

Steve Smigie - Raymond James

Okay, great. Thank you.

Operator

We will take our next questionfrom Tristan Gerra, Robert W. Baird

Tristan Gerra - Robert W. Baird

Hi, guys. It sounds like yourdiscrete sell-through couldn't be a little bit higher than you are sellingguidance for Q4. If that's correct is it safe to assume that distinct inventorydays are going to pick up a little bit in the first half of '08 and that Q3-Q4at less than 11 weeks is basically a 12.

Mark Thompson

So Tristan, we have not changedour range of distribution inventories. So, we try to put control limits on of11 plus or minus one week. And so when we get into the high end of the range wewatch carefully to make sure it doesn't go too high. When we get in the low endof the range, we watch carefully to make sure it doesn't get too low.

So, we are well into the bottomhalf of the range at closer to 10 and 11. So, we are watching very closely towhere we want to make sure that we don't under ship the channel any further andmake sure that we have enough inventory to meet demand.

As I did comment to an earlierquestion, the average forecast that we get from our distributors is overstatedfor December, so we've deliberately led a little bit out of that and so we wantto make sure that we are positioned, so that we don't grow at channel inventoryexcessively in the event at point of sale is soft in the back-half of December.

We are well positioned for that.So, even at the sort of two sigma outcome for point-of-sale in December, wewill still be inside of our range. And we don't expect to have to correctanything meaningfully in 2008 as a result.

Tristan Gerra - Robert W. Baird

Great. And also, could you giveus a sense of what [total] communication revenues in the quarter?

Mark Frey

Tristan, is that a handsetquestion?

Tristan Gerra - Robert W. Baird

Well, you have talked a littlebit about the handset, but anything else basically that could have been affectthere?

Mark Thompson

Yes. It's mostly handsets.

Tristan Gerra - Robert W. Baird

Okay.

Mark Thompson

Most of our communications numberis handsets and as we talked about in some of the prepared comments, we had avery strong handset quarter. And then we've got good starting backlog positionfor Q4 as well.

Hey, just one point to you toclarify on our channel inventory, we are below the mid point but I would justcharacterize is as that we are not and we wouldn't say that we are necessarilyright on the bottom end of that range but we are definitely below the mid pointin our channel inventory, Tristan.

Tristan Gerra - Robert W. Baird

Okay. And just the final quickone. What is the percentage or a rough estimate of your distribution where youhave computer systems in place to track sell-through. I know that you've takena lot of steps in that regard of the past year, year and a half but do you feelthat you have covered pretty much of all the main [disties] or how is yourvisibility in that regard.

Mark Thompson

Sure Tristan, you're correct. Weput lot of energy into our point-of-sale information. We get from our largestmultinational distribution partners, we can get daily point-of-sale informationfrom our smaller private ones, they have more customized reports but we getlet's just say better than 90% reconciliation every week. So, that's actualsand forecast updates is the way that works. And so again we can't from a --we're never more than a week out of phase with what's going on in themarketplace and that's really why we have a lot of confidence that we reallycan manage the business very accurately to a point-of-sale basis.

Tristan Gerra - Robert W. Baird

Great, thank you.

Operator

(Operator Instructions). We willgo next to Quinn Bolton, Needham.

Quinn Bolton - Needham

I wanted to ask a capacityquestion, Dan I think you had said that the capacity utilization was up atleast the front-end capacity near 90%. It looks like your inventories arepretty lean in the channel, demand seems pretty good, so it sounds likecapacity could become tighter as you get into the calendar 2008. So justwondering if you have any preliminary thoughts on CapEx looking into next year?And then also if you are around 90% on a CapEx, do you have additional cleanroom space where you can just add additional equipment to increase capacity ordo you have to start looking at new -- building out new clean rooms to expandcapacity?

Mark Frey

Kevin, this is Mark. Our CapExfor next year is till more focused on back-end and front-end. We upgraded themain plant to 8-inches this year and that's coming on board now. So that's ahighly leveraged operation and we'll continue to build out that 8-inch toolingnext year. We made some investments in [Boshang] at the mid point of this yearand that's about to come online too. So, we are very comfortable with theleverage point in our front-end in order to expand capacity. No, we don’t seeneeding to build out like a clean room environment for another couple years atleast.

Quinn Bolton - Needham

Okay, looking at your additionaltools on the front-end and then focus on increase in the backend production andtrying to in-source a greater percent of your requirements through thosebackend facilities.

Mark Frey

That’s pretty good summary.

Quinn Bolton - Needham

Okay, great. Thank you.

Operator

And this does conclude today'squestion-and-answer session. Mr. Janson, I would like to turn the call backover to you for any additional or closing remarks.

Dan Janson

Great, well, thank you all forjoining us. We appreciate your attention.

Operator

And this does conclude today'sconference. If you would like to listen to a replay of the call, it does starttoday at 11 o'clock am and runs through November 17, up to midnight. To dial-infor the replay please dial, 1-888-203-1112 or 1-719-457-0820. The confirmationcode for the replay is 8451338. Again, that is 8451338. We do thank you foryour participation. You may now disconnect.

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Source: Fairchild Semiconductor International Q3 2007 Earnings Call Transcript

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