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Fairchild Semiconductor International, Inc. (NASDAQ:FCS)

Q1 FY08 Earnings Call

April 17, 2008, 09:00 AM ET

Executives

Dan Janson - IR

Mark S. Frey - EVP, CFO and Treasurer

Mark S. Thompson - President, CEO and Director

Analysts

Ross Seymore - Deutsche Bank Securities

Craig Ellis - Citigroup Smith Barney

Romit Shah - Lehman Brothers

Shawn Webster - JPMorgan

Steven Smigie - Raymond James

Kevin Cassidy - Thomas Weisel Partners

Tristan Gerra - Robert W. Baird

Eric Ghernati - Banc of America Securities

Operator

Good day everyone and welcome to the Fairchild Semiconductor First Quarter Earnings Call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like turn things to Dan Janson. Please go ahead, sir.

Dan Janson - Investor Relations

Thanks. Good morning and thank you for dialing into Fairchild Semiconductor's first quarter 2008 financial results conference call. With me today is Mark Thompson, Fairchild's President and CEO; and Mark Frey, our Executive Vice President and CFO.

Let me begin by mentioning that we are attending a number of industrial conferences this quarter, including the Baird Growth Conference in Chicago, the JPMorgan Tech Conference in Boston, Banc of America's conference in California, and the Wedbush and FBR conferences in New York. Mark Frey will start today's call with a review of our first quarter financial results and discuss our forward guidance for the second quarter of 2008. Mark Thompson will then discuss our new products and product line results, end-markets, and operational performance in more detail. Finally, we'll reserve time for questions and answers. This call is scheduled to last for approximately 60 minutes and is being simultaneously webcast from our 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 in this conference call. These statements, including all statements about future results and performance are mainly based on assumptions and estimates and involve risk and uncertainty. Many factors could cause actual results to differ materially from those expressed in forward-looking statements. A discussion of these risk factors is provided in the quarterly and annual reports we filed with the SEC. In addition during this call, we may refer to adjusted or financial measures that are not prepared in accordance with Generally Accepted Accounting Principles. We use non-GAAP measures, because we believe they provide use conformation about the operating performance of our businesses that should be considered by investors in conjunction with GAAP measures that we also provide. You can find a reconciliation of non-GAAP to comparable GAAP measures at the Investor Relations section of our website at investor.fairchildsemi.com. Website also contains 2008, Q1 fact sheets, updated financial section with updated unaudited financial highlights including detailed breakouts, the segment and regional revenues, gross margins, EBIT and EBITDA.

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

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

Thanks, Dan; good morning and thanks for joining us. I am sure most of you have had a chance to review our earnings press release that was issued earlier this morning, so I'll focus on just the key points in my comments. For the first quarter of 2008, Fairchild reported sales of $406.3 million, down 6% sequentially and up 1% compared to the prior year. In response to weaker sell through in China during February, we reduced our shipments in the distributors, which resulted in about a $6 million reduction of channel inventory. Had we not trained channel inventory, our sales would have been nearly at the midpoint of our guidance range.

Gross margin was down 110 basis points from the prior quarter due to lower sales volume and factory loadings as well as normal first quarter increases in payroll and benefits costs. Higher gold and cooper prices also had a negative impact on gross margins. These factors were partially offset by improved product mix and greater new product sales, R&D and SG&A expenses of $89.9 million were higher than the prior quarter and in line with our expectations. The increase compared to Q4 was driven by seasonal changes in payroll and benefits expenses that occurred at the start of each New Year. Net interest and other expenses were $5.2 million in the first quarter as we realize lower average interest rates on our cash investments. Our adjusted effective tax rate was 15.3% in the quarter. Overall, we delivered solid financial results for the first quarter while maintaining inventories within our target range.

Now, I would like to review first quarter highlights of our sales and gross margin performance for each of our product groups. We call that we implemented previously announced reorganization of APG and FPG along end market segments affective day one 2008. Some mobile computing consumer and communications or MCQ group will focus on supplying these fast growing end market segments with innovative power and signal path solutions including our industry leading low voltage MOSFETs and analog switches. The power conversion, industrial, and auto or PCIA group will focus on providing high efficiency power solutions to these attractive end markets. The Standard Products group remains unchanged in its mission to profitably manage its business for superior cash flow and return on assets. You can find detailed financial results for our new product launch structure, including five years of restated history on our Investor Relations website.

Our MCQ group recorded a 7% sequential decrease in sales, which reflect seasonally weaker computing and handset demand particularly in China. An anticipation of seasonally lower demand in Q1, we reduced factory loadings back in the fourth quarter to keep inventories in line. Gross margin was sequentially down 270 basis points due primarily to this lower factory utilization. Seasonal increases in first quarter payroll and benefits expenses as well as higher gold and copper expenses.

In our PCIA group, sales decreased to 5% from the prior quarter due to lower sales of high voltage products. This was primarily due to a slower than expected ramp of our internal assembly and test capacity as we bring more of this production in house. We believe that we have addressed these issues and expect to report solid revenue growth in Q2 as we ramp our latest field stop IGBTs, industry leading supreme mass products and are highly integrated smart power modules. Gross margin improved 40 basis points sequentially due primarily to greater sales of higher margin new products and more stable factory loadings.

The Standard Products group sales were down 5%, and gross margin was slightly lower compared to the prior quarter due to continued rationalization of bipolar transistor and standard linear product lines. Reviewing our balance sheet; internal inventories increased $5.8 million resulting in about of 4.5 day increases from the prior quarter. Some of this increase was related to plant builds to support in-sourcing transfers as well as some strategic inventory for our new high frequency voltage regulators. At less than 80 days, we continue to maintain one of the leanest inventory levels in the industry.

DSOs increased to 43 days as collections in Asia were slower than normal and shipments were ramped to the end of the quarter. Cash and marketable securities increased $3 million to $465 million in the first quarter, which reflected cash flow from operations of $38 million and capital spending of $31 million. This represents the 12th consecutive quarter for positive cash flow from operations.

Turning now to our forward guidance; we expect second quarter revenue to be flat to up 3% in response to higher demand. At the start of the quarter, we had about 89% of this sales guidance booked and scheduled this year. We expect gross margin to be down 75 to 125 basis points sequentially due to the delayed impact of lower factory starts in the first quarter. We expect R&D and SG&A expenses to be approximately $89 million to $91 million and net interest and other expenses to be about $5.5 million for the second quarter.

Now I will turn the call over Mark Thompson.

Mark S. Thompson - President, Chief Executive Officer and Director

Thanks, Mark. Let me start by reviewing the end markets and some key operational metrics. End market demand was roughly inline with our expectations with the exception of weaker distribution sales in China during February. First quarter sales into Europe and Korea were up about 9% while the Americas and Japan were flat to slightly lower sequentially.

Our sales into the OEM channel were sequentially flat as increased new product revenue offset the normal seasonal decline in demand. Since the holiday period, bookings have been strong across a wide range of end markets. Distributor sell-through was down about 6% sequentially in Q1 due to the softer China demand in February, but has since rebounded solidly and is back to normal seasonal levels. We decreased our sales into distribution during the first quarter to keep channel inventory within the targeted range for weeks of supply. We expect channel inventory to decrease further in Q2 as sell through improves sequentially.

Overall product pricing was down slightly more than 1% sequentially, which remains at a reasonable level. Our pricing trends are benefiting from our steady shift to higher value products. Also industry discipline and adding capacity and managing inventories helps to provide a stable pricing environment. We held lead times within a stable range of seven to nine weeks during the quarter and expect to maintain this level during Q2. Factory utilization improved slightly later in the quarter as we adjusted start to improving demand.

Turning now to product line results; as Mark mentioned, we recently reorganized our APG and FPG product lines into the mew MCQ and PCIA groups. We believe that this market segment structure will allow us to better leverage our product and market knowledge to provide customers of more comprehensive set apart management and analog solutions.

We are already seeing some exciting opportunities arise from this new segment focus. In the MCQ group, we expect the steady acceleration in new product sales in 2008. Especially for solution targeted to the handset and ultra portable markets. We grew sales of our latest high frequency voltage regulators even in the seasonally slow first quarter. Our bookings for these products indicate that sales should be stronger in Q2 and stronger again in the second half. We posted 35% sequential sales growth for our latest video filters for set-top box application and even higher bookings for subsequent quarters.

The worldwide conversion to digital TV is clearly driving this business. We are also excited about the transition to standard USB connectors and the handset market. We believe this will be a significant growth driver for our USB switch sales later this year and in 2009. While sales of our low voltage MOSFETs was seasonally lower in the first quarter, we expect demand to improve steadily during the year, driven by strong growth in notebook, PCs, handsets, and flat panel filters.

The PCIA group focuses to capitalize on the growing demand for greater energy efficiency in power supplies, battery chargers and automobiles. The message is clear from our customers; improving the efficiency of their products is vital to meeting new regulations and their customers' need for lower operating costs. Effectively managing the power conversion and initial voltage regulation and power supplies is one of the greatest opportunities, we have to improve overall system efficiency. Fairchild is the largest supplier to world of innovative power conversion products necessary to improve power supply efficiency. We are leader in power factor correction, low standby power consumption designs and innovative switching techniques that enable greater efficiency under varying loads.

Our smart power modules or SPM business posted another record quarter for sales despite the manufacturing issues that impact our output. We are working hard to increase our capacity to keep up with the strong demand we enjoy for these highly integrated power management solutions. Our addressable market continues to grow as we increase our penetration into lighting, e-bike, and industrial applications in addition to our current expensive portfolio for motion control and appliances. We are excited about our latest field stop IGBT and high voltage MOSFET technologies, which offer industry leading performance in smaller diodes.

We posted solid sales growth for our latest IGBTs and expect both of these new product families to drive steady sales growth during 2008 and 2009 at higher margins. Standard Products group sales were down 5% or gross margin approximately flat sequentially as we continue to rationalize and resize our lower margin bipolar transistors and standard linear businesses. Our strategy for FPG is to run the business for strong profitability in cash flow while augmenting sales with higher margin new products. Our new family of logic translators posted record sales in Q1 with margins well above of even the total company average. Strong bookings indicate sales for these innovative products should continue to grow rapidly in 2008.

We also want to update those of you, who may be wandering about the status of our ongoing patent litigations with Power Integrations. In PI's case against Fairchild, we are waiting for the court to schedule a hearing date with regard to our claims of inequitable conduct against Power Integrations and post trial motions in that case. We have recently learned that the U.S. patent office, which is in the process of redesign... re-examining the three unexpired patents PI asserted against Fairchild has issued preliminary rejections of all claims asserted from two of the three patents based on prior ones [ph].

The patent office has not acted on the third patent yet. In another lawsuit dropped by Power Integrations against System General before we acquired System General, the patent office re-examined all four patents asserted in that case and has issued preliminary rejections against all Power Integrations' patent claims asserted against System General as well. We expect these actions of the patent office may have effects on the course of these lawsuits, and we expect to provide information as it becomes available. We understand the process with the patent office is continuing, and at this point of the process, we are limiting our comments to providing this updated information. We are not making any statement or representation about the ultimate outcome of the re-examination proceedings to PI and the patent office.

In summary, I believe Fairchild is well positioned to take advantage of the demand growth our customers expect during the rest of 2008. Bookings have been strong since the Lunar New Year, and we expect solid growth and distribution sell through in the second quarter. We also expect strong sales for our OEM customers as we accelerate their segment in new products. Our stable lead times in well managed inventories will enable us to respond quickly to our customers' needs as demand improves. This supply changes discipline also a allowed us to pose the fairly needed one quarter drop as we now guide for higher sales in the second quarter. We continue to improve our cycle performance and look forward to raising our peak sales and margins as the industry returns to demand growth again.

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

Dan Janson - Investor Relations

Great; thanks Mark. We'll now open the call to questions. I would ask that in order to more of you to ask questions, we limit each person to one question and one follow up. Thanks now; let's take the first take the first question, please.

Question And Answer

Operator

Thank you. That question will come from Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank Securities

Thanks guys, just a couple of questions; first in that first quarter revenues. You pointed to the Chinese markets slow down in February; was that really a surprise with the magnitude greater than expected and that's why you chose to bring down channel inventory?

Mark S. Thompson - President, Chief Executive Officer and Director

Ross, it wasn't a surprise, but the magnitude response was certainly a bit larger than we expected. The normal trend as we have tried to expand on in the past for Q1 is that fairly erratic demand profile that in very early January and then debt again around Chinese New Year; and then normally, it ramps pretty strongly in March, and so you are watching the recovery in March. So, the notch is particularly around Chinese New Year were deeper than they normally are. And while the ramp was also larger than it normally is in March, it wasn't enough to offset the debts of those trials. So, it's not... wasn't a radical effect, but cumulatively, that's a very large market for us, so that had an impact.

Ross Seymore - Deutsche Bank Securities

Okay, and then I guess the follow-up question will be more in the gross margin side. I was a little surprised that it's supposed to be down as much it is in the second quarter. I thought loadings were supposed to be relatively flat and mix was going to improve in the second quarter. Where am I wrong in those assumptions?

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

Well, Ross, this is Mark Frey. Recall that the real financial effect of lower loadings happens... delayed by about one quarter because of the inventory value of what you are building is still in inventory at the end of any given quarter. And it ships out in the costs of good sold in the following quarters. So, you get that delayed offset effect of the accounting.

Ross Seymore - Deutsche Bank Securities

Right, but I thought the fourth quarter is where you brought loading down; you were going to keep them relatively flat in the first quarter, and therefore what you sold in the second. We have an incremental drop in your fixed costs coverage. So, did something change and you ended up bringing down loadings?

Mark S. Thompson - President, Chief Executive Officer and Director

We began to bring them down in the fourth quarter, but that was really quarter end effect, and we brought them down across Q1.

Ross Seymore - Deutsche Bank Securities

Okay. And what's... and my final one; loadings in the second quarter, expect them to be up or down sequentially?

Mark S. Thompson - President, Chief Executive Officer and Director

Slightly up, so we are managing loadings to bring our internal inventories down slightly by the end of the quarter.

Ross Seymore - Deutsche Bank Securities

Great, thank you.

Dan Janson - Investor Relations

Hi Ross, this is Dan too. The other point that I'd make is that we did drain explain of inventory out of the channel, so we were pretty aggressive at keeping that in line, and that's the way we are going to manage this. So, we are going to depending on how re-sales play out. We think they are going to be up pretty solidly in the second quarter, in a low adjust that we start accordingly.

Ross Seymore - Deutsche Bank Securities

Thanks.

Operator

[Operator Instructions]. Our next question will come from Craig Ellis at Citi.

Craig Ellis - Citigroup Smith Barney

Thanks guys. The first question is related to the new segments that you've got. Can you, Mark Frey, just frame for us the segment gross margin targets that we should be thinking about, short-term and long-term, the way you have done in the past with the power segment reporting?

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

Craig,we are not really ready to do that yet. We will have an investor conference when we will go through those businesses with people in a great deal more detail. Obviously, you can see that we've ended up with a more balanced set of product groups with two groups in around the $650 million per year revenue area at gross margin now that are closer to see each other. And then within those businesses obviously, they have some higher margin sub groups and some lower margins sub groups. And we are working to that and will provide. Obviously, we don't think that changes our targets for the company, because these groups in just rearrangements of existing product lines, and we do our strategic analysis at the product line level, but I don't have updated targets at those new product division levels.

Craig Ellis - Citigroup Smith Barney

Okay. And then the follow up for me is, we go back to the analyst day that you... one of the things you guys mentioned was there was $30 million to $50 million of mix out headwinds for the business this year. Where do we stand on working through that and can you talk about for whatever is remaining, which is the segments would that be in?

Mark S. Thompson - President, Chief Executive Officer and Director

Craig, the dominant piece of that is in our standard products, particularly in bipolar and small signal and diodes. And we are continuing to explore a number of options ranging from divestiture to streamlining those products. And so as things become announceable, we will keep you informed. But that is something that the details of which we are actively working currently.

Craig Ellis - Citigroup Smith Barney

Mark, is that something that you can pull the trigger on now, or do we really need to see revenues move up, so you have better overhead absorption on the rest of the business before you feel comfortable divesting the revenues.

Unidentified Company Representative

So the key to it is that we'll keep that earnings neutral, so whatever we do we're committed to at being sort of instantaneously being after the small players right some, whatever structure, restructuring those along with that, it will earnings neutral and at that point then we have a growth base that we could grow earnings from. So that's really the go, no go decision for any of the choices that we're looking at is instantaneously earnings neutral for better.

Craig Ellis - Citigroup Smith Barney

Okay thanks Mark.

Operator

Our next question will come from Romit Shah with Lehman Brothers.

Romit Shah - Lehman Brothers

Thanks for taking my question. It sounds like gross margins are bottoming here in Q2. If the sales run rate in the second half gets back to the run rates in the second half of last year, should we expect gross margins to be higher then they were in that comparable period?

Unidentified Company Representative

That's certainly the way we're modeling Romit. It's not guidance, but that reflects new combination of manufacturing cost reductions and the positive product mix and new product impacts. Obviously, off-set somewhat by some commodity price increases that we had to absorb.

Unidentified Company Representative

Romit if you look at the cycles, so this if you compare the trajectory for the first half of the year trough for this year is exactly like last, but Q1 is 200ish basis points above last year and we're guiding in the 50 to a 100 basis points better in the second half. So we'd expect any improvement in the trough to be at least reflected on the given set of assumptions in the peak, and then of course there are a number of key improvements that will roll the year as we've talked about in the past. So we feel pretty comfortable modeling the business based on that.

Romit Shah - Lehman Brothers

Great and then just on the up-tick in bookings, you guys have had good starts to orders in prior quarters. Does this quarter, does the up-tick this quarter feel like it's perhaps some more sustainable that we've seen in previous periods?

Unidentified Company Representative

Romit [ph], it's always difficult to comment on sustainability and January actually was pretty strong and then rolled over quite hard as we entered into February. What I will say is that so far April has been substantially stronger than January was and is significantly ahead of expectations. So we've been running the 10% to 15% more incoming orders than required to meet our guidance at this point in the quarter. Again, we know that there is... these things do move around and there is always anticipation of third quarter ramps and these things get reschedule and so forth, but as of this moment in time, the current inflow of orders is exceeding our expectations.

Romit Shah - Lehman Brothers

And it's fair to say that Q2 is not going to be as erratic as Q1, because you don't have events like Chinese New Year?

Unidentified Company Representative

Q1 following Q4 is always, I call it the weight muscle [ph] quarter, because you have these big notches down in demand and then you're relying on March to get you out on the whole and it's just the way that the seasons roll out. And so yes, we normally Q2 and Q3 are very smooth in demand and then gain, Q4 has its own personality to the demand profile.

Romit Shah - Lehman Brothers

If I could, just one last question on OpEx. It looks like you guys are on a run rate to grow OpEx at a higher rate than sale. This turns out to be a flattish year in revenues. What sort of growth in OpEx should we assume?

Unidentified Company Representative

Well, Ron, it will, we'll manage our OpEx to our strategic target over time of 20%. There are... and within the year with... consistent with at least our revenue expectations. We're going to hold OpEx at about the level that attack [ph], if revenue doesn't develop then we'll look at other ideas. You recall that we do, we don't take large restructuring opposed to OpEx control, we've done probably, actions in four of the last six quarters and we're continuing to do that operationally, as we take, particularly SG&A expenses down. The impact in Q1 was obviously a reset of compensation costs, because late last year, first of all that's a quarter with very high vacation patterns. March is typically the quarter with very low vacation patterns.

We have to start matching benefit costs which you sort of ramp that down as the year progresses. Our equity comp accruals are also ramped into Q1, the way we do our kind of the retirement benefits, plus there was actually a sum of about $2 million of either one time benefits that we had in Q4 or one time penalties that we paid in Q1. So we expect to be able to maintain that level as we go through the year. Obviously, if the environment changes, we're... we stand ready to make the appropriate changes to OpEx.

Romit Shah - Lehman Brothers

So you plan to maintain it in terms of dollars?

Unidentified Company Representative

In terms of dollars. Yes.

Romit Shah - Lehman Brothers

Okay, great, thank you so much.

Operator

Our next question will come from Shawn Webster with JPMorgan.

Shawn Webster - JPMorgan

Yeah. Thank you for taking my question. On the utilization rates can you quantify what the rates were in Q1 and whether you expect them to I think you said come up or go down in Q2.

Unidentified Company Representative

Yeah Shawn, we don't provide exact details on utilization rates, but I think what you heard mark say is that we did slightly raise factory start, so obviously utilization would have come up a little bit at the end of last quarter and we'd expect that trend to continue again at a slightly increased rate in Q2.

Shawn Webster - JPMorgan

Okay and then for the gross margins, is it possible to dissect the various effects you had to reconcile the sequential change in gross margins?

Unidentified Company Representative

What do you mean by that Shawn?

Shawn Webster - JPMorgan

Well you mentioned several different areas, including utilizations, higher parallel costs and material costs, can you dissect the effect on your gross margins?

Unidentified Company Representative

In Q1, it was primarily the increased payroll costs and the impact of gold. In Q2 it really is this sort of accounting delay of absorption of overheads in the inventory.

Shawn Webster - JPMorgan

Okay.

Unidentified Company Representative

Is that what you meant?

Shawn Webster - JPMorgan

Yes, have you been seeing the impact of gold previous to now. I don't recall you guys mentioning it before as an intact item on your gross margins.

Unidentified Company Representative

Yes, I mean you know it was in 700 range, as it went into the 800 range that had about a $6 million impact last year. I am trying to dip into my memory and close to a $2 million impact in Q1.

Shawn Webster - JPMorgan

Okay, and then last question can you give us some flavor of how your orders are progressing for Q2 in terms of your end markets, which one's are relatively stronger, which one's are weaker?

Unidentified Company Representative

The strength is really across the board, so there is always customer specific patterns, computing is very strong in notebook, very week in desktop, as I think that's pretty consistent with what others are seeing. Again, cellular is local handset and China has been weak, but in general and there are some continued customers specific weaknesses there, but the general industrial power supply, automotive, all of them are progressing pretty strongly. So it's a broad-base strength that we are seeing right now.

Shawn Webster - JPMorgan

Okay, thank you.

Operator

Tom Pitso [ph] with Credit Suisse has your next question.

Unidentified Analyst

Thank you, this is Deepak [indiscernible] for John. I guess, first just a follow up on the June quarter revenue guidance. Can you help us understand how much of your guidance is based on building some amount of channel inventory in 2Q?

Unidentified Company Representative

So we commented that we were planning to reduce channel inventory in Q2.

Unidentified Analyst

Okay, so does the lower end of your guidance anticipate inventories coming down by a similar amount as in first quarter or?

Unidentified Company Representative

So, we would expect it to go down in weeks, but so we would expect it to come down close to the middle of the range, that's our current model.

Unidentified Analyst

Okay, and just as a follow up, can you remind us of what normal seasonality for the September quarter looks like?

Unidentified Company Representative

Ted [ph], do you want to handle that?

Unidentified Company Representative

Sure, yes actually if you look at our three year average, we're basically guiding right, actually a little above that 1.4% and that normalizes for, you remember you... in 2006 we had a 53 week year, we had an extra year.

Unidentified Analyst

Right, then that was June right? So, how about September?

Unidentified Company Representative

The September quarter... I don't have that data in front of me. I'd say the last couple of years we have probably been up a couple of percent.

Unidentified Analyst

Okay great, thank you.

Operator

Our next question will come from Steven Smigie with Raymond James.

Steven Smigie - Raymond James

Great, thank you. You could talk a little bit more about the reorganizing of your groups here and talk a little bit about what changes you may have to make internally in terms of how you focus your sales force? How you focus manufacturing and should we expect to see any charges due to reorganization of any of that?

Unidentified Company Representative

No, Steve the motivation for the reorganization is... was to focus as I think is behind your question, really to narrow our customer focus. Previously, in FPG and APG we really had a, sorry everybody focusing on all customers and it's a hard thing to do and so we really have a concentration now of customers. So for both PCAA [ph] and McQ, they have really got less than 10 major customers each that they get very close to and so from a product development point of view, that doesn't change a lot. But to your point, how you go to market, and then how you sell, and there is opportunities to really scream on that and get much closer to customer and that's really the focus of what we are doing. So we did actually take a big chunk of that last year, when we took across the year about $7 million out of selling costs, as we rationalize that. We expect to do a little bit of that this year, but it'll be less and so again it may pop up above the $1 million number and show up as a restructuring item, or if it's below that we typically just absorb it in the income statement.

But I don't expect there to be a dramatic change, rather just continued efficiencies in marketing and selling that will be taken a customer, a country at a time.

Steven Smigie - Raymond James

Okay and sort of following up on that, it's a little bit... its always tricky determining the focus on a customer or do you bring in the people with the best product expertise and is... do you say, if you could talk to us a little bit about what you are thinking then and what did it look like if you know, you have particular customer or sales person [ph] with the customer FAE. Do you come to decision at some point, just to bring somebody else in how [indiscernible] particular product. Just how that works and then just a... totally separate question, but if you could a comment a little bit on the mix of the analog, versus non-analog product going in to these Chinese distributors and that will be my question. Thanks.

Unidentified Company Representative

So the... I think all success starts with your tier one customers but I guess in terms of who drives that success. One of the things that all successful companies do is, as they get a broad cross section of key people in front of the customer. And so that means the sales person, that means the application engineer and that means the designing, the design depending on what you're working on. And really solving the next generation problems that are unique in a value added way.

So in fact what we historically had as a company was that a procurement centered selling effort which didn't reach enough back into the product development efforts. And of course interface with procurement is extremely important, but interface with the engineering, so engineering teams, our engineering teams working with the OEM's, engineering teams is really where we've been concentrating the effort, because that's where all good new stuff comes from. And so that's really been the flow that we've been concentrating on getting in the places where you see success occurring as really where we got that click and that engagement with the customer and the new products are flowing from that, and so we are replicating that across all our tier one customers. So that's really the focus of the segment structure. But I'm sorry. Can you repeat your second question?

Steven Smigie - Raymond James

Yeah it was just that you mentioned that sales into the Chinese distributors where a was little bit one of your areas weakness, I was hoping you could comment a little bit on how much of what you sell those Chinese distributors as analog products, versus non-analog products?

Unidentified Company Representative

It's about to same mix as the company's mix. So and the weakness was pretty broad based, so as $1 million chunk set of number of different product lines.

Steven Smigie - Raymond James

Okay great, thank you very much.

Operator

We'll go next to Kevin Cassidy with Thomas Weisel Partners.

Kevin Cassidy - Thomas Weisel Partners

Thank you. Good morning. Can you talk a little bit about the competitive environment with business being a little softer, where ASP's down lower than expected?

Unidentified Company Representative

And so the ASP reduction that we cited in our release, our script was down on 1.2% which is in the range of the normal. So analytically pricing is well within the normal range at this time.

Kevin Cassidy - Thomas Weisel Partners

I guess, do you have any explanation of why that may be?

Unidentified Company Representative

Well I think the whole industry is doing a much better job of managing its supply chain, so in the past, people tended to overcapitalize in the up cycle and then had to find homes for... to fill that capacity in the down cycle and had to do sort of suicidally aggressive pricing in order to make that happen. I just think that the industry is managed better, the lot of money has been spent on supply chain tools and that reflects itself in less dramatic swings for everyone, of, sort of written [ph] deficit of capacity and as a result our pricing cycles, I think everywhere save memory are more muted, than they've been historically. And I think that, I believe that's true for everyone or most everyone, general trend in other words.

Kevin Cassidy - Thomas Weisel Partners

Okay, and, so, you've really have even [ph] some of the new competitors coming from Asia, not having as much of effect on the ASPs?

Unidentified Company Representative

Kevin, when you... obviously this is a segment by segment thing and so when you do get a segment like desktop, where capacity exceeds demand, you'll get higher than average. So we've got some product lines where the competition is, say not Asian based, that's below average and in those other pockets, it will be above the average. But that's clearly Asians coming into a market to impact pricing and we have to respond, but we haven't seen anything off trend.

Unidentified Company Representative

So I guess, I'd add to that, again it really depends on the performance requirements of the product. So, if you look in desktop... desktop has been defined, that has been expect to be as cheap as possible. So you can take a three generation's old MOSFET and the thing will start-up and run most of your software, and that's what they expect. Whereas in notebook efficiency requirements play in and there you don't you find the well established leaders in the space who take those sockets, and it's not just a price play. That trend again if you look in some of the businesses that we have highlighted that we're evaluating exiting, like some of the standard diode business and small signal transistors. Again those are essentially pure commodity products. There is a lot of local supply. And there is not really anything you could do about that.

And so again I think you have to look at the application, you have to the required specification. And certainly you will find chunks where if it's commodity and there is capacity flowing into the market then the pricing is going to be bad. But less and less of our business looks like that, and that's reflected in the very moderate average price reduction going from Q4 to Q1.

Kevin Cassidy - Thomas Weisel Partners

Okay thank you very much.

Operator

Our next question will come from Tristan Gerra with Robert W. Baird.

Tristan Gerra - Robert W. Baird

Hi guys. Excluding the pick-up in factory loading this quarter, what do you think is going to be your single biggest gross margin catalyst for the rest of the year of the variety of potential catalyst that you have mentioned in your last Analyst Day?

Mark S. Thompson - President, Chief Executive Officer and Director

Tristan, a couple of the big ones for us are voltage regulators into cellular is a key one. Is attractive of margins, high volumes and a good ramp. The SPM products are getting, as appliance manufacturers very broadly are moving to DC motors for efficiency reasons. Those are tremendous demand... we're struggling to keep up with demand in those cases. Those are all very significant. Analogue switch continues to be... have an escalating speck associated with it. As data goes through... is switched through ports... as video is switch through ports. That's been a very strong contributor to success of the Company and will continue, will accelerate across the year.

Some more integration as we commented in the microUSB. We're very well positioned in that that will start to hit across the year. And then of course insourcing is another one. And SupreMOS which is our very small die size technology for high voltage, begins to ramp in a meaningful way in the second half of the year as well.

So those are just some of the big chunks of things that will be moving the margins positively across the year.

Tristan Gerra - Robert W. Baird

Okay, and then just a quick follow-up, you mention microUSB, it looks as if there is an increasing number cell phone OEMs which plan on ramping a standard connectivity solution with microUSB. Could you talk about some of the volume opportunities and also the type of margin profile on those products?

Mark S. Thompson - President, Chief Executive Officer and Director

Sure the... I mean the volume opportunity at some point in the future and... there are different opinions on that. I'll just say three to five years from now the industry will have almost entirely standardize on some version like that. I mean it's just, it's so compelling, standardization of adaptors and such, it's been actually quite surprising that to remain customized for so long. Different OEMs see that aggregation point in different ways. And so again consistent with architectures being unique and market profiles being unique for each of the major cellular OEMs, each has its own roadmap for the kinds of things that it wants to integrate, but it's all for everyone it's some combination of power management and data switching, analog switch of some sort or another, potentially some audio features embedded into it, smart detection, so it can tell one thing from another, because again you got you don't have very many pins, so you have got a lot of signals.

So that should be able to tell data from power, has to do so very quickly. So, it's actually a very interesting and a very rich node. As such it should command, for those who get it right, it should be very attractive business at above average margin levels. And so I think that's the way to look at it, but as yet it's still playing out. So it will be interesting. And in fact one of the things that you see the OEMs doing is trying to figure out how ambitious to be in the early stages in terms of using it as an integration node. So again I think you will see it start maybe a little more modestly and just a couple of features and then having roadmaps integrating more audio and power management features into it.

Tristan Gerra - Robert W. Baird

Right, thank you.

Operator

Next from Banc of America Securities, we have Eric Ghernati.

Eric Ghernati - Banc of America Securities

Mark Thompson first. Could you please clarify your comments on the gross margin progression for the second half of '08, in other word were you saying that you expect the gross margins to be up 50 to 100 basis points in second half of '08 relative to second half of '07 or

Mark S. Thompson - President, Chief Executive Officer and Director

So let me start by saying that we are not providing gross margin guidance for the second half of the year. We only... we think it's only realistic to provide visibility a quarter at a time which is what we've consistently done. All I was suggesting is, what I believe is a analytically sound model of looking at the gross margin cycle and to recognize that we've been steadily raising the trough and that the peak should raise at least as much as the trough or more. So since we don't know... we haven't gotten to the peak yet, but we have to the trough, I'm simply suggesting that in a normal demand environment, the peak should go up at least as much as the trough even if you haven't ramped a set of new products and done a bunch of favorable things to your mix. We've modeled a number of things from insourcing to a very rich stream of new products which again in a normal demand environment would enhance that progression by some meaningful amount. We quantify the insourcing in the range of one to two points, 100 to 200 basis points for example. New product mix is harder to quantify but it should be significant as well. But... so that was just an analytical method that I know some of our analysts use, and we do too, as a way to look at progress through the cycle.

Eric Ghernati - Banc of America Securities

Okay, but just to put it in simple terms, I guess, you also said that you're guiding in the 50 to 100 basis points better in the second half, is that a fair...

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

So, we are not guiding anything to the second half, we're saying we've got some positive catalysts in the second half, would be... which is typically higher volumes, expected success in new products that would drive richer margin revenue, and the impact of insourcing which when the program is complete we expect to have one to two point impact, uplift in the gross margin profile.

Mark S. Thompson - President, Chief Executive Officer and Director

So, those are all margin catalysts that will play out more or less depending on the demand environment which is obviously, for all of us, unknown for the second half of the year.

Eric Ghernati - Banc of America Securities

Then just looking at the channel inventory your distribution sell through was down 4% in the fourth quarter, down 6% in the first quarter. And I assume it should be up in the second quarter yet your channel inventory took it down in the first quarter. Why do you feel necessary to take it down again in the second quarter?

Mark S. Thompson - President, Chief Executive Officer and Director

Well, it will be...

Eric Ghernati - Banc of America Securities

Given... at least given the comments you suggested that you had very, very bookings exceeding your expectations.

Mark S. Thompson - President, Chief Executive Officer and Director

So, again, we'll adjust that as we go through the quarter. Most of the reduction will be, again, you have to look at it whether it's in dollars. From a dollar point of view we may not take it down much if at all. From a days point of view it will go down just in response to point of sale, because the denominator gets bigger. And so that's currently what we've anticipated. So we would not expect a $6 million... $6 million reduction in channel inventory heading into the second quarter.

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

Let me also add that. Channel inventory, sort of, isn't a financial function to us, it's an operation strategy. And to the extent that you can provide world-class services with less inventory that's a better thing to do, and that's better for the overall supply chain. So, we kind of take a primary look that way, and as our processes improve, as our capabilities improve, we would expect to be able to improve the management of the channel.

Eric Ghernati - Banc of America Securities

Okay, thanks.

Operator: [Operator Instructions] We will take a follow-up question from Shawn Webster with JPMorgan.

Shawn Webster - JPMorgan

Yes, thank you. Just a couple of quick ones. On the channel inventory question, it was, I believe, 11.1 weeks last quarter. What was it this quarter?

Mark S. Thompson - President, Chief Executive Officer and Director

It wasn't 11.1 weeks last quarter, it was... we were between... we were more like around 11.5, and so we're up about a day, day-and-a-half from that.

Shawn Webster - JPMorgan

There it was 11.5 in Q4 and about 12.5 to 13 in Q1?

Mark S. Thompson - President, Chief Executive Officer and Director

No a day.

Shawn Webster - JPMorgan

Oh, I'm sorry a day.

Mark S. Thompson - President, Chief Executive Officer and Director

We're still under our target range. We're, like a 11.7, 11.8, right now weeks.

Shawn Webster - JPMorgan

Great, thank you. And then the other one was what were your plan for paying off or redoing your debt?

Mark S. Thompson - President, Chief Executive Officer and Director

We're working with some banks right now. So, number one is to get well ahead of the transaction date for the convertible which is next November. And obviously it's a challenging credit market right now, but we feel we have options available to us to be able to refinance that to something different. And we have a preference to do that with pure debt at this point rather than anything that has an equity component for obvious reasons when you look at our stock price.

Shawn Webster - JPMorgan

Okay thank you.

Operator

We will take another follow-up question from Eric Ghernati with Banc of America.

Eric Ghernati - Banc of America Securities

Hi Mark, thanks again. Just don't want to beat some dead horse here, but I am looking at your sales back in December '06, 418; now you are looking more like a 412. Back then your gross margins are 29. You were looking at the gross margins again of 29. And you have been through restructuring mode for quite a period of time here. But it's clear that the progress has not materialized yet. At least it's not evident in terms of the financial performance. Can you just help us understand when do you expect some sort of inflection point to hit given all the good things that we have heard at the recent analysts meeting as far as the gross margin you know benefits that should come at some point.

Mark S. Thompson - President, Chief Executive Officer and Director

So, if you look at the... there is sort of two pieces to the trajectory. The first one that we focused on was reduction of the magnitude of trough to peak, which historically for the Company was in 8% range over of couple of cycles and could be as large as 10. And we have reduced that to the two to three range. So we use to become unprofitable in the down cycle and now in down cycles we remain firmly profitable. We have also, as we stabilize that begun to focus on raising each trough and raising each peak. And if you plot our quarterly margins over a five year trajectory I think you will see very clearly the progress in our raising both the trough and the peak. And so while we certainly seek to accelerate the rate of improvement, the rate of improvement on both of those dimensions as well as the overall average I think just flows straight from the numbers and is reflected in improved rolling averages for EPS, for example.

Eric Ghernati - Banc of America Securities

I guess what I meant by going back to the rate of improvement. It just seems like at least for... I understand the peak and trough analysis, but just the rate of improvement seems to have stalled somewhat, you would think that's with the better mix and all that you would be at least generating slightly better gross margins than what you're guiding for?

Mark S. Thompson - President, Chief Executive Officer and Director

So again any quarter to one quarter there are numerous [ph], there is a lot of noise that occurs, just one-time events. The way order pattern, shipment patterns, factory loadings occur. And so again, I think if you have to look across multiple cycles. So again our guidance reflects this trough being something between 50 and 200 basis points above the last trough. The last peak was more than a 100 basis points above the previous peak. And we expect... so that's the progress rate... that history that we have shown with history. And we are at the phase in our evolution with enough new products that we expect to accelerate that rate. But I feel pretty comfortable that the arithmetic of improvement has been demonstrated, but we are very committed to improving the rate of that improvement.

Eric Ghernati - Banc of America Securities

Thanks Mark.

Operator

There are no other questions at this time.

Dan Janson - Investor Relations

Great. Let's go ahead and wrap it up with that then please.

Operator

That does conclude our call today. We would like thank everyone for their participation. Have a great day.

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Source: Fairchild Semiconductor International, Inc. Q1 2008 Earnings Call Transcript
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