Q1 2010 Earnings Call Transcript

Transcript Call Date 04/15/2010

Operator: Good day and welcome to the Fairchild Semiconductor First Quarter 2010 Earnings Conference. Today’s conference is being recorded.

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

Dan Janson - VP, IR: Good morning and thank you for dialing in to Fairchild Semiconductor’s first quarter of 2010 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 Deutsche Bank One-on-One Conference on May 13 in San Francisco, Robert Baird Growth Stock Conference in Chicago on May 18 and the Raymond James Investor Conference in Boston on June 10, as well as other investor road show meetings during the quarter.

We’ll start today’s call with Mark Frey who will review our first quarter financial results and discuss the current status of the second 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 Replay for this call will be publicly available for approximately 30 days.

Fairchild management will be making forward-looking statements in this conference call. These statements, including all statements about future results and performance, are made based on assumptions and estimates that involve 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 other financial measures that are not prepared according to Generally Accepted Accounting Principles. We use non-GAAP measures because we believe they provide useful information about the operating performance of our businesses that should be considered by investors in conjunction with GAAP measures that we also provide. You can find a reconciliation of non-GAAP to comparable GAAP measures at the Investor Relations section of our website, at

The website also contains a 2010 Q1 fact sheet and a financial section with updated unaudited financial highlights, including detailed breakouts of segment, regional revenues, gross margins, EBIT and EBITDA.

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

Mark S. Frey - EVP, CFO and Treasurer: Thanks, Dan. Good morning and thank you for joining us. I’m sure most of you have had a chance to review our earnings press release that was issued earlier this morning, so I’ll focus on just a few key points.

We continued to improve our product mix and cost structure during Q1 to deliver another solid quarter of financial results. We achieved a number of significant milestones in the first quarter; including the highest gross margins since the year 2000, record low channel inventory and growing our cash and securities balance to now exceed our total debt for the first time in our history.

Let’s review some of the details, starting with the income statement. For the first quarter of 2010, Fairchild reported sales of $378 million, up 7% sequentially and 69% higher than the first quarter of 2009.

Gross margin on a GAAP basis was 32.2% and included $1.3 million of accelerated depreciation. Adjusted gross was 32.5%, up 220 basis points from the prior quarter, as we continued improving product mix by ramping new products and mixing out lower margin products. Gross margin also benefited from higher factory loadings.

R&D and SG&A expenses of $81 million were above our original forecast, due primarily to higher variable costs driven by stronger than expected demand. Our R&D and SG&A spending is expected to be slightly below 21% of sales in Q2 and on track to reach our target of 20% of sales due to the significant structural cost reduction actions during the year.

First quarter adjusted net income of $32 million included adjusted tax expense of 20%, which is at the high end of our expectations, due to some discrete tax items and a distribution of profits in higher tax jurisdiction. Adjusted EPS was $0.25.

Now, I’ll review the first quarter highlights of our sales and gross margin performance for each of our product groups. In our MCCC business, sales increased 3% sequentially in what is typically the seasonally weakest quarter of the year. Sales growth was driven primarily through strong demand and new design wins at key wireless and computing customers. MCCC gross margin was up 1 percentage point sequentially to more than 35% due primarily to the impact of new products and a better overall product mix.

We grew PCIA sales 11% sequentially, driven primarily by higher demand for power conversion solutions, high voltage MOSFETs, Smart Power Modules used in appliance applications and power products for the automotive market. Gross margin increased 3 percentage points from the prior quarter to 34% due primarily to the ramp of new products at higher margins and mix out of less profitable products.

Standard Products sales increased less than 3%, while unit shipments actually decreased 8% sequentially as we continue to shift our production capacity to a higher value product mix. Gross margin improved more than 3 percentage points compared to the prior quarter as a result of this effort.

Turning to our balance sheet and cash flow, we held internal inventory roughly flat at 69 days, as sales growth offset the $9 million increase in our work-in-process inventories in raw materials. We improved the mix of fast-turning inventory again in Q1, which enables us to provide comparable service levels with lower inventory. Days of sales outstanding or DSOs increased about 2 days from the prior quarter to 37 days and remained better than our historical average.

We generated $36 million of free cash flow during the quarter, bought back roughly $8 million of stock and ended the quarter with $481 million in cash and securities. We are particularly excited that our efforts to reduce debt and increase cash generation over the last year enabled us to build a cash and securities balance that now exceeds our total debt. We have the best balance sheet in our history now, and we expect to further improve cash generation and reduce debt in coming quarters.

Now, turning to forward guidance. Given our backlog position and new product momentum, we expect to increase sales to $395 million to $400 million in the second quarter. Our current scheduled backlog is sufficient to achieve the low end of this range. We still have availability for certain packages in the current quarter and we’re working on numerous approaches to optimize supply, which, combined, could support sales at the high end of the range or better.

We expect to increase gross margin to 33% to 34% due primarily to a richer product mix as a number of new designs ramp into production. We anticipate R&D and SG&A spending of $82 million to $84 million in the second quarter, which, at the midpoint, is slightly under 21% of sales. We expect to hold this level of R&D and SG&A spending until we reach our target of 20% of sales.

Net interest expense is forecast to be roughly $2 million to $3 million per quarter this year. The blended adjusted tax rate is forecast at 15% to 20% 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 second quarter results.

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

Mark S. Thompson - Chairman, President and CEO: Thanks, Mark. We made significant progress over the last year, sustainably improving our product portfolio, tightening our R&D focus, streamlining our operations, improving inventory management and reducing costs.

Our first quarter results clearly reflect this progress as we significantly increased sales, gross margin and earnings, while maintaining record low inventories. What may be less apparent is the pipeline of exciting new products and design wins that are ramping now and expected to accelerate throughout 2010 and 2011.

I’ll begin my comments with more details about these new opportunities and explain how we’re building a sustainable advantage in key new technologies. I’ll wrap up with a review of current quarter performance.

PCIA posted 11% sales growth in the first quarter, driven by a broad lineup of power solutions supporting the rapid content growth in consumer, industrial, power supply and automotive end markets. We made significant investments in silicon and package technologies over the last five years, which has positioned us as a clear leader in power modules, high voltage MOSFETs and IGBTs. We also invested heavily in power conversion technologies, including the acquisition of System General a few years ago that enable us to provide industry-leading efficiency across a wide range of power requirements.

Our new technologies are ideally positioned to capitalize on our customers’ increased focus on improving power efficiency. Our innovative (T Series) power conversion products provide the highest level of integration performance in the mid power range available in the market. Our advanced package provides low profile form factors, which enabled panel TV makers to further reduce thickness of LED backlight products. We’re ramping this product line rapidly in response to very strong demand.

Our latest Fairchild Power Switch or FPS solutions provide industry-leading standby power consumption performance. We are scaling our production for these products to support new design wins in two major game platforms as well as a number of new set-top box designs.

We’re shipping our third-generation primary side regulator or PSR solutions that enable exceptional standby power performance, while reducing component count in low to mid power battery chargers. We have a number of key design wins for these products and are expected to ramp in the second half of the year.

Our high voltage product posted a 13% sequential gain in sales, led by strong demand in the LCD TV backlighting, power supply, server power appliance and industrial markets. Customers are increasingly choosing our power modules and power MOSFETs and IGBTs to develop products with greater efficiency.

The move to more efficient designs is particularly evident in the consumer appliance market in Asia. The largest appliance makers in the world are moving rapidly to variable speed inverter-type motors to dramatically improve the energy efficiency of refrigerators, washing machines and air conditioners.

Fairchild is an industry leader in power module solutions. Customers need to make this transition from single-speed AC motors to the latest inverter types. The results are evident in the 36% sequential sales growth we posted for our Smart Power Modules or SPM product line in this quarter. We expect this strong growth trend to continue for many years as customers continue to make the conversions to new designs.

Our content in these designs is typically $4 or more compared to little or no content in the old generations. When you consider that more than 60 million refrigerators alone will be built in 2010 and only a tiny fraction have converted to inverter motors, you can understand the opportunity. This is rapidly becoming a large and very profitable market for Fairchild.

Sales for power management solutions for the automotive sector jumped 15% from the prior quarter as we expanded our market into power steering modules. We’re designing power steering modules at three major automobile manufacturers and have more design wins in progress. We expect strong sales growth for these solutions as carmakers seek greater fuel economy in their products. We also continue to be a market leader in high voltage IGBTs for ignition coils.

MCCC sales increased 3% sequentially in what is typically a down quarter. Our better than seasonal growth was due primarily to strength in computing demand coupled with a number of new products ramping into production for the handset market.

Over the last five years, we made significant investments to develop our analog franchise in the mobile segment. We built on our industry-leading analog switch technology and now offer a wide of range of USB and multimedia switch solutions, as well as high frequency voltage regulators for a number of handset subsystems.

In our low voltage MOSFET business, we are recognized as an industry leader in technology and performance. Our superior technology enables the smallest die size and best performance, which translates into higher unit output at industry-leading margins.

We continue to win new designs for our innovative USB analog switches in the handset market. We’re ramping these new products at two major customers now and expect to proliferate these solutions at other leading handset makers in the next year. We are rapidly expanding our relationship with a new smartphone customer for a wide range of analog and power management solutions.

In our voltage regulator business, we’re gaining share at a number of new handset customers and expect sales to grow significantly as these models begin shipping. We remain a technology leader in low voltage MOSFET and as we roll out our latest PT7 and PT8-based products. These advanced trench products are 30% to 40% smaller in die size, which allows us to provide greater unit output at attractive margins.

Our new dual-pole package technology provides the best combination of form factor and MOSFET performance available today. We’re scaling up production to support new design wins for these products in computing, telecom, servers and consumer electronics applications.

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

Distribution sell-through increased 5% sequentially in the first quarter, which is significantly better than seasonal and our fourth consecutive quarter of growth. The strong sell-through drove reduction in channel inventory of about 2% from the prior quarter, resulting in a record low 7.8 weeks of inventory. While this level of inventory is quite low historically, the mix of fast-moving products to slow-turning inventory improved again in Q1.

After five consecutive quarters of reducing the inventory of our product in the distribution channel, we believe the supply chain is extremely lean at all levels. Order rates were robust across a broad range of end markets with the great strength in computing, industrial and automotive. Geographically, we posted double-digit sequential gains in North America, Europe and Korea, while Asia continued to be very solid.

Sales growth were similar and above seasonal in both our OEM and our distribution channels. We raised adjusted gross margin another 2 points to 32.5%, which is the highest level since 2000. Many of the design wins I discussed earlier are just starting to ship, so we expect to build on the margin and earnings improvement momentum through 2010 and beyond.

Overall product pricing in Q1 remained better than typical as was the case last quarter. Most of our product sales were to top-tier customers where pricing trends were typically negotiated well in advance. We are raising some prices on lower margin standard products to proactively manage our supply and free up capacity for faster growing, more profitable products.

Our margin expansion in MCCC and PCIA is driven primarily through new products and better mix. Pricing has not been a significant driver in those performances.

Factory utilization increased again in Q1, and we continue to improve equipment efficiency, optimize our product mix and selectively add capacity to support our key customers. Lead times also increased during the quarter, reflecting our higher utilization.

We’re working closely with our top tier customers, which represent about 75% of our sales, and believe we have excellent visibility to their demand. We maintained capacity reservation in our order management systems for these key customers, so they can be confident in our supply commitment.

In closing, I think there are a number of key points to take away from our current results and future guidance. First, our focus on car management and mobile markets has helped us to deliver strong sales and earnings growth. We invested heavily in silicon and packaged capabilities over the last five years to build a sustainable technology advantage that we’re now leveraging to provide greater unit output at higher margins.

We tightened our R&D focus a year ago, which is driving better execution on new products, and in turn, supports sales and margin expansion. Inventories remain lean throughout the supply chain and the mix of fast-turning products continues to improve. This allows us to better support customer needs at historically low inventory levels.

Finally, we’re effectively optimizing our supply through improvements in equipment efficiency, product mix management, new silicon technologies that increase die output, selective use of external manufacturers and disciplined capital investment. I believe these actions will allow us to gain share in key power management and analog markets, while sustainably improving margin and earnings.

Thank you. And I’ll turn it back to Dan.

Dan Janson - VP, IR: Thanks, Mark. We’ll now open the call to questions. I would ask that in order to allow more of you to ask questions, we limit each person to one question and one follow-up. Thanks and let’s take the first question please.

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