Apr 19, 2007
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Executives
Dan Janson - VP of IR Mark Frey - EVP and CFO Mark Thompson - President and CEO
Analysts
Ross Seymore - Deutsche Bank Craig Ellis - Citigroup Romit Shah - Lehman Brothers Shawn Webster - J.P. Morgan Steve Smigie - Raymond James Eric Gomberg - Thomas Weisel Partners Michael Masdea - Credit Suisse Tristan Gerra - Robert W.
Baird Michael McConnell - Pacific Crest Securities Quinn Bolton - Needham & Company Craig Berger - Wedbush Morgan Kevin Cassidy - Piper Jaffray
Operator
Good morning, and welcome ladies and gentlemen to the First Quarter Earnings Results Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in listen-only mode.
At the request of the company, we will open up the conference for questions and answers after the presentation. I will now turn conference over to Mr.
Dan Janson. Please go ahead, sir.
Dan Janson
Good morning, and thank you for dialing into Fairchild Semiconductor's first quarter 2007 financial results conference call. With me today is Mark Thompson, Fairchild's President and CEO; and Mark Frey, our Executive Vice President and CFO.
We will be attending a number of investor conferences this quarter, including the Robert Baird Growth Stock Conference in Chicago; the Piper Jaffray, Credit Suisse and Wedbush conferences in New York. Deutsche Bank's Tech Conference in San Francisco, as well as J.P.
Morgan and Merrill Lynch's conferences in Boston. I also want to note that we plan to publish a mid-quarter press release to update our business outlook on June 6, before the market opens.
Mark Frey will start today's call with a review of our first quarter financial results and discuss our forward guidance to the second quarter of 2007. Mark Thompson, will then address in more detail our operational performance and new product plans.
Finally, we will reserve time for questions and answers. This call is scheduled to last approximately 60 minutes and is being simultaneously webcast from the Investor Relations section of our website at fairchildsemi.com.
The replay 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 filed with the SEC. In addition, during this call, we may refer to adjusted or other financial measures that are not prepared in 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.
The website also contains the 2007 Q1 fact sheet, an updated financial section with updated unaudited financial highlights, including detailed breakouts of segment and regional revenues, gross margins, EBIT and EBITDA. Now I'll turn the discussion over to Mark Frey.
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Mark Frey
Thanks Dan. I am sure most of you had a chance to review our results that we released earlier this morning.
So, I will focus on just the key points in my comments. Keep in mind that our first quarter results include System General, for the period after February 5, when we became the majority stockholder.
Sales for the first quarter were 3.7% lower sequentially, which includes $5.1 million of revenue from System General. We continue to tightly control production output to match end market demand.
This resulted in lower factory utilization in the first quarter, and caused adjusted gross margins to decrease 80 basis points sequentially. This adjusted gross margin includes a 20 basis point favorable impact from the acquisition of System General.
A relatively modest decline in sales and more stable gross margin compared to past years, are an encouraging result of the many improvements we have made, and how we manage the business cycles. Operating expenses were lower than the prior quarter, even with the addition of System General's results due to spending controls, adjustment to the bonus accrual, lower than expected legal expenses due to the push-out of the trial with Power Integrations, and some non-recurring credits to spending.
Our net interest and other expenses increased to 4.7 million for the quarter due to a reduction in the interest income from our lower level of invested cash. Now, I would like to review highlights of sales and gross margin performance for our product groups.
But before reviewing these results, it's important to note that beginning in the first quarter of 2007, we transferred responsibility for our bipolar transistors product line from FPG to SPG. This business generated approximately $15 million of revenue in the fourth quarter of 2006, at a gross margin substantially below the FPG average.
Management believes that the opportunities and challenges facing this business are better suited to the management-focusing capabilities of the SPG management team. The financial performance of FPG and SPG have been restated in the historical financial metrics published in our website, so that investors can better understand the progression of our businesses.
All commentary about product group performance in this conference call, will be based on these restated results. The Analog Product Group posted sales of $79.9 million, including $5.1 million from System General.
APG gross margin increased 80 basis points compared to the fourth quarter, excluding the impact of System General purchase accounting. This was essentially all due to the favorable product mix impact from the addition of System General results.
In our Functional Power Group sales totaled $227 million, a sequential decrease of 3%, while gross margin improved 60 basis points, as a result of relatively stable plant loadings. The Standard Products Group experienced a sequential sales decrease of 7% and a little more than 5 point decrease in gross margin to 19.7%, due primarily to lower factory utilization, product mix and incrementally lower prices.
Reviewing our balance sheet, internal inventories decreased $3.6 million from the prior quarter, when you exclude the $6.1 million we obtained from the System General acquisition. Cash and marketable securities decreased $157.6 million to $428.8 million in the first quarter, which reflected cash flow from operations of $24 million, offset primarily by our net cash payment of $171.8 million to acquire a controlling interest in System General.
Turning now to our forward guidance. We expect second quarter revenues to be up 1% to 4% and gross margin to be approximately flat sequentially.
At the start of the second quarter, we had about 90% of the sales guidance booked and scheduled to ship. We expect R&D and SG&A spending to be approximately $91 million to $93 million and net interest and other expenses to be $5 million to $5.5 million for the second quarter.
Beginning with this quarter, our guidance includes the expected results of System General. Now, I'll turn the call over to Mark Thompson.
Mark Thompson
Thanks Mark. Fairchild delivered solid sales results for the first quarter while continuing to tightly control inventories.
I've always believed that we could be one of the most stable semiconductors in the industry given our broad product portfolio and balanced end market exposure. During this cycle, we've shown this greater level of consistency due to our better management and supply chain, and distribution channel.
Exiting the first quarter, we reduced channel inventories slightly and also lowered our internal inventories after adjusting for the impact of the System General acquisition. While the first half of 2007 maybe weaker than normal for the industry, our supply chain is well positioned and we're planning on a number of new product introductions and mix improvements, that we believe will drive greater content and higher margins in the second half of 2007.
I'll begin with a review of the first quarter and then discuss these drivers for higher sales and margins in the rest of 2007. Looking first, sales by product lines.
Our FPG business has delivered solid sales, down just 3% as strength in high voltage solutions helped to offset the weakness in the PC space. APG sales were down about 2% sequentially or 9%, excluding System General, due to a combination of seasonal factors and weaker desktop PC demand and due in part to our efforts to lower inventory.
We were also impacted by selected weakness for analog switch and micro-SerDes for handsets in Q1. We expect that business to begin to rebound in the second quarter, as we have reached a comfortable level of inventory for our products that support the PC end market and anticipate greater new product sales.
Finally, sales were down a little more than average for FPG due to a combination of weaker demand in the PC end market and our own selectivity to maintain margins. [Sales by] end market were generally in line with our expectations.
With the exception of some selected weakness in the handset market. We have seen an improvement in order rates since the Chinese New Year, which enable us to start Q2 with a slightly higher backlog position.
We recorded the biggest increase in our order rates for our products supporting the industrial and notebook computer end markets, while the demand remained weak for desktop computers. Distributor sell-through increased a little more than 1% sequentially and we forecast another sequential increase in resales in the second quarter.
Factory utilization was sequentially lower in the first quarter, but we expect this to improve in the second quarter, as we gradually increase loadings to support higher demand in Q2 and second half of 2007. Average lead times remained in the range of 9 weeks to 10 weeks, with the longest lead times on our analog power conversion and leading-edge functional power products that continue to experience strong demand.
Putting this all together, we believe that our improved supply chain and channel management process allowed us to turn the corner in this cycle and deliver more stable results than any cycle in our recent history. With this improved process and lean supply chain as our foundation, we can focus more keenly on the fundamentally important new product development efforts at Fairchild.
Our top priority for 2007 is to accelerate our new product development, introduction, and design wins to achieve our gross margin targets. Let's review some of the new products that we're working on for 2007.
I will begin with analog and our acquisition of System General, which is progressing on schedule. We are integrating the two teams into a single power conversion powerhouse, with expected 2007 sales of over $200 million.
As we move to the integration process, we have gained important insights on how we can transform our existing power conversion business to perform at the level of SG. We are also finding many power supply accounts are excited by our greater ability to service, nearly all of their silicon needs and [we are] actively working on account penetration plan to turn this into higher power conversion revenue.
We're also well-down the path of planning manufacturing synergies that should payback even more than we originally expected over the next few years. As we finalize these plans, we will share quantitative detail with you.
For now, we can iterate, the System General acquisition will definitely help our overall margins and sales across our entire power conversion business. We're also rolling out our latest [E-Power] solutions that provide better performance and even lower standby power consumption than our previous power switch product.
Our customers increasingly require power factor correction to improve efficiency, and Fairchild continues to be a leader in providing standalone and as well as integrated PFC solutions. We are particularly excited about our line of high voltage power controllers with integrated power factor correction designed for LCD televisions.
We recently won a significant amount of new business for these products with a large customer. We see additional opportunities with other customers.
Our signal path products continue to record strong new product growth led by our analog switches. We are the dominant supplier of audio switches to the handset and MP3 player market and are adding USB, multimedia, and HDMI switches to the portfolio.
We are also designed in at 11 of the top 12 handset manufacturers and expect to be in all 12 by the end of 2007. As an all advanced analog solution, integration and the ability to deliver more value to the customer, is the key to staying ahead of the competition.
Our innovative multimedia switches deliver on a new level of integration by providing a complete solution for routing all the signals handled through the mini USB port. We are already seeing strong growth for these new switches, and expect them to help drive more than a 20% annual increase in our analog switch sales in 2007.
In our System Power group, we are rolling out our latest VRD 11 compliant voltage regulators that provide better performance to our PC customers and higher margins for us. We also released a family of advanced MOSFET drivers that complement our extensive portfolio of MOSFETs.
These high performance general purpose analog solutions generate strong margins and are targeted to a wide range of high performance power supplies. We are particularly excited about our work in high frequency DC-DC voltage regulators for the ultra-portable end market.
We expect to release our first products in late Q2 and early Q3, which should generate incremental sales and good margins starting in late Q3 of this year. We are working on a number of other exciting opportunities in the power analog space.
They have the potentials of truly advancing to state-of-the-art, stay tuned for more in coming quarters. Turning to our functional power products.
We released a number of new products on our latest low voltage PowerTrench and high voltage IGBT and Trench processes. These new products deliver better performance in much smaller die size, which improves their form factor, and our margins.
We expect to release more than 30 new Smart Power Modules in 2007, serving a variety of consumers in the industrial end market. We are on track to begin the shipping of new SPM chipset for the 50-inch plasma display, market this quarter.
These innovative solutions greatly simplify the design of the sustaining energy recovery blocks in Plasma televisions, and will drive $25 to $30 of content per TV just from these solutions. We won our first design for our new Driver MOS product that integrates an advanced driver and MOSFET in a single package.
These devices are optimized to support high-frequency switching and are ideal for applications that require small size and greater efficiency at high-frequencies such as PC's and games. We also expect to release more than 20 new IntelliMAX load switches this year, which are targeted at handset and gaming applications.
Both the Driver MOS and IntelliMAX solutions are good examples of how we are using innovative package and IP circuit technologies, to complement our leading MOSFET products to deliver more value to our customers, while driving higher margins in our functional power business. These are just some of the new products we have planned for 2007.
There is much more to come. Thank you and I will turn it back over to Dan.
Dan Janson
Thanks Mark. We will open the call now to questions.
I would ask that in order to allow more of you to ask questions, we limit each person to one question and one follow-up. Thanks.
Now, let's take the first question please.
Operator
Thank you. Our first question will come from Ross Seymore with Deutsche Bank.
Please go ahead.
Ross Seymore - Deutsche Bank
Thanks guys, can you hear me alright?
Mark Frey
Yes.
Ross Seymore - Deutsche Bank
Great. Looks like the revenues were pretty much in line with what people were thinking but on the margin front, I am little confused, as to why the gross margin guidance would be flat, if utilization is going up, you have more System General revenues going up, etcetera?
Mark Frey
Well, Ross, the gross margin doesn't go in complete lockstep with the sales. The early cost of the sales in Q2 is actually product build in Q1 at lower utilization.
So, you get a bit of lag impact on the efficiency of the costs involved. But then we would see that as run through and in a position for Q3 to accelerate rapidly.
Ross Seymore - Deutsche Bank
So, the mix from the System General side doesn't offset that lower utilization that blends through from the first quarter. Is that generally the idea?
Mark Frey
Yes.
Ross Seymore - Deutsche Bank
And then the second question, also margin related, would be on the OpEx front. Looks like it was a little lower than expected in the March quarter, but higher for the June quarter.
Can you give us an idea how much System General was in each of those two quarters and if that explains that delta?
Mark Frey
System General is in the $2 million to $3 million range and that's kind of what we pick up. Going forward we are not going to isolate System General.
But, yes that is what accounts for the Q2 guidance, and there is a little bit of internal OpEx growth built into that as well, obviously.
Ross Seymore - Deutsche Bank
Okay. Thank you.
Operator
Then move on to Craig Ellis with Citigroup. Please go ahead.
Craig Ellis - Citigroup
Thank you. First, a clarification.
You mentioned that there were three dynamics that impacted Standard Products' margin in the first quarter, mixed utilization and pricing. Can you just break out the relative magnitude of those three?
Mark Frey
Sure. Mix and pricing is around 100 to 150 basis points and obviously the most important was utilization.
And that's because, number one, the sales were down significantly. We did also lower our inventory.
So the production build for SPG was pretty dramatic relative to Q4, where we had some sales drop off, but we actually built a little inventory.
Craig Ellis - Citigroup
Okay. And then the question is really longer-term in nature.
And I appreciate the product details and the roadmap insights earlier. Can you help us translate that into how we should think about the relative pace of gross margin improvement, in both Functional Power and Standard Products, and where we might think about exiting the year, with gross margins in those two businesses?
Mark Frey
Well, I am not going to give you an exit guidance for the individual businesses. But I can tell you that even after moving the bipolar transistors into SPG.
We believe that, the management team can get that business in the 23% to 27% intermediate term margin goal for those businesses. And do that on fairly low asset investments and OpEx investments.
I think that will be fairly rapid in this year, because there will be a utilization improvement. SPG as you could see, it showed a modest improvement in Q1.
So, I think its improvement over the year will be reasonably linear.
Craig Ellis - Citigroup
Okay. And then should we expect some nice steady improvement in Functional Power's [watermark], especially given the shrink that you have on the high voltage side of that coming up?
Mark Frey
I actually thought that was, my second statement was Functional Power, that it will show steady improvement from pretty much all of our variables. We've got some mix-up going with some improved processes, particularly in our high voltage business.
And we'll have some impact of higher utilization in growth as well I think.
Mark Thompson
Yeah, so Craig, Mark here just a few other, just to complete the picture. We still believe that with a strong second half, we'll exit as a company in the range that we offered at the beginning of the year.
So, if you do the arithmetic on that, I think you will see it requires steady progression across the three product lines with analog moving sharply toward 40 in the back half of the year and progression both from SPG and FPG.
Craig Ellis - Citigroup
Great. And then lastly CapEx for the year, guys?
Mark Frey
We're still on our 6% to 8% band. I think we'll be closer to the higher end of that as we assess some opportunities to expand capacity in some areas that will increase profitability.
Craig Ellis - Citigroup
Great thanks.
Operator
Our next question comes from Romit Shah with Lehman Brothers. Please go ahead.
Romit Shah - Lehman Brothers
Yes thanks. Can you guys just go over the gross margin target by the end of the year at 32.5% to 33%, how you get there?
I know that was your target at the beginning of the year, but now gross margins were a little weaker in March, you are forecasting to be flat in June. So what type of ramp are you guys assuming?
And is that mostly volume driven, mix driven or are you expecting additional cost reductions than you previously expected?
Mark Thompson
About half of the progression of, let's say the 28% base is volume and leverage oriented. And it assumes that sales would be about north of 450 for the non-SG part of the company.
The rest would be new products and mix-up improvements.
Dan Janson
Romit, this is Dan. If you remember the last time that we peaked, we were around 31% and we actually drained some inventory within analog at the time we were doing that.
But even then, we were around 31% and that's when we were running the factories at a reasonable utilization rate. So our sense is getting back to 31%, is that first leg, getting the factories loaded back up, which as we said in the call we started to increase factory loadings at the end of last quarter and we expect to continue that through this quarter as demand continues to pickup.
And then as Mark said, the next leg it will be a combination of mix and new products.
Romit Shah - Lehman Brothers
Okay. So, to get to the 32.5% and 33% gross margin target by the end of the year, sales need to get to the 450 run rate ex System General?
Mark Thompson
Approximately yes.
Romit Shah - Lehman Brothers
Okay. And have you guys already started to increase your factory loadings, or is that something you plan to do as the quarter progresses?
Mark Thompson
Yes, Romit, Mark here. We have already begun the process of increasing factory loadings, although not aggressively during the second quarter.
We're continuing to watch the order rate, closely which is strengthening, but we don't want to overrate it. So, as the loading ramps that will occur and the financial impact of that will tend to be in the following quarter.
As Mark commented on earlier, is that the utilization rate, typically will more affect the subsequent quarter than the quarter that it actually occurs in. So, there is a strong mix of Q1 loading, baked into the Q2 results, as a natural result of GAAP accounting.
Mark Frey
I think it's important to keep in mind that we've just come out, for the industry, what, three quarters of sub-seasonal performance. Fairchild has actually experienced two quarters of sub-seasonal [trudge].
And basically we had a flat Q4, which is unusual for us. Our Q1 was down 5%, which is probably a little more than normal.
So given that as a backdrop, clearly, we've been running products through factories at lower factory utilization levels than we typically expect and like. And therefore that shows up in the costs.
And so that's what we're going to be shipping this quarter. But as Mark said, we've already started to increase the factory loadings.
Expect to continue that gradual process through Q2, and that just becomes a tailwind for us in margins for the second half for the year.
Romit Shah - Lehman Brothers
Okay. Thank you.
Best of luck.
Operator
We'll now move on to Shawn Webster with J.P. Morgan.
Please go ahead.
Shawn Webster - J.P. Morgan
Good morning. Thank you.
So, utilization rates were down. Can you tell us what the rates were?
I believe they were somewhere in the mid 80s range last quarter. Can you tell us where they sat in Q1?
Dan Janson
Yeah Shawn this is Dan. We notched down a couple of points.
So, we range from low 70s for our analog fab to 90 plus percent range for some of our discrete fabs. So, probably a kind of blended average somewhere in the low 80s, low to mid 80s.
Shawn Webster - J.P. Morgan
Lower to mid 80s?
Dan Janson
Yeah. And we expect to see that notch up a few points this quarter.
As we said, we've already started loading the factories at a higher rate now.
Shawn Webster - J.P. Morgan
Okay. How was pricing in the quarter?
What did it do sequentially? Can you give us a sense of how the pricing environment is for you in your price sensitive divisions?
Dan Janson
Well, obviously in some of the businesses, the analog business and so on, the pricing isn't much of an issue. Things are fairly stable there.
But in some of the other businesses, and especially in some of the standard products businesses, as you would expect in this part of the cycle, pricing is a little more aggressive, obviously we are managing it carefully. And given that bookings haven't started to improve at a good clip.
We are also watching that carefully to be sure that we are poised to take advantage of a stronger demand environment going forward in pricing.
Shawn Webster - J.P. Morgan
Okay. And channel inventory, I think you said came down.
Does that mean it's at roughly 11 days?
Dan Janson
We came down a day in channel. So, we were, as you recall, last quarter we were at the high-end of our range.
Our range 11 plus or minus a week. So, we were at closer to 12.
So, we came down a day. So, we are very much in a comfortable range right now in the channel.
And remember that was due to our resales being up a little more than a percent, which is pretty strong for us. I mean, when you consider that three quarters of our sales are in Asia and most of that is through the channel, having an up Q1 for resales is a pretty good signal of market share strength for all products going on that channel.
Shawn Webster - J.P. Morgan
Okay. And then last question, you said that your backlog was up sequentially, is that correct?
How much was it?
Dan Janson
I would say slightly up. But it's nice to be in a position where we are actually starting the quarter with slightly higher backlog position and we haven't had that for a couple of quarters.
Shawn Webster - J.P. Morgan
Okay. Thanks a lot.
Operator
Our next question comes from Michael Masdea with Credit Suisse. Please go ahead.
Michael Masdea - Credit Suisse
Yeah. Just in the desktop market, one of your competitors last night was saying that it was pretty strong.
Is there any competitive dynamics plan out there? I mean and maybe even to the point, you guys had made a comment, I think it's more in Standard Products Group.
Where you talked about maintaining your margins, that's one of reasons for some of the weakness. Can you comment on both of those things that would be appreciated?
Mark Thompson
So, two things Mike. First is, I am guessing it depends on whether you are defining desktop as including server or not.
And I think, if you lump server in with desktop, then it's strong and if you separate server, as we do, from desktop, then the pure desktop portion is weak. So, that I would speculate is the most likely reason for maybe the difference in interpretation.
I am not aware, in fact I am fairly confident that there is no company specific competitive dynamic at least as it relates to Fairchild. What was the second question?
Michael Masdea - Credit Suisse
The other question, I think, when you are going through your SPG commentary, I thought you said something about one of the reasons for some of the weakness being maintaining margins. Anything more color on that or do I misinterpret that?
Mark Thompson
No. The SPG comment, we did, specifically say those are our most commodity products and our most sensitive to market downturns like we have been in.
And so, there are certain businesses that we didn't feel could maintain our margin goals for that business. And so, those are ones that we've selectively backed away from during this cycle.
And so that push revenues a little bit. That's consistent with, I believe what we've said along on the SPG, is that, for a while it would be shrinking, as we tuned, or not growing as much as market depending on your view point.
As we tuned that up to have a portfolio, that can achieve our long-term margin and operating income goal.
Michael Masdea - Credit Suisse
Great, thank you.
Operator
We'll now go to Steve Smigie with Raymond James. Please go ahead.
Steve Smigie - Raymond James
Great, thank you. Could you talk a little bit about how much you think you have left to work down in that Standard Products Group now that you’ve moved some stuff out of Functional Power into that?
Mark Thompson
There is some more thinning of the portfolio that will occur during 2007. But, we would expect from this point forward that that business will grow for us, but probably, slightly less than the market.
But the lion share of the minimization of businesses that we didn't think we could achieve our goals in, has already occurred.
Steve Smigie - Raymond James
Okay. And just to return to the inventory in the channel.
If you are saying you are close to 12 weeks and if it was down one day, are you still pretty close to 12 weeks at this point?
Mark Thompson
Exiting Q4, we were at 11.9 weeks, I believe. And this quarter, we exited at 11.7 approximately.
So that's close to the numbers.
Steve Smigie - Raymond James
Great. And maybe you discussed it and I didn't hear, but it seems like the gross margin on the stuff you got from System General was somewhat higher than what you guys already had internally.
I would have thought it might have pulled that up a little bit more than what I saw that the overall in our gross margin, or was I misreading that to [Taiwanese GAAP] or something?
Mark Frey
Well, you might. First of all there are only two months out of the quarter.
So check whether you are doing the math on that. But the margins that we got on that business was in the upper 40's, as we guided, when we did the acquisition.
Steve Smigie - Raymond James
Okay.
Mark Thompson
And the overall arithmetic impact to the company of adding it. For the entire company, it's 20 to 30 basis points for the quarter, and for analog it's around a point.
Steve Smigie - Raymond James
Okay. And then last question, what I want is just.
For the analog stuff, it looks like you restated some of the FPG and SPG stuff or some moves in products there. You did not go back and restate any of this historical stuff for SG, that's just on the go forward basis you include SPG or if you may System General in terms of gross margin calculation there?
Mark Thompson
Correct.
Steve Smigie - Raymond James
Okay. Great, thank you.
Operator
We will now go to Eric Gomberg with Thomas Weisel Partners. Please go ahead.
Eric Gomberg - Thomas Weisel Partners
Yeah. I have a couple of questions, first just wondering, where we should be thinking about OpEx exiting 2007.
Would you expect some leverage on operating expenses?
Mark Frey
We are always looking for leverage on operating expenses, the guidance for the quarter. The biggest impact is going to be the strength of the second half and what that's going to do to bonus plans.
But I wouldn't expect us to range much higher than the high point of next quarters guidance.
Eric Gomberg - Thomas Weisel Partners
Okay. I guess, wondering about the strength of the second half, in the prepared remarks you talked about potentially weaker first half, and it sounds like inventory in the channel at this point is fairly normal.
So, wondering if the weakness relates mostly to end markets simply being fairly tepid or what is causing the weak first half, and why you have confidence, I guess, on strong end demand in the back half of the year beyond Fairchild having solid product positioning.
Mark Thompson
The weakness that we've experienced starting in Q4 and in the first half of this year is consistent with what everyone else has seen. So, there is no market specific story there or nor a Fairchild specific story.
If you look at our revenue softness, peak to troughs versus late last year versus this, we are down certainly no more and in many cases less than the competitive group. So there is a couple of things.
I think that there is a general sentiment, if you look at a lot of the models for the cyclicality in the industry. It predicts an improvement in demand profile in the OEM space for the second half.
Consistent with that, we've seen pretty significant shifts in our book-to-bill, if you look at shorter rolling averages. So, a 13 week rolling averages is less than one, it crosses one at about a seven-week rolling average, and a four-week rolling average is substantially greater than one.
And so, that is very consistent with the picture of an accelerating environment going into the second half.
Eric Gomberg - Thomas Weisel Partners
And just one last question, where would you like to see days inventory or inventory turns by year end?
Mark Thompson
We've targeted channel turns at five, and so that's a goal that we maintain, we think that's a good balance of availability and also return. Our internal inventories will vary by product line, but will be approximately in that range as well.
Operator
We'll now go to Tristan Gerra with Robert W. Baird.
Please go ahead.
Tristan Gerra - Robert W. Baird
Hey good morning. So, if we exclude System General from your gross margin guidance for Q2, we get to something that it is actually a decline sequentially.
Is it possible to quantify the impact on gross margin of the inventory drain that took place in Q1?
Mark Frey
Well, we quantified the impact from the point of time when our gross margins were around 31% to the current situation. That's mostly leverage and utilization oriented, and that story will be true on the upside as well, so 250 to 300 basis points.
Is that what you were asking Tristan?
Tristan Gerra - Robert W. Baird
Yes, that helps a lot. And then a quick follow up.
Is it possible to get some color on the mix, this POEM in the quarter?
Dan Janson
You are talking about for the last quarter?
Tristan Gerra - Robert W. Baird
Yes.
Dan Janson
Yes, sure we didn't give that you, hold on a sec Tristan. So the last quarter it was pretty much consistent with what it normally runs basically two thirds of our sales goes through the channel and about one third is through combination of OEM-EMS.
Tristan Gerra - Robert W. Baird
Great. Thank you.
Operator
We will now go to Michael McConnell with Pacific Crest Securities. Please go ahead.
Michael McConnell - Pacific Crest Securities
Thanks. What was the book-to-bill?
Mark Thompson
I will offer three rolling averages, which I think gives a picture fairly accurately, the books, the 13-week rolling average for book-to-bill is less than one. The one rolling average is seven weeks and the four week rolling average is above 1.2.
Michael McConnell - Pacific Crest Securities
Okay, and then I might have missed it. What's the System General revenue in Q2?
Mark Frey
5.1.
Mark Thompson
No.
Mark Frey
I am sorry. We are not going to give specific, because generally we don't give guidance below the total company line.
So we gave it this quarter because obviously you had to know to deal the tie back. But going forward our guidance is inclusive of System General and we won't be breaking it out separately.
Michael McConnell - Pacific Crest Securities
Okay. We are just trying to get engaged in your core business so what's growing in Q2, so I guess then may if its $5 million in Q1, how much was that a month that, that encapsulated of Q1?
Mark Thompson
If you turn the Q1 number into, if you quarterize it for the business, it was in the 7 to 8 range for Q1.
Michael McConnell - Pacific Crest Securities
Okay. And then finally just looking at last year, you guys were obviously trying to mix up and a portion of that strategy was raising price at some of your products.
Has there been any residual impact in the front half of the year in terms of some customers, now that your lead times have come in somewhat. Looking at other sources of suppliers based on some of the price hikes that you guys enacted last year?
Mark Thompson
We don't believe and we've worked this one very carefully that there are any substantive, unintended consequences of what we've done. We've tried to work in a very responsible way with our customers, where, if we have a product that we don't, we can't make an acceptable amount of money on, we've offered very long-term supply opportunities for them and opportunities to move that business to other people.
And so we've tried very hard and it's been our primary goal to do right by our customers and to have a productive long-term relationship. And so I feel pretty comfortable that we've not had unintended consequences from that process and that process is continuing into 2007 in the sense of us particularly in a high voltage MOSFET arena working through our portfolio to position it to achieve our goal.
Dan Janson
And Michael, one other thing, I think that's important to note is that, that high voltage product line that we've talked a lot about working the product mix up, it is a product line that still experiences very high demand. So, we are doing it in a good market.
The market is very strong. It certainly is working on our favor to be able to work more favorable pricing environment that makes sense for that business for us.
I mean, as Mark said, some of those products you basically just going to the customer and say, this is just not a good long-term business for us to be in and in this kind of market with this kind of level of demand, I think generally they are more receptive.
Michael McConnell - Pacific Crest Securities
So, you guys were comfortable that the TAM within the high voltage MOSFET business due to the mix-up and the higher pricing won't be falling at a faster rate than the earnings you can generate off of that particular product line.
Mark Thompson
No, we've modeled that pretty carefully and update our plans as we get specific programs account-by-account. So, no, we actually feel confident that the overall TAM, when you include the transition to module business and some of the other products, is actually an expanded one not a contracted one.
Dan Janson
I mean we've been raising prices and working on the product mix now for almost a year and the demand on that product line still continues to be quite robust.
Michael McConnell - Pacific Crest Securities
Right. Yeah, but I think that's probably easier when your lead times are out.
When lead times come in though, sometimes that can become an issue.
Mark Thompson
So, if we, I guess to get as specific as possible, if you look at the overall picture, part of this is to have a smaller portion of the business be old line planer MOSFET, I mean that's a given. So, for a customer that is exclusively in once this very commodity grade, planer MOSFETs than we would see that specific segment TAM go down.
But, for the high-end power supply maker, that product is actually becoming less important to them as they go to more sophisticated power supply solutions where they need to meet standby power requirements and efficiency and different precision outputs. So, we feel that the strategy is actually aligned better with our most important growing key accounts in the power supply space versus a kind of trailing low-end view of the, put just a planer MOSFET perspective on the thing.
And so, that's the transition that we're trying to manage thoughtfully and as smoothly as possible.
Michael McConnell - Pacific Crest Securities
Okay, and then one last one from me. If we were just to take a high voltage MOSFET segment, is there anyway to quantify what percentage of revenue that is right now?
Mark Frey
It's now 25% of revenue.
Michael McConnell - Pacific Crest Securities
25%. Great, thank you very much.
Operator
Our next question comes from Quinn Bolton with Needham & Company. Please go ahead.
Quinn Bolton - Needham & Company
Hey guys. Sorry I might have missed this.
But can you just sort of comment whether you felt you were under shipping or in line within market consumption in Q1. I am assuming you were probably a little bit under end market consumption given your comments about just the re-sales being up 1% quarter-over-quarter.
And then just sort of where you think shipments will be in the second quarter as it pertains to sort of end consumptions of the devices?
Mark Thompson
So, we definitely and consciously under shipped the channel in Q1 as the point of sale increased in Q1 versus Q4 and our sale into the channel decreased from Q4 to Q1. So, that's the way that played out.
The current numbers assume approximately a match for sell-in and sell-out in distribution in Q2.
Quinn Bolton - Needham & Company
Okay. So, the 1% to 4% sequential growth in sales sort of assumes that you are coming back in line with end market consumption in to this channel.
Mark Thompson
Yes.
Quinn Bolton - Needham & Company
Okay. Second question, I noted you said you've started to increase fab loading slight in the March quarter and that's continued through April.
Any sense where you think internal inventories and on a dollar basis in Q2, I know that in addition to your increased fab loadings if you guys are building or depleting internal inventory that can have an effect on gross margins. So, I just wondered if you could give us some inventory commentary as it pertains to the gross margin outlook for the second half of the year.
Mark Thompson
Well, so presently as we already commented the channel will stay approximately flat. The current model would have us product to build, maybe it takes the day back that we took out in Q1.
But that's about it. Now, if the present order rate continues then I think we will definitely need to put more inventory in place.
But, we have not yet made that choice and we are watching the order rate for a while more before we would elect to do that. So, our current one represents, I guess, a longer term average of current demand profile.
So, it's relatively conservative in the sense of we are highly confident of an upswing then the factories would be turned on more aggressively because we need to build more die bank and so forth. But that is not represented aggressively in our current financial model.
Quinn Bolton - Needham & Company
That’s not represented in the second quarter’s gross margin outlook that would be more something that you would see in the second half of the year.
Mark Thompson
Yes. So if demand occurs as the current upturn in orders suggests, we will be turning the factories on more aggressively in the second half of Q2 than are currently reflected in these models and which would result in a very substantial movement of margins in Q3 because of utilization effect.
Quinn Bolton - Needham & Company
Okay. Great, then just last question.
Any sense from speaking through the distributors or your OEM customers? Do you think we are going to see any kind of channel, restocking activity ahead of the holiday season?
I know that’s typically a seasonal pattern. Do you think you see it this year or as the channel is still pretty caught in this before just coming off an inventory correction so there’s not a lot of willingness that yet to rebuild stocks ahead of the holiday.
I am just kind of curious what you think happens in to the holiday season?
Mark Frey
Which holiday season are you referring to?
Quinn Bolton - Needham & Company
The U.S. holiday season, Christmas.
Mark Thompson
Oh, Christmas okay. We have actually seen a surprising amount of activity aimed at Q3 and 4.
These are not an unusual roughly looking like our booking or rather our billing partitioning between OEM and distribution but there does appear to be quite a bit of anticipation of the seasonal build if you look at the order pattern. I mean we are actually booking substantial amounts for Q4 at this time.
Quinn Bolton - Needham & Company
Okay great. Thank you.
Operator
And we will now go to Craig Berger with Wedbush Morgan. Please go ahead.
Craig Berger - Wedbush Morgan
Good morning. Just a couple of housekeeping questions, one, on the tax rate.
What should we be using for 2007?
Mark Frey
As you can see in Q1, it was about 19% which is a bit more than we averaged in 2006 from an adjusted standpoint. And that was due to the jurisdictional location of our income being a bit unfavorable.
I don’t think that changes my model for the remainder of the year. So, 15% plus or minus, I said 3% last quarter and proved myself wrong, so, plus or minus 3% to 4%.
And again that will vary based on where we make our profits.
Craig Berger - Wedbush Morgan
Great. And then, also with respect to the (inaudible) lawsuit, is there any legal spending in the Q2 guidance or when do you see the majority of the legal spending associated with that?
Mark Frey
Yeah, there is a fair amount of spending incorporated in the Q2 guidance.
Craig Berger - Wedbush Morgan
So, does some of that roll off in the back half of the year?
Mark Frey
Depending on how the litigation, as you know it's very hard to predict how litigation is going to go. But the major next trial is set for June.
And so if we add a flurry of activity there, then yes it would be reasonable that it would tail off.
Craig Berger - Wedbush Morgan
Right, and then -- okay. Thank you.
And then, last question, on the channel inventories, you said they sell a day if you shipped in down 5% sequential ex System General and they shipped out plus 1, wouldn’t that argue for a larger decline in days than the one day. I think the math goes out to like three days.
Mark Thompson
Well, I think that they might able to short I think your -- I probably don't let Dan do accounting. So, yeah I think you are closer to right than Dan is.
We went from 11.9 to 11.7, so it's just two-tenths of a week, one to two days.
Craig Berger - Wedbush Morgan
Let me ask that differently if two-thirds of your business rolls through a [Destin], you're still 0.7 weeks above your normal range of 11, 11 is the normal range. Does that mean that there is still 3% or 4% to be taken out of the channel?
Mark Thompson
No, so our current -- the guidance that we gave for Q2, is an approximate match of ship in and ship out. So, recall that the weeks, there is movement in both the numerator and the denominator.
So, when the ship out base goes down of course the weeks will climb even if the dollar amount is constant. So, you get a double negative going down and a double positive going up.
So, that's one of -- partly what was behind my comment, so we don't believe that we should take Channel inventories down anymore. In fact, I think we are at the inflection point between where we are more risking having too little in the Channel than too much.
If you put just a moderately aggressive growth into Q3, you would quickly see it fall below 11, as the [POS] climbed. And so that's what we are watching very-very carefully, we actually actively do not want to pull it down anymore.
And will move shipments up in response to POS climbing.
Craig Berger - Wedbush Morgan
Great, let me ask one last question, just a big picture here. Is the semi industry still a growth industry?
Are we going to grow outside of the seasonal impacts of building in late Q2, Q3 ahead of Christmas? Or can PC and handsets still grow, or is it really just a market share gain at this point?
Mark Frey
Craig, this is Mark. The power semi business we view as a very attractive, high single-digit and low double-digit growth opportunity, for all the reasons that I am sure you've seen in terms of the price of energy and the importance of energy efficiencies.
And it’s those opportunities that were really attacking. I wish I could help with the semiconductor in general, but obviously as it gets bigger it's going to grow closer to either overall electronics or GDP.
Craig Berger - Wedbush Morgan
Great. Thank you and good luck.
Operator
Our next question comes from Kevin Cassidy with Piper Jaffray. Please go ahead.
Kevin Cassidy - Piper Jaffray
Thanks for taking my call. A lot of my questions have answered already, but what about raw material costs?
Have you seen any pressure there going from fourth quarter to first quarter and even any discussions of it going [UP] in the future?
Mark Frey
As you probably remember, we had pretty serious raw material pressure in copper, gold and poly last year. That has pretty much abated and normalized.
We saw more than seasonal pressure on silicon early in the year, as a result of so much consumption for solar applications. And we've dealt with that and that's been incorporated in our guidance.
Kevin Cassidy - Piper Jaffray
Okay. Thank you.
Mark Frey
Thanks.
Operator
We would now like to take a follow-up from Michael McConnell with Pacific Crest Securities. Please go ahead.
Michael McConnell - Pacific Crest Securities
Yeah, just one thing, the guidance for flat gross margin, that’s roughly 28.2% right now to 27.7%, so also the adjusted the gross margins?
Mark Frey
Yes, that's correct.
Michael McConnell - Pacific Crest Securities
Okay, great. Thanks.
Mark Frey
Okay, we have time for one more.
Operator
And there are no further questions.
Mark Thompson
So we'll go ahead and conclude the call here then. I want to thank everybody for joining us today.
Look forward to chatting with you in the quarter. Thanks.
Operator
Ladies and gentlemen, if you wish to access the replay of this call, you may do so by dialing 1-888-203-1112 or 1-719-457-0820, with the pass code of 6740857. This concludes our conference for today.
Thank you all for participating and have a nice day. All parties may now disconnect.
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