Jul 19, 2007
TRANSCRIPT SPONSOR
Executives
Dan Janson - VP, IR Mark S. Frey - EVP and CFO Mark S.
Thompson - President and CEO
Analysts
Ross Seymore - Deutsche Bank Securities Craig A. Ellis - Citigroup Steve Smigie - Raymond James & Associates Quinn Bolton - Needham & Co.
Tristan Gerra - Robert W. Baird & Co., Inc.
Romit Shah - Lehman Brothers Craig Berger - Wedbush Morgan Securities Shawn Webster - J.P. Morgan Kevin Cassidy - Piper Jaffray & Co
Operator
Good morning and afternoon, and welcome ladies and gentlemen to the Second Quarter 2007 Earnings Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode.
At the request of the company, we will open the conference for questions and answers after the presentation. I will now turn the call over to Dan Janson so that we may begin.
Go ahead Dan.
Dan Janson - Vice President, Investor Relations
Yes, good morning and thank you for dialing into Fairchild Semiconductor's second 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.
Let me begin by mentioning that we are attending a couple of investor conferences this quarter including the Pacific Crest Tech Forum in Vail and Citigroup's Annual Tech Conference in New York. Mark Frey will start today's call with a review of our second quarter financial results and discuss our forward guidance for the third quarter of 2007.
Mark Thompson will then address in more detail our pipeline results, end markets and operational performance. Finally, we will reserve time for questions and answers.
The 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. Now these statements including all statements of our 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 the 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 investor.fairchildsemi.com. The website also contains 2007 Q2 fact sheet, updated financial section and an 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.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Thanks Dan. Good morning and thanks for joining us.
I am sure most of you had a chance to review the financial results that we released earlier this morning. So I'll focus on just the key points in my comments.
Keep in mind that our second quarter numbers included an entire quarter of System General results. Sales for the second quarter were up $6.3 million or 2% sequentially.
As expected, Q1 did mark a drop for us in the latest semiconductor cycle and represented a relatively modest sales decline of 5% and adjusted growth margin decrease of 270 basis points from peak to trough. This is a substantially better cycle management than we have ever recorded, and we look forward to the next phase of the cycle where we expect to drive further top-line growth and increase margins above our prior peak.
We continue to closely match our output to the improving end market demand which drove higher factory loadings during the quarter. Remember that there is about one quarter offset from when we changed factory loadings to when we see the financial impact on the P&L.
Adjusted gross margin improved 20 basis points sequentially and should benefit significantly in Q3 from the higher factory loadings in the second quarter. We also anticipate a favorable impact on gross margin from improved product mix in the third quarter.
Adjusted operating expenses were $89.1 million, $5 million higher than the prior quarter and favorable to our guidance range of $91 million to $93 million. Recall that our first quarter operating expenses benefited from some non-recurring credits and lower legal expenses.
We came in at under forecast due to good cost controls, lower bonus accruals and legal expenses. We expected a....
as expected our net interest and other expenses increased to $5.5 million in the second quarter due to a reduction in interest income from our lower level of invested cash after the System General acquisition. Now I would like to review second quarter highlights for our sales and gross margin performance for each of our product groups.
The Analog Products Group recorded a 6% sequential increase in sales to $84.6 million, paced by another record sales quarter for our analog switches. APG adjusted gross margin improved slightly compared to first quarter.
In our Functional Power Group, sales totaled $225.2 million, a sequential decrease of 1% primarily due to continued mix-out actions in high voltage business as well as some selective geographic weakness. Adjusted gross margin was down slightly from the prior quarter and was negatively impacted by pricing pressure primarily in our low voltage business especially in the desktop computer and gaming space.
The Standard Products Group posted 3.5% sequential increase in sales and also improved their adjusted gross margin by more than a point driven by improved product mix. Turning to our balance sheet, internal inventories were essentially flat with prior quarter.
Our days of inventory declined slightly. DSO is essentially flat with the prior quarter at about 39 days.
Cash and marketable securities increased $19 million to 470... $447.8 million in the second quarter which reflected cash flow from operations of $49.5 million and capital spending of $34 million.
Turning now to our forward guidance, we expect third quarter revenues to be up 2% to 4% and gross margin to be approximately 100 to 236 basis points higher sequentially. At the start of the third 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 $88 million to $90 million in the third quarter as we continue to exercise good control over spending. Net interest and other expenses are expected to be $5 million to $5.5 million for the third quarter.
Given the greater stability of our business during the last cycle, we will no longer be providing a scheduled mid-quarter update. Of course, if we need to materially alter guidance we will issue a press release as appropriate.
Many of you follow us closely and know that we attend major investor conferences each quarter and review publicly our business conditions at those venues. Our Investor Relations website has been voted one of the best among mid-cap stocks that includes the comprehensive financial package including segment breakouts.
We are committed to providing excellent investor communications and try ourselves in providing a high degree of transparency to the financial community. Now I'll turn over to Mark Thompson.
Mark S. Thompson - President and Chief Executive Officer
Thank you, Mark. As expected, the first quarter marked the inflection point in the cycle for Fairchild, and we were able to expand sales and growth margins once again in Q2.
We increased our cross gross margin of 48 points while recording only a modest decrease in sales in the past cycle by making a number of improvements to our supply chain and cycle management processes. The impact of these changes is most noticeable in our internal and channel inventories which have remained within target range throughout the entire cycle.
In fact, our internal inventories entering the second quarter were among the lowest in the industry. We have also focused a great deal of our management time and resources on new product development and mix improvements during the last cycle.
I would like to take a few minutes to review our progress and talk about some of the current trends of the end markets and our operations. The APG business, including the full quarter of System General results, have posted the best growth in the company with sales of nearly $85 million in the second quarter.
We expect APG to grow strongly in 2007 as we benefit from a number of new products and design wins. The power conversion product line now accounts for 55% of total APG sales and is benefiting from the addition of System General products and technical capabilities.
With the help of Tom Yang and the System General management team, we developed a detailed roadmap to drive significant margin improvement in this business over the next two years. We are also benefiting from a strong power conversion demand environment as distributor resales grew 8% sequentially in Q2.
Our analog switch products reported record sales in the second quarter growing more than 20% sequentially due to new wins of major handset customers. Our latest USB and multimedia switches are also driving additional business as well...
at well above average margin. Our micro-SerDes sales were down in the second quarter as we just had a major handset customer impacted results and is inspected also way on Q3 performance.
We are engaged with all the major handset manufacturers and expect to gain important design wins in the second half that will further diversify our customer base. We won new designs for their high voltage control ICs for compact fluorescent lights and are excited about the potential of this rapidly growing market.
Finally, we secured our first analog voltage regulators design win with a major handset customer and have more in the pipeline for the second half. Our analog strategy is on track, and we expect to post strong sales and margin gains in the third quarter.
Our FPG sales were down slightly in Q2 due to some softness in high voltage products in the Americas and Europe coupled with the continued effort to mix-out low margin business. The low voltage business nearly offset the weakness in high voltages as demand in the notebook and LCD TV market was up significantly in the quarter.
Order rates for our optimized MOSFET for notebook applications have been very strong, and our 13-week backlog as we entered Q3 is up more than 20% from the quarter ago. We have seen some pricing pressure in the FPG markets as lower game sales for some competitors to look for other markets to absorb this supply.
Our Smart Power Module posted record sales again in Q2, and we won new designs in white good applications with Japanese, European and Asian customers during the quarter. We are tracking to more than a 40% annual growth rate for the SPM business for 2007, and we expect this business to continue to benefit from the increased emphasis on driving greater energy with efficiency in appliance, motor, power supplies and flat screen TVs.
Similarly, our Driver MOS solutions that enable greater efficiency and high frequency power management applications continue to win new designs in the computing end markets. We also secured new design for our IntelliMAX, intelligent load switch products at a number of major handset manufacturers.
We believe the combination of advanced silicon based technology and a rowing line-up of new functional product solutions will enable steady improvement in FPG sales and financial results. FPG sales were up $3 million and adjusted growth margin improved more than a point sequentially in Q2.
Our new family of logic translators expect to see a nice step-up in sales in Q3 as new designs reach production. I'll now review end market demand and some key operational metrics.
Sales by end market were generally within our expectations during the second quarter. We recorded a greater sales growth for products and services, computing and consumer applications where we saw some softness for certain industrial applications in the U.S.
Order rates for Q3 and Q4 were highest for the computing, consumer and handset end markets. We built backlog during the quarter as order rates improved significantly over the prior period.
Our distributors recorded about a 1% increase in resale and ended Q2 at roughly slight inventories from the prior quarter. We made significant progress during the last cycle in driving distributor resales growth.
In fact, our cross resale level excluding the impact of SG were 20% higher this cycle versus the last. We increased factory loading in response to higher demand during the quarter and are now running all our fabs at about 85% utilization.
Average lead times increased slightly during the quarter to a range of 10 to 12 weeks with the longest lead times continue to be in our analog power conversion and leading edge functional power products that continue to experience strong demand. Let me wrap up with a quick summary of our progress and my view of how we are positioned as we enter the new cycle.
We have accomplished a number of important objectives during the last cycle as we reported historically high growth profit margins... as to high cost gross margin and a record low peak of power sales corrections.
Our resales growth was strong during the cycle and were posted as one of the best inventory management performances in the industry. The many new products and design wins I reviewed earlier are the results of our greater focus on new product development and efforts to become more important supplier to our customer.
The acquisition of System General, which remains unscheduled to be completed in Q3, is a critical catalyst in improving the value of our power conversion business. We enter this new cycle with a foundation of strong supply chain and channel management, comfortable inventory levels and the best pipeline of new products in our history.
Our focus now is clearly on raising peak gross margins and earnings as we progress through the emerging semiconductor cycle. Thanks and I'll turn the call back to Dan.
Dan Janson - Vice President, Investor Relations
Thanks Mark. We will now open the call to questions.
I would ask you in order to allow more of you to ask question to limit each person to one question and one follow-up. Thanks again and let's take the first question.
Question And Answer
Operator
Thank you sir. [Operator Instructions].
Our first question comes from Michael Masdea; go ahead. Please state your question.
Ross Seymore - Deutsche Bank Securities
I am Mr. Ross calling in.
In your press release, you talked about higher order rates driving longer lead times. Could you discuss how much of the order increase you attribute to higher lead times and what you do think order rates would have done, had lead times remained flat?
Mark S. Thompson - President and Chief Executive Officer
We wouldn't attribute any of the higher order rates to increase lead times. The increase in lead-time is very small and if we look at the effect of that, we don't believe it's any of increased order rates.
Ross Seymore - Deutsche Bank Securities
Okay. And so can you just further discuss then, I mean as we go into the second half year...
of the year, what is the overall costumer mentality and what is your outlook for the second half?
Mark S. Thompson - President and Chief Executive Officer
Well the general outlook for the second half across all the segments is in aggregate. People are seeing stronger general demand than they saw in the first half of the year and that's we believe what's driving the higher order rates.
Obviously there are some very strong segments, notebook computing as a particularly strong segment that stands at the top of that. There is also certainly some selective customer weakness and enhance that for example that's at the lower end of that range.
But in aggregate we see a more positive environment in the second half of the year than we saw in the first half.
Ross Seymore - Deutsche Bank Securities
Okay. And finally could you just give a book to bill?
I don't know if you gave that earlier.
Mark S. Frey - Executive Vice President and Chief Financial Officer
We don't give specific book to bills, but as we said in the call, the order rates were up significantly over our last quarter's and we did build backlog during the quarter.
Ross Seymore - Deutsche Bank Securities
Okay, thank you.
Operator
Okay. Our next question comes from Craig Ellis.
Go ahead Craig, your line is now open.
Craig A. Ellis - Citigroup
Thank you. The question is for Mark Frey.
Mark, you mentioned in the third quarter gross margins would benefit from mix. Is that really an inter-segment dynamic or an intra-segment dynamic or would something that might be happening within functional products or analog?
Mark S. Thompson - President and Chief Executive Officer
It's Tom, Craig, we will have a higher component of analog business. It will grow faster than the other businesses.
But we are also doing mix-up operations within product lines, like high voltage and even the FPG areas [ph].
Craig A. Ellis - Citigroup
Okay. And for high voltage functional powers, the right way to think about margin improvement there is still the next shrink that's coming down to 35 and that enabling a lower cost and a better margin on the products?
Mark S. Frey - Executive Vice President and Chief Financial Officer
Correct. Although that will be more of an influence in the fourth quarter.
Craig A. Ellis - Citigroup
Okay. All right.
Thank you guys.
Operator
Our next question comes from Steve Smigie. Go ahead Steve, your line is now open.
Steve Smigie - Raymond James & Associates
Great, thanks. You guys did see some nice margin improvement, but revenues were a little short of the mid point of your guided range.
Just curious what were the factors that were maybe... might have had you a little bit short of mid point from the revenue?
Mark S. Frey - Executive Vice President and Chief Financial Officer
Probably the weakness in the higher voltage that we mentioned as we were being more selective with market opportunities in order to mix up our gross margin profile.
Mark S. Thompson - President and Chief Executive Officer
Probably the other point I would add to Mark's comment is that we are not relying on significant improvement in some customer specific cellular space as well. If that happens then that will be a positive but we thought it imprudent to place that into our guidance.
Steve Smigie - Raymond James & Associates
Okay. So would you say that you could have a little bit higher revenue if you decided not to walk away from business during the quarter, is that...?
Mark S. Thompson - President and Chief Executive Officer
Absolutely.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Yes.
Steve Smigie - Raymond James & Associates
And if I can just ask on the outlook for Q3, I mean you have also talked about improving order rate, better back half, strong notebooks. You are really being fairly conservative here or given some of the data points, given you had Europe up in your guidance shift in the Q3?
Mark S. Thompson - President and Chief Executive Officer
I wouldn't call it conservative. We would regard it as prudent.
Our philosophy on guidance is that it's a reliable estimate that doesn't require a disproportionate share of good news or happy results. So certainly there would be upside in any of our guidance models if certain positive events were to happen.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Let me also add that we don't guide more than one quarter ahead because we don't have the visibility. So when you talk about for fourth quarter we'll have to see how this recovery develops.
Dan Janson - Vice President, Investor Relations
You know Steve I would only add to that if you look historically say for the last five years, our sequential revenue growth from Q2 to Q3 has typically been at that flat, typically down a little bit. Now in the last couple of years obviously we have made great strives at improving for better stability and better cycle management.
And so last year was probably a better more instructive example of what, as we are running the business to really meet consumption that we could do. And we were up little lower 2.5% quarter-on-quarter in Q3.
So our mid point of guidance is higher than that. So from our perspective we are probably guiding for at least seasonal maybe little better than seasonal going forward.
And of course you have to recognize that Q3 is by its nature a back-end loaded quarter where we typically see that are still happening more late in the quarter. And so you have to give yourself little room there as well.
Steve Smigie - Raymond James & Associates
Okay.
Operator
Thank you. Our next question comes from Quinn Bolton.
Go ahead Quinn, you line is now open.
Quinn Bolton - Needham & Co.
I just wanted to follow on that last question, Dan, about the seasonality. I think this time last year you guys actually commented that you are starting to see a shift in the quarterly pattern of revenues where you might see more growth in September and less growth in December.
Given that you are guiding to, sort of 2% to 4 % growth here in September, do you think you are going to see historical growth rates in the fourth quarter? Do you think we are staring to see some of that fourth quarter strength getting pulled into the September quarter given you are more consumer focused or just dominance of consumer products?
Mark S. Thompson - President and Chief Executive Officer
Sothere is a couple of moving parts there. First is that as we commented before that we have changed our supply chain practices so much that we actually have to pretty heavily discount our historical cycle performance.
So we actually don't have a lot of data in terms of the way we currently run the company, what the cycle performance is and what the quarter-to-quarter progression is. So this is actually, with our current supply chain model, this is our first fresh up cycle, if you will.
And so we just... we don't have a model to predict that.
Quinn Bolton - Needham & Co.
Okay. Looking further to that question for Mark, if I look into sort of the gross margin improvements in Q3 of 100 to 200 basis points, wondering if you can comment, I think you guys had previously said you are targeted to exit the year at the 32% to 33% level.
Is that still a good estimate for the end of the year?
Mark S. Frey - Executive Vice President and Chief Financial Officer
Well, we are not guiding for Q4 but the drivers for margin improvement is, first of all, volume, which drives factory efficiency and drives up margins. A better product mix as you have seen in all of our businesses and new products that we sell at higher prices particularly in the analog stakes.
And we see positive momentum in Q3 and we see that positive momentum continuing in Q4 but we will have to wait until Q4 begins to, actually see what guidance is going to look to like.
Quinn Bolton - Needham & Co.
Okay, but am I wrong? I mean, I thought you guys had previously talked about a 32% to 33% target for the end of the year.
Am I mistaken?
Mark S. Thompson - President and Chief Executive Officer
No, the model that we put out at the beginning of the year was... what we tried to communicate was, if we exceeded $450 million with assumed mix that we would have modeled that in the 32.5% to 33.5% range.
So the... I guess the first operative question, maybe they're still...
we are still happy with our mix. And we are happy with the progression of new products and the design wins.
The biggest question mark is the top line. And so the model is still a sound model and it depends on what the revenue will turn out to be.
And as of course at this stage it's... we see Q4, the early evidence is that it's likely to be stronger than Q3, whether it's strong enough to drag it above the 450 line or not is just...
we just don't have enough data to reliably put that number out there.
Mark S. Frey - Executive Vice President and Chief Financial Officer
You know Quinn I would just kind of summarize what we've just said by saying that look, we come into this up cycle with very lean inventories. Our channel inventory is at right where we wanted, certainly within our target range.
We are in a position where we are basically matching the consumption rate. And so, that's really going to be kind of the operative thing for us.
As that demand picks up and the end markets that we're in, we've got a very diverse end market exposure. As those end markets pick up, we don't have any sort of an inventory overhang, that's...
to hold us back. So we are going to grow at those end markets.
You've heard us talk about the new product drivers. We think that's going to help us as well.
We've got some great content improvements, especially in the handset world that will help us. So there is lot of favorables here that are going to help us to grow the top line.
And as long as you know, those markets perform well in the second half and you can expect Fairchild to perform quite well as well. Obviously, we are not at a point where we can guide Q4 at this point, but we like what we see ahead of us.
Quinn Bolton - Needham & Co.
Great. Okay, thank you.
Operator
Our next question comes from Tristan Gerra. Go ahead Tristan.
Tristan Gerra - Robert W. Baird & Co., Inc.
Your resales to be up sequentially this quarter and where would you expect then these inventories to be at the end of Q3 in weeks?
Mark S. Thompson - President and Chief Executive Officer
We expect our inventories to be approximately flat within... we are in the range where we want to be in.
And the noise should just be random noise. It should be relatively at the same level.
Tristan Gerra - Robert W. Baird & Co., Inc.
Okay. And analog products gross margins are now three quarters in a recovery.
Once you get to the 90% utilization rates, where do you think those analog gross margin can go and what's the new peak potential?
Mark S. Thompson - President and Chief Executive Officer
So, we expect the strongest margin progression in the company to be in the analog in the third quarter. So if you look at our...
both our revenue and our margin progression in the third quarter for the company, the biggest driver of that will be analog. And so we feel very confident that last year at the analyst day, we set a three year goal of driving margins above 45% and moving cumulative revenues close to $500 million per year.
And we feel that we are on track for that. And Q3 will be another significant step toward that long-term goal.
Tristan Gerra - Robert W. Baird & Co., Inc.
Great, thank you.
Operator
Our next question comes from our next question from Romit Shah. Go ahead Romit.
Romit Shah - Lehman Brothers
Hi, thanks guys. I am just going back to an earlier question.
I mean given the stronger orders and extending lead times, I would have expected to see a stronger acceleration now in Q2, into Q3 as well. And you mentioned that you are walking away from some business.
Can you just elaborate on that and why it's potentially more than you previously thought?
Mark S. Thompson - President and Chief Executive Officer
So the biggest portion of business that we are moving away from, are in planer high voltage MOSFETs. And what we are doing there is making room for the next generation high voltage MOSFETs that Craig asked about earlier in the call in our Bucheon factory and that we expect strong demand for those products and we don't want to capitalize low margin business.
So we are lining up for exiting some of those businesses. It's always difficult to control exactly the rate at which you exit a business because you have to commit to supply to a customer and then you work with them while they find alternative supply.
And so that wound up in the second quarter, certainly moving faster than we had originally modeled. In the long term we don't see that as a bad thing at all.
In the short term it provided a little bit of a headwind from a revenue point of view but from a margin point of view of course it's stable.
Romit Shah - Lehman Brothers
And is that an element that could impact your revenue growth in Q3 as well?
Mark S. Thompson - President and Chief Executive Officer
Well that the increased rate of that is factored into our guidance. So I wouldn't expect it to be an incremental negative to the guidance.
It's already included in the way we modeled it.
Romit Shah - Lehman Brothers
Okay.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Romit the other point that I would make is that we said in the last couple of quarters that there is an offset in seeing the increased loadings hitting the P&L. So as we said the guidance in Q3 comprehends that increased factory loadings that we had in Q2.
Here is the point I would make is that this was a much more stable cycle for us. In the past when we had bigger sales and gross margin corrections it was...
we would typically see the larger and faster bounce back because we were much lower and we were so dramatically under a shifting consumption. We really haven't done that this cycle.
So we have presented a much smaller gross margin reset less than 3 percentage points. It's certainly the best in our history and better than many peers.
So I think people should expect that it's going to be a steady nice progression going forward but more stable in that progression trajectory.
Romit Shah - Lehman Brothers
And what's the fab loading strategy for the second half of the year?
Mark S. Thompson - President and Chief Executive Officer
Well the strategy is eluded to match end demand in a net sense. So we think that, that will wind up loading up particularly the MOSFET plants incrementally across the year.
The analog one is a little bit harder to model in the sense that we are in the middle of an 8 inch conversion. And so the moment you switch on your 8 inch conversion your capacity goes up dramatically and so your loadings go down significantly.
However it doesn't have a big negative impact. And so we will be...
we are still working through that trajectory and we'll be talking about that some more particularly at analyst day is the good time to provide a little bit more detail into the moving parts on that. So we will be...
we do anticipate, the loading is going down fairly significantly at analog but not to the detrimental of the financial performance.
Romit Shah - Lehman Brothers
Okay. And just Mark lastly, Intersil made a comment yesterday that they are seeing some double ordering in their computing business.
Are you guys seeing any of that as well?
Mark S. Thompson - President and Chief Executive Officer
We put a lot of work into scrubbing backlog integrity as part of the supply chain processes we've worked over the last cycle. And we feel very good that we understand the integrity of our backlog very well and feel quite confident that there is no material double ordering represented in our current backlog.
Romit Shah - Lehman Brothers
All right. Thank you.
Operator
[Operator instructions]. We now have a question from Craig Berger, go ahead Craig.
Craig Berger - Wedbush Morgan Securities
Good morning. Thanks for taking my questions.
I wonder if you talk a little about System General. I guess you guys have had about four or five months since you acquired System General.
Can you discuss some of the synergies you have identified and maybe how long it did... would take for you to roll those benefits through the rest of the company?
Mark S. Thompson - President and Chief Executive Officer
Sure. So we feel more enthusiastic about the potential for System General to impact our business even then we did a close.
We are very much... and I think anticipated in your question, we are still in the planning.
We are on the custody of transitioning from the planning stage to the execution stage. And so, if you look at where we expected to begin to meaningfully move the needle, just begins in Q4 and actually plays out quite dramatically across...
across '08 and particularly, in the form of an expanded portfolio and more complete solutions to our power supply customers as one of the dimensions. But the other dimension is that that they have some design and process insights that are allowing us to do some quite significant dye size reductions on some high volume products.
And those will be rolling through the product family, starting in Q4 and then and really moving across '08. So our general goal that we articulated when we started as we bought a 45 point business and we were operating a low 30 point businesses that we believed that we can use their model and more complete product families to get the overall family above 40%.
And we've now identified kind of all the moving parts to do that and have turned those into specific plans and are beginning to execute those across the company.
Craig Berger - Wedbush Morgan Securities
Great. I see here.
Can you comment on chip pricing maybe within some of your main segments or in total?
Dan Janson - Vice President, Investor Relations
Yes, I mean, overall... Craig, this is Dan.
Pricing was pretty much within our range of expectations. We noted in the script that we saw some pressure in the low voltage area in particular.
I think as we talked about publicly last quarter because the gaming end market was a little slower than people had predicted we found some of the competitors looking for homes for those products that we typically saw on to the gaming markets, generally had better margins, looking for homes in the desktop space. And so we saw some pressure in that market.
And so, we got a little more selective in that business, but it obviously still impacted us a little bit. The rest of market was pretty much where we expected it to be.
Craig Berger - Wedbush Morgan Securities
So what... that's down 1% to 2% sequential?
Dan Janson - Vice President, Investor Relations
That's correct. Yes.
Craig Berger - Wedbush Morgan Securities
Okay. Can you comment on your assembly test capacity?
Do you see any shortages forming? How much do you do in turnovers at external?
Mark S. Frey - Executive Vice President and Chief Financial Officer
What we have know some packages that are inside supply, but generally, across the board we have got plenty of room to move up in utilization in our back-end processes.
Craig Berger - Wedbush Morgan Securities
How much is internal versus external?
Mark S. Frey - Executive Vice President and Chief Financial Officer
External is about 60%, internal about 40%.
Craig Berger - Wedbush Morgan Securities
Okay. Just stepping back looking at the big picture.
The gross margins to, you are still in the below 30% range. Looks like you may break above 30% here in Q3.
But over the long term, what can you guys do to secularly increase gross margins to say 35% or 40%? Obviously, System General you touched on but what else and that's kind of how quick?
Mark S. Frey - Executive Vice President and Chief Financial Officer
You can refer back to our analyst day presentation. I think there is still a table on our website that shows three-year progressions of our three businesses separately.
And so we look at our margin progression separately for each one of them and then we believe that they will grow at different rates. When you sum those two functions, you come up with a gross margin range that we presented last year between 36% and 38% weighted for the company, over a three year period.
I think we've already explained the analog component of that, which was to grow that business to around $500 million and to achieve margins above 45%. It incorporated expectations that we roughly maintained the FPG business where it is today but move its margin profile to the 23% to 27% range.
And in the functional power business to move it into where we see other discrete companies operating very easily today 35% to 37%. And we see ourselves progressing on all those fronts.
FPG actually met the higher end of its target last year and then stepped down in the down cycle. We also moved the product line that that was below the average.
That kind of reset FPG, now down to about 20%, but we see them through cost controls and through continued product mix being able to move at continually up into the mid to upper 20s. And so when you combine those three factors, we still expect to be able to move our margins into the 36% to 38% range.
Craig Berger - Wedbush Morgan Securities
Great. Thank you for that detail.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Thank you, Craig.
Mark S. Thompson - President and Chief Executive Officer
Next question please.
Operator
Thank you. Our next question comes from Shawn Webster.
Go ahead Shawn, your line is now open.
Shawn Webster - J.P. Morgan
Thank you. Can I verify something?
Did you say your utilization rates were in the high 80s on average for your factory network?
Mark S. Thompson - President and Chief Executive Officer
We said above 85%.
Mark S. Frey - Executive Vice President and Chief Financial Officer
For our fabs.
Shawn Webster - J.P. Morgan
For your fabs. Do you expect them to tip above 90% in Q3?
Mark S. Thompson - President and Chief Executive Officer
I think we will probably in jump a little bit depending on how demand plays out through the quarter.
Shawn Webster - J.P. Morgan
Okay. And then on the...
can you tell us what that $5.5 million restructuring charge was? And do you expect similar charges in Q3 or Q4?
Mark S. Frey - Executive Vice President and Chief Financial Officer
Yes, It primarily consisted of the closure of a small manufacturing facility in Singapore, which we think will allow us to lower our costs in that product area and the consolidation of two development operations in Colorado, which we also think will increase efficiency of some R&D operations, combined with some asset impairments for some manufacturing equipments which was obsoleted by certain process improvements that we put in place that create cheaper economies on other equipments and obsoleted some of the underlying equipment. And yes, we continue to look for opportunities to lower both our manufacturing spending and also our global line spending.
And so you saw it in Q4 when we sold some reserves for IT programs that we want to drive our IT expenses down as a percentage of revenue. We did some additional modest ones in Q1 and Q2.
And I would expect to see again some modest actions in the second half of the year as well.
Shawn Webster - J.P. Morgan
Okay.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Just as a reminder, also when we provided gross margin targets to the company that was a accompanied with below line targets of 20% OpEx, divided 7% for R&D and 13% SG&A. We are operating above that level in SG&A and we expect through cost management and through revenue increases that we will still be able to attain that, to get within the three year period.
Shawn Webster - J.P. Morgan
Okay. And then the...
so the OpEx targets that you gave us exclude any kind of restructuring charges you may be doing in Q3 as well?
Mark S. Frey - Executive Vice President and Chief Financial Officer
No, I think we would need to again do some normal operational improvements that would not be viewed... would not be part of restructuring.
That would take our OpEx down. We would have revenue growth that would not drive OpEx growth and we will have restructuring operations...
our restructuring actions that would... as more discontinue...
discontinuous manner take our OpEx down or manufacturing effects down. So, all three of those phenomena will contribute to a general progression to an OpEx model of about 20%.
Dan Janson - Vice President, Investor Relations
So Shawn, just to summarize that. We are not expecting to take any more charges related to these kind of things that you heard about that were the result of the $5.5 million charge that we recorded in Q2.
We will now have a minor charge for the purchase accounting that we'll be doing... that will be in the last piece of our System General charge that we'll take.
That will be in Q3 and that will be in the end of that.
Shawn Webster - J.P. Morgan
Okay. Thanks and then a final quick one on the SG.
Can you tell us what the revenues for that were for Q2?
Mark S. Thompson - President and Chief Executive Officer
We are not breaking out specific numbers. Actually, it is hard to partition at this point.
They're sufficiently blended with our core power conversion business that I am not sure we would know how we to report it separately. So we don't.
Shawn Webster - J.P. Morgan
Okay.
Dan Janson - Vice President, Investor Relations
But you would see growth in our power conversion business.
Mark S. Thompson - President and Chief Executive Officer
Yes.
Shawn Webster - J.P. Morgan
Okay, thank you very much.
Operator
Our next question comes from Tristan Gerra. Go ahead Tristan.
Tristan Gerra - Robert W. Baird & Co., Inc.
In the past you have seen benefits from a strong euro. What impact does it currently have on your pricing and specifically your pricing outlook relative to some of your MOSFET competitors in Europe?
Mark S. Frey - Executive Vice President and Chief Financial Officer
You know we get this question from time to time. And it's always a tough one for us Tristan, because ultimately it would imply that sales guys are motivated by exchange rates.
And I don't know if that we've ever noticed that connection. We see the European guys, Infineon, NXP and so on being as aggressive as they've ever been.
So I don't know if there's really any difference in their behavior.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Let me also point out that probably half the cost of a MOSFET is the package and everybody packages in either Malaysian currencies or Chinese currencies or Philippine currencies. So everyone is sort of equal in that regard and at least one of the European competitors, fabs in Malaysia.
So there might be marginal...
Dan Janson - Vice President, Investor Relations
Pricing with dollars.
Mark S. Frey - Executive Vice President and Chief Financial Officer
Yes, and also the pricing structure tends to be in dollars worldwide.
Tristan Gerra - Robert W. Baird & Co., Inc.
Great, thank you.
Operator
Our next question comes from Kevin Cassidy. Go ahead Kevin.
Kevin your line is now open.
Kevin Cassidy - Piper Jaffray & Co
Yes thank you. This is Kevin Cassidy from Piper Jaffray.
On the lead time stretching out, can you say what part was... was that fab loading or was it test and assembly that pushed it out?
Mark S. Thompson - President and Chief Executive Officer
Test and assembly is the most common.
Dan Janson - Vice President, Investor Relations
Right.
Kevin Cassidy - Piper Jaffray & Co
Okay. And also what was your split between disti and OEM?
Dan Janson - Vice President, Investor Relations
About 69% disti and the remainder is OEM and EMS.
Kevin Cassidy - Piper Jaffray & Co
Okay. And how about, within the disti, how much is Asia and versus the rest of the world?
Mark S. Frey - Executive Vice President and Chief Financial Officer
Asia is more disti oriented than rest of the world but we don't really publish those specific split-outs.
Kevin Cassidy - Piper Jaffray & Co
Okay. And are you building backlogs for fourth quarter now?
Mark S. Thompson - President and Chief Executive Officer
Yes
Kevin Cassidy - Piper Jaffray & Co
Okay. Thank you.
Operator
[Operator Instructions]. We have a question from Craig Berger.
Go ahead Craig.
Craig Berger - Wedbush Morgan Securities
Could you guys comment on a little bit on the industrial weakness?
Mark S. Thompson - President and Chief Executive Officer
Sure. From an end market we've commented earlier about the...
a piece of that is minimizing our presence in planer MOSFET which tends to map pretty heavily into the industrial segment. So that's certainly a chunk of it.
We also saw North America being pretty weak in the quarter.
Craig Berger - Wedbush Morgan Securities
Is that at all related to the kind of weakening, home building environment, weakening consumer etcetera or completely different?
Mark S. Thompson - President and Chief Executive Officer
It's difficult to give it a specific... that tends to be heavily distribution oriented and small customer oriented.
So understanding the dynamics of those end market from the distributor is all that hard to do. And so I am not sure we could provide coherent color there.
Craig Berger - Wedbush Morgan Securities
Thank you.
Operator
Our next question comes from Steve Smigie. Go ahead Steve.
Steve Smigie - Raymond James & Associates
Great, thank you. I think this question was partially asked earlier but for the inventory in the channel I think in the last call you had then said about 11 weeks.
And I was just curious today if it inched up a little bit from there?
Mark S. Thompson - President and Chief Executive Officer
It was closer to 12 than 11 weeks and it went up 10th of a week.
Steve Smigie - Raymond James & Associates
Okay.
Mark S. Thompson - President and Chief Executive Officer
So in that what we would regard is in the noise and albeit, I guess I'd further add we... when we put our targets out of managing our channel inventory 11 weeks plus or minus 1, anywhere within that range we think is completely acceptable in terms of meeting both our turns requirements of our customers and availability for taking opportunistic business.
Steve Smigie - Raymond James & Associates
Okay. And if I am reading the numbers right, I think Europe was down about 7% sequentially.
I was just curious you comment on how that compared to seasonal, normal seasonality?
Mark S. Frey - Executive Vice President and Chief Financial Officer
Well Q1 is normally very good for Europe seasonally and it was particularly good for us in Q1. So it was more of a comparison with a very strong Q1 number than real seasonal weakness in Q2.
Dan Janson - Vice President, Investor Relations
Yes our Q1 was the strongest European Q1 that we've had probably since the roll-off [ph]. I mean it was a really big quarter for us.
Steve Smigie - Raymond James & Associates
And then on micro-SerDes, I know UMAX was a little bit weak here and the comment I think you made was that you are working on some diversification of handset customers. Was that specific to micro-SerDes or was that was just in general?
Mark S. Thompson - President and Chief Executive Officer
No, that's a general comment. So, we have very active diversification to really have all of the top five handset manufacturers significantly represented in our sales mix.
That's not been the case for Fairchild historically, and we put a lot of effort into making sure that it's broadened. We made significant strides to broaden that during 2007, but that's a process that will continue across 2008.
And it's across... it's really across all of our ultra-portable analog products.
Steve Smigie - Raymond James & Associates
Okay. And just the last question was on specifically on the micro-SerDes, it seems like a pretty good product and I know you'd had a good bit of successes in handset design wins, and also it has seen...
I think the photo makers. I was curious if you could talk how that's looking on photo makers as they start to penetrate into new applications and if you've seen any competition come into that market?
Mark S. Thompson - President and Chief Executive Officer
It's a couple of things. I mean it is a very attractive space.
And so we are seeing some highly respected competitors enter that space. It remains highly focused for us at least on cellular.
We are doing some work in printing applications. But I guess what I would add is that even with the downward tick in the second quarter and we expect a substantial growth in 2007 are like 3x kind of versus 2006 and that trajectory continuing then into '08?
Dan Janson - Vice President, Investor Relations
I mean Steve, if we'd had all of the handset guys clicking on all cylinders, we probably would have had 4x growth, so 3x growth is still pretty respectable there. And one of the things that we have noted in this space is, as Mark said we have been very focused on the handset market because even within the handset market, the potential applications seem to be growing here where this used to be more of a claim self slider application.
We are seeing interest... we keep our guys because they are seeing the benefits of the simplification of their design by using this micro-SerDes type solutions, as driving cost savings and then other benefits to them.
So we see the market actually growing within the handset space more we originally contemplated.
Steve Smigie - Raymond James & Associates
Okay. Great.
Thanks a lot guys.
Dan Janson - Vice President, Investor Relations
There is time for one more question.
Operator
[Operator Instructions]. If there are no other questions, I will now turn the conference back to Dan.
Dan Janson - Vice President, Investor Relations
Okay. Thank you very much and I appreciate everybody's interest in Fairchild.
Operator
Ladies and gentlemen if you wish to access the replay for this call you may do so by dialing 1-866-286-6997or 440-207-906-8543 with the playback reference ID number of 207938#. This concludes our conference for today.
Thank you all for your participating and have a nice day. All parties may now disconnect.